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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended June 30, 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
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MedSource Technologies, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-2094496
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
110 Cheshire Lane, Suite 100
Minneapolis, Minnesota 55305
(Address of principal executive offices) (Zip Code)
(952) 807-1234
(Registrant's telephone number, including area code)
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
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Common stock, par value $0.01 Nasdaq National Market
per share
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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.
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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
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Unless the context otherwise requires, all references to "we," "us," "our,"
"MedSource" or the "Company" include MedSource Technologies, Inc. and our
subsidiaries.
Forward-Looking Statements
The following discussion contains "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, as amended. In many cases, you can identify
forward-looking statements by terminology such as may," "will," "should,"
"expect," "plan," "anticipate," "believe," "estimate, ""predict," "intend,"
"potential" or "continue" or the negative of these terms or other comparable
terminology. These forward-looking statements involve risks and uncertainties.
Our actual results could differ materially from those indicated in these
statements as a result of certain factors, as more fully discussed below and
under the heading "risk factors" contained elsewhere in this Annual Report on
Form 10-K. Readers should not place undue reliance on any such forward-looking
statements, which are made pursuant to the Private Securities Litigation Reform
Act of 1995 and, as such, speak only as of the date made. We do not assume any
obligation to update the forward-looking statements after the date hereof.
PART I
ITEM 1. BUSINESS
We are an engineering and manufacturing services provider to the medical
device industry. Our customers include many of the largest medical device
companies in the world, such as Johnson & Johnson affiliates, Medtronic, and
Boston Scientific as well as other large and emerging medical device companies.
We provide engineering services, 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.
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Our Products and Services
We offer our customers a broad range of products and services for their
medical engineering and manufacturing needs, including:
. 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.
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. 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
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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.
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. 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.
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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
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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
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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.
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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.
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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
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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.
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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.
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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:
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. 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
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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.
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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
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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
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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.
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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.
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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;
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. 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.
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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 Fi