================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-K [X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 30, 2003 OR [_] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________ to ________ Commission file number 000-49702 ---------- MedSource Technologies, Inc. (Exact name of registrant as specified in its charter) Delaware 52-2094496 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 110 Cheshire Lane, Suite 100 Minneapolis, Minnesota 55305 (Address of principal executive offices) (Zip Code) (952) 807-1234 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Name of Each Exchange on Which Title of Each Class Registered - ------------------------------ ----------------------------------- Common stock, par value $0.01 Nasdaq National Market per share ---------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No: [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-K or any amendment to this Form 10-K: [_] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No: [_] State the aggregate market value of the voting and non-voting common equity stock held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter: $119,721,094 approximately, based on the closing sales price of $6.76 per share on the Nasdaq National Market on December 29, 2002. Shares of common stock held by each executive officer, director, holders of greater than 10% of the outstanding common stock of the registrant and persons or entities known to the registrant to be affiliates of the foregoing as of such date have been excluded in that such persons may have been deemed to be affiliates. This assumption regarding affiliate status is not necessarily a conclusive determination for other purposes. Indicate the number of shares outstanding of the registrant's common stock as of September 5, 2003: 28,822,266 shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's proxy statement relating to the registrant's 2003 annual meeting of stockholders are incorporated by reference into Part III of this Form 10-K. ================================================================================ TABLE OF CONTENTS PART I Item 1. Business...........................................................3 Item 2. Properties........................................................25 Item 3. Legal Proceedings.................................................25 Item 4. Submission of Matters to a Vote of Security Holders...............25 PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters...........................................................26 Item 6. Selected Financial Data...........................................27 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................................29 Item 7A. Quantitative and Qualitative Disclosures about Market Risk........40 Item 8. Financial Statements and Supplementary Data.......................41 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure..........................................71 Item 9A. Controls and Procedures...........................................71 PART III Item 10. Directors and Executive Officers of the Registrant................71 Item 11. Executive Compensation............................................71 Item 12. Security Ownership of Certain Beneficial Owners and Management....71 Item 13. Certain Relationships and Related Transactions....................71 Item 14. Principal Accountant Fees and Services............................71 PART IV Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K...71 Signatures....................................................................78 -2- Unless the context otherwise requires, all references to "we," "us," "our," "MedSource" or the "Company" include MedSource Technologies, Inc. and our subsidiaries. Forward-Looking Statements The following discussion contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended. In many cases, you can identify forward-looking statements by terminology such as may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate, ""predict," "intend," "potential" or "continue" or the negative of these terms or other comparable terminology. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those indicated in these statements as a result of certain factors, as more fully discussed below and under the heading "risk factors" contained elsewhere in this Annual Report on Form 10-K. Readers should not place undue reliance on any such forward-looking statements, which are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made. We do not assume any obligation to update the forward-looking statements after the date hereof. PART I ITEM 1. BUSINESS We are an engineering and manufacturing services provider to the medical device industry. Our customers include many of the largest medical device companies in the world, such as Johnson & Johnson affiliates, Medtronic, and Boston Scientific as well as other large and emerging medical device companies. We provide engineering services, including product design, development and technology transfer, and manufacturing services, including device assembly, packaging, and precision component plastic and metal processing. In addition, we provide supply chain management services, including the sourcing of components that we do not manufacture internally, such as electronic circuitry, from third party suppliers for the devices we assemble for our customers. Through these products and services, we offer our customers an integrated outsourcing solution for their device development and manufacturing needs, delivering accelerated product development time and reduced costs, allowing them to focus on their core competencies such as research and sales and marketing. Examples of the medical devices and components we manufacture for our customers include minimally invasive surgical instruments, components for pacemakers and defibrillators, interventional catheters and guidewires, and orthopedic implants such as hips and knees. We began operations during March 1999 through the acquisition of seven companies with complementary capabilities and subsequently broadened our capabilities by completing six additional acquisitions through June 30, 2003. Since our launch, we have focused our efforts on integrating and growing our business and have made significant investments in our product design and development capabilities, sales and marketing teams, operations, quality systems and information technology infrastructure to support that growth. As of June 30, 2003, we had multiple manufacturing facilities located in various states as well as one located in Mexico with an aggregate of approximately 531,500 square feet and approximately 1,500 employees. -3- Our Products and Services We offer our customers a broad range of products and services for their medical engineering and manufacturing needs, including: . Engineering Services. Our program management, product design, design for manufacture and assembly, development and prototyping capabilities and manufacturing transfer services allow us to participate throughout the entire product development process to help reduce our customers' costs, accelerate product development times and secure ongoing manufacturing relationships. Equipping our facilities with rapid prototyping technologies and using these technologies across multiple disciplines (e.g., machining and plastic molding) is an important element of our product development services. In providing these services, our internal program management group, internal product design and development engineers and manufacturing transfer engineers provide our customers with expertise in desired disciplines. . Component Manufacturing. Precision metal and plastics processing are core elements of our manufacturing capabilities. Our metal manufacturing capabilities include milling, lathe turning, drilling, grinding, polishing, lapping, laser cutting, sintering, wire forming, stamping and precision metal injection manufacturing with materials as diverse as stainless steel, titanium, and shape memory alloys. Trends in the medical industry towards minimally-invasive surgical techniques have made our micro-machining capabilities increasingly important. These micro-machining capabilities include computer numerically controlled, or CNC, multi-axis and Swiss-machining, as well as electric discharge machining, or EDM. Our plastics manufacturing capabilities include precision tubing (dip coating and extrusion), molding (injection, insert and thermoforming) and machining, with a wide range of engineering polymer materials. . Product Assembly and Supply Chain Management Services. Our product assembly and supply chain management capabilities allow us to provide customers with completed medical devices and subassemblies. Our assembly capabilities include mechanical, electromechanical and instrumentation assembly, as well as functional testing, inspection, complex integration (with advanced materials), kitting and packaging. We utilize our supply chain management services to source components and services, either from internal operations or from third party suppliers, to facilitate our customers need for streamlined inbound logistics, as well as to provide vendor managed inventory services to facilitate outbound logistics management for our customers. Our assembly and supply chain management capabilities enable us to extend our vertically integrated manufacturing business and further distinguish us from suppliers with more limited capabilities. We provide our products and services to each of the following primary target markets: . Surgical Instrumentation - devices and components for both the minimally invasive and general surgery markets. Surgical devices are typically produced from metal or plastic components and, in the case of powered products, electronic components. We manufacture a variety of surgical device and component products for our customers for wound closure, endo-laparoscopy, electosurgery, arthoscopy, cardiac surgery, ophthalmology, and urogynecology applications. -4- . Electro-Medical Implants - devices and components for active electronic implantable devices. These products are high precision and are typically produced from metal and plastic materials and electronic components. We manufacture a variety of component products and provide our customers with laser welding and device assembly services for use in cardiac rhythm management, or CRM, including pacemakers and defibrillators, neurostimulation, hearing assist, and implantable drug delivery markets. . Interventional - devices and components for vascular intervention. These products are typically produced from a combination of metal and plastic materials. We manufacture a variety of interventional products and components for our customers, including stent delivery catheters, steerable guidewires, diagnostic and therapeutic catheters and accessory devices for use in the cardiology, radiology, neuroradiology, vascular access and electrophysiology markets. . Orthopedics - implants and instruments for reconstructive, spinal and trauma procedures. We manufacture a variety of orthopedic implants from metal, plastic and ceramic materials for our customers, such as hips, knees, plates, rods, screws as well as procedural instruments for the placement of these implants. Our Customer Solution Our medical engineering and manufacturing services enable our customers to concentrate their internal resources on research and development for new therapies and treatments and on marketing their product offerings. The key components of our customer solution are: . Provide an integrated outsourcing solution. By providing a comprehensive range of design, engineering, development, process technology, manufacturing and assembly and supply chain management capabilities, we offer our customers the ability to outsource all or part of the production of a device to a single provider. We have won several significant projects under which we design, manufacture and package finished devices for leading global medical device companies. In addition, we work closely with smaller, emerging medical device companies as their engineering and manufacturing partner. . Accelerate product development cycle time. Our experience in design engineering, collaborative product development and rapid prototyping positions us as a valuable resource early in the new product development process and enables critical processes to occur simultaneously, which reduces the overall time-to-market. We employ over 130 engineers of whom approximately 70 are devoted to supporting our customers' new product introductions. Our engineers provide technical expertise to transform our customers' concepts into finished devices that can be efficiently manufactured on a commercial scale. . Provide quality products and practices. Quality is of the highest importance to our customers due to the serious and costly consequences of product failure. We operate our facilities under a single integrated quality system. Each of these facilities has been certified by independent certification bodies to comply with the ISO 9001 quality management standard and ISO 13485 medical device-specific standard. In addition, each of our facilities has been registered with the Food and Drug Administration, or FDA, as a contract manufacturing facility, which establishes good manufacturing practice -5- requirements for product design, manufacture, management, packaging, labeling, distribution and installation. . Reduce costs for customers. We reduce our customers' total costs associated with manufacturing by: - designing for manufacture and assembly; - managing a streamlined supply chain; and - delivering manufacturing processes that lower costs through increased efficiencies and continuous improvement efforts. In addition, by offering an integrated outsourcing solution encompassing design, engineering, manufacturing, assembly, sterilization and packaging, we are able to lower the total cost of the products that we deliver to our customers by designing optimal manufacturing processes and reducing coordination costs, redundant engineering and overhead related to quality and purchasing. Our Strategy Our objective is to be the leading medical engineering and manufacturing services provider to established, as well as emerging, medical device companies. We expect to grow by focusing our sales and marketing teams on cross-selling our design and engineering, manufacturing, assembly and supply chain management services to both existing customers and new customers. The key elements of our business strategy include: . Continue to grow within core markets. We are focused on continued growth within our four core markets: surgical instrumentation, electro-medical implants, interventional products, and orthopedic implants and instruments. We believe that these markets present a promising growth opportunity, and we will continue to use a market-focused sales strategy to further penetrate these markets. Our existing customer relationships provide a foundation for future growth, and we also look for opportunities to expand our scope of services in these markets to provide an enhanced offering. . Strengthen our customer relationships by collaborating in the design and engineering of new products. Working closely with customers in the design and engineering of new products provides significant opportunity to anticipate customers' needs and secure ongoing manufacturing relationships. Increasingly, our customers provide only functional or system performance specifications and request that we provide much of the design and engineering specifications associated with new products or product modifications. Our ability to provide product design and development services enables us to secure long term manufacturing relationships for finished devices, sub-assemblies and components. . Drive additional component manufacturing business by continuing to expand our device assembly services. As we increase our assembly business, we have the opportunity to also increase our manufacturing of components because the assembler, or sub-assembler, of a device typically controls the source of the components used in that device. Our manufacturing capabilities position us well to produce many of the components for the products we assemble. -6- . Focus on business excellence. We are committed to continuous improvement of our business processes and services, which we believe have already distinguished us as a leading high quality medical engineering and manufacturing services provider. We are implementing a strategy founded on the principles of employee excellence, technology deployment, six sigma quality-driven operations, an integrated low-cost manufacturing network, lean manufacturing and customer satisfaction. Our engineering and manufacturing competencies are supported and extended through continued investment in advanced process technologies. . Pursue product line transfers and acquisitions of customers' manufacturing assets. We believe that the transfer of the manufacturing responsibility for product lines and our acquisition of customer manufacturing facilities will provide a vehicle for substantial growth, as well as a mechanism to develop closer relationships with leading medical device companies. These transactions allow our customers to reduce capital employed and focus resources on their core competencies, including research and sales and marketing. We believe that product line transfers and asset acquisitions of this kind are becoming increasingly attractive to our customers. We have established a dedicated transfer team with well defined policies, procedures and protocols, which is staffed with experienced manufacturing engineers to support these activities. . Selectively acquire new companies. We plan to make select acquisitions of complementary medical engineering and manufacturing services providers that bring desired capabilities, customers or geographic coverage and either strengthen our position in our target markets or provide us with a significant presence in a new market. We have experienced business development personnel capable of identifying acquisitions and integrating these acquisitions into our operations. Since our formation through the acquisition of seven companies in March 1999, we have completed six additional acquisitions. We believe that we can create a competitive advantage through our ability to acquire and integrate acquisitions. . Increase competitiveness through operating cost reductions. We intend to pursue opportunities to lower our operating cost structure in an effort to become more profitable, which will allow us to pursue more growth opportunities. We plan to lower operating costs by increasing our plant utilization rates, which will reduce overhead expenses, and by transferring more manufacturing operations to our plant in Navojoa, Mexico. We believe that our operations in Navojoa, Mexico will provide us with a low cost growth platform. . Offer financial stability. We believe the medical engineering and manufacturing services industry includes over 3,000 companies, many of which have annual revenues of less than $5.0 million in medical device products. We believe our customers prefer working with large and stable medical engineering and manufacturing service providers such as MedSource, who can ensure a continuous supply of products and services. Additionally, we have the financial capability to allow us to respond rapidly to our customers' requirements, such as higher production volumes. We intend to continue to build our brand name and deploy our sales and marketing team, as well as to use our information technology infrastructure, to further implement our strategy. In addition, we believe that our scale and resources provide our customers with security and reliability. -7- Sales and Marketing Our sales organization uses a team approach that integrates the activities of approximately 40 account managers, technical service managers, customer support managers and project managers. Our sales teams are organized around our four major target markets. This team approach is designed to allow us to serve our customers while providing both a high level of market expertise and a single point of contact through each phase of a project. We believe this customer team approach distinguishes us by enabling us to handle complex projects involving outsourcing of completed medical devices from design to delivery. We have a group of technical service managers who are trained in our various manufacturing technologies and processes. These managers assist our customers' engineering groups and our sales professionals by specifying the best manufacturing technology for a particular device or component. These managers are supported by process experts in each of the facilities who provide functional expertise in each of the various manufacturing processes. Our market development team provides strategic marketing support to our sales and operations organizations. Market development helps align our sales and application engineering resources across our four key target markets and aligns their efforts with our manufacturing capabilities and capacity. In addition, this team plays an important role in tailoring our broad product and service offerings, including key account and market strategies, pricing strategies, capability bundling strategies, marketing campaigns. We invest significant resources to develop the MedSource brand name by participating in a number of medical related tradeshows, including medical design and manufacturing shows in the United States and Europe and by advertising our capabilities in a number of medical device and equipment industry magazines and trade publications. Customers We serve leading medical device companies as well as many other private and public emerging medical device companies. During fiscal 2003, we had sales to over 230 medical device companies, and our customers include seven of the largest ten medical device companies (by revenues), including Johnson & Johnson affiliates, Medtronic, and Boston Scientific. Johnson & Johnson affiliates, Medtronic and Boston Scientific each accounted for more than 10% of our revenues during our year ended June 30, 2003. We work with our customers on a product by product basis and often work with many different divisions of our largest customers. To date, most of our new sales have been made to existing customers that, we believe, have typically ordered new products from us based upon their past experience and our capabilities. The products that we manufacture are made to order based on the customer's specifications and may be designed using our design and engineering services. Our customers retain ownership of and the rights to their product's design while we generally retain the rights to any of our proprietary manufacturing processes. Information Technology We believe that our use of information technology will be a competitive advantage. We are installing the Oracle 11i enterprise resource planning, or ERP, system in all of our facilities. We successfully completed the implementation of the full ERP application at five sites, a company-wide order management system at all sites and an integrated financial reporting system at all locations. We are continuing to implement the full Oracle ERP application at the remainder of our manufacturing sites and -8- introduce new productivity tools within the Oracle 11i application as appropriate. In addition, we have standardized our computer aided design, or CAD, and computer aided manufacturing, or CAM, software at our facilities. We expect these systems to provide several key benefits to us, our customers and our suppliers. The systems enable the sharing of customer, supplier and engineering data across our company. We believe that this will enable us to better understand and predict customer demand, take advantage of economies of scale, provide greater flexibility to move product design between sites and improve the accuracy of capturing and estimating our manufacturing and engineering costs. In addition, the systems provide greater visibility into the operations of the enterprise through integrated financial and management reporting capabilities. This system also benefits our suppliers by giving them more accurate and timely information about our requirements. Overall, these systems will provide the infrastructure that will enable us to provide additional value to our customers through improved supply chain management capability, reduced costs and accelerated product development. Manufacturing We combine advanced manufacturing technology, such as CAD/CAM, with manufacturing techniques such as just-in-time manufacturing, and the "MedSource Business Excellence initiative," which we implemented during fiscal 2003. Just-in-time manufacturing is a production technique that minimizes work-in-process inventory and manufacturing cycle time while enabling delivery of products to customers in the quantities and time frame required. The MedSource Business Excellence initiative is a continuous improvement effort based on the principles of Six Sigma and lean manufacturing. We believe that the application of these principles will reduce total costs, improve cycle times, and improve working capital efficiency. To serve our market as a comprehensive manufacturing solution for medical device companies, we address customers' requirements from a "quote-to-order," "order-to-fill" and an after sales service perspective. We have identified the key processes within this structure and are currently implementing standard operating procedures to create a seamless process within our organization structure and with our customers. This approach to customer service is vital in maintaining and developing customer relationships and differentiating us from our competitors. We intend to continue to offer our customers advanced manufacturing process technologies, which currently include computer integrated manufacturing, CNC machines, laser cutting, injection molding, stamping, dip coating, extruding and our patented precision metal injection manufacturing. Our flexible manufacturing capability allows us to efficiently produce both high-volume products and low-volume products. Our investment in new equipment will position us to continue to provide efficient and flexible medical engineering and manufacturing services to medical device companies. We operate a multi-facility manufacturing network strategically located throughout the United States and in Mexico. We completed reviews of our manufacturing operations and support functions in fiscal 2001 and again in fiscal 2003. Based on our evaluation of the unique and common characteristics of our various facilities, we determined that we could reduce operating costs by closing several of our facilities, thus improving capacity utilization and efficiency of the remaining facilities. Criteria in our evaluation included current capacity utilization, uniqueness of manufacturing capabilities, current operating costs, difficulty and cost associated with relocation and recertification of key equipment, and customer supply requirements. We sold facilities in Pittsfield and East Longmeadow, Massachusetts during our fiscal year ended June 30, 2002. In addition, we initiated the shutdown of our facility in Danbury, Connecticut during our fiscal year ended June 30, 2002. We closed the Danbury facility during -9- the fiscal year ended June 30, 2003. In conjunction with our plant rationalization during fiscal 2003 and 2002, we initiated the expansion of our manufacturing facilities located in Corry, Pennsylvania, Brooklyn Park, Minnesota, Laconia, New Hampshire, and Navojoa, Mexico to accommodate the transfer of selected products and product lines for specific medical companies. Overall, we have not experienced any significant capacity constraints within our manufacturing network. We expect that we have adequate capacity to meet future growth requirements. Quality We believe that product quality is a critical success factor in the medical engineering and manufacturing services market. We strive for continuous improvement of our processes and have adopted a number of quality improvement and measurement techniques to monitor our performance. We operate our facilities under a single integrated quality system and comply with the ISO 9001 quality management standard and the ISO 13485 medical device-specific quality management standard, and they are certified to such standards by independent certification bodies. The ISO 9001 standard specifies quality system requirements for product design and production. ISO 13485 establishes additional, more specific requirements for medical devices in particular. Newly acquired facilities are promptly brought into conformity with our integrated quality system, generally within six months to one year. We believe our quality system also complies with FDA quality system regulations with respect to all of our products, services and internal processes. With our integrated company-wide quality system in place, customers are able to audit select MedSource facilities knowing that every facility that has been integrated into the system is subject to the same quality system and process controls, as applicable to the facility's particular operations. This system can provide significant time and cost savings for customers, as well as reduced risk of non-conforming products resulting in customer dissatisfaction, product recall or patient adverse events. The FDA quality system regulation establishes good manufacturing practice requirements for product design, manufacture, management, packaging, labeling, distribution and installation. We register each of our facilities with the FDA as a contract manufacturing facility within one year of acquisition. Supply Arrangements We have established relationships with many of our materials providers. However, most of the raw materials that are used in our products are subject to fluctuations in market price. In particular, the prices of stainless steel, titanium and platinum have historically fluctuated, and the prices that we pay for these materials, and, in some cases, their availability, are dependent upon general market conditions. In the short term, we generally cannot pass these cost increases on to our customers. Our current internal manufacturing and engineering capabilities do not include all elements that are required to satisfy all of our customers' requirements. When we do not possess the appropriate manufacturing or engineering capabilities internally, such as electronic circuitry manufacturing, we subcontract with third party providers for the necessary components or services. As we provide our customers with a fully integrated supply chain solution, we will continue to rely on third party suppliers, subcontractors and other outside sources for components or services that we cannot provide through our internal resources. To date we have not experienced any difficulty obtaining necessary raw materials or subcontractor services. -10- Intellectual Property The products that we manufacture are made to order based on the customer's specifications and may be designed using our design and engineering services. Our customers retain ownership of and the rights to their product's design while we generally retain the rights to any of our proprietary manufacturing processes. We generally rely on know-how to manufacture products to our customers' specifications. We use a combination of patents, licenses and trade secrets to establish and protect the proprietary rights to our technologies and products used in connection with precision metal injection manufacturing processes, guidewire technology, plastic tubing manufacturing processes, surgical instrumentation manufacturing processes, and surface texturing for implantable devices. We own an aggregate of two United States and one foreign patents in connection with our precision metal injection manufacturing processes. We also have five foreign pending patent applications at various stages of approval. The United States patents relating to our precision metal injection manufacturing processes expire in 2015, and our foreign patent expires in 2016. In addition, we are a party to several license agreements with third parties pursuant to which we have obtained, on varying terms, non-exclusive rights to patents held by third parties in connection with precision metal injection manufacturing technology. We own an aggregate of nine United States patents that we use in connection with the manufacture of our guidewire products. We also have one United States and six foreign pending patent applications at various stages of approval. The United States patents relating to our guidewire products expire between 2010 and 2015. We own an aggregate of seven other United States patents that we use in connection with other manufacturing processes. We also have one United States pending patent application. The United States patents relating to these other manufacturing processes expire between 2014 and 2019. We jointly own four United States patents in a surface texturing process to improve bone adhesion of medical implants in which we have the selling rights. These patents expire between 2010 and 2013. There is also a pending patent for a specialized process in which a third party would have exclusive rights to the process. In addition, we are a party to a license agreement with a third party pursuant to which we have obtained exclusive manufacturing and marketing rights, for the medical industry, to a patent in connection with the manufacture of thin sheet alginate membrane structures. This patent expires in 2019. We do not believe that the expiration of any of our patents or the termination of any of our licenses would have a material effect on our business. It is our policy to require all employees, consultants and other parties to execute confidentiality agreements. These agreements prohibit disclosure of confidential information to third parties except in specified circumstances. In the case of employees and consultants, the agreements generally provide that all confidential information relating to our business is the exclusive property of MedSource. We have an agreement with one of our former employees that provides him with an exclusive license to our precision metal injection technology for use only outside the medical industry. This license is royalty-free. In addition, we must obtain the former employee's consent if we desire to sublicense or exploit this technology for non-medical applications. -11- Competition We compete with different companies depending on the type of product or service offered or the geographic area served. Our management believes that the primary basis of competition in our targeted markets is existing customer relationships, as well as reputation, quality, delivery, responsiveness, breadth of capabilities and price. We have as customers many of the leading medical device companies in our four target markets. In addition, we believe that our integrated quality system and manufacturing network allow us to compete favorably in terms of breadth of product and service offerings, quality, responsiveness and price. To remain competitive, we must continue to provide a single source solution, accelerate product development time, provide quality products and practices, reduce costs for our customers and offer financial stability. Our existing or potential competitors include the internal operations of medical device companies themselves and other medical engineering and manufacturing services providers. Other medical engineering and manufacturing services providers currently compete in some but not all of the same target markets that we do. We believe that the medical engineering and manufacturing services industry is highly fragmented with over 3,000 companies that have limited manufacturing capabilities and limited sales and marketing expertise. Many of these 3,000 companies have less than $5.0 million in annual revenues from medical device companies. Government Regulation We are a medical device and component engineering and manufacturing services provider. Some of the products that we manufacture may be considered finished medical devices, and the manufacturing processes used in the production of finished medical devices are subject to FDA regulatory- inspection and assessment, and must comply with FDA regulations, including its Quality System Regulation. The FDA quality system regulation establishes good manufacturing practice requirements for product design, manufacture, management, packaging, labeling, distribution, and installation for medical devices. Additional FDA regulations impose requirements for record keeping, reporting, facility and product registration, product safety and effectiveness, and product tracking. Failure to comply with these regulatory requirements may result in civil and criminal enforcement actions, including financial penalties, seizures, injunctions and other measures. Our products must also comply with state and foreign regulatory requirements. Also, in order to comply with regulatory requirements, our customers may wish to audit our operations to evaluate our quality systems. Accordingly, we routinely permit audits by our customers. In addition, the FDA and state and foreign governmental agencies regulate many of our customers' products as medical devices. FDA approval/clearance is required for those products prior to commercialization in the United States, and approval of regulatory authorities in other countries may also be required prior to commercialization in those jurisdictions. Moreover, in the event that we build or acquire additional facilities outside the United States, we will be subject to the medical device manufacturing regulations of those countries. Some other countries may rely upon compliance with United States regulations or upon ISO certification as sufficient to satisfy certain of their own regulatory requirements for a product or the manufacturing process for a product. Other than as described in the prior two paragraphs, our business is not subject to direct governmental regulation other than the laws and regulations generally applicable to businesses in the jurisdictions in which we operate, including those federal, state and local environmental laws and regulations governing the emission, discharge, use, storage and disposal of hazardous materials and the -12- remediation of contamination associated with the release of these materials at our facilities and at off-site disposal locations. Our manufacturing activities involve the controlled use of, and some of our products contain, small amounts of hazardous materials. Liabilities associated with hazardous material releases arise principally under the Clean Water Act, the Clean Air Act, the Resource Conservation and Recovery Act and the Comprehensive Environmental Response, Compensation and Liability Act and analogous state laws which impose strict, joint and several liability on owners and operators of contaminated facilities and parties that arrange for the off-site disposal of hazardous materials. We are not aware of any material noncompliance with the environmental laws currently applicable to our business and we are not subject to any material claim for liability with respect to contamination at any company facility or any off-site location. We cannot assure you, however, that we will not be subject to such environmental liabilities in the future as a result of historic or current operations. Access to SEC Filings Our SEC filings are available through the SEC web site at http://www.sec.gov, or through our web site at http://www.medsourcetech.com in the Investor Relations section under SEC filings. The annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our Internet web site as soon as reasonably practicable after they are electronically filed with the SEC RISK FACTORS You should carefully consider the following risk factors together with all of the other information contained in this Annual Report on Form 10-K before making an investment decision with respect to our common stock. Any of the following risks, as well as other risks and uncertainties described in this Annual Report on Form 10-K, could harm our business, financial condition and results of operations and could adversely affect the value of our common stock. Risks Related to Our Business Adverse trends or business conditions affecting the medical device industry or our customers could harm our operating results. Our business depends on trends in the medical device industry, which is subject to rapid technological changes, short product life-cycles, frequent new product introductions and evolving industry standards, as well as economic cycles. Conditions or technological innovations adversely affecting any of our major customers, the medical device industry in general or the surgical instrumentation, electro-medical implant, interventional and orthopedic markets we target in particular, could adversely affect our operating results. For example, the discovery and market acceptance of non-device treatments for specific medical conditions could make the medical devices used to treat these conditions obsolete. In addition, the products and services that we provide to our customers generally are specific to a particular medical device being developed or marketed by them. If a customer's medical device does not gain or maintain market acceptance because of competing medical devices or treatments, changing market conditions, unfavorable regulatory actions or other reasons, our revenues from that customer and our results of operations would be adversely affected. Because a significant portion of our revenue comes from a few large customers, any decrease in sales to these customers could harm our operating results. -13- The medical device industry is concentrated, with relatively few companies accounting for a large percentage of sales in the surgical instrumentation, electro-medical implant, interventional and orthopedic markets that we target. Accordingly, our revenue and profitability are highly dependent on our relationships with a limited number of large medical device companies. In fiscal 2003, our top four customers accounted for approximately 56% of our revenues, with one customer accounting for 27% of our revenues, another accounting for 12% and a third customer accounting for 11% of our revenues. In fiscal 2002, our top four customers accounted for approximately 52% of our revenues, with one customer accounting for 25% of our revenues and another accounting for 12% of our revenues. In fiscal 2001, our top four customers accounted for approximately 41% of our revenues, with one customer accounting for 18% of our revenues and another accounting for 12% of our revenues. We provide products and services to several different divisions of our top customers. We are likely to continue to experience a high degree of customer concentration, particularly if there is further consolidation within the medical device industry. We cannot assure you that there will not be a loss or reduction in business from one or more of our major customers. In addition, we cannot assure you that revenues from customers that have accounted for significant revenues in the past, either individually or as a group, will reach or exceed historical levels in any future period. The loss or a significant reduction of business from any of our major customers would adversely affect our results of operations. Our growth may be slow if the trend toward outsourcing by medical device companies does not continue or if our customers decide to manufacture internally products that we currently provide. To date, we have benefited from the growing trend of medical device companies to outsource all or a portion of their engineering, product development, manufacturing and assembly requirements. Although we expect medical device companies to increase their outsourcing of these requirements in the future, we cannot be certain that this trend will continue or that, if it continues, we will benefit from it. Even if the outsourcing trend in the industry continues, one or more of our principal customers could decide to decrease its reliance on or use of outsourcing, which would reduce our customer base. Also, as part of our growth strategy, we are seeking to accept full supply chain management and manufacturing responsibility for selected product lines from our customers and, in some cases, to acquire the related manufacturing assets from these customers. While we believe that product line transfers and asset acquisitions of this kind are becoming increasingly attractive to our customers, we have only consummated one of these transactions to date. We cannot be sure that opportunities of this nature will be available, especially if the trend toward outsourcing does not continue. We have few contracts with our customers that ensure us future business, and cancellations, reductions or delays in customer orders could harm our operating results. Generally, we work with our customers on a project-by-project or purchase order-by-purchase order basis, without any long-term revenue, volume or other commitments to ensure us future business. Customer orders typically may be cancelled and volume levels may be changed or delayed at any time. We cannot assure you that we can replace delayed, cancelled or reduced projects with new business in a timely manner. Also, we may not fully recover our costs in connection with cancelled, delayed or reduced projects. Our quarterly operating results fluctuate significantly, and if we fail to meet the expectations of securities analysts or investors, our stock price may decrease. -14- Our operating results have fluctuated in the past from quarter to quarter and are likely to fluctuate significantly in the future due to a variety of factors, including: . the timing of actual customer orders and the accuracy of our customers' forecasts of future production requirements; . the introduction and market acceptance of our customers' new products and changes in demand for our customers' existing products; . changes in the relative portion of our revenue represented by our various products, services and customers, including the relative mix of our business across our target markets; . changes in competitive or economic conditions generally or in our customers' markets; . changes in availability or costs of raw materials or supplies; and . demand for our products and services, which, during our limited operating history, has been higher than average during the last quarter of our fiscal year and lower than average during the first quarter of our fiscal year. For all these reasons, our quarterly results are difficult to predict and should not be relied upon as an indication of future performance. Fluctuations in our quarterly results could result in our failing to meet the expectations of the investment community, which could adversely affect the market price of our common stock even if those fluctuations are unrelated to our long term operating performance or prospects. Risks relating to acquisitions, including failure to successfully manage our growth and integrate acquired businesses, may adversely affect our financial performance. We were formed in March 1999 through the acquisition of seven separate businesses. In January 2000, we acquired the business of Tenax Corporation; in February 2000, we acquired Apex Engineering; in May 2000, we acquired Thermat Precision Technology, Inc.; in December 2000, we acquired ACT Medical, Inc.; in January 2002, we acquired HV Technologies; and in September 2002, we acquired Cycam, Inc. As a result, we are experiencing rapid growth that could strain our managerial and other resources. We also plan to seek to make select acquisitions of complementary medical engineering and manufacturing services providers that bring desired capabilities, customers or geographic coverage and either strengthen our position in our target markets or provide us with a significant presence in a new market. The risks we may encounter in pursuing these acquisitions include expenses associated with, and difficulties in identifying, potential targets, costs associated with acquisitions we ultimately are unable to complete and higher prices for acquired companies due to competition for attractive targets. Completing acquisitions also may result in dilution to our existing stockholders and may require us to seek additional capital, if available, including by increasing our indebtedness. Once acquired, the successful integration and operation of a business requires communication and cooperation among key managers, the transition of customer relationships, the management of ongoing projects of acquired companies and the management of new projects across previously independent facilities. Acquisitions also involve a number of other risks, including: -15- . the diversion of management attention; . difficulties in integrating the operations and products of an acquired business or in realizing projected operational results, synergies and cost savings; . inaccurate assessments of undisclosed liabilities; and . potential loss of key customers or employees of the acquired businesses. Customer satisfaction or performance problems with an acquired company could also harm our reputation as a whole, and any acquired business could significantly underperform relative to our expectations. Because three of our acquisitions were completed in the past 36 months, we are currently facing all of these challenges and our ability to meet them over the long term has not been established. For all these reasons, our pursuit of an overall acquisition strategy or any individual completed, pending or future acquisition may adversely affect the realization of our strategic goals. In addition, while we anticipate cost savings, operating efficiencies and other synergies as a result of our acquisitions, the consolidation of functions and the integration of departments, systems and procedures present significant management challenges. We cannot assure you that we will: . successfully accomplish those actions as rapidly as anticipated; . achieve the cost savings and efficiencies that we expect from our acquisitions; . successfully manage the integration of new locations or acquired operations; . fully use new capacity; or . enhance our business as a result of any past or future acquisition, including those mentioned above. The acquisition of new operations can also introduce new types of risks to our business. For example, new acquisitions may require greater effort to address United States Food and Drug Administration, or FDA, regulation or similar foreign regulation. We may face product liability claims that could result in costly litigation and divert the attention of our management. We may be exposed to product liability claims and product recalls, including those which may arise from misuse or malfunction of, or design flaws in, our customers' products, whether or not such problems directly relate to the products and services we have provided. In some circumstances, we have agreements in place with our customers governing liability for product liability and recalls. Even where we have agreements with customers that contain provisions attempting to limit our damages, these provisions may not be enforceable or may otherwise fail to protect us from liability. Product liability claims or product recalls, regardless of their ultimate outcome, could require us to spend significant time and money in litigation or require us to pay significant damages. The occurrence of product liability claims or product recalls could cause our results of operations to be adversely affected. We carry $20.0 million of product liability insurance coverage, which is limited in scope. Our management believes that our insurance coverage is adequate given the risks we face. We cannot assure -16- you that we will be able to maintain this insurance or to do so at reasonable cost and on reasonable terms. We also cannot assure you that this insurance will be adequate to protect us against a product liability claim that may arise in the future. If we experience decreasing prices for our products and services and we are unable to reduce our expenses, our results of operations will suffer. We may experience decreasing prices for the products and services we offer due to: . pricing pressure experienced by our customers from managed care organizations and other third-party payors; . increased market power of our customers as the medical device industry consolidates; and . increased competition among medical engineering and manufacturing services providers. If the prices for our products and services decrease for whatever reason and we are unable to reduce our expenses, our results of operations will be adversely affected. If our manufacturing processes, products and services fail to meet the highest quality standards, our reputation could be damaged and our results of operations could be harmed. Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our success depends in part on our ability to manufacture to exact design specifications precision engineered plastic and metal components, subassemblies and finished devices from multiple materials. If our products and services fail to meet the highest quality standards or fail to adapt to evolution in those standards, our reputation could be harmed and our competitive position could be damaged. In addition, our quality systems and certifications are critical to the marketing success of our products and services. If we fail to maintain our quality systems or certifications, our reputation could be damaged and our results of operations could be adversely affected. Competition from our customers' internal operations as well as from other medical engineering and manufacturing service providers could result in downward pressure on prices, fewer new business opportunities and loss of market share. Our current and prospective customers often evaluate our product and service offerings against the merits of internal design and engineering, manufacturing, assembly and supply chain management. In this sense, we often compete for business with the internal resources of our customers, many of whom are leading medical device companies with long-standing internal design and engineering, manufacturing and supply chain management capabilities. Our success therefore depends heavily upon our ability to demonstrate and deliver cost savings and accelerated time to market for our customers as compared to use of internal resources, without loss of quality, confidentiality or reliability. In addition, we believe the medical engineering and manufacturing services industry is very competitive and fragmented with over 3,000 companies, many of which are specialized. To the extent that medical device companies seek to outsource more of the design, prototyping and manufacturing of their products, we will face increasing competitive pressures to broaden our capabilities and grow our business in order to maintain our competitive position, and we may encounter competition from other companies with design, technological and manufacturing capabilities similar or superior to ours. -17- If we fail to comply with the covenants under our senior credit facility or other indebtedness, are unable to pay interest and principal when due or experience increased interest costs, our operating results and financial condition could be harmed. Failure to comply with the covenants under our senior credit facility or with respect to any future indebtedness may result in an event of default. If an event of default occurs and is not cured or waived, substantially all of our indebtedness could become immediately due and payable. The ability to pay interest and principal on our debt obligations will depend on our future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, many of which are beyond our control. There can be no assurance that our operations will generate earnings in any future period sufficient to cover the fixed charges. In addition, we may experience variable financial results as a consequence of floating interest rate debt. As interest rates fluctuate, we may experience increases in interest expense, which may materially affect financial results. If we cannot obtain the additional capital required to fund our operations and finance acquisitions on favorable terms or at all, we may have to delay or abandon our growth strategy. Our growth strategy will require additional capital for, among other purposes, completing acquisitions of companies and customers' product lines and manufacturing assets, integrating acquired companies and assets, acquiring new equipment and maintaining the condition of existing equipment. If cash generated internally is insufficient to fund capital requirements, if funds are not available under our senior credit facility, or if we desire to make acquisitions, we will require additional debt or equity financing. Adequate financing may not be available or, if available, may not be available on terms satisfactory to us. If we raise additional capital by issuing equity or convertible debt securities, the issuances may dilute the share ownership of the existing investors. In addition, we may grant future investors rights that are superior to those of our existing investors. If we fail to obtain sufficient additional capital in the future, we could be forced to curtail our growth strategy by reducing or delaying capital expenditures and acquisitions, selling assets or restructuring or refinancing our indebtedness. Our growth may be limited and our competitive position may be harmed if we are unable to identify and consummate future acquisitions. Our continued growth may depend on our ability to identify and acquire on acceptable terms companies that complement or enhance our business. We may not be able to identify or complete future acquisitions. Some of the risks that we may encounter include expenses associated with, and difficulties in identifying, potential targets, the costs associated with incomplete acquisitions and higher prices for acquired companies because of competition for attractive acquisition targets. If we fail to acquire additional capabilities, we may be unable to compete with other companies in our industry that are able to provide more complete outsourcing capabilities and services to medical device companies, which could adversely affect our results of operations. A substantial amount of our assets represents goodwill, and our net income will be reduced if our goodwill becomes impaired. As of June 30, 2003, goodwill represented approximately $96.6 million, or 44%, of our total assets. Goodwill is generated in our acquisitions when the cost of an acquisition exceeds the fair value of the net tangible and identifiable intangible assets we acquire. We historically had recorded goodwill on our balance sheet and amortized it, generally on a straight-line basis over twenty years. We adopted Statement of Financial Accounting Standard, or SFAS, No. 142, Goodwill and Other Intangible Assets, effective July 1, 2001. Goodwill is no longer amortized under generally accepted accounting principles as -18- a result of SFAS No. 142. Instead, goodwill is subject to an impairment analysis at least annually based on the fair value of the reporting unit. We could be required to recognize reductions in our net income caused by the write-down of goodwill, if impaired, that if significant could materially and adversely affect our results of operations. For example, in fiscal 2003 we recorded a goodwill impairment charge of $37.7 million under SFAS No. 142. In addition, in fiscal 2001 we recognized a goodwill impairment charge of $2.6 million in conjunction with our fiscal 2001 restructuring plan. We depend on outside suppliers and subcontractors, and our production and reputation could be harmed if they are unable to meet our volume and quality requirements and alternative sources are not available. Our current capabilities do not include all elements that are required to satisfy all of our customers' requirements. As we increasingly position ourselves to provide our customers with a single source solution, we may rely increasingly on third party suppliers, subcontractors and other outside sources for components or services. Manufacturing problems may occur with these third parties. A supplier may fail to develop and supply products and components to us on a timely basis, or may supply us with products and components that do not meet our quality, quantity or cost requirements. If any of these problems occur, we may be unable to obtain substitute sources of these products and components on a timely basis or on terms acceptable to us, which could harm our ability to manufacture our own products and components profitably or on time. In addition, if the processes that our suppliers use to manufacture products and components are proprietary, we may be unable to obtain comparable components from alternative suppliers. If we are unable to maintain our expertise in manufacturing processes or if our customers demand capabilities that we cannot provide, we will be unable to compete successfully. We use highly engineered, proprietary processes and sophisticated machining equipment to meet the specifications of our customers. Without the timely incorporation of new processes and enhancements, particularly relating to quality standards and cost-effective production, our manufacturing capabilities would likely become outdated, which would cause us to lose customers. In addition, new or revised technologies could render our existing process technology less competitive or obsolete or could reduce demand for our products and services. It is also possible that finished medical device products introduced by our customers may require fewer of our components or may require components that we lack the capabilities to manufacture or assemble. In addition, we cannot assure you that any investment that we make in new technologies will result in commercially viable processes for our business. Although we anticipate that our manufacturing and marketing expertise will enable us to successfully develop and market our capabilities, any failure by us to anticipate or respond in a cost-effective and timely manner to technological developments or changes in industry standards or customer requirements, or any significant delays in capability development or introduction could adversely affect our results of operations. There are operational and financial risks associated with our new facility in Mexico that could harm our operating results. We operate a manufacturing facility in Navojoa, Mexico and are in the process of significantly expanding that facility. Our operations at this facility currently comprise a small portion of our business; however, we expect that these operations will increase as we expand our device assembly service offering. Our operations in Mexico may expose us to risks and uncertainties that are different from those we experience in the United States, including political, social and economic instability, difficulties in staffing -19- and managing international operations and controlling manufacturing quality, product or material transportation delays or disruption, trade restrictions, currency fluctuation and changes in tariffs, regulatory restrictions and import and export license requirements. In addition, we will be subject to currency fluctuations with respect to our labor and facilities costs in Mexico. If any of these risks materializes, our business may be harmed. Our cost of products sold may be harmed by fluctuations in the availability and price of raw materials. Raw materials needed for our business are susceptible to fluctuations in price and availability due to transportation costs, government regulations, price controls, changes in economic climate or other unforeseen circumstances. In particular, stainless steel, titanium and platinum are used in some of our products and are in limited supply and subject to fluctuations in price. Our cost of products sold may be adversely impacted by decreases in the availability and increases in the market prices of the raw materials used in our manufacturing processes. There can be no assurance that price increases in raw materials can be passed on to our customers through increases in product prices. Even when we are able to pass along all or a portion of our raw material price increases, there is typically a lag time between the actual cost increase of raw materials and the corresponding increase in the price of our products. We and our customers are subject to governmental health, safety and consumer product regulations that are burdensome and carry significant penalties for noncompliance. We and our customers are subject to federal, state and local health and safety and consumer product regulation, including regulation by the FDA, and to similar regulatory requirements in other countries. These regulations govern a wide variety of activities from product safety and effectiveness to design and development to labeling, manufacturing, promotion, sales and distribution. We believe that we are in compliance with the requirements of FDA, of state and local authorities and, as applicable, of equivalent foreign authorities. In the event that we build or acquire additional facilities outside the United States, we will be subject to medical device manufacturing regulation in those jurisdictions as well. Also, our customers' products are subject to regulation, including manufacturing standards, of other countries in which they sell their products. As a result, we also may be obliged to comply with these manufacturing standards. To maintain manufacturing approvals, we are generally required, among other things, to register certain of our manufacturing facilities with the FDA and with certain state and foreign agencies, maintain extensive records and submit to periodic inspections by the FDA and certain state and foreign agencies. We may be required to incur significant expenses and to spend significant amounts of time to comply with these regulations or to remedy violations of these regulations. These efforts could be burdensome. In addition, any failure by us to comply with applicable government regulations could result in cessation of portions or all of our operations, imposition of fines and restrictions on our ability to carry on or expand our operations. Compliance by our customers with governmental regulations and their remedying of violations of these regulations also may be time consuming, burdensome and expensive and could negatively affect our customers' abilities to sell their products, which in turn could adversely affect our ability to sell our products and services. The regulations to which we are subject are complex, change frequently and have tended to become more stringent over time. In addition, future laws and regulations may increase governmental involvement in healthcare and lead to increased compliance costs. Our facilities are subject to environmental regulation that exposes us to potential financial liability. -20- Federal, state and local laws impose various environmental controls on the management, handling, generation, manufacturing, transportation, storage, use and disposal of hazardous chemicals and other materials used or generated in our manufacturing activities. If we fail to comply with any present or future environmental laws, we could be subject to future liabilities or the suspension of production. We cannot assure you that our operations will not require expenditures for clean-up in the future. Although we do not anticipate that these remediation efforts will be material, we cannot assure you that the costs associated with these efforts will not have an adverse effect on our business, financial condition or results of operations. Changes in environmental laws may impose costly compliance requirements on us or otherwise subject us to future liabilities and additional laws relating to the management, handling, generation, manufacture, transportation, storage, use and disposal of materials used in or generated by the manufacture of our products may be imposed. In addition, we cannot predict the effect that these potential requirements may have on us or our customers. Accidents at our facilities could delay production, adversely affect our operations and expose us to financial liability. Our business involves complex manufacturing processes and hazardous materials that can be dangerous to our employees. Although we employ safety procedures in the design and operation of our facilities and we have not experienced any serious accidents or deaths, there is a risk that an accident or death could occur in one of our facilities. Any accident could result in significant manufacturing delays or claims for damages resulting from injuries, which would harm our operations and financial condition. The potential liability resulting from any such accident or death could cause our business to suffer. Any disruption of operations at any of our facilities could harm our business. If we lose our key personnel, our ability to operate our company and our results of operations may suffer. Our future success depends in part on our ability to attract and retain key executive, engineering, marketing and sales personnel. Our key personnel include Mr. Effress and our other executive officers and the loss of certain key personnel could have a material adverse effect on us. We face intense competition for these professionals from our competitors, our customers and other companies operating in our industry. To the extent that the services of members of our senior management team and key technical personnel would be unavailable to us for any reason, we would be required to hire other personnel to manage and operate our company and to develop our products and technology. We cannot assure you that we would be able to locate or employ such qualified personnel on acceptable terms. If we are unable to attract additional qualified personnel, our growth strategy could be adversely affected. Our success will depend in large part upon our ability to attract, train, retain and motivate highly skilled employees and management. There is currently aggressive competition for employees who have experience in the engineering and technology used in our products and services. We compete intensely with other companies to recruit and hire from this pool. The industries in which we compete for employees are characterized by high levels of employee attrition. Although we believe we offer competitive salaries and benefits, we may have to increase spending in order to retain personnel. Our business is indirectly subject to healthcare industry cost containment measures that could result in reduced sales of medical devices containing our components. -21- Our customers and the healthcare providers to whom our customers supply medical devices may rely on third party payors, including government programs and private health insurance plans, to reimburse some or all of the cost of the procedures in which medical devices that incorporate components manufactured or assembled by us are used. The continuing efforts of government, insurance companies and other payors of healthcare costs to contain or reduce those costs could lead to patients being unable to obtain approval for payment from these third party payors. If that occurred, sales of finished medical devices that include our components may decline significantly, and our customers may reduce or eliminate purchases of our components. We and our customers may be subject to infringement claims by third parties that could subject us to financial liability or limit our product and service offerings, and our competitive position could be harmed if we are unable to protect our intellectual property. Litigation to enforce and defend patent and other intellectual property rights is common in the medical device industry. Although we do not believe that any of our products, services or processes infringe the intellectual property rights of third parties, we may be accused of infringing the rights of others. Our customers' products also may be the subject of third-party infringement claims, which could seek damages from both the customer and from us. With most of our customers, we do not have formal agreements governing allocation of liability for such claims. Even where we do not have liability to third parties, an infringement claim against one of our customers could result in reduced demand for our products and services or increased pricing pressure. Any infringement claim, significant charge or injunction against our products or those of our customers could harm our business. We rely on a combination of patent, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect our intellectual property, which relates principally to proprietary manufacturing processes. We cannot be sure that the steps we take to protect our proprietary rights will adequately deter unauthorized disclosure or misappropriation of our intellectual property, technical knowledge, practice or procedures. We may be required to spend significant resources to monitor and defend our intellectual property rights, we may be unable to detect or defend against infringement of these rights and we may lose any competitive advantage associated with these rights. Risks Related to the Securities Markets and Ownership of Our Common Stock Our stock price could be extremely volatile and, as a result, you may not be able to resell your shares at or above the price you paid for them. Among the factors that could affect our stock price are: . industry trends and the business success of our customers; . loss of a key customer; . fluctuations in our results of operations; . our failure to meet the expectations of the investment community and changes in investment community recommendations or estimates of our future results of operations; . strategic moves by our competitors, such as product announcements or acquisitions; . regulatory developments; -22- . litigation; . general market conditions; and . other domestic and international macroeconomic factors unrelated to our performance. The stock market has recently experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted. If a securities class action suit is filed against us, we would incur substantial legal fees and our management's attention and resources would be diverted from operating our business in order to respond to the litigation. Our principal stockholders and management own a significant percentage of our company and will be able to exercise significant influence over our company and their interests may differ from those of other stockholders. As of September 5, 2003, our executive officers and directors and principal stockholders and their affiliated entities controlled approximately 24% of our outstanding common stock. Accordingly, these stockholders, if they act together, will likely be able to control the composition of our board of directors and many other matters requiring stockholder approval and will continue to have significant influence over our affairs. This concentration of ownership also could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us. Provisions in our charter documents and Delaware law may deter takeover efforts that you feel would be beneficial to stockholder value. Our certificate of incorporation and bylaws and Delaware law contain provisions which could make it difficult for a third party to acquire us without the consent of our board of directors. These provisions include a classified board of directors and limitations on actions by our stockholders. In addition, our board of directors has the right to issue preferred stock without stockholder approval that could be used to dilute a potential hostile acquiror. Delaware law also imposes restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. While we believe these provisions provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders, and a takeover bid otherwise favored by a majority of our stockholders might be rejected by our board of directors. Additionally, we have adopted a rights agreement, commonly referred to as a "poison pill," that grants holders of our common stock preferential rights in the event of an unsolicited takeover attempt. These rights are denied to any stockholder involved in a takeover attempt, which has the effect of requiring cooperation with our board of directors. This may also prevent an increase in the market price of our common stock resulting from actual or rumored takeover attempts. The rights agreement could also discourage potential acquirors from making unsolicited acquisition bids. -23- ITEM 2. PROPERTIES As of June 30, 2003, our principal operations were conducted at the following locations: Approx. Leased/ Location Square Feet Owned - -------------------------------------------------- ----------- --------- Brimfield, Massachusetts.......................... 30,000 Owned Brooklyn Park, Minnesota.......................... 74,000 Leased Corry, Pennsylvania............................... 67,000 Leased Englewood, Colorado............................... 36,000 Leased Laconia, New Hampshire............................ 41,000 Leased Minneapolis, Minnesota (a)........................ 7,000 Leased Navojoa, Mexico................................... 38,000 Leased Newton, Massachusetts............................. 65,000 Leased Norwell, Massachusetts............................ 39,000 Leased Orchard Park, New York............................ 41,000 Leased Santa Clara, California........................... 10,000 Leased Trenton, Georgia.................................. 16,000 Leased Trenton, Georgia.................................. 32,500 Owned Pittsburgh, Pennsylvania.......................... 35,000 Owned ----------- Total.......................................... 531,500 =========== - ----------- (a) Corporate offices. We believe these facilities and the manufacturing and assembly capacity they provide are adequate for our current needs. We believe we can either expand current facilities or acquire additional space when needed to meet increased demand requirements. ITEM 3. LEGAL PROCEEDINGS From time to time, we are involved in legal proceedings in the ordinary course of our business. We are not currently involved in any pending legal proceedings that we believe could have a material adverse effect on our financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. -24- PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS Price Range of Common Stock Our common stock has traded on the Nasdaq National Market under the symbol "MEDT" since our initial public offering on March 27, 2002. The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock as reported on the Nasdaq National Market: High Low ----------- ---------- Fiscal Year 2002 - -------------------------------------------- Third quarter (beginning March 27, 2002) $ 13.00 $ 12.96 Fourth quarter 15.11 9.91 Fiscal Year 2003 - -------------------------------------------- First quarter............................... 12.90 6.50 Second quarter.............................. 9.34 6.45 Third quarter............................... 6.75 1.66 Fourth quarter.............................. 4.53 1.46 On September 5, 2003 there were approximately 200 holders of record of our common stock. This does not include the number of persons whose stock is in nominee or "street name" accounts through brokers. The last reported sale price of our common stock on the Nasdaq National Market on that date was $5.49 per share. Dividend Policy We anticipate that we will retain future earnings, if any, to finance the continued development and expansion of our business. In addition, our senior credit facility restricts our payment of dividends. Any future determination with respect to the payment of dividends will be dependent upon, among other things, our earnings, capital requirements, the terms of our then existing indebtedness, applicable requirements of Delaware corporate law, general economic conditions and other factors considered relevant by our board of directors. Recent Sales of Unregistered Securities During March 2003, we issued an aggregate of 6,910 shares of our common stock to five directors as payment of their $2,500 quarterly directors' fee. We issued these securities in reliance on the exemption from registration provided by Section 4(2) of the Securities Act on 1933 as transactions not involving any public offering and Rule 506 thereunder. During June 2003, we issued an aggregate of 33,240 shares of our common stock upon exercise of warrants issued to one of the investors who had purchased our Series E preferred stock in 2001. The exercise price of the warrants was $0.01 per share, and the investor used a "cashless" exercise provision that enabled him to surrender the right to receive upon exercise of the warrants a number of shares of common stock with a value equal to the aggregate exercise price of the warrants and, as a result, surrendered the right to receive an aggregate of 93 shares. We issued these securities in reliance on the -25- exemption from registration provided by Section 4(2) of the Securities Act on 1933 as transactions not involving any public offering and Rule 506 thereunder. ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected statement of operations data for our fiscal years ended June 30, 2003, June 30, 2002, June 30, 2001 and July 1, 2000 and for the period from March 31, 1999 (inception) through July 3, 1999 and balance sheet data as of the end of each such fiscal year. Period from March 31, Fiscal Year Ended 1999 ---------------------------- (inception) June 30, June 30, June 30, July 1, through 2003 2002 2001 2000 July 3, 1999 ------------ ------------ ------------ ------------ ------------ (In Thousands, Except Share and Per Share Amounts) Statement of Operations Data: Revenues .................................. $ 177,298 $ 158,899 $ 128,462 $ 89,352 $ 21,968 Costs and expenses: Cost of products sold .................. 131,970 117,089 94,386 59,811 13,437 Selling, general and administrative expense ............................... 33,495 29,876 26,199 21,167 4,458 Amortization of goodwill and other intangibles ........................... 338 340 5,640 4,255 4,135 Organization and start-up costs ........ -- -- -- -- 4,981 Impairment of intangible assets ........ 40,000 -- -- -- -- Restructuring charges .................. 3,724 -- 11,464 -- -- ------------ ------------ ------------ ------------ ------------ Total costs and expenses ............ 209,527 147,305 137,689 85,233 27,011 ------------ ------------ ------------ ------------ ------------ Operating (loss) income ................... (32,229) 11,594 (9,227) 4,119 (5,043) Interest expense, net ..................... (2,669) (7,671) (10,213) (10,682) (2,658) Loss on debt extinguishment ............... -- (6,857) -- -- -- Other (expense) income .................... (100) (4,782) 53 (7) (289) ------------ ------------ ------------ ------------ ------------ Loss before income taxes .................. (34,998) (7,716) (19,387) (6,570) (7,990) Income tax (expense) benefit .............. (267) 118 (70) 535 2,975 ------------ ------------ ------------ ------------ ------------ Net loss .................................. (35,265) (7,598) (19,457) (6,035) (5,015) Preferred stock dividends and accretion of discount on preferred stock .................................... -- (31,168) (9,688) (8,345) (2,078) ------------ ------------ ------------ ------------ ------------ Net loss attributed to common stockholders ............................. (35,265) $ (38,766) $ (29,145) $ (14,380) $ (7,093) ============ ============ ============ ============ ============ Net loss per share attributed to common stockholders (basic and diluted) .. $ (1.28) $ (3.50) $ (5.55) $ (3.10) $ (1.60) ============ ============ ============ ============ ============ Weighted average number of shares of common stock outstanding (basic and diluted) ................................. 27,602,806 11,086,103 5,252,749 4,633,571 4,448,000 ============ ============ ============ ============ ============ Balance Sheet Data (at end of period): Cash and cash equivalents ................. $ 10,781 $ 38,268 $ 20,289 $ 2,210 $ 1,808 Current assets ............................ 64,426 85,204 58,242 28,282 18,109 Property and equipment, net ............... 52,752 42,045 38,873 34,956 21,550 Total assets .............................. 218,217 247,829 203,965 151,101 126,792 Total debt ................................ 41,788 41,906 89,544 98,653 81,224 Mandatorily redeemable preferred stock -- 1,974 98,867 22,293 16,250 Total stockholders equity (deficit) ....... 156,081 186,320 (13,261) 15,072 21,248 -26- We began operations on March 30, 1999 through the acquisition of seven unaffiliated businesses, to whom we refer as our "predecessor companies." The following tables set forth certain historical financial data of six of the individual predecessor companies. Kelco W.N. Rushwood, Inc. Industries, d/b/a Hayden Precision Inc. Industries ------------- --------------------------- Eleven Months Three Months Ended March Year Ended Ended March 30, December 31, 30, 1999 1998 1999 ------------- ------------- ------------ Statement of Operations Data (in thousands): Net sales.......................... $ 22,877 $ 9,777 $ 2,227 Gross profit....................... 9,951 2,787 448 Operating expenses................. 2,784 1,072 195 ------------- ------------- ------------ Operating income................... 7,167 1,715 253 Other income (expense)............. 76 (241) (100) ------------- ------------- ------------ Income before taxes................ 7,243 1,474 153 Net income......................... $ 7,243 $ 1,474 $ 153 ============= ============= ============ Balance Sheet Data (in thousands) (at end of period) Total assets....................... $ 18,962 $ 7,066 $ 7,206 Long-term debt..................... -- 3,174 3,744 Stockholders' equity............... 16,215 1,685 1,753 National Wire and The MicroSpring Company, Inc. Stamping, Inc. ----------------------------- --------------------------- Three Months Three Months Year Ended Ended March Year Ended Ended March December 31, 30, December 31, 30, 1998 1999 1998 1999 ------------- ------------- ------------ ------------ Statement of Operations Data (in thousands): Net sales........................... $ 10,176 $ 1,792 $ 8,619 $ 1,636 Gross profit........................ 2,896 394 3,618 669 Operating expenses.................. 3,343 1,314 3,057 800 ------------- ------------- ------------ ------------ Operating (loss) income............. (447) (920) 561 (131) Other income (expense).............. (32) 1 126 125 ------------- ------------- ------------ ------------ Income before taxes................. (479) (919) 687 (6) Income taxes........................ 7 3 264 45 ------------- ------------- ------------ ------------ Net (loss) income................... $ (486) $ (922) $ 423 $ (51) ============= ============= ============ ============ Balance Sheet Data (in thousands) (at end of period) Total assets........................ $ 3,984 $ 3,895 $ 4,373 $ 3,250 Long-term debt...................... 250 -- 107 -- Stockholders' equity................ 2,990 3,076 2,757 2,664 Portlyn Corporation Texcel, Inc. ----------------------------- --------------------------- Three Months Three Months Year Ended Ended March Year Ended Ended March December 31, 30, December 31, 30, 1998 1999 1998 1999 ------------- ------------- ------------ ------------ Statement of Operations Data (in thousands): Net sales........................... $ 5,773 $ 1,180 $ 6,184 $ 2,045 Gross profit........................ 2,573 473 2,295 941 Operating expenses.................. 2,572 522 952 270 ------------- ------------- ------------ ------------ Operating income (loss)............. 1 (49) 1,343 671 Other expense....................... (74) (14) (68) (11) ------------- ------------- ------------ ------------ Income before taxes................. (73) (63) 1,275 660 Income taxes........................ -- -- 15 14 ------------- ------------- ------------ ------------ Net income (loss)................... $ (73) $ (63) $ 1,260 $ 646 ============= ============= ============ ============ Balance Sheet Data (in thousands) (at end of period) Total assets........................ $ 1,886 $ 1,818 $ 3,278 $ 3,363 Long-term debt...................... 82 75 451 770 Stockholders' equity................ 578 514 2,009 1,265 -27- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview We provide product development and design services, precision metal and plastic part manufacturing, product assembly services and supply chain management. We provide our products and services to each of the following primary target markets: . Surgical Instrumentation devices and components; . Electro-Medical Implant devices and components; . Interventional devices and components; and . Orthopedic implants and instruments. Company History During 1998, our co-founders, Richard J. Effress and William J. Kidd, established MedSource to identify business opportunities in the medical engineering and manufacturing services industry. During March 1999, with additional equity capital from Whitney & Co., we acquired seven unaffiliated businesses to begin our operations. The original seven acquisitions were Kelco Industries, W.N. Rushwood d/b/a Hayden Precision Industries, National Wire and Stamping, The MicroSpring Company, Portlyn, Texcel and Brimfield Precision. Our first fiscal period, which ended July 3,1999, consisted of only three months of consolidated results, which included material one-time expenses for business combination and formation. Since our initial acquisitions, we had acquired six additional businesses through June 30, 2003. We acquired Tenax in January 2000, Apex Engineering in February 2000 and Thermat Precision in May 2000. The acquisition of Tenax provided injection molding capability, the acquisition of Thermat added injection molding and precision metal injection manufacturing capabilities to our operations, enabling us to manufacture low cost precision stainless steel components, and the acquisition of Apex Engineering provided mold design and plastic injection molding and mold making capabilities. We acquired ACT Medical in December 2000. The acquisition of ACT Medical enhanced our product design and development engineering expertise and provided a low cost assembly operation in Mexico. We acquired HV Technologies, or HVT, in January 2002. The acquisition of HVT, a specialized manufacturer of polyimide and composite micro-tubing used in interventional and minimally invasive catheters, delivery systems and instruments, enabled us to expand our offering of proprietary manufacturing capabilities to our customers in the interventional device market. We acquired Cycam Inc. in September 2002. The acquisition of Cycam, a manufacturer of reconstructive implants, provided us with complimentary capabilities of plastic machining, surface coatings, near net shape forging and sterilized packaging and kitting of orthopedic implants. Cycam also had strong relationships with several leading orthopedic companies where we had only a minor presence. All of our acquisitions were accounted for using the purchase method of accounting. Restructuring Activity During fiscal 2003, we performed a comprehensive review of our manufacturing operations and support functions to consolidate facilities in an effort to achieve greater economies of scale. As a result of -28- this analysis we identified opportunities to further restructure our operations. We estimate the total cost of this restructuring plan will be approximately $15.0 - $20.0 million and we expect to incur these charges through fiscal 2005. As of June 30, 2003 we had incurred $1.3 million in charges related to this restructuring plan. In addition, we estimate that we will invest $1.7 million in plant and equipment to ensure the facility consolidation does not disrupt operations. During fiscal 2004 and fiscal 2005, we expect to incur $5.8 - 8.3 million and 7.9 - $10.4 million, respectively, in restructuring charges related to this plan. $5.8 - $8.3 million and $7.9 - $10.4 During June 2001, we completed the first review of our manufacturing operations and support functions. Based on our evaluation of the unique and common characteristics of our various facilities, we determined that we could achieve over-all cost savings by closing three of the facilities, thus improving capacity utilization and efficiency of the remaining facilities. We sold our facilities in Pittsfield and East Longmeadow, Massachusetts during our fiscal year ended June 30, 2002. During fiscal 2003 we shut down our Danbury, Connecticut facility. In addition, during fiscal 2003 management decided to close a fourth facility located in Redwood City, California as part of this restructuring plan. This decision led to additional restructuring charges during fiscal 2003. Results of Operations Revenues We primarily recognize product revenue at the time products are shipped. Product shipments are supported by purchase orders from customers that indicate the price for each product. For services, we recognize revenues primarily on a time and materials basis. Service revenues are supported by customer orders or contracts that indicate the price for the services being rendered. For fiscal 2003, service revenues were less than 10% of total revenues. Revenues for product shipments and services rendered must also have reasonable assurance of collectability from the customer. Reserves for returns and allowances are recorded against revenues based on management's estimates and historical experience. We target the sale of our products and services to medical device companies in four target markets. As we have continued to focus on these markets, our sales to nonmedical customers as a percentage of our total revenues have been decreasing over time. Sales to nonmedical customers were approximately 2% of our total revenues for the year ended June 30, 2003. We expect sales to nonmedical customers as a percentage of our total revenues to continue to decrease in the future. Historically, most of our revenues were derived from the manufacture of components used in medical devices. However, in order to accelerate revenue growth and better serve our customers, we aggressively pursued opportunities for the assembly of completed devices. To support this effort, we have completed a number of acquisitions to expand our product offerings and enhance our supply chain services. Over time, we anticipate that revenues from the assembly of completed devices will likely continue to grow as a percentage of our total revenues. Nevertheless, we will continue to aggressively pursue component sales opportunities. Our top four customers accounted for 56% of our revenues for the year ended June 30, 2003, with one customer accounting for 27% of our revenues, another accounting for 12%, and a third customer accounting for 11% of our revenues. For the year ended June 30, 2002, our top four customers accounted for 52% of our revenues, with one customer accounting for 25% of our revenues and another accounting for 12% of our revenues. We expect revenues from our largest customers to continue to constitute a significant portion of our total revenues. -29- We primarily derive our revenues from serving leading medical device companies. These customers are typically large companies with substantial market share in one or more of our four target markets, and we believe that expanding our relationships with these customers represents our most important revenue opportunity. As a result, we devote significant sales efforts to securing additional business from the business units and product lines of the leading medical device companies that we currently serve, as well as developing business with other business units and product lines of these customers. As we increasingly focus on serving customers and expanding our offerings to them by developing or acquiring additional engineering and manufacturing capabilities, we expect the percentage of revenues we derive from these customers to increase over time, as compared with revenues from non-medical device companies. We also intend to continue to selectively pursue promising opportunities with emerging medical device companies. As discussed above, we have acquired six businesses since we began operations during March 1999. A substantial portion of our revenue growth to date has been attributable to the addition of these acquired companies' revenues. In the periods following these acquisitions, we have grown our revenues by offering our existing customers access to our newly acquired engineering and manufacturing capabilities, as well as by offering the customers of the acquired businesses access to our existing capabilities. We generally have retained the medical device customers of the companies that we have acquired, but have selectively discontinued business with customers of the acquired businesses that did not fit our strategic focus of serving leading and select emerging medical device companies in our four target markets or related medical fields. We expect to continue to make select acquisitions of complementary medical engineering and manufacturing services providers that bring desired capabilities, customers and / or geographic coverage that either strengthens our position in our target markets or provide us with a significant presence in a new market. We generally do not have long-term volume commitments from our customers, and they may cancel their orders or change or delay volume levels at any time. Cost and Expenses Cost of products sold includes expenses for raw materials, purchased components, outside services, supervisory, engineering and direct production manpower including benefits, production supplies, depreciation and other related expenses to support product manufacturing. We purchase most of the raw materials that are used in our products at prevailing market prices and, as a result, are subject to fluctuations in the market price of those raw materials. In particular, the prices of stainless steel, titanium and platinum have historically fluctuated, and the prices that we pay for these materials, and, in some cases, their availability, are dependent upon general market conditions. Gross margins as a percentage of revenues for the years ended June 30, 2003 and 2002 were 25.6% and 26.3%, respectively. Our margins are driven by sales mix between devices and components as well as the respective product mixes within our various product categories. Historically, our component business produced strong gross margins. When we were initially formed during March 1999, we were predominately a components supplier. However, in order to expand the scope of our services and accelerate revenue growth, we aggressively pursued opportunities for the assembly of completed devices, which generally have higher material content and a lower value added content, resulting in slightly lower gross margins but with lower capital investment. Selling, general and administrative expense includes support of our facilities for production and shipments to the customer as well as strategic investments in our sales and marketing, operations and quality teams, and our corporate support staff. -30- We have accounted for all of our acquisitions by using the purchase method of accounting. Through our year ended June 30, 2001, we amortized goodwill and other intangibles attributable to our acquisitions and incurred associated amortization expense. Effective July 1, 2001, in connection with our adoption of SFAS No. 142," Goodwill and Other Intangibles," we no longer amortize goodwill. Instead, we periodically test goodwill and intangibles for impairment and record an expense if those assets become impaired, as further discussed under "--Recent Accounting Pronouncements." Comparison of Fiscal Years Ended June 30, 2003 and June 30, 2002 Revenues for our fiscal year ended June 30, 2003 totaled $177.3 million compared to $158.9 million for the fiscal year ended June 30, 2002, an increase of 12%. Approximately 5% of this increase was due to the acquisition of Cycam, with the other 7% due to internal growth. Our internal, or organic, growth was primarily driven by strength in our surgical instrumentation market, orthopedics market, and our electro-medical implant market. A small portion of our internal growth also resulted from new surgical instrumentation and interventional business that we secured by offering our existing customers additional manufacturing capabilities that we acquired. Cost of products sold for the fiscal year ended June 30, 2003 totaled $132.0 million compared to $117.1 million for the fiscal year ended June 30, 2002. The increase in cost of products sold resulted principally from the increased revenues over the prior fiscal year. Gross margins for the fiscal year ended June 30, 2003 were 25.6% compared to 26.3% for the year ended June 30, 2002. Our margins are driven by the sales mix between devices and components and the respective product mixes within our various product categories. Selling, general and administrative expense was $33.5 million, or 18.9% of revenues, for the fiscal year ended June 30, 2003 and $29.9 million, or 18.8% of revenues, for the fiscal year ended June 30, 2002. The $3.6 million fiscal 2003 increase was primarily the result of the Cycam acquisition, continued investment in information technology systems, and new investments in engineering services and business excellence programs. Amortization of intangibles was $0.3 million for the fiscal years ended June 30, 2003 and June 30, 2002. During fiscal 2003, we reduced our revenue forecast. Since the reduction in forecasted revenue indicated that our goodwill and intangible assets might be impaired we performed an impairment test using the income approach. We compared the present value of the estimated future cash flows of our business to the carrying value of net assets. This analysis indicated that our goodwill and intangible assets were impaired. Therefore, with the help of external sources, we evaluated the fair value of our net assets as if we were being purchased in a business combination. We recognized a $37.7 million goodwill impairment charge and a $2.3 million impairment charge related to our intangible assets. Restructuring charges for the fiscal year ended June 30, 2003 were $3.7 million. These charges were related to our previously announced growth and restructuring plan as well as additional charges incurred related to our fiscal 2001 restructuring plan. The additional charges related to our fiscal 2001 restructuring plan were caused by a decision to shutdown our Redwood City, California plant. No such charges were incurred during fiscal 2002. -31- Net interest expense was $2.7 million for the fiscal year ended June 30, 2003, compared to $7.7 million for the fiscal year ended June 30, 2002. This decrease was due primarily to the lower amounts outstanding under our senior credit facility during the most recent fiscal year. During our fiscal year ended June 30, 2002, we also incurred a loss on debt extinguishment of $6.9 million as a result of the repayment of our subordinated debt and the debt under our old senior credit facility. The loss included a write off of $5.5 million in unamortized financing costs and discounts and a $1.4 million prepayment fee. No such loss was recorded during our fiscal year ended June 30, 2003. Other expenses for fiscal 2003 totaled $0.1 million compared to other expenses of $4.8 million for the prior year. During fiscal 2002 we incurred a $1.9 million interest rate swap breakage fee associated with the repayment of debt and $2.9 million for service agreements terminated in conjunction with our initial public offering. We incurred charges related to the accrual of dividends and accretion of discount on preferred stock of $31.2 million for our fiscal year ended June 30, 2002. This charge was mainly due to charges incurred in connection with the conversion of these shares into common stock in conjunction with our initial public offering. Net loss attributed to common stockholders for fiscal 2003 totaled $35.3 million, or $1.28 per share, while net loss attributed to common stockholders for fiscal 2002 was $38.8 million, or $3.50 per share. Comparison of Fiscal Years Ended June 30, 2002 and June 30, 2001 Revenues for our fiscal year ended June 30, 2002 totaled $158.9 million compared to $128.5 million for the fiscal year ended June 30, 2001, an increase of 24%. Approximately 15% of this increase was due to the acquisitions of HVT and ACT Medical, with the other 9% due to internal growth. Our internal, or organic, growth was primarily driven by strength in our surgical instrumentation market, orthopedics market, as well as strength in our electro-medical implant market. A small portion of our internal growth also resulted from new surgical instrumentation and interventional business that we secured by offering our existing customers additional manufacturing capabilities that we acquired. Cost of products sold for the fiscal year ended June 30, 2002 totaled $117.1 million compared to $94.4 million for the fiscal year ended June 30, 2001. The increase in cost of products sold resulted principally from the increased revenues over the prior fiscal year. Gross margins for the fiscal year ended June 30, 2002 were 26.3% compared to 26.5% for the year ended June 30, 2001. Our margins are driven by the sales mix between devices and components and the respective product mixes within our various product categories. Selling, general and administrative expense was $29.9 million, or 18.8% of revenues, for the fiscal year ended June 30, 2002 and $26.2 million, or 20.4% of revenues, for the fiscal year ended June 30, 2001. The $3.7 million increase was due to the selling, general and administrative expense attributable to the business of HVT, which we acquired during January 2002, and the business of ACT Medical, which we acquired during fiscal 2001. Net interest expense was $7.7 million for the fiscal year ended June 30, 2002 compared to $10.2 million for the fiscal year ended June 30, 2001. This decrease was due primarily to the lower amounts -32- outstanding under our senior credit facility during the fourth quarter of our fiscal year ended June 30, 2002. Other expense for the year totaled $4.8 million compared to other income of $0.1 million for the prior year. The increase is a result of two charges, $1.9 million of interest rate swap breakage fees associated with the repayment of debt and $2.9 million for service agreements terminated in conjunction with our initial public offering. During our fiscal year ended June 30, 2002, we also incurred a loss on debt extinguishment of $6.9 million as a result of the repayment of our subordinated debt and the debt under our old senior credit facility. The loss included a write off of $5.5 million in unamortized financing costs and discount and a $1.4 million prepayment fee. We incurred charges related to the accrual of dividends and accretion of discount on preferred stock of $31.2 million for our fiscal year ended June 30, 2002, compared to $9.7 million for our fiscal year ended June 30, 2001. The increase was mainly due to charges in connection with the conversion of these shares into common stock in conjunction with our initial public offering. Net loss attributed to common stockholders for fiscal 2002 totaled $38.8 million, or $3.50 per share, while net loss attributed to common stockholders for fiscal 2001 was $29.1 million, or $5.55 per share. Liquidity and Capital Resources Our principal sources of liquidity are cash provided by operations and borrowings under our senior credit facility, which includes a $15 million unused revolving credit facility. Our cash is primarily used to finance acquisitions, meet debt service requirements, finance capital expenditures, and fund working capital requirements. We expect that these uses will continue in the future. Management believes that current cash balances and cash generated from operations, combined with available borrowings under our senior credit facility, will be adequate to fund requirements for working capital, capital expenditures, and future expansion through fiscal 2004. Operating Activities Net cash provided by operating activities totaled $9.4 million for the year ended June 30, 2003 compared to net cash used in operating activities of $7.8 million for the prior year. The increase in cash provided by operating activities over the prior year period is primarily the result of an $8.2 million improvement in net operating asset management, and a $8.6 million decrease in net cash losses from operations. Investing Activities Cash used in investing activities was $35.3 million for the year ended June 30, 2003, compared to $14.7 million for the year ended June 30, 2002. This increase was due to an increase in cash paid for acquisitions of $16.3 million over the prior year period, as a result of the acquisition of Cycam in fiscal 2003. Cash paid for capital expenditures was up $4.2 million when compared to the prior year period. We expect capital expenditures in fiscal 2004 to be approximately $9.5 million. -33- Financing Activities Cash used in financing activities was $1.5 million for the year ended June 30, 2003 compared to $40.4 million provided by financing activities for the year ended June 30, 2002. The $41.6 million decrease was primarily due to IPO proceeds received during fiscal 2002. However, this decrease was partially offset by $8.0 million of proceeds from our acquisition line and $3.8 million in proceeds from a sale-leaseback of manufacturing equipment in fiscal 2003. No transactions of this nature were recognized in fiscal 2002. 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. Commitments As of June 30, 2003, we had the following future contractual cash commitments: Payments Due by Period ---------------------- Total 1 Year 2-3 Years 4-5 Years After 5 Years ------------ ------------ ------------ ------------ ------------- (Dollars in Millions) Long-term debt (a) ......................... $ 36,500 $ 6,427 $ 20,369 $ 9,704 $ -- Capital lease obligations .................. 5,288 1,326 2,647 1,315 -- Operating leases ........................... 25,690 3,329 5,307 4,397 12,657 ------------ ------------ ------------ ------------ ------------- Total future contractual cash obligations .. $ 67,478 $ 11,082 $ 28,323 $ 15,416 $ 12,657 ============ ============ ============ ============ ============= (a) All long term debt is described below under the caption "-- Senior Credit Facility." As of June 30, 2003, we had $2.0 million of future commercial commitments, related to our capital leases, that may result in future cash outflows. These commitments are letters of credit and will expire in accordance with our capital lease expiration dates. Senior Credit Facility In fiscal 2003, we amended our senior credit facility to provide relief from certain of our debt covenants. The amendment reduced our revolving credit facility to $15.0 million from $25.0 million. Prior to the amendment, we also had a $40.0 million term loan and an $8.0 million acquisition loan under the senior credit facility (earlier in fiscal 2003, we had borrowed $8.0 million under the acquisition line (which is no longer available) to finance our acquisition of Cycam). In conjunction with the amendment of the credit facility, we made a payment of $7.5 million. Of the $7.5 million payment, $6.5 million represented a payment on the $40.0 million term loan and the remainder was applied toward the acquisition loan. All loans under our amended senior credit facility will mature in fiscal 2007. During fiscal 2004, we will be required to make payments under the term loan of $5.0 million payable in quarterly installments. During fiscal 2005, fiscal 2006, and fiscal 2007, we will be required to make payments of $7.4 million, $9.2 million, and $7.9 million, respectively, each also payable in quarterly installments. During fiscal 2004, we will also be required to make payments under the acquisition loan of $1.4 million, also payable in quarterly installments. During fiscal 2005, fiscal 2006, and fiscal 2007, we -34- will be required to make payments of $1.6 million, $2.2 million, and $1.8 million on the acquisition loan, each also payable in quarterly installments. At our option, interest rates applicable to loans under our new senior credit facility will be either: . The greater of the bank's prime rate plus a margin, which depends upon our leverage ratio, ranging from 50 to 175 basis points, or . LIBOR plus a margin, which depends upon our leverage ratio, ranging from 225 to 350 basis points. We have entered into an interest rate cap agreement to protect against interest rate fluctuations with respect to the term loans outstanding under our senior credit facility. This agreement, executed with a highly-rated financial counter-party, provides for the counter-party to make payments to us in the event that a reference floating rate index exceeds an agreed-upon fixed rate. Changes in the fair value of the interest rate cap agreement are accounted for as a cash flow hedge. The amended senior credit facility contains affirmative and negative covenants and limitations, including, but not limited to, required minimum coverage of our obligations to pay interest and incur fixed charges, restrictions on our ability to pay dividends, make other payments and enter into sale transactions, limitations on liens, limitations on our ability to incur additional indebtedness and agreements that we use excess cash on hand and proceeds from future equity issuances to pay down our senior credit facility. Consistent with credit facilities of this type, if we do not comply with the covenants in the credit facility, the maturity date of our obligations under the credit facility could be accelerated. In addition, we also need the consent of the lender's to make any acquisition in which we pay more than $10.0 million (including more than $5.0 million in cash, deferred payments and the assumption of debt) or pay more than $20.0 million (including more than $10.0 million in cash, deferred payments and the assumption of debt) for all of the acquisitions that we complete during any fiscal year. The amended senior credit facility is secured by all of our assets and contains various events of default, including, but not limited to, defaults upon the occurrence of a change of control of MedSource and defaults for non-payment of principal interest or fees, breaches of warranties or covenants, bankruptcy or insolvency, ERISA violations and cross-defaults to other indebtedness. Issuances of Preferred Stock for Cash In fiscal 2001, we received an aggregate of $5.5 million from the issuance of our Series E preferred stock, and we received an additional $0.5 million in January 2002. In connection with these issuances, we also issued warrants to purchase an aggregate of 200,000 shares of our common stock at $0.01 per share. The proceeds from the Series E preferred stock were used to help finance the acquisition of HVT. During April 2002 we redeemed 4,065 shares of the 6,000 outstanding shares. The remaining 1,935 shares were redeemed during August 2002. -35- Quarterly Results The following tables set forth selected unaudited quarterly consolidated financial information for the eight quarters ended June 30, 2003. This unaudited quarterly consolidated information, in the opinion of management, includes all adjustments necessary for a fair presentation of such information in accordance with generally accepted accounting principles. These quarterly results are not necessarily indicative of future results, growth rates or quarter-to-quarter comparisons. We have completed six acquisitions since July 1, 2000, but the quarterly consolidated financial information set forth below is presented on an actual historical basis, not on a pro forma basis for any of those acquisitions. The increase in revenues over the periods presented resulted from both acquisitions and growth in our base business. In addition, during our limited operating history, excluding the impact of acquisitions, we have experienced higher than average revenues during the last quarter of our fiscal year and lower than average revenues during the first quarter of our fiscal year, but we cannot predict whether this will continue. Quarter Ended September December March 30, June 30, September December March 30, June 30, 30, 2001 30, 2001 2002 2002 29, 2002 29, 2002 2003 2003 --------------------------------------------------------------------------------------------- (In Millions) Statement of Operations Data: Revenues .......................... $ 33.9 $ 38.3 $ 42.2 $ 44.6 $ 41.0 $ 44.6 $ 44.5 $ 47.2 Cost and expenses: Cost of products sold ............. 26.1 28.5 31.5 31.0 30.8 33.2 34.0 34.0 Selling, general and administrative expense ......... 6.4 7.7 8.2 7.6 7.9 8.0 8.3 9.3 Amortization of goodwill and other intangibles.. 0.1 0.1 0.1 0.1 0.1 0.1 0.1 -- Impairment of goodwill and other intangibles(a) ....... -- -- -- -- -- -- 30.0 10.0 Restructuring charge(b) ........... -- -- -- -- -- -- 1.9 1.8 --------------------------------------------------------------------------------------------- Operating Income (loss) ........... 1.3 2.0 2.4 5.9 2.2 3.3 (29.8) (7.9) Interest expense, net ............. (2.5) (2.4) (2.3) (0.4) (0.5) (0.7) (0.6) (0.9) Extraordinary loss ................ -- -- -- (6.9) -- -- -- -- Other expense ..................... -- -- (2.9) (1.9) -- -- -- (0.1) Income tax benefit (expense) ...... -- -- -- 0.1 -- -- -- (0.3) Net loss .......................... $ (1.2) $ (0.4) $ (2.8) $ (3.2) $ 1.7 $ 2.6 $ (30.4) $ (9.2) ========= ========= ========= ========= ========= ========= ========= ========= - ---------- <FN> <F1> (a) Effective at the beginning of fiscal 2002, we adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. During the third quarter of fiscal 2003 we performed an impairment test on our goodwill and certain other intangible assets because of the presence of impairment indicators. The impairment test indicated that a significant impairment of our goodwill and other intangible assets had occurred and as a result we recognized impairment charges of $30.0 million and $10.0 million in the third and fourth quarter of fiscal 2003, respectively. <F2> (b) In January 2003, we completed a strategic review of our manufacturing operations and support functions. Based on this review and with board approval, we began actions to eliminate redundant facilities. These actions resulted in pre-tax charges of $1.9 million and $1.8 million during the third and fourth quarter of fiscal 2003, respectively. The charges included employee termination benefits of $2.6 million and other exit costs of $1.1 million. </FN> -36- Critical Accounting Policies Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our customers, and information available from other outside sources, as appropriate. Actual results may differ from these judgments under different assumptions or conditions. Our accounting policies that require management to apply significant judgment include: . Allowances for doubtful accounts. We specifically analyze our accounts receivable, historical bad debts, customer concentrations, customer credit-worthiness, and current economic trends, when evaluating the adequacy of our allowance for doubtful accounts. The reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. We are not able to predict changes in our customers' financial condition. If the condition of our customers deteriorates we may have to update our estimates, which could have a material adverse effect on our financial condition. As of June 30, 2003, we had $0.8 million reserved against our accounts receivable. . Excess and obsolete inventories. We state our inventory at the lower of first-in first-out cost or market. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next six to nine months. Generally, our inventory reserve requirements decrease as demand increases. Likewise, as demand decreases our inventory reserve requirements increase. Any significant unanticipated changes in demand due technological obsolescence, product life cycles, or declining market conditions could have a significant impact on the value of our inventory and our reported operating results. . Impairment of goodwill and other intangibles. We adopted SFAS 142, Goodwill and Other Intangible Assets, during fiscal 2002. We are required to test goodwill for impairment annually or at other times if indicators of impairment exist that indicate the carrying value of our goodwill may not be recoverable. The impairment test for goodwill involves a two-step process: step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill associated with the reporting unit. If the carrying amount is in excess of the fair value, step two requires the comparison of the implied fair value of the reporting unit goodwill with the carrying value of the reporting unit goodwill. Any excess in the carrying amount of the reporting unit goodwill over the implied fair value of the reporting unit goodwill will be recorded as an impairment loss. Fair value of the reporting unit was determined using the income approach. Under the income approach, fair value is determined by estimating the present value of the future economic benefits to be derived from the reporting unit. We have concluded that we have one reporting unit for purposes of this impairment test. The income approach requires significant estimates of future cash flows. Future adverse changes in business or market conditions could negatively affect our future cash flows and impair the value of our goodwill. See Note 6 to the Consolidated Financial Statements in -37- Item 8 of this form 10-K for information about the results of the goodwill impairment tests. As of June 30, 2003, $96.6 million of goodwill remained on our balance sheet, which represents 44.3% of our total assets. Recent Accounting Pronouncements In October 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standard, or SFAS, No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets," which replaced SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long -Lived Assets to Be Disposed Of." Though SFAS No. 144 retained the basic guidance of SFAS No. 121, regarding when and how to measure an impairment loss, it provided additional implementation guidelines. We adopted this statement in the first quarter of fiscal 2003 and do not believe its adoption will have a material impact on our financial statements. In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statement No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical corrections. SFAS No. 145 required us to reclassify the fiscal 2002 $6.9 million loss on debt extinguishment as a loss from continuing operations rather than an extraordinary item. The provisions of SFAS No. 145 are effective for fiscal years beginning after May 15, 2002. Accordingly, we adopted this standard beginning in the first quarter of fiscal 2003. The reclassification will have no impact on our net loss, cash flows or financial position. In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated With Exit or Disposal Activities." SFAS No. 146 superseded Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principle difference between SFAS No. 146 and EITF 94-3 relates to when an entity can recognize a liability related to exit or disposal activities. SFAS No. 146 requires that a liability be recognized for cost associated with an exit or disposal activity when the liability is incurred. EITF 94-3 allowed a liability related to an exit or disposal activity to be recognized on the date the entity committed to an exit plan. We adopted this standard on January 1, 2003, which was the standards effective date. The standard did not materially impact our consolidated financial results or financial position upon adoption, but will impact the timing of when we recognize expected restructuring charges in future periods. In November of 2003, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others," which requires a guarantor to recognize and measure certain types of guarantees at fair value. In addition, Interpretation No. 45 requires the guarantor to make new disclosures for these guarantees and other types of guarantees that are not subject to the initial recognition and initial measurement provisions. The disclosure requirements are effective for interim or annual periods ended after December 31, 2002, while the recognition and measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. We adopted the initial recognition and measurement provisions as well as the disclosure provisions of Interpretation No. 45 during the third quarter of fiscal 2003. The initial recognition and measurement provisions did not have a material impact on our consolidated financial results or financial condition. In December of 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." The provisions of SFAS No. 148 amend SFAS No. 123, "Accounting for Stock Based Compensation," to provide alternative methods of transitioning to a fair value-based method of accounting for stock-based compensation. In addition, SFAS No. 148 also expands the disclosure requirements of SFAS No. 123 by requiring more detailed disclosure in both annual and -38- interim financial statements. The transition provisions of SFAS No. 148 did not have a material impact on our financial results, as we did not adopt the fair value-based accounting provisions of SFAS No. 123, which is commonly referred to as expensing the fair value of stock options. The disclosure provisions of SFAS No. 148 are effective for interim periods beginning after December 15, 2002. Accordingly, we adopted the disclosure provisions during the third quarter of fiscal 2003. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk represents the risk of changes in value of a financial instrument, derivative or non-derivative, caused by fluctuations in interest rates, foreign exchange rates or equity prices. Changes in these factors could cause fluctuations in earnings and cash flows. Interest Rate Risk For fixed rate debt, changes in interest rates generally affect the fair market value of the debt instrument, but not earnings or cash flows. We do not have any obligations under any fixed rate debt. For variable rate debt, changes in interest rates generally do not impact the fair market value of the debt instrument, but do affect future earnings and cash flows. We had $36.5 million of variable rate debt outstanding under our senior credit facility at June 30, 2003. To reduce our exposure to interest rate risk, we entered into an interest rate cap agreement to hedge our exposure to interest rate risk under our new senior credit facility. The effect of a 10% increase in interest rates would have resulted in an immaterial increase in interest expense during our year ended June 30, 2003. Foreign Currency Risk The majority of our sales and purchases are denominated in United States dollars and as a result, we have relatively little exposure to foreign currency exchange risk with respect to our sales. Accordingly, we do not use forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instrument for trading or speculative purposes. -39- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TABLE OF CONTENTS Report of independent auditors................................................41 Consolidated balance sheets...................................................42 Consolidated statements of operations.........................................43 Consolidated statement of changes in mandatory redeemable convertible stock and stockholders' equity (deficit)......................................44 Consolidated statements of cash flows.........................................46 Notes to consolidated financial statements....................................47 -40- REPORT OF INDEPENDENT AUDITORS The Board of Directors MedSource Technologies, Inc. We have audited the accompanying consolidated balance sheets of MedSource Technologies, Inc. and subsidiaries as of June 30, 2003 and 2002, and the related consolidated statements of operations, changes in mandatory redeemable convertible stock and stockholders' equity (deficit), and cash flows for each of the three years in the period ended June 30, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of MedSource Technologies, Inc. and subsidiaries at June 30, 2003 and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 2003, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Minneapolis, Minnesota July 28, 2003 -41- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Amounts) June 30, June 30, 2003 2002 ------------ ------------ Assets Current assets: Cash and cash equivalents $ 10,781 $ 38,268 Accounts receivable, net of allowance of $818 in 2003 and $646 in 2002 23,710 24,031 Inventories 25,617 20,503 Prepaid expenses and other current assets 4,318 2,402 ------------ ------------ Total current assets 64,426 85,204 Property, plant, and equipment, net 52,752 42,045 Goodwill 96,582 113,113 Other identifiable intangible assets, net 1,432 4,092 Deferred financing costs 1,682 1,971 Other assets 1,343 1,404 ------------ ------------ Total assets $ 218,217 $ 247,829 ============ ============ Liabilities and stockholders' equity Current liabilities: Accounts payable $ 10,868 $ 7,924 Accrued compensation and benefits 5,498 5,352 Other accrued expenses 2,293 3,491 Reserve for restructuring 958 2,381 Current portion of obligations under capital leases 1,326 439 Current portion of long-term debt 6,427 5,500 ------------ ------------ Total current liabilities 27,370 25,087 Obligations under capital leases 3,962 1,467 Long-term debt, less current portion 30,073 34,500 Other long-term liabilities 731 455 Stockholders' equity: 6% Series E preferred stock, par value $0.01 per share: Authorized shares--6,000 Issued and outstanding shares-- none at 2003 and 1,935 at 2002 -- 1,974 Common stock, par value $0.01 per share: Authorized shares-- 70,000,000 at 2003 and 2002 Issued shares-- 28,905,719 at 2003 and 26,918,533 at 2002 289 269 Additional paid-in capital 277,791 268,455 Treasury stock, 113,696 at 2003 and 97,576 at 2002 (1,463) (1,282) Accumulated other comprehensive loss (288) -- Accumulated deficit (118,326) (83,025) Unearned compensation (1,922) (71) ------------ ------------ Total stockholders' equity 156,081 186,320 ------------ ------------ Total liabilities and stockholders' equity $ 218,217 $ 247,829 ============ ============ See accompanying notes. -42- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Share and Per Share Amounts) Fiscal Year Ended June 30, -------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Revenues $ 177,298 $ 158,899 $ 128,462 Cost and expenses: Cost of products sold 131,970 117,089 94,386 Selling, general, and administrative expense 33,495 29,876 26,199 Amortization of goodwill and other intangibles 338 340 5,640 Impairment of intangible assets 40,000 -- -- Restructuring charges 3,724 -- 11,464 ------------ ------------ ------------ Total cost and expenses 209,527 147,305 137,689 ------------ ------------ ------------ Operating (loss) income (32,229) 11,594 (9,227) Interest expense, net (2,669) (7,671) (10,213) Loss on debt extinguishment -- (6,857) -- Other (expense) income (100) (4,782) 53 ------------ ------------ ------------ Loss before income taxes (34,998) (7,716) (19,387) Income tax (expense) benefit (267) 118 (70) ------------ ------------ ------------ Net loss (35,265) (7,598) (19,457) Preferred stock dividends and accretion of discount on preferred stock -- (31,168) (9,688) ------------ ------------ ------------ Net loss attributed to common stockholders $ (35,265) $ (38,766) $ (29,145) ============ ============ ============ Net loss per share attributed to common stockholders--basic and diluted $ (1.28) $ (3.50) $ (5.55) ============ ============ ============ Weighted average common shares outstanding--basic and diluted 27,602,806 11,086,103 5,252,749 ============ ============ ============ See accompanying notes. -43- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN MANDATORY REDEEMABLE CONVERTIBLE STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) (In Thousands) Mandatory Redeemable Convertible Stock ------------------------------------------------ Series B Series C Series D Series F Preferred Preferred Preferred Preferred Stock Stock Stock Stock ---------- ---------- ---------- ----------- Balance at July 1, 2000 22,293 -- -- -- Cumulative effect change due to implementation of SFAS No. 133 -- -- -- -- Change in fair value of interest rate swaps -- -- -- -- Net loss for the year -- -- -- -- Comprehensive loss for the period -- -- -- -- Sale and issuance of Series C preferred stock, net of costs of $3,061 -- 37,239 -- -- Issuance of Series D preferred stock and options for acquired business -- -- 31,575 -- Issuance of stock pursuant to option exercises -- -- 374 -- Accretion of discounts on mandatory redeemable convertible preferred stock 2,379 275 391 -- Accrued dividends on mandatory redeemable convertible preferred stock 1,617 1,676 1,048 -- Amortization of unearned compensation -- -- -- -- ---------- ---------- ---------- ----------- Balance at June 30, 2001 26,289 39,190 33,388 -- Change in fair value of interest rate swaps -- -- -- -- Net loss for the period -- -- -- -- Comprehensive loss for the period -- -- -- -- Issuance of stock pursuant to option exercises -- -- 48 -- Sale of Series E preferred stock and common stock purchase warrants -- -- -- -- Accretion of discounts on mandatory redeemable convertible preferred stock 177 310 598 -- Accrued dividends on mandatory redeemable convertible preferred stock 1,276 2,415 1,571 -- Amortization of unearned compensation -- -- -- -- Issuance of preferred and common stock for acquired business -- -- -- 3,636 Conversion of Series Z to common stock -- -- -- -- Conversion of Series A to common stock -- -- -- -- Conversion of Series B to common stock (22,980) -- -- -- Conversion of Series D to common stock -- -- (35,605) -- Conversion of Series C to common stock -- (41,915) -- -- Payment of Series B dividend (4,762) -- -- -- Sale of common stock, net of issuance costs -- -- -- -- Amortization of discount on redeemable preferred stock -- -- -- 364 Amortization of dividend on redeemable preferred stock -- -- -- 63 Return on Series C preferred stock -- -- -- -- Termination of interest rate swap -- -- -- -- Redemption of Series F preferred stock -- -- -- (4,063) Redemption of Series E preferred stock -- -- -- -- Shares received from sale of business -- -- -- -- ---------- ---------- ---------- ----------- Balance at June 30, 2002 -- -- -- -- Change in fair value of interest rate cap -- -- -- -- Net loss for the period -- -- -- -- Comprehensive loss for the period -- -- -- -- Common stock issued for acquired business -- -- -- -- Redemption of Series E preferred stock -- -- -- -- Sale of common stock, net of issuance costs -- -- -- -- Issuance of restricted common stock -- -- -- -- Forfeiture of restricted common stock -- -- -- -- Amortization of unearned compensation -- -- -- -- ---------- ---------- ---------- ----------- Balance at June 30, 2003 $ -- $ -- $ -- $ -- ========== ========== ========== =========== See accompanying notes. -44- Stockholders' Equity (Deficit) - ---------------------------------------------------------------------------------------------------------------------------------- Series A Series E Accumulated Total Convertible Convertible Series Z Number of Additional Other Stockholders' Preferred Preferred Preferred Common Common Paid-In Treasury Comprehensive Accumulated Unearned Equity Stock Stock Stock Shares Stock Capital Stock Loss Deficit Compensation (Deficit) - ----------- ----------- --------- --------- --------- ----------- --------- ------------- ------------ ------------- ------------- -- -- 1 5,235 52 33,591 -- -- (18,572) -- 15,072 -- -- -- -- -- -- -- 1,097 -- -- 1,097 -- -- -- -- -- -- -- (2,657) -- -- (2,657) -- -- -- -- -- -- -- -- (19,457) -- (19,457) ------------- -- -- -- -- -- -- -- -- -- -- (22,114) -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- (286) (286) -- -- -- 21 -- 284 -- -- -- -- 284 -- -- -- -- -- -- -- -- (3,045) -- (3,045) -- -- -- -- -- -- -- -- (4,341) -- (4,341) -- -- -- -- -- -- -- -- -- 72 72 - ----------- ----------- --------- --------- --------- ----------- --------- ------------- ------------ ------------- ------------- -- -- 1 5,256 52 33,875 -- (1,560) (45,415) (214) (13,261) -- -- -- -- -- -- -- (374) -- -- (374) -- -- -- -- -- -- -- -- (7,598) -- (7,598) ------------- -- -- -- -- -- -- -- -- -- -- (7,972) -- -- -- -- -- 19 -- -- -- -- 19 -- 4,168 -- -- -- 1,832 -- -- -- -- 6,000 -- -- -- -- -- -- -- -- (1,085) -- (1,085) -- -- -- -- -- -- -- -- (5,262) -- (5,262) -- -- -- -- -- -- -- -- -- 143 143 -- -- -- 824 8 9,883 -- -- -- -- 9,891 -- -- (1) 650 7 (6) -- -- -- -- -- -- -- -- 1,919 19 (19) -- -- -- -- -- -- -- -- 3,327 33 22,947 -- -- -- -- 22,980 -- -- -- 1,770 18 35,587 -- -- -- -- 35,605 -- -- -- 3,906 39 41,876 -- -- -- -- 41,915 -- -- -- -- -- -- -- -- -- -- -- -- -- -- 9,266 93 101,174 -- -- -- -- 101,267 -- 1,832 -- -- -- -- -- -- (2,196) -- (364) -- 119 -- -- -- -- -- -- (182) -- (63) -- -- -- -- -- 21,287 -- -- (21,287) -- -- -- -- -- -- -- -- -- 1,934 -- -- 1,934 -- -- -- -- -- -- -- -- -- -- -- -- (4,145) -- -- -- -- -- -- -- -- (4,145) -- -- -- -- -- -- (1,282) -- -- -- (1,282) - ----------- ----------- --------- --------- --------- ----------- --------- ------------- ------------ ------------- ------------- -- 1,974 -- 26,918 269 268,455 (1,282) -- (83,025) (71) 186,320 -- -- -- -- -- -- -- (288) -- -- (288) -- -- -- -- -- -- -- -- (35,265) -- (35,265) ------------- -- -- -- -- -- -- -- -- -- -- (35,553) -- -- -- 667 7 5,997 -- -- -- -- 6,004 -- (1,974) -- -- -- -- -- -- (36) -- (2,010) -- -- -- 430 4 926 -- -- -- -- 930 -- -- -- 875 9 2,413 -- -- -- (2,422) -- -- -- -- 16 -- -- (181) -- -- 159 (22) -- -- -- -- -- -- -- -- -- 412 412 - ----------- ----------- --------- --------- --------- ----------- --------- ------------- ------------ ------------- ------------- $ -- $ -- $ -- 28,906 $ 289 $ 277,791 $ (1,463)$ (288) $ (118,326) $ (1,922) $ 156,081 =========== =========== ========= ========= ========= =========== ========= ============= ============ ============= ============= See accompanying notes. -45- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) Fiscal Year Ended June 30, -------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Operating activities Net loss $ (35,265) $ (7,598) $ (19,457) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation 8,648 7,791 6,555 Amortization of goodwill and other intangibles 338 340 5,640 Amortization of deferred financing costs and discount on long-term debt 658 6,157 1,122 Amortization of unearned compensation 412 143 72 Impairment of intangible assets 40,000 -- -- Restructuring charges -- -- 11,464 Loss (gain) on sale of equipment 926 -- (29) Changes in operating assets and liabilities, net of effect of businesses acquired: Accounts and notes receivable 1,221 (1,682) (4,296) Inventories (4,676) (6,889) (1,775) Prepaid expenses and other current assets (1,494) 768 (836) Interest escrow fund -- 1,849 2,500 Accounts payable, accrued compensation and benefits, accrued expenses, and other (926) (7,514) 476 Other (484) (1,120) (183) ------------ ------------ ------------ Net cash provided by (used in) operating activities 9,358 (7,755) 1,253 Investing activities Acquisition of businesses, net of cash acquired (22,617) (6,312) (378) Other additions to plant and equipment, net (12,783) (8,598) (11,491) Proceeds from sale of equipment 80 245 242 ------------ ------------ ------------ Net cash used in investing activities (35,320) (14,665) (11,627) Financing activities Proceeds from sale and leaseback of equipment 3,818 -- -- Proceeds from issuance of long-term debt, net of financing costs, and interest escrow fund 8,000 37,939 105 Payments of long-term debt (12,307) (91,890) (5,549) Proceeds from sale of Series C and D preferred stock, net of costs -- -- 37,897 Proceeds from sale of Series E preferred stock and common stock, net of costs 974 107,286 -- Payments of Series B dividends -- (4,762) -- Redemption of Series E and F preferred stock (2,010) (8,208) -- Net payments on lines of credit -- -- (4,000) Other -- 34 -- ------------ ------------ ------------ Net cash (used in) provided by financing activities (1,525) 40,399 28,453 ------------ ------------ ------------ (Decrease) increase in cash and cash equivalents (27,487) 17,979 18,079 Cash and cash equivalents at beginning of period 38,268 20,289 2,210 ------------ ------------ ------------ Cash and cash equivalents at end of period $ 10,781 $ 38,268 $ 20,289 ============ ============ ============ Supplemental disclosure of cash flow information Cash paid for interest $ 2,672 $ 7,018 $ 9,319 ============ ============ ============ Cash paid for income taxes $ -- $ 108 $ 150 ============ ============ ============ Preferred and common stock issued for acquisitions $ 6,004 $ 13,527 $ 31,289 ============ ============ ============ See accompanying notes. -46- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Description of Business MedSource Technologies, Inc. (the "Company") was formed as a Delaware corporation on April 14, 1998. For the period from April 14, 1998 through March 30, 1999 (inception of operations), the Company had no employees or other operations. The Company and its subsidiaries operate in one business segment and provide product development and design services, precision metal and plastic part manufacturing, product assembly services and supply chain management primarily for the medical device industry. The Company's operations and customer base are located primarily in North America. 2. Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Cash Equivalents Cash equivalents include money market mutual funds and other highly liquid investments purchased with maturities of three months or less. The cash equivalents are carried at cost, which approximates market. Allowances for doubtful accounts. We specifically analyze our accounts receivable, historical bad debts, customer concentrations, customer credit-worthiness, and current economic trends, when evaluating the adequacy of our allowance for doubtful accounts. The reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. We are not able to predict changes in our customers' financial condition. If the condition of our customers deteriorates we may have to update our estimates, which could have a material adverse effect on our financial condition. As of June 30, 2003, we had $0.8 million reserved against our accounts receivable. Inventories Inventories include material, labor and overhead and are stated at the lower of cost, using the FIFO (first-in, first-out) method, or market. In assessing the ultimate realization of inventories, we are required to make judgments as to future demand requirements compared to current or committed inventory levels. Our reserve requirements generally increase as demand decreases due to changes in among other things, market conditions, product life cycles, and technological obsolescence. Property, Plant, and Equipment Property, plant, and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Amortization of capital leases and leasehold improvements is provided on a straight-line basis over the lives of the related assets or the life of the lease, whichever is shorter, and is included with depreciation expense. -47- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Goodwill and Other Intangible Assets Goodwill represents the cost in excess of the fair value of the tangible and identifiable intangible assets of the businesses acquired and, prior to July 1, 2001, was being amortized on a straight-line basis over 20 years based on the operating histories and market niches of these businesses. Effective July 1, 2001, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill must be tested for impairment annually, or more often if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, using a two-step approach. Step one is to compare the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test will be performed to measure the amount of impairment loss, if any. Step two compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination is determined. If the carrying amount of a reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The Company has one operating segment consisting of multiple manufacturing facilities with similar economic characteristics producing goods for a similar set of customers (i.e., the medical device industry). Thus the Company has concluded that it currently has one reporting unit for purposes of the goodwill impairment test. The Company estimates the present value of its estimated future cash flows or other market valuation techniques to measure the fair value of the reporting unit. The identifiable intangible assets consist mainly of patents and are amortized over the life of the patents. See Note 6--Goodwill and Other Intangible Assets for a more detailed discussion of the fiscal 2003 impairment test and $40.0 million impairment charge. Impairment of Long-Lived Assets The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the Company plans to continue to use the assets in ongoing operations, the estimated future cash flows (undiscounted and without interest charges) from the use of the assets are compared to the current carrying amount. If the current carrying value of the assets is greater than the assets' fair market value, an impairment charge is recognized equal to the difference. If the Company plans to dispose of the assets via sale, estimates of fair market value are taken from appropriate external sources. If the asset's carrying value exceeds the asset's fair market value an impairment charge is recognized equal to the difference, and the asset is reclassified on the consolidated balance sheet to the assets held for sale category. Deferred Financing Costs Costs incurred in connection with arranging the Company's long-term debt agreements are capitalized and amortized over the life of the related debt issuance using the effective interest method. Accumulated amortization was $0.7 million at June 30, 2003, $0.1 million at June 30, 2002 and $1.9 million at June 30, 2001. See Note 7 - Long-Term Debt for a detailed description of our long-term debt transactions. -48- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Deferred Income Taxes Deferred income taxes are determined using the liability method, which gives consideration to the future tax consequences associated with differences between the financial accounting and tax basis of assets and liabilities. This method also gives immediate effect to changes in income tax laws. Revenue Recognition The Company recognizes revenue when persuasive evidence of a final agreement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Revenue from product sales is primarily recognized at the time of shipment. Product shipments are supported by purchase orders from customers that indicate the price for each product. For services, we recognize revenue primarily on a time and materials basis. Service revenues are supported by customer orders or contracts that indicate the price for the services being rendered. For fiscal 2003, 2002, and 2001 service revenues were less than 10% of total revenues. Shipping and Handling Costs The Company includes shipping and handling costs in the cost of products sold. Stock-Based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, in the primary financial statements and to provide the supplemental disclosures required by SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure. Stock compensation is awarded to key employees in the form of stock options and restricted stock. All stock options are issued at fair market value on the date of grant. Accordingly, we did not recognize stock compensation expenses for stock options granted during the periods presented. In determining the fair value of options granted during fiscal 2003, the Company used the Black-Scholes option-pricing model with the following weighted average assumptions: expected volatility factor of 94.5%; risk-free interest rate of 1.975%; dividend yield of zero; and an expected option life of four years. For options granted prior to fiscal 2003, we determined the fair value of options granted using the minimum value option pricing model with the following weighted average assumptions: risk-free interest rate of 5.5%; dividend yield of zero; and an expected option life of four years. The change in option pricing methodologies in fiscal 2003 is the result of being a public traded company during the entire fiscal year. The minimum value-option pricing model is not permitted for publicly traded companies under SFAS No. 123. The following table summarizes what our operating results would have been if we had utilized the fair value method of accounting for stock options (in thousands): FY2003 FY2002 FY2001 ------------ ------------ ------------ Net loss as reported $ (35,265) $ (38,766) $ (29,145) Stock compensation expense - fair value based method (1,721) (1,022) (482) ------------ ------------ ------------ Pro forma net loss $ (36,986) $ (39,788) $ (29,627) ============ ============ ============ Loss per share as reported (basic and diluted) $ (1.28) $ (3.50) $ (5.55) ============ ============ ============ Pro forma loss per share (basic and diluted) $ (1.34) $ (3.59) $ (5.64) ============ ============ ============ -49- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) We have issued restricted stock as part of employee incentive plans. The fair market value of the restricted stock is amortized over the projected remaining vesting period. During the fiscal year ended June 30, 2003, we incurred $0.3 million of non-cash stock compensation expenses related to restricted stock issuances. No such charges were incurred in fiscal 2002 and fiscal 2001. (see Note 10--Mandatory Redeemable Convertible Stock and Stockholders' Equity). Concentration of Credit Risks Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents and accounts receivable. The Company performs ongoing credit evaluations of its customers, does not generally require collateral or other security, and maintains an allowance for potential credit losses. Significant Customers Customers that accounted for more than 10% of consolidated revenues are as follows: Year Ended June 30, ------------------- 2003 2002 2001 ---- ---- ----- Customer A................... 27% 25% 18% Customer B................... 12 12 12 Customer C................... 11 -- -- At June 30, 2003 and 2002 receivables from these customers represented 37% and 17% respectively, of total accounts receivable. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash equivalents, accounts receivable, accounts payable, and debt instruments. The carrying amounts of financial instruments other than the debt instruments are representative of their fair values due to their short maturities. The Company's principal long-term debt agreements bear interest at market rates; thus, management believes their carrying amounts approximate fair value. Management believes the carrying amount of the remaining loans is not materially different from estimated fair value. Net Loss Per Common Share Net loss per common share attributed to common stockholders is based on the net loss for the period adjusted for dividend requirements on all preferred stock and accretion of discounts on mandatory redeemable preferred stock. The resulting net loss attributed to common stockholders is divided by the weighted average number of shares of common stock outstanding during the period to arrive at the basic net loss per share attributed to common stockholders. For all periods presented, the impact of the assumed exercise of certain options, warrants, and unvested restricted stock was anti-dilutive, and those securities were therefore excluded from the computation. Hedging Activities The Company accounts for its derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The statement requires the Company to -50- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. We have a derivative financial instrument to hedge our exposure to changes in interest rates. The financial instrument is marked-to-market each financial statement date. The change in the hedge's fair market value was recognized in other comprehensive income. Upon payment of the underlying note payable the unrealized gain or loss recognized in accumulated comprehensive income will be reclassified as a realized gain or loss in our operating results. (See Note 7--Long-Term Debt.) Reclassification Certain prior year amounts have been reclassified to conform with the current year presentation. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Recent Accounting Pronouncements In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets," which replaced SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long -Lived Assets to Be Disposed Of." Though SFAS No. 144 retained the basic guidance of SFAS No. 121, regarding when and how to measure an impairment loss, it provides additional implementation guidelines. The Company adopted this statement in the first quarter of fiscal 2003 and its adoption did not have a material impact on the Company's financial statements. In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statement No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical corrections. SFAS No. 145 required us to reclassify the fiscal 2002 $6.9 million loss on debt extinguishment as a loss from continuing operations rather than an extraordinary item. The provisions of SFAS No. 145 are effective for fiscal years beginning after May 15, 2002. Accordingly, we adopted this standard beginning in the first quarter of fiscal 2003. The reclassification had no impact on our net loss, cash flows or financial position. In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated With Exit or Disposal Activities." SFAS No. 146 superseded Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principal difference between SFAS No. 146 and EITF 94-3 relates to when an entity can recognize a liability related to exit or disposal activities. SFAS No. 146 requires that a liability be recognized for cost associated with an exit or disposal activity when the liability is incurred. EITF 94-3 allowed a liability related to an exit or disposal activity to be recognized on the date the entity commits to an exit plan. We adopted this standard on January 1, 2003, -51- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) which was the standard's effective date. The standard did not materially impact our consolidated financial results or financial position upon adoption, but will affect the timing of when we recognize expected restructuring charges in future periods. In November of 2003, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others," which requires a guarantor to recognize and measure certain types of guarantees at fair value. In addition, Interpretation No. 45 requires the guarantor to make new disclosures for these guarantees and other types of guarantees that are not subject to the initial recognition and initial measurement provisions. The disclosure requirements are effective for interim or annual periods ended after December 31, 2002, while the recognition and measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. We adopted the initial recognition and measurement provisions as well as the disclosure provisions of Interpretation No. 45 during the third quarter of fiscal 2003. The initial recognition and measurement provisions did not have a material impact on our consolidated financial results or financial condition. In December of 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." The provisions of SFAS No. 148 amend SFAS No. 123, "Accounting for Stock Based Compensation," to provide alternative methods of transitioning to a fair value-based method of accounting for stock-based compensation. In addition, SFAS No. 148 also expands the disclosure requirements of SFAS No. 123 by requiring more detailed disclosure in both annual and interim financial statements. The transition provisions of SFAS No. 148 did not have a material impact on our financial results, as we did not adopt the fair value-based accounting provisions of SFAS No. 123, which is commonly referred to as expensing of stock options. The disclosure provisions of SFAS No. 148 are effective for interim periods beginning after December 15, 2002. Accordingly, we adopted the disclosure provisions during the third quarter if fiscal 2003. 3. Acquisitions Fiscal 2003 On September 4, 2002, the Company acquired Cycam, Inc. ("Cycam"), a company located in Houston, Pennsylvania that manufactures reconstructive implants and instruments. The total purchase price was approximately $24.4 million, which included $18.4 million in cash and 667,175 shares of common stock valued at $6.0 million. The fair market value of the shares issued in connection with the Cycam acquisition was based on the market price of our common stock on the date of issuance. The acquisition was recorded using the purchase method of accounting. The purchase price allocation was $5.9 million to net tangible assets and $18.5 million to goodwill. In conjunction with the acquisition, the Company drew $8.0 million from the acquisition line under the Company's existing credit facility. The effect of the acquisition on our historical financial position and results of operations is not material, and therefore no pro forma data of this acquisition is presented. Cycam's operating results have been included in our consolidated operating results since the date of acquisition. The acquisition of Cycam expanded our capacity and capabilities in the metal machining of orthopedic reconstructive implants. In addition, Cycam provided us with the complimentary capabilities of plastic machining, surface coatings, near net shape forging, and sterilized packaging and kitting of orthopedic implants. Cycam also had strong relationships with several leading orthopedic companies where we had only a minor presence. -52- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Fiscal 2002 During our fiscal year ended June 30, 2002, the Company completed the acquisition of HV Technologies, Inc. ("HV Technologies"), a company located in Trenton, Georgia that manufactures polyimide and composite micro-tubing used in interventional and minimally invasive catheters, delivery systems and instruments. The total purchase price was approximately $19.1 million, including cash of $5.6 million, 4,000 shares of Series F preferred stock valued at $3.6 million, and 824,255 shares of common stock valued at $9.9 million. The results of HVT are included in the Company's consolidated Statement of Operations from the date of acquisition and were not material. To help provide financing for the acquisition, the Company issued 6,000 shares of its 6% Series E preferred stock (the "Series E preferred stock") and warrants to purchase an aggregate of 200,000 shares of its common stock. The Company had agreed that the total number of shares issuable upon exercise of the warrants would increase on each of the first five anniversaries of the date of issuance of the Series E Preferred Stock by an aggregate of 45,000 shares per year for each year that the Series E preferred stock remained outstanding. However, as discussed below, the Company redeemed all of the Series E preferred stock before the first anniversary of its issuance. The Company recorded a discount of $1.8 million to the carrying value of the Series E preferred stock equal to the consideration allocated to the warrants. The Series E preferred stock and the Series F preferred stock accrued dividends at $60 per year during the first year from issuance, payable at the discretion of the Board of Directors, and at the rate of $160 per year on a retroactive basis after the first anniversary of issuance. The Company redeemed the Series F preferred stock and 4,065 shares of the Series E preferred stock in April 2002, at a price equal to $1,000 per share plus accrued and unpaid dividends. During fiscal 2003, the Company redeemed the remaining 1,935 shares of Series E preferred stock at a price equal to $1,000 per share plus accrued and unpaid dividends. In connection with the Company's issuance of Series E preferred stock, the Company obtained the consent of the holders of its $20.0 million of Senior Subordinated Promissory Notes (the "Notes") to complete the acquisition of HV Technologies and changed some of the covenants to which the Company was subject under an agreement between the Company and those holders. At the same time, the Company agreed to increase by $1.0 million the amount payable by the Company upon redemption of the Notes. As of April 2, 2002 the Company repaid the Notes, including the prepayment fees. The Company allocated the purchase price as follows: $2.7 million for fair value of tangible assets acquired, net of liabilities assumed, and deferred taxes and $16.4 million for goodwill. Fiscal 2001 During fiscal 2001, the Company completed the acquisition of ACT Medical, Inc., a Massachusetts company with additional facilities in Santa Clara, California and a contract for production and assembly services in Navojoa, Mexico. The acquisition was completed by the issuance of 33,423 shares of 6% Series D cumulative convertible redeemable preferred stock, rollover of options for an additional 6,920 shares of Series D preferred stock, and cash payments of $1.0 million to stockholders electing to receive cash instead of stock. The rollover of options represented replacement of outstanding options to purchase the common stock of ACT Medical that had been issued under a plan sponsored by ACT Medical with options to purchase the Series D preferred stock of the Company. The fair value of the options to purchase the Series D preferred stock of the Company of $3.4 million was included in the -53- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) purchase price, and the intrinsic value related to the unvested options was recorded as unearned compensation. The acquisition was recorded using the purchase method of accounting, and the operating results are included in the Company's consolidated statements of operations since the date of acquisition (December 30, 2000). The total purchase price was allocated as follows (in thousands): Fair value of tangible assets acquired, net of liabilities assumed, and deferred taxes....................................... $ 1,649 Identifiable intangible assets, net of deferred taxes............. 3,648 Goodwill.......................................................... 28,440 ------------ $ 33,737 ============ The following unaudited pro forma summary presents the consolidated results of operations as if the acquisition had occurred at the beginning of the fiscal 2001 (in thousands, except per share): Net revenues..................................................... $ 141,248 Loss before taxes................................................ (20,750) Net loss......................................................... (20,820) Net loss attributed to common stockholders....................... (31,825) ----------- Net loss per share attributed to common stockholders............. $ (6.06) =========== 4. Inventories Inventories consist of the following (in thousands): June 30, June 30, 2003 2002 ---------- ---------- Raw materials.......................................... $ 13,806 $ 10,638 Work in progress....................................... 8,389 6,529 Finished goods......................................... 3,422 3,336 ---------- ---------- Total.................................................. $ 25,617 $ 20,503 ========== ========== -54- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 5. Property, Plant, and Equipment Property, plant, and equipment consists of the following (in thousands): Estimated Useful Lives June 30, June 30, (Years) 2003 2002 ------------ ----------- ----------- Land................................................... $ 569 $ 169 Buildings and improvements............................. 1 to 20 2,106 46 Leasehold improvements................................. 2 to 20 7,461 6,320 Machinery and equipment................................ 3 to 15 52,880 39,796 Furniture and fixtures................................. 1 to 7 10,259 6,136 Automobiles............................................ 2 to 3 34 82 Software............................................... 3 to 8 1,016 626 Construction in progress............................... 5,986 6,410 ----------- ----------- Total.................................................. 80,311 59,585 Less accumulated depreciation and amortization......... (27,559) (17,540) ----------- ----------- Net property, plant, and equipment..................... $ 52,752 $ 42,045 =========== =========== As of June 30, 2003 capital leases with a gross amount of $6.3 million were included in machinery and equipment. The assets have $0.7 million of accumulated depreciation and are reported at a net book value of $5.6 million. 6. Goodwill and Other Identifiable Intangible Assets In June 2001, the FASB issued SFAS No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001 with early adoption permitted for companies with fiscal years beginning after March 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives are not amortized but instead are subject to an impairment test annually or at other times if indicators of impairment exist. Other intangible assets will continue to be amortized over their useful lives. The Company adopted these standards beginning in the first quarter of fiscal 2002. Amounts previously recorded as separately identifiable intangibles for acquired work force and customer base have been subsumed to goodwill in accordance with SFAS No. 141, increasing goodwill by $34.5 million as of the date of adoption. Effective with the July 1, 2002 adoption of SFAS No. 142, goodwill is no longer amortized but is instead subject to an impairment test annually or at other times if indicators of impairment exist. During fiscal 2003, we reduced our revenue forecast. Since the reduction in forecasted revenue indicated that our goodwill and intangible assets might be impaired we performed an impairment test using the income approach. We compared the present value of the estimated future cash flows of our business to the carrying value of net assets. This analysis indicated that our goodwill and intangible assets were impaired. Therefore, with the help of external sources, we evaluated the fair value of our net assets as if we were being purchased in a business combination. We recognized a $37.7 million goodwill impairment charge and a $2.3 million impairment charge related to our intangible assets. Goodwill represents a substantial portion of our assets. Therefore, future adverse changes in business or market conditions may -55- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) result in additional goodwill impairment charges, which could have a material adverse effect on our financial results and financial position. Goodwill and other identifiable intangible assets resulting from acquisitions of businesses and the formation of the Company consist of the following (in thousands): June 30, June 30, 2003 2002 -------------- -------------- Goodwill at beginning of period................... $ 113,113 $ 62,210 SFAS No. 142 reclassification.................. -- 34,530 Acquisitions................................... 21,130 16,373 Impairment charges............................. (37,661) -- -------------- -------------- Goodwill at end of period......................... $ 96,582 $ 113,113 ============== ============== Other identifiable intangibles: Patents and intellectual properties............ 1,441 4,383 Covenants not to compete....................... -- 476 -------------- -------------- 1,441 4,859 Less accumulated amortization..................... (9) (767) -------------- -------------- $ 1,432 $ 4,092 ============== ============== The $2.7 million net decrease in other identifiable intangibles was primarily related to the impairment charges mentioned above. Of the $37.7 million goodwill impairment charge, $30.0 million was recognized during the third quarter of fiscal 2003 and the remainder was recognized during the fourth quarter of fiscal 2003. The entire $2.7 million patent impairment was recognized during the fourth quarter of fiscal 2003. The patents and intellectual properties have a remaining estimated useful life of 12 years. We expect to incur approximately $0.1 million of amortization expense per year over the remaining life of the intangible assets. With the adoption of SFAS No. 142, the Company ceased amortization of goodwill as of July 1, 2001. The following table presents the results of the Company for all periods presented on a comparable basis (in thousands, except per share data): -56- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Fiscal Year Ended -------------------------------------------- June 30, June 30, June 30, 2003 2002 2001 ------------ ------------ ------------ Net loss attributed to common stockholders, as reported ............... $ (35,265) $ (38,766) $ (29,145) Add back goodwill, workforce, and customer base amortization (net of tax) .......... -- -- 5,268 ------------ ------------ ------------ Adjusted net loss attributed to common stockholders ............................ $ (35,265) $ (38,766) $ (23,877) ============ ============ ============ Basic and diluted net loss per share: Net loss attributed to common stockholders, as reported ............ $ (1.28) $ (3.50) $ (5.55) Goodwill, workforce, and customer base amortization (net of tax) ....... -- -- 1.00 ------------ ------------ ------------ Adjusted net loss attributed to common stockholders .......................... $ (1.28) $ (3.50) $ (4.55) ============ ============ ============ 7. Long-Term Debt Long-term debt consists of the following (in thousands): June 30, June 30, 2003 2002 --------------- -------------- Notes payable................................ $ 29,455 $ 40,000 Acquisition loans............................ 7,045 -- Obligations under capital leases............. 5,288 1,906 --------------- -------------- 41,788 41,906 Less: Current portion........................... (7,753) (5,939) --------------- -------------- $ 34,035 $ 35,967 =============== ============== -57- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) Credit Agreement In fiscal 2003, we amended our senior credit facility. We originally entered into the senior credit facility in fiscal 2002 after paying off the entire outstanding balance of our former credit facility with proceeds received from our initial public offering ("IPO"). The amendment reduced our revolving credit facility to $15.0 million from $25.0 million. Prior to the amendment, we also had a $40.0 million term loan and an $8.0 million acquisition loan under the senior credit facility (earlier in fiscal 2003, we had borrowed $8.0 million under the acquisition line (which is no longer available) to finance our acquisition of Cycam). In conjunction with the amendment of the credit facility, we made a payment of $7.5 million. Of the $7.5 million payment, $6.5 million represented a payment on the $40.0 million term loan, and the remainder was applied toward the acquisition line term loan. All loans under our amended senior credit facility will mature in fiscal 2007. During fiscal 2004, we will be required to make payments under the term loan of $5.0 million, payable in quarterly installments. During fiscal 2005, fiscal 2006, and fiscal 2007, we will be required to make payments of $7.4 million, $9.2 million, and $7.9 million, respectively, each payable in quarterly installments. During fiscal 2004, we will also be required to make payments under the acquisition loan of $1.4 million, also payable in quarterly installments. During fiscal 2005, fiscal 2006, and fiscal 2007, we will be required to make payments of $1.6 million, $2.2 million, and $1.8 million on the acquisition line term loan, each also payable in quarterly installments. Concurrent with receipt of funds from the Company's IPO on April 2, 2002, the Company repaid the entire $66.3 million outstanding under its former senior credit facility and the entire $21.4 million outstanding (including a $1.4 million pre-payment fee) under its former Senior Subordinated Notes. As a result of repaying our former senior subordinated debt the Company recognized a loss of $6.9 million, inclusive of a $5.5 million write-off of unamortized financing costs and discount and a $1.4 million prepayment fee. The Company also recognized a charge of $1.9 million for terminating the interest rate swap agreements that was recognized as interest expense. At the Company's option, interest rates applicable to loans under its new senior credit facility will be either: . The greater of the bank's prime rate plus a margin, which depends upon the Company's leverage ratio, ranging from 50 to 175 basis points, or . LIBOR plus a margin, which depends upon our leverage ratio, ranging from 225 to 350 basis points. The Company has entered into an interest rate cap agreement to protect against interest rate fluctuations with respect to the term loans outstanding under its new senior credit facility. This agreement, executed with a highly-rated financial counter-party, requires the counter-party to make payments to the Company in the event that a reference floating rate index exceeds an agreed upon fixed rate. Changes in the fair value of the cap agreement are accounted for as a cash flow hedge. The amended senior credit facility contains affirmative and negative covenants and limitations, including, but not limited to, required minimum coverage of the Company's obligations to pay interest and incur fixed charges, restrictions on its ability to pay dividends, make other payments and enter into sale transactions, limitations on liens, limitations on its ability to incur additional indebtedness and agreements that the Company use excess cash on hand and proceeds from future equity issuances to pay down its -58- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) senior credit facility. In addition, the Company also needs the lender's consent to make any acquisition in which it pays more than $10.0 million (including more than $5.0 million in cash, deferred payments and the assumption of debt) or to pay more than $20.0 million (including more than $10.0 million in cash, deferred payments and the assumption of debt) for all of the acquisitions that the Company completes during any fiscal year. The senior credit facility is secured by all of the Company's assets and contains various events of default, including, but not limited to, defaults upon the occurrence of a change of control of the Company and defaults for non-payment of principal interest or fees, breaches of warranties or covenants, bankruptcy or insolvency, ERISA violations and cross-defaults to other indebtedness. We are involved in several capital leases related to our machinery and equipment. As of June 30, 2003, we have obligations totaling $5.3 million under capital leases, of which $1.3 million will be paid before the end of fiscal 2004. These leases will expire in fiscal 2007. The interest rate incurred on these capital leases ranges from 7.1% - 9.2%. The leases expire beginning in fiscal 2005 through fiscal 2007. Maturities of long-term debt outstanding and obligations under capital leases at June 30, 2003, are summarized by fiscal year as follows (in thousands): 2004.......................................... $ 7,753 2005.......................................... 10,292 2006.......................................... 12,724 2007.......................................... 11,019 ------------ $ 41,788 ============ 8. Related-Party Transactions Closing Fees and Management Fees The Company had entered into management services agreements ("MSAs") with entities associated with certain of the Company's directors and stockholders whereby the Company paid fees plus reimbursement of out-of-pocket expenses for management services rendered. As of April 2002, all MSAs were terminated. Fees incurred for the years ended June 30, 2002, and 2001 totaled $1.5 million, and $1.7 million, respectively. In addition, pursuant to the MSAs, the Company paid fees based on a percentage of the aggregate consideration of each future business acquisition, plus reimbursement of out-of-pocket expenses. Such fees and expenses totaled $0.3 million and $0.6 million, relating to the acquisitions made in the years ended June 30, 2002 and 2001, respectively. Real Estate Leases Certain of the Company's subsidiaries lease their facilities from related parties as a result of acquisitions. Total rent expense under these leases for the years ended June 30, 2003, June 30, 2002 and July 1, 2001 was approximately $0.2 million, $0.6 million, and $0.7 million, respectively. Future minimum lease commitments at June 30, 2003 in connection with these related-party leases are approximately $0.2 million per year with a total future commitment of $1.8 million. -59- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) 9. Income Taxes Income tax benefit (expense) consists of the following (in thousands): Year Ended June 30, -------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Current: Federal ..................... $ -- $ 208 $ -- State ....................... (267) (90) (70) ------------ ------------ ------------ (267) 118 (70) Deferred: Federal ..................... -- -- -- State ....................... -- -- -- ------------ ------------ ------------ -- -- -- ------------ ------------ ------------ $ (267) $ 118 $ (70) ============ ============ ============ Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets and liabilities are as follows (in thousands): June 30, June 30, June 30, 2003 2002 2001 ---------- ---------- ---------- Deferred tax assets: Organization costs ................................. $ 516 $ 889 $ 1,798 Nondeductible reserves and current liabilities ..... 1,189 900 1,335 Restructuring reserve .............................. 373 1,330 3,704 Net operating loss carryforwards ................... 18,005 16,838 8,708 Valuation reserve .................................. (11,143) (12,805) (6,147) ---------- ---------- ---------- Total deferred tax assets ....................... 8,940 7,132 9,398 Deferred tax liabilities: Identified intangible assets ....................... (485) (1,450) (6,187) Property, plant, and equipment ..................... (2,860) (1,666) (1,530) Goodwill ........................................... (5,394) (4,013) (1,662) Other .............................................. (201) (3) (19) ---------- ---------- ---------- Total deferred tax liabilities .................. (8,940) (7,132) (9,398) ---------- ---------- ---------- Net deferred tax liabilities .......................... $ -- $ -- $ -- ========== ========== ========== The Company has U.S. net operating loss carryforwards of approximately $45.0 million, subject to certain limitations, which expire at different times beginning in 2019 and extending through 2023. -60- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) A reconciliation between the income tax benefit computed at the federal statutory rate and the recorded income tax benefit (expense) is as follows (in thousands): June 30, June 30, June 30, 2003 2002 2001 ------------ ------------ ------------ Income tax benefit computed at the federal statutory rate ...... $ 12,250 $ 2,698 $ 6,785 State income taxes, net of federal benefit ..................... 1,482 315 899 Goodwill impairment, not deductible for tax purposes ........... (15,058) -- -- Restructuring reserve, portion not deductible for tax purposes . -- -- (882) Amortization of goodwill, not deductible for tax purposes ...... -- -- (401) Valuation reserve .............................................. 1,069 (3,108) (6,462) Other .......................................................... (10) 213 (9) ------------ ------------ ------------ Income tax benefit (expense) ................................... $ (267) $ 118 $ (70) ============ ============ ============ 10 Mandatory Redeemable Convertible Stock and Stockholders' Equity Mandatory Redeemable Convertible Stock Series B On March 30, 1999, the Company sold 300,000 shares of 6% Series B Cumulative Convertible Redeemable Preferred Stock (the "Series B preferred stock"), $0.01 par value per share, for cash in a private placement. On May 14, 1999, the Company sold an additional 32,728 shares for cash in a private placement. All Series B preferred stock was converted in connection with the Company's IPO on April 2, 2002. As a result of the conversion, the Company paid $4.8 million in accrued dividends. Series C On October 24, 2000, the Company sold 40,000 shares of 6% Series C Cumulative Convertible Redeemable Preferred Stock (the "Series C preferred stock"), $0.01 par value per share, for cash in a private placement. On April 18, 2001, the Company sold an additional 300 shares for cash in a private placement. In addition to the shares purchased at a price of $1,000 per share, each purchaser also received an option to purchase an additional .2857 shares at a price of $1,000 per share for each share acquired. The option was exercisable prior to or coincident with the earlier to occur of (i) a qualified public offering (as defined) and (ii) October 24, 2001. The options were not exercised and expired on October 24, 2001. All Series C preferred stock was converted in connection with the Company's IPO on April 2, 2002. Additionally, on February 27, 2001, the Company issued a warrant to purchase 525 shares of Series C preferred stock for $1,000 per share to the placement agent it had used in connection with the issuance of the Series C preferred stock on October 24, 2000. The warrant was exercised upon the completion of the IPO. In connection with the Company's initial public offering, our Series C preferred stock converted into a number of shares of our common stock based upon the initial public offering price of our common stock. The Company's net loss for the fiscal year ending June 30, 2002 includes a deemed preferred stock dividend of approximately $21.3 million for the value of the additional shares of our common stock issued to the holders of our Series C preferred stock upon conversion and to reflect the beneficial conversion feature. -61- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) Series D In conjunction with the acquisition of ACT Medical, Inc. (see Note 3), the Company issued 33,423 shares of 6% Series D Cumulative Convertible Redeemable Preferred Stock (the "Series D preferred stock"), $0.01 par value per share, and rolled over options for an additional 6,920 shares of Series D preferred stock. All Series D preferred stock was converted in connection with the Company's IPO on April 2, 2002. Other Preferred and Common Stock Series A On March 30, 1999, the Company issued 37,440 shares of Series A Preferred Stock (the "Series A preferred stock"), $.01 par value per share, in connection with the acquisition of businesses. In addition, the Company also issued 600 shares of Series A preferred stock to key employees of an acquired company in conjunction with the acquisition. The fair value of these shares totaled approximately $201,000 and was included in the Company's organization and start-up costs in the period ended July 3, 1999. Subsequent to March 30, 1999, the Company sold an additional 330 shares of Series A preferred stock to key employees for cash at fair value as determined at March 30, 1999. All Series A preferred stock was converted in connection with the Company's IPO on April 2, 2002. Series Z On March 30, 1999, the Company sold 65,000 shares of Series Z Convertible Nominal Value Redeemable Preferred Stock (the "Series Z preferred stock"), $0.01 par value per share, for cash in a private placement. The Series Z preferred stock had no dividend rights and was senior only to the common stock with respect to rights on liquidation. The Series Z preferred stock was convertible at the option of the holder into common stock at any time. The initial conversion rate was one share of Series Z preferred stock for 10 shares of common stock, subject to anti-dilution provisions. All Series Z preferred stock were converted in connection with the Company's IPO on March 27, 2002. Series E On fiscal 2002, the Company issued 6,000 shares of its 6% Series E Preferred Stock (the "Series E preferred stock"), $.01 par value per share, for cash in a private placement (see Note 3--Acquisitions). The Series E preferred stock accrues dividends at $60 per year during the first year from issuance, payable at the discretion of the Board of Directors, and at the rate of $160 per year on a retroactive basis after the first anniversary of issuance. During April 2002, 4,065 shares of the Series E preferred stock were redeemed for $1,000 per share plus accumulated dividends. During fiscal 2003, the remaining 1,935 shares of Series E preferred stock were redeemed. Common Stock On April 14, 1998, the Company was incorporated with the sale of 100 shares of common stock at $1 per share. In February 1999, an additional 65 shares were sold to individuals at $1,000 per share. On March 30, 1999, in conjunction with the acquisitions and the commencement of business operations, the stock was split 2,209-for-1 (adjusting the pre-split shares to 363,594 shares) and an additional 38,706 -62- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) shares were sold for cash to existing stockholders. The amount paid for the common stock was based on fair value. Also on March 30, 1999, 42,500 shares of common stock were issued in connection with the acquisition of a business. In January 2000, the Company's common stock was split 10-for-1 and all share references to common stock have been adjusted to give effect to the split. The adjusted post-split outstanding common shares was 4,448,000. On March 27, 2002, the Company commenced its IPO in which it initially sold 8,340,000 shares of common stock at a price of $12.00 per share. The net proceeds of the IPO, which the Company received on April 2, 2002, after deducting underwriting discounts, were approximately $93.1 million. The Company used these proceeds to pay down senior debt in the amount of $66.3 million, extinguish senior subordinated debt in the amount of $21.4 million (including a $1.4 million pre-payment fee), redeem Series E preferred stock in the amount of $4.1 million (including dividends), redeem Series F preferred stock in the amount of $4.1 million (including dividends), pay accrued and unpaid dividends on Series B preferred stock in the amount of $4.8 million and to pay fees under service agreements with Kidd & Co. and Whitney Mezzanine Management Company. The Company also incurred approximately $2.0 million in other expenses related to the IPO. Additionally, in April 2002, the Company's underwriters exercised their option to purchase an additional 1,251,000 shares of common stock at $12.00 per share, with 926,000 shares sold by the Company and 325,000 shares sold by two stockholders. This resulted in additional net proceeds, which the Company received on April 17, 2002, of $10.3 million after deducting underwriting discounts. Upon consummation of the IPO all shares of the Company's Series A, Series B, Series C, Series D and Series Z preferred stock converted to common stock. The conversion amounts of common shares were as follows: Series A............................................1,918,500 Series B............................................3,327,279 Series C............................................3,934,870 Series D............................................1,769,549 Series Z..............................................650,000 Series C Warrant........................................2,916 Accumulated Unpaid Dividends During fiscal 2003, the remaining 1,935 shares of Series E Preferred Stock were redeemed for $1,000 per share plus accumulated unpaid dividends. Therefore, as of June 30, 2003 there were no accumulated unpaid dividends. Stock Compensation The Company originally had reserved 4,430,000 shares of its common stock for issuance to directors, officers, employees, and consultants under the 1999 Stock Plan (the Plan). The table below shows the activity in the Plan: -63- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) Weighted Average Initial Options Shares Exercise Outstanding Reserved Price ----------- ---------- ------------ Balance at July 1, 2000 ........... 1,441,070 308,930 Reserved ....................... -- 1,680,000 Granted ........................ 1,555,660 (1,555,660) $ 17.13 Exercised ...................... (20,308) -- 13.99 Canceled ....................... (401,038) 401,038 14.40 ----------- ---------- Balance at June 30, 2001 .......... 2,575,384 834,308 15.54 Reserved ....................... -- 1,000,000 Granted ........................ 739,624 (739,624) 16.96 Exercised ...................... (400) -- 12.00 Canceled ....................... (461,996) 461,996 17.58 ----------- ---------- Balance at June 30, 2002 .......... 2,852,612 1,556,680 15.58 Reserved ....................... -- -- -- Granted ........................ 671,750 (671,750) 10.33 Exercised ...................... -- -- -- Canceled ....................... (3,082,149) 3,082,149 15.00 ----------- ---------- Balance at June 30, 2003 .......... 442,213 3,967,079 $ 13.00 =========== ========== The options outstanding at June 30, 2003 include 34,000 options with an initial exercise price of $2.25 per share, 222,018 options with an initial exercise price of $8.25-$12.00 per share, 100,305 options with an exercise price of $13.19-$16.24 per share, and 85,890 options with an exercise price of $17.00-$20.00. Options granted through June 30, 2003 are exercisable for 10 years from date of grant and vest 25% each year. The initial exercise price of the options applies to the options vesting at the first anniversary date. The initial exercise price remains fixed for all options granted after June 30, 2001. Prior to June 30, 2001, all options had variable exercise prices equal to 110%, 121% and 131.1% of the initial exercise price on the second, third and fourth grant date anniversary, respectively, except options granted at $16.24 in fiscal 2001, which had a fixed exercise price. There were 201,337 options outstanding with an initial exercise price between $12.00-$14.00 per share and 75,560 options outstanding with an initial exercise price between $16.24-$20.00 per share that were fully vested and exercisable at June 30, 2003. The weighted average grant date fair values of options to purchase common stock granted in fiscal years 2003, 2002 and 2001 were $6.91, $3.35 and $3.38, respectively. During fiscal 2003, we implemented a stock option exchange program. The exchange program was offered to all employees and non-employee directors. Under the stock option exchange program, employees were eligible to cancel outstanding stock options under the 1999 stock plan in exchange for new options that will be awarded six months and a day after the cancellation date, which was June 6, 2003. The number of shares subject to the new option will be equal to one half the number of shares subjected to cancelled options. The new options will vest in four annual installments, with respect to employees, or three annual installments, with respect to non-employee directors. A total of 2,243,786 options were cancelled on June 6, 2003 in conjunction with the stock option exchange program. The Company also has 106,978 options outstanding that were assumed in connection with the ACT Medical acquisition (see Note 3 - Acquisitions). -64- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) All stock options and unvested restricted stock were antidilutive due to the net loss incurred in fiscal 2003. In addition, if we had net income certain shares of common stock and unvested restricted stock would have been antidilutive because they had an exercise price greater than the average market price during the year. If we had net income for fiscal 2003 diluted weighted average commons shares outstanding would have increased by 647,414 shares. In addition to stock options, we have issued restricted stock as part of employee incentive plans. The fair market value of the restricted stock is amortized over the vesting period. During the fiscal year ended June 30, 2003 we incurred $0.3 million of non-cash stock compensation expenses related to restricted stock issuances. No such charges were incurred during fiscal 2002 and 2001. During fiscal 2003 we issued 824,442 and 50,407 shares of restricted stock at a grant date market value of $2.25 and $11.25 per share, respectively. As of June 30, 2003, we had 854,952 shares of restricted stock outstanding, all of which were granted under the 1999 Stock Plan. Reserved Shares of Common Stock The Company has reserved the following shares of common stock as of June 30, 2003: 1999 Stock Plan ........................ 3,548,550 Series D Options ....................... 106,978 Series E Warrants ...................... 66,329 Employee Stock Purchase Plan ........... 273,773 --------- Total ............................... 3,995,630 ========= The number of shares reserved for issuance under the Employee Stock Purchase Plan is subject to an annual increase on the first day of each fiscal year equal to the lower of 750,000 shares of common stock, 2.5% of the number of shares of common stock outstanding on that date or such lesser amount that may be determined by the Company's board of directors. The 3,548,550 shares of common stock reserved for issuance under the 1999 Stock Plan as of June 30, 2003, reflects the 860,742 shares of restricted stock that were issued under the plan during fiscal 2003, net of forfeited shares due to employee terminations. Employee Stock Purchase Plan We have an employee stock purchase plan that is available to substantially all employees. Eligible employees may purchase our common stock through payroll deductions. Employees can purchase our common stock at a price equal to the lower of 85% of the closing market price of our common stock at the beginning or end of each stock purchase period. We issued 0.2 million shares of common stock during fiscal 2003 in connection with our employee stock purchase plan. Prior to fiscal 2003, no common stock was issued in connection with the employee stock purchase plan. 11. Employee Benefits 401(k) Plan The Company offers their qualified employees the opportunity to participate in a defined contribution retirement plan qualifying under the provisions of Section 401(k) of the Internal Revenue -65- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) Code. Expenses recorded by the Company with respect to 401(k) plan for the years ended June 30, 2003, June 30, 2002 and June 30, 2001 were $1.2 million, $1.6 million, and $0.6 million, respectively. 12. Leases The Company has operating leases relating principally to its buildings. Total rent expense the for the years ended June 30, 2003, June 30, 2002, and June 30, 2001 (including amounts to related parties--see Note 8--Related-Party Transactions) was approximately $3.9 million, $2.5 million and $3.5 million, respectively. Future minimum lease commitments at June 30, 2003, for leases with initial or remaining terms of more than one year, including amounts due to related parties, are summarized by fiscal year as follows (in thousands): 2004 ................................... $ 3,329 2005 ................................... 2,923 2006 ................................... 2,384 2007 ................................... 2,253 2008 ................................... 2,144 Thereafter ............................. 12,657 ------------ $ 25,690 ============ 13. Restructuring Charge In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated With Exit or Disposal Activities." SFAS No. 146 superseded Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principle difference between SFAS No. 146 and EITF 94-3 relates to when an entity can recognize a liability related to exit or disposal activities. SFAS No. 146 requires that a liability be recognized for costs associated with an exit or disposal activity when the liability is incurred. EITF 94-3 allowed a liability related to an exit or disposal activity to be recognized on the date the entity commits to an exit plan. We adopted this standard on January 1, 2003, which was the standard's effective date. The standard did not materially impact our consolidated financial results or financial position upon adoption, but did affect the timing of when we recognized restructuring charges related to the fiscal 2003 restructuring plan. In fiscal 2003, we implemented our second restructuring plan to reconfigure our resources in an effort to meet our customer's needs and lower our cost of operations. The restructuring plan includes facility consolidations, employee terminations, and other activities. Based on an evaluation of the unique and common characteristics of the various facilities, management determined that it could achieve overall cost savings by closing several facilities, thus improving capacity utilization and efficiency at the remaining facilities. Criteria in this evaluation included: current capacity utilization; uniqueness of manufacturing capabilities; current operating costs; difficulty and cost associated with relocation and revalidation of key processes and equipment; and customer supply requirements. We estimate the total cost of this restructuring plan will be $15.0 - $20.0 million and to complete the plan by the end of fiscal 2005. In addition to these charges, we will invest $1.7 million in plant and equipment to ensure the facility consolidation does not disrupt operations. The estimate is based on the best available facts at this time. These estimates may change as new information becomes available. The following table contains detailed -66- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) information about the charges incurred to date, recorded in accordance with SFAS No. 146, related to the fiscal 2003 restructuring plan (in millions): Fiscal Estimate Estimated 2003 Remaining Description Charges Charges Charges - --------------------------------------- --------- -------- --------- Employee termination $ 4.8 $ 0.7 $ 4.1 Facility consolidation 4.6 -- 4.6 Property, plant and equipment disposals 2.2 -- 2.2 Other direct costs 6.7 0.6 6.1 --------- -------- --------- Total $ 18.3 $ 1.3 $ 17.0 ========= ======== ========= Employee termination charges represent the cost of reducing our workforce in conjunction with facility consolidations. During fiscal 2003 we terminated 43 people in as a result of the fiscal 2003 restructuring plan. We estimate that a total of approximately 270 people will be terminated as a result of this restructuring plan. Facility consolidation charges represent the direct costs of moving property, plant and equipment to new facilities. Property, plant and equipment disposals represents the write-off of redundant assets that will no longer be used in ongoing operations as a result of our facility consolidation initiative. The following table contains information regarding our restructuring liability as of June 30, 2003 (in millions): Beginning Ending Description Balance Additions Payments Balance - ---------------------------------------- ------------ ------------ ------------ ------------ Employee termination $ -- $ 0.7 $ 0.2 $ 0.5 Facility consolidation -- -- -- -- Property, plant and equipment disposals -- -- -- -- Other direct costs -- 0.6 0.6 -- ------------ ------------ ------------ ------------ Total $ -- $ 1.3 $ 0.8 $ 0.5 ============ ============ ============ ============ We estimate that we will incur $5.8 - $8.3 million and $7.9 - $10.4 million of charges in fiscal 2004 and fiscal 2005, respectively, related to the fiscal 2003 restructuring plan. In June 2001, the Company completed a strategic review of its manufacturing operations and support functions. Based on this review and with approval of the Board of Directors, management implemented its first restructuring plan and began actions to eliminate redundant facilities. We recognized an $11.5 million restructuring charge in accordance with EITF 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Information relating to the fiscal 2001 restructuring charges is as follows (in millions): -67- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued) Payments Balance through at Initial Reclass- Additional June 30, June 30, Accrual ification Accrual 2003 2003 -------- --------- ---------- -------- -------- Impairment of goodwill and other intangibles ............... $ 3.6 $ -- $ -- $ 3.6 $ -- Impairment of property, plant and equipment ................ 1.9 2.3 -- 4.2 -- Employee termination benefits .............................. 3.8 (1.2) 1.9 4.0 0.5 Other direct costs ......................................... 2.2 (1.1) 0.5 1.6 -- -------- --------- ---------- -------- -------- $ 11.5 $ -- $ 2.4 $ 13.4 $ 0.5 ======== ========= ========== ======== ======== Facilities at Danbury, Connecticut, Pittsfield, Massachusetts, and East Longmeadow, Massachusetts were identified to be closed or sold with production absorbed into existing facilities in Pennsylvania, Minnesota, New Hampshire, and Mexico. During fiscal 2002 the Company sold the Pittsfield and East Longmeadow facilities. The Danbury facility was closed during fiscal 2003. In addition, management decided to close its Redwood City, California facility as part of this restructuring plan. This decision led to additional restructuring charges, which are reflected in the "additions" column in the table above. Because management expected that it would not retain all of the customers served by these four facilities, a portion of the customer base intangible asset ($0.5 million) was written off as well as the entire remaining acquired workforce intangible for each facility ($0.5 million). In addition, because management believed the residual goodwill recorded at each acquisition was significantly related to the local operations, it concluded that goodwill was impaired by the closure of the facilities and wrote off the related goodwill ($2.6 million). Other recorded charges related to the restructuring include employee termination benefits expected to be paid based on the Company's announced termination benefits policy ($3.3 million), costs of plant and equipment not expected to be recovered ($4.2 million), and other exit costs ($1.6 million), including costs related to lease terminations, facilities restoration, equipment dismantlement and disposal, legal costs, and other costs. Costs related to realignment of leadership positions in the corporate support organization also were accrued at June 30, 2002 ($1.2 million). A reclassification in the allocation of the reserve as shown in the table above was a result of selling the Pittsfield and East Longmeadow facilities as opposed to closing them. Employee termination benefits consist of payments to employees based on the Company's severance policy of two weeks pay for each year of credited service with a minimum of six weeks payment and outplacement consultation services. The $3.3 million accrual for employee termination benefits was based on approximately 225 individuals estimated to be affected, actual credited service, and actual compensation. The $1.2 million accrual for corporate management severance benefits included salary continuation, outplacement consultation services and legal cost for seven individuals employed by the Company's corporate headquarters operations whose positions were eliminated as a result of the Company-wide restructuring. The charge for other direct costs which aggregated $1.6 million was comprised of estimated costs for (1) lease terminations, real estate taxes and property insurance of $0.5 million, (2) plant shut down costs and restoration of facilities to pre-lease conditions of $0.5 million, (3) dismantlement and disposal of obsolete equipment of $0.3 million, (4) legal costs of $0.2 million and (5) other related shut down costs of $0.1 million. 14. Comprehensive Income (Loss) Comprehensive income (loss) represents net loss attributed to common stockholders plus the results of any stockholders' equity changes related to the Company's previous interest rate swaps and -68- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) current interest rate cap agreements. For fiscal 2003, 2002 and 2001 comprehensive loss, net-of-tax, was $35.6 million, $8.0 million, and $22.1 million, respectively. 15. Quarterly Financial Data (Unaudited) (In thousands, except share and per share amounts) First Quarter Second Quarter Third Quarter Fourth Quarter Total -------------- -------------- -------------- -------------- -------------- 2003 Net sales $ 41,003 $ 44,621 $ 44,511 $ 47,163 $ 177,298 Cost of sales 30,812 33,170 34,007 33,981 131,970 Income (loss) before income taxes 1,681 2,707 (30,413) (8,973) (34,998) Income tax (expense) benefit (2) (13) (12) (240) (267) -------------- -------------- -------------- -------------- -------------- Net loss $ 1,679 $ 2,694 $ (30,425) $ (9,213) $ (35,265) ============== ============== ============== ============== ============== Average common shares outstanding basic 27,135,481 27,652,413 27,639,127 27,856,085 27,602,806 ============== ============== ============== ============== ============== Average common shares outstanding diluted 27,453,441 27,862,127 27,639,127 27,856,085 27,602,806 ============== ============== ============== ============== ============== Income (loss) per share basic and diluted $ 0.06 $ 0.10 $ (1.10)(1) $ (0.33)(2) $ (1.28) ============== ============== ============== ============== ============== 2002 Net sales $ 33,865 $ 38,290 $ 42,150 $ 44,594 $ 158,899 Cost of sales 26,107 28,509 31,483 30,990 117,089 Loss before income taxes (1,223) (400) (2,836) (3,257) (7,716) Income tax benefit -- -- 3 115 118 -------------- -------------- -------------- -------------- -------------- Net loss $ (1,223) $ (400) $ (2,833) $ (3,142) $ (7,598) Net loss attributed to common stockholders (3,884) (3,061) (28,650) (3,171) (38,766) ============== ============== ============== ============== ============== Average common shares outstanding - basic and diluted 5,255,755 5,256,155 7,146,444 26,779,727 11,086,103 ============== ============== ============== ============== ============== Loss per share basic and diluted $ (0.74) $ (0.58) $ (4.01) $ (0.12) $ (3.50) ============== ============== ============== ============== ============== <FN> <F1> (1) Includes $30.0 million goodwill impairment charge, and $1.9 million restructuring charges. <F2> (2) Includes $10.0 million goodwill and other intangible asset impairment charges, and $1.8 million restructuring charges. </FN> -69- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we are required to file under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management's control objectives. Management believes that there are reasonable assurances that our controls and procedures will achieve management's control objectives. We have carried out an evaluation, under the supervision and with the participation of our management, including our Chairman of the Board and Chief Executive Officer and our Senior Vice President - Finance and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 as of June 30, 2003. Based upon the foregoing, our Chairman of the Board and Chief Executive Officer and our Senior Vice President - Finance and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to MedSource (and its consolidated subsidiaries) required to be included in our Exchange Act reports. Changes in Internal Controls Over Financial Reporting The evaluation referred to above did not identify any changes in our internal controls over financial reporting that occurred during our quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. PART III The information called for by Part III (Items 10, 11, 12, 13, and 14) of Form 10-K is incorporated herein by reference to such information, which will be contained in our definitive proxy statement relating to our 2003 annual meeting of stockholders, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after the end of the fiscal year covered by this Form 10-K. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial statements: All financial statements are filed in Part II of this report under Item 8 - -- "Financial Statements and Supplementary Data." -70- 2. Financial statement schedules: Schedule II -- Valuation and Qualifying Accounts for the three fiscal years ended June 30, 2003. All other schedules are omitted as the required information is inapplicable or the information is presented in our consolidated financial statements and notes thereto in Item 8 above. 3. Exhibits: The following exhibits are filed herewith or are incorporated by reference to exhibits previously filed with the SEC. We will furnish copies of the exhibits for a reasonable fee (covering the expense of furnishing copies) upon request: Exhibit Number Description - ------- ---------------------------------------------------------------------- 2.1 Asset Purchase Agreement dated December 18, 1998 among the registrant, Brimfield Acquisition Corp., Brimfield Precision, Inc. and Image Guided Technologies, Inc. (incorporated by reference to Exhibit 2.1 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.2 Asset Contribution and Exchange Agreement dated January 25, 1999 among the registrant, Kelco Acquisition LLC, Kelco Industries, Inc., Paul D. Kelly, individually and as trustee of the Paul D. Kelly 1997 Annuity Trust, and Wayne A. Kelly (incorporated by reference to Exhibit 2.2 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.3 Stock Contribution and Exchange Agreement dated March 11, 1999 among the registrant, MedSource Technologies, LLC, Laurence S. Derose, as Special Trustee of the Laurence S. Derose Trust, Barbara M. Derose, as Trustee of the BMD Irrevocable Trust of 1998, Jeffrey L. Derose, as Trustee of the Jeffrey L. Derose Irrevocable Trust and Kevin L. Derose, as Trustee of the Kevin L. Derose Irrevocable Trust (incorporated by reference to Exhibit 2.3 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.4 Asset Contribution and Exchange Agreement dated March 22, 1999 among the registrant, Hayden Acquisition LLC, W.N. Rushwood, Inc., d/b/a/ Hayden Precision Industries, William H. Heywood, William B. Heywood, Nancy A. Heywood, individually and as trustee of the Trust for the benefit of Michele Lynn Dunbar, and Michele Lynn Dunbar, as trustee of the Trust for the benefit of Michele Lynn Dunbar (incorporated by reference to Exhibit 2.4 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.5 Stock Contribution and Exchange Agreement dated March 22, 1999 among the registrant, MedSource Technologies, LLC, Peter J. Neidecker, Peter J. Neidecker Limited Partnership, Peter C. Neidecker Irrevocable Trust, Sally N. Morris and Sylvia N. Coors (incorporated by reference to Exhibit 2.5 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.6 Asset Contribution and Exchange Agreement dated March 24, 1999 among the registrant, Portlyn Acquisition LLC, Portlyn Corporation, David E. Porter, Ronald V. Porter, Ronald V. Porter Amended and Restated Revocable Trust d/t/d 9/7/95, Porter Family 1997 Irrevocable Trust d/t/d 7/8/97 and Shirley J. Porter Amended and Restated Revocable Trust d/t/d 9/7/95 (incorporated by reference to Exhibit 2.6 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) -71- Exhibit Number Description - ------- ---------------------------------------------------------------------- 2.7 Asset Contribution and Exchange Agreement dated as of March 24, 1999 among the registrant, The MicroSpring Company, LLC, The MicroSpring Co., Inc., George Fowle, William S. Hodgson, Paul J. Dobson, James F. Marten, David G. Lubrano, Katherine Griswold, Mary Dashiell, Julie Parsons, Donald E. Milley, Louisa J. Dekkers, Joseph Keller, Robert F. Coughlin, Benjamin B. Brock, Patricia A. Van Blarcom, William T. McDonough, Kevin K. Gee, Carmine Sammarco and In Sup Choi, M.D. (incorporated by reference to Exhibit 2.7 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.8 Asset Purchase Agreement dated as of January 11, 2000 by and among the registrant, Bespak Inc., Tenax Corporation and Tenax, LLC (incorporated by reference to Exhibit 2.8 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.9 Agreement and Plan of Merger dated January 31, 2000 among the registrant, A.P.X. Acquisition Corp., Apex Engineering, Inc., Donald R. Rochelo and Donna L. Rochelo (incorporated by reference to Exhibit 2.9 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.10 Agreement and Plan of Merger dated May 15, 2000 among the registrant, Thermat Acquisition Corp., Thermat Precision Technology, Inc., Thomas J. Roche and Karl Frank Hens (incorporated by reference to Exhibit 2.10 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.11 Agreement and Plan of Merger dated as of December 8, 2000 among the registrant, ACT Acquisition Corp., ACT Medical, Inc., The Tolkoff Family Limited Partnership and M. Joshua Tolkoff (incorporated by reference to Exhibit 2.11 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.12 Agreement and Plan of Merger dated December 31, 2001 among the registrant, MedSource Trenton, Inc., HV Technologies, Inc. and Rudolph E. Carlson (incorporated by reference to Exhibit 2.12 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 2.13 Stock and Asset Purchase Agreement dated as of August 31, 2002 among the registrant, MedSource Technologies, LLC, MedSource Technologies Pittsburgh, Inc., Cycam, Inc., ELX, Inc., Wagner ELX and Donald J. Wagner (incorporated by reference to Exhibit 10.2 to the registrant's quarterly report on Form 10-Q for the quarter ended September 29, 2002, Commission File No. 000-49702, filed with the SEC on November 4, 2002) 3.1 Form of registrant's restated certificate of incorporation (incorporated by reference to Exhibit 3.1 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 3.2 Form of registrant's amended and restated bylaws (incorporated by reference to Exhibit 3.2 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 3.3 Certificate of the registrant's Designation of Rights, Preferences and Privileges of Series G Participating Preferred Stock (incorporated by reference to Exhibit 3.3 to the registrant's Form 8-A for registrant of certain classes of securities pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934, Commission File No. 000-49702, filed with the SEC on August 19, 2003) 4.1 Specimen certificate representing the registrant's common stock (incorporated by reference to Exhibit 4.1 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) -72- Exhibit Number Description - ------- ---------------------------------------------------------------------- 4.2 Credit Agreement among the registrant, MedSource Technologies, LLC, the domestic subsidiaries of the registrant from time to time party thereto, the lenders party thereto, First Union National Bank, as administrative agent, and First Union Securities, Inc., as lead arranger (incorporated by reference to Exhibit 4.2 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 4.3 Waiver and Second Amendment to Credit Agreement dated as of May 9, 2003 among the registrant, its subsidiaries, Wachovia Bank, National Association, and the lenders named therein (incorporated by reference to Exhibit 10.1 to the registrant's quarterly report on Form 10-Q for the quarter ended March 30, 2003, Commission File No. 000-49702, filed with the SEC on May 14, 2003) 4.4 Rights Agreement dated as of August 12, 2003 between the registrant and Wachovia Bank, National Association, including the Certificate of Designation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibit A, B and C, respectively (incorporated by reference to Exhibit 4.1 to the registrant's current report on Form 8-K dated (date of earliest event reported) August 12, 2003, Commission File No. 000-49702, filed with the SEC on August 19, 2003) 10.1 Registration Rights Agreement dated as of March 30, 1999 among the registrant, William J. Kidd, Carla G. Kidd, Edward R. Mandell, as Trustee under the Catherine M. Kidd Trust, Edward R. Mandell, as Trustee under the Cara E. Kidd Trust, Edward R. Mandell, as Trustee under the Thomas C. Kidd Trust, Clarice E. Webb, John P. Neafsey, Richard J. Effress, Andrew D. Lipman, Adam D. Lehrhoff, John C. Hertig, William Altieri, J.H. Whitney Mezzanine Fund, L.P., Whitney Strategic Partners, III, L.P., J.H. Whitney III, L.P. and German American Capital Corporation (incorporated by reference to Exhibit 10.1 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.2 Registration Rights Agreement dated as of March 30, 1999 among the registrant, William J. Kidd, Carla G. Kidd, Edward R. Mandell, as Trustee under the Catherine M. Kidd Trust, Edward R. Mandell, as Trustee under the Cara E. Kidd Trust, Edward R. Mandell, as Trustee under the Thomas C. Kidd Trust, Clarice E. Webb, John P. Neafsey, Richard J. Effress, Andrew D. Lipman, Adam D. Lehrhoff, John C. Hertig, William Altieri, Portlyn Corporation, Kelco Industries, Inc., The MicroSpring Company, Inc., Laurence S. Derose Trust, BMD Irrevocable Trust of 1998, Jeffrey L. Derose Irrevocable Trust, Kevin L. Derose Irrevocable Trust, W.N. Rushwood, Inc. d/b/a Hayden Precision Industries, Peter J. Neidecker, Peter J. Neidecker Limited Partnership, Peter C. Neidecker Irrevocable Trust, Sally N. Morris and Sylvia N. Coors (incorporated by reference to Exhibit 10.2 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.3 Registration Rights Agreement dated as of May 14, 1999 between the registrant and IndoSuez MST Partners (incorporated by reference to Exhibit 10.3 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.4 Registration Rights Agreement dated as of October 25, 2000 among the registrant, The 1818 Fund III, L.P., William J. Kidd, Carla G. Kidd, Edward R. Mandell, as trustee under the William J. Kidd Grantor Trust, Richard J. Effress, Andrew D. Lipman, John W. Galiardo and Manire Limited Partnership (incorporated by reference to Exhibit 10.6 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.5 Registration Rights Agreement dated as of February 27, 2001 between the registrant and Thomas Weisel Partners LLC (incorporated by reference to Exhibit 10.8 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.6 Registration Rights Agreement dated as of January 2, 2002 among the registrant and each of the investors in its Series E Preferred Stock (incorporated by reference to Exhibit 10.9 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.7 Registration Rights Agreement dated as of January 2 2002 among the registrant and each of the former stockholders of HV Technologies, Inc. (incorporated by reference to Exhibit 10.10 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) -73- Exhibit Number Description - ------- ---------------------------------------------------------------------- *10.8 1999 Stock Plan of the registrant (as amended and restated through December 14, 2001) (incorporated by reference to Exhibit 10.11 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.9 Omnibus Stock Plan of ACT Medical, Inc. (as amended and restated through April 4, 2000) (incorporated by reference to Exhibit 10.12 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.10 2001 Employee Stock Purchase Plan of the registrant (incorporated by reference to Exhibit 10.13 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.11 Employment agreement dated as of August 8, 2000 between the registrant and Richard J. Effress (incorporated by reference to Exhibit 10.14 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.12 Employment Severance and Termination Agreements, each dated as of March 2002 between the registrant and Richard J. Effress (incorporated by reference to Exhibit 10.22 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.13 Employment agreement between the registrant and William Ellerkamp (incorporated by reference to Exhibit 10.16 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.14 Employment agreement between the registrant and William Ellerkamp (incorporated by reference to Exhibit 10.18 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.15 Employment agreement dated as of April 1, 1999 between the registrant and Ralph Polumbo (incorporated by reference to Exhibit 10.19 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.16 Employment Severance and Termination Agreements, each dated as of March 2002 between the registrant and Ralph Polumbo (incorporated by reference to Exhibit 10.28 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.17 Employment Severance and Termination Agreements, each dated as of March 2002 between the registrant and Dan Croteau (incorporated by reference to Exhibit 10.24 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.18 Employment Severance and Termination Agreements, each dated as of March 2002 between the registrant and Robert R. Snider (incorporated by reference to Exhibit 10.29 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.19 Form of Employment Severance and Termination Agreement between the registrant and William J. Kullback (incorporated by reference to Exhibit 10.1 to the registrant's quarterly report on Form 10-Q for the quarter ended December 29, 2002, Commission File No. 000-49702, filed with the SEC on February 10, 2003) *10.20 Form of Employment Severance and Termination Agreement between the registrant and Rolf Dahl (incorporated by reference to Exhibit 10.2 to the registrant's quarterly report on Form 10-Q for the quarter ended December 29, 2002, Commission File No. 000-49702, filed with the SEC on February 10, 2003) *10.21 Form of Restricted Stock Award Contract entered into by the registrant with certain of its executive officers (incorporated by reference to Exhibit 10.1 to the registrant's quarterly report on Form 10-Q for the quarter ended September 29, 2002, Commission File No. 000-49702, filed with the SEC on November 4, 2002) 10.22 Business Conduct Policy and form of acknowledgement for the registrant's employees (incorporated by reference to Exhibit 10.30 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) -74- Exhibit Number Description - ------- ---------------------------------------------------------------------- 10.23 Form of Confidentiality Agreement for the registrant's employees (incorporated by reference to Exhibit 10.31 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.24 Form of Disclosure Policy and acknowledgement for the registrant's employees (incorporated by reference to Exhibit 10.32 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) *10.25 The registrant's Management Bonus Plan description (incorporated by reference to Exhibit 10.40 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.26 Share Transfer Agreement dated as of March 30, 1999 among the registrant, J.H. Whitney III, L.P., Whitney Strategic Partners III, L.P. and the stockholders of the registrant named therein, and amendment thereto dated June 2000 (incorporated by reference to Exhibit 10.41 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 10.27 Share Escrow Agreement dated as of March 30, 1999 among the registrant, J.H. Whitney III, L.P., Whitney Strategic Partners III, L.P. and the stockholders of the registrant named therein (incorporated by reference to Exhibit 10.42 filed as part of the registrant's registration statement on Form S-1, Registration No. 333-76842) 21.1 List of Subsidiaries 23.1 Consent of Ernst & Young LLP 24.1 Power of attorney (set forth on signature page) 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended 32.1 Certificate of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certificate of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - ---------- * Management contract, compensation plan or arrangement. (b) Reports on Form 8-K On April 29, 2003, we filed a Report on Form 8-K to file a press release announcing our financial results for the third quarter ended March 30, 2003. -75- Schedule II MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts Balance Charged at to Costs Charged to Balance Beginning and Other at End of of Period Expense Accounts Deductions Period ---------- ---------- ---------- ----------- ---------- Year ended June 30, 2003: Deduct from asset accounts: Allowance for doubtful accounts ................... $ 646 $ 355 $ 88/(2)/ $ (271)/(1)/ $ 818 Year ended June 30, 2002: Deduct from asset accounts: Allowance for doubtful accounts ................... $ 596 $ 530 -- $ (480)/(1)/ $ 646 Year ended June 30, 2001: Deduct from asset accounts: Allowance for doubtful accounts ................... $ 427 $ 101 $ 295/(2)/ $ (227)/(1)/ $ 596 <FN> <F1> (1) Deductions were for write-offs against the allowance. <F2> (2) Represents allowances from acquired companies. </FN> -76- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on September 26, 2003. MEDSOURCE TECHNOLOGIES, INC. By: /s/ Richard J. Effress ------------------------------------ Name: Richard J. Effress Title: Chairman and CEO POWER OF ATTORNEY Each person whose signature appears below hereby constitutes and appoints Richard J. Effress and William J. Kullback and each one of them, acting individually and without the other, as his attorney-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signatures Title Date - ----------------------------- ---------------------------- ------------------ /s/ Richard J. Effress Chairman of the Board of September 26, 2003 - ----------------------------- Directors and Chief Richard J. Effress Executive Officer (Principal Executive Officer) /s/ William J. Kullback Senior Vice President and September 26, 2003 - ----------------------------- Chief Financial Officer William J. Kullback (Principal Financial Officer and Principal Accounting Officer) Director - ----------------------------- Joseph Ciffolillo /s/ Paul E. Fulchino Director September 26, 2003 - ----------------------------- Paul Fulchino /s/ John W. Galiardo Director September 26, 2003 - ----------------------------- John Galiardo /s/ William J. Kidd Director September 26, 2003 - ----------------------------- William J. Kidd -77- Signatures Title Date - ----------------------------- ---------------------------- ------------------ /s/ T. Michael Long Director September 26, 2003 - ----------------------------- T. Michael Long /s/ Ross Manire Director September 26, 2003 - ----------------------------- Ross Manire /s/ Carl S. Sloane Director September 26, 2003 - ----------------------------- Carl Sloane -78-