10-Q 1 f10q-3302003.txt 03/30/2003 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended MARCH 30, 2003 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission file number 000-49702 MEDSOURCE TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter) State of incorporation: DELAWARE IRS Employer Identification No: 52-2094496 110 CHESHIRE LANE, SUITE 100, MINNEAPOLIS, MN 55305 (Address and zip code of principal executive office) (952) 807-1234 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No: | | Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No: |X| The number of shares of the registrant's Common Stock, par value $0.01 per share, outstanding as of May 12, 2003 was 28,683,225. TABLE OF CONTENTS Part I: Financial Information ----------------------------- Item 1. Financial Statements.................................................3 Consolidated Balance Sheets..........................................3 Consolidated Statements of Operations................................4 Consolidated Statements of Cash Flows................................5 Notes to Consolidated Financial Statements...........................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................9 Item 3. Quantitative and Qualitative Disclosures About Financial Market Risk.........................................................14 Item 4. Controls and Procedures.............................................14 Part II: Other Information -------------------------- Item 1. Legal Proceedings...................................................16 Item 2. Changes in Securities and Use of Proceeds...........................16 Item 3. Defaults Upon Senior Securities.....................................16 Item 4. Submission of Matters to a Vote of Security Holders.................16 Item 5. Other Information...................................................16 Item 6. Exhibits and Reports on Form 8-K....................................16 Signatures ...................................................................16 -2- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) MARCH 30, JUNE 30, 2003 2002 ---------------------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 14,126 $ 38,268 Accounts receivable, net 24,800 24,031 Inventories, net 24,300 20,503 Prepaid expenses and other current assets 3,069 2,402 --------- --------- Total current assets 66,295 85,204 Property, plant, and equipment, net 52,030 42,045 Goodwill 104,170 113,113 Other identifiable intangible assets, net 3,839 4,092 Deferred financing costs 1,838 1,971 Other assets 1,612 1,404 --------- --------- Total assets $ 229,784 $ 247,829 ========= ========= LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 9,671 $ 7,924 Accrued compensation and benefits 4,439 5,352 Other accrued expenses 2,260 3,491 Restructuring reserve 953 2,381 Current portion of long-term debt 11,830 5,939 --------- --------- Total current liabilities 29,153 25,087 Long-term debt, less current portion 35,080 35,967 Other long-term liabilities 766 455 Stockholders' equity: Preferred stock -- 1,974 Common stock 277 269 Additional paid-in capital 275,197 268,455 Treasury stock (1,282) (1,282) Accumulated other comprehensive loss (294) -- Accumulated deficit (109,113) (83,025) Unearned compensation -- (71) --------- --------- Total stockholders' equity 164,785 186,320 --------- --------- LIABILITIES & STOCKHOLDERS' EQUITY $ 229,784 $ 247,829 ========= ========= See accompanying notes. -3- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED ----------------------------------- ---------------------------------- MARCH 30, MARCH 31, MARCH 30, MARCH 31, 2003 2002 2003 2002 Revenues $ 44,511 $ 42,150 $ 130,135 $ 114,306 Costs and expenses: Cost of product sold 34,007 31,483 97,989 86,099 Selling, general and administrative expense 8,379 8,283 24,475 22,550 Restructuring charges 1,948 -- 1,948 -- Goodwill impairment 30,000 -- 30,000 -- ------------ ----------- ------------ ----------- Operating (loss) income (29,823) 2,384 (24,277) 5,657 ------------ ----------- ------------ ----------- Interest expense, net (596) (2,363) (1,776) (7,248) Other income (expense) 6 (2,857) 28 (2,867) ------------ ----------- ------------ ----------- Loss before income taxes (30,413) (2,836) (26,025) (4,458) Income tax (expense) benefit (12) 3 (27) 3 ------------ ----------- ------------ ----------- Net loss (30,425) (2,833) (26,052) (4,455) Preferred stock dividends and accretion of discount on preferred stock -- (25,817) -- (31,139) ------------ ----------- ------------ ----------- Net loss attributed to common stockholders $ (30,425) $ (28,650) $ (26,052) $ (35,594) ============ =========== ============ =========== Net loss per share attributed to common stockholders Basic and diluted $ (1.10) $ (4.01) $ (0.95) $ (6.06) ============ =========== ============ =========== Weighted average common shares outstanding Basic and diluted 27,639,127 7,146,444 27,413,489 5,876,987
See accompanying notes. -4- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
FOR THE NINE MONTHS ENDED MARCH 30, MARCH 31, 2003 2002 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(26,052) $ (4,455) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation 6,324 5,907 Amortization of other intangibles 253 277 Goodwill impairment 30,000 -- Amortization of deferred financing costs and discount on long-term debt 305 876 Amortization of unearned compensation 71 107 Loss on retirement of equipment 1,122 -- Changes in operating assets and liabilities, net of effect of business acquired: Accounts receivable 145 1,610 Inventories (3,306) (5,342) Prepaid expenses and other current assets (590) (809) Interest escrow fund -- 1,849 Accounts payable, accrued compensation and benefits, accrued expenses (2,806) 391 Other (280) (292) -------- -------- Net cash provided by operating activities 5,186 119 CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of businesses, net of cash acquired (22,591) (5,408) Other additions to plant and equipment, net (10,623) (7,109) Proceeds from sale of equipment 80 -- -------- -------- Net cash used in investing activities (33,134) (12,517) CASH FLOWS FROM FINANCING ACTIVITIES: Payments of long-term debt (2,997) (5,111) Proceeds from long-term debt 8,000 -- Redemption of Series E preferred stock (2,010) -- Proceeds from sale of Series E preferred stock and common stock net of costs 813 97,137 -------- -------- Net cash provided by financing activities 3,806 92,026 -------- -------- (Decrease) increase in cash and cash equivalents (24,142) 79,628 Cash and cash equivalents at beginning of period 38,268 20,289 -------- -------- Cash and cash equivalents at end of period $ 14,126 $ 99,917 -------- --------
See accompanying notes. -5- MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. INTERIM FINANCIAL STATEMENTS MedSource Technologies, Inc. (the "Company") has prepared the unaudited interim consolidated financial statements presented herein in accordance with accounting principles generally accepted in the United States for interim financial statements and in accordance with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The consolidated financial statements are unaudited but, reflect all adjustments, consisting of normal recurring adjustments and accruals which, in the opinion of management, are considered necessary for a fair presentation of our financial position and results of operations and cash flows for the interim periods presented. The consolidated financial statements should be read in conjunction with the summary of significant accounting policies and notes to consolidated financial statements included in the Company's annual report for its fiscal year ended June 30, 2002. Results of operations for interim periods are not necessarily indicative of the results that may be expected for the full fiscal year. STOCK BASED COMPENSATION The Company accounts for its stock-based employee compensation plans under the intrinsic value method in accordance with Accounts Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation," to its stock based employee compensation.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED MARCH 30, MARCH 31, MARCH 30, MARCH 31, 2003 2002 2003 2002 ---- ---- ---- ---- Net loss, as reported $ (30,425) $ (28,650) $ (35,594) $ (35,594) Less: Total stock-based employee compensation expense determined under the fair value based method for all awards (272) (256) (325) (767) ------------------------------------------------------------------------------------------------------------------------- Pro forma net loss $ (30,697) $ (28,906) $ (36,377) $ (36,361) Basic and diluted-as reported $ (1.10) $ (4.01) $ (0.95) $ (6.06) Basic and diluted-as pro forma $ (1.11) $ (4.04) $ (0.96) $ (6.19)
2. ACQUISITION On September 4, 2002, the Company acquired Cycam, Inc., a company located in Houston, Pennsylvania that manufactures reconstructive implants and instruments. The total purchase price was approximately $24.4 million, which included $18.4 million in cash and 667,175 shares of common stock valued at $6.0 million. The acquisition was recorded using the purchase method of accounting. The preliminary purchase price allocation was $6.0 million to net tangible assets and $18.5 million to goodwill. In conjunction with the acquisition, the Company utilized $8.0 million from the acquisition line under the Company's existing credit facility. -6- The effect of the acquisition on the financial position and results of operations is not material, and therefore no pro forma data of this acquisition is required or presented. 3. INVENTORIES Inventories consisted of the following (in thousands): MARCH 30, JUNE 30, 2003 2002 ----------------------- ---------------------- (UNAUDITED) Raw material $14,843 $10,638 Work-in-progress 6,923 6,529 Finished goods 2,534 3,336 ----------------------- ---------------------- Total $24,300 $20,503 ======================= ====================== 4. COMPREHENSIVE LOSS Comprehensive loss represents net loss attributed to common stockholders plus the results of any stockholders' equity changes relating to the Company's previous interest rate swaps and current interest rate cap agreements. For the three-months ended March 30, 2003 and March 31, 2002, comprehensive loss was $30.5 million and $28.7 million, respectively. For the nine-months ended March 30, 2003 and March 31, 2002, comprehensive loss was $26.3 million and $35.6 million, respectively. 5. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001 with early adoption permitted for companies with fiscal years beginning after March 15, 2001. The Company adopted the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of fiscal 2002. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the statements. Other intangible assets will continue to be amortized over their useful lives. In accordance with SFAS No. 142, as a result of impairment indicators MedSource initiated a goodwill impairment assessment during the third quarter of fiscal 2003. As a result of its preliminary analysis, MedSource recorded a $30 million non-cash impairment charge. The non-cash impairment charge amount may be adjusted when the analysis is finalized during the fourth quarter of 2003. 6. RESTRUCTURING CHARGES In June 2001, the Company completed a strategic review of its manufacturing operations and support functions. Based on this review and with approval of the Board of Directors, management began actions to eliminate redundant facilities and recorded a restructuring charge of $11.5 million. During the period ended March 30, 2003 the Company recorded an additional charge of $1.4 million to cover identified restructuring costs in excess of the original charge of $11.5 million. These excess restructuring costs were a result of closing an additional facility, which was not part of the original restructuring plan. As of the March 30, 2003 all of these restructuring efforts have been completed and their costs recorded. -7- Information relating to the restructuring charges is as follows (in millions):
INCURRED THROUGH BALANCE AT INITIAL ADDITIONAL MARCH 30, MARCH 30, ACCRUAL RECLASS ACCRUAL 2003 2003 ------------- ------------- -------------- ------------ ----------- Impairment of goodwill and other intangibles $ 3.6 -- -- $ 3.6 $ -- Impairment of property, plant and equipment 1.9 $ 2.3 -- 4.2 -- Employee termination benefits 3.8 (1.2) $ 1.2 3.8 0.8 Other direct costs 2.2 (1.1) 0.2 1.3 -- ------------- ------------- -------------- ----------- ------------ $ 11.5 $ 0.0 $ 1.4 $ 12.9 $ 0.8 ============= ============= ============== =========== ============
In June 2002, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit of Disposal Activities, effective for exit or disposal activities that are initiated after December 31, 2002. In January 2003, the Company announced a restructuring initiative that will involve continuing consolidation of our operations network, resulting in a decrease in overall floor space and related overhead costs. Pre-tax charges related to the continuing restructuring efforts are projected to total approximately $15.0 million to $20.0 million and will be incurred through the end of fiscal 2005. In accordance with SFAS 146, these restructuring charges will be recognized when the liability is incurred. As of March 30, 2003 the Company has recognized $0.5 million of costs associated with this initiative. Information relating to the restructuring charges is as follows (in millions):
INCURRED EXPENSED AS OF THROUGH BALANCE AT MARCH 30, MARCH 30, MARCH 30, 2003 2003 2003 ---------------- ---------------- ------------------ Employee termination benefits $ 0.5 $ 0.3 $ 0.2 ---------------- ---------------- ------------------ $ 0.5 $ 0.3 $ 0.2 ================ ================ ==================
7. SUBSEQUENT EVENTS On May 9, 2003, the Company completed an amendment to the Credit Agreement dated April 2, 2002. The amendment contains certain convents, which require the Company to maintain, among other things, a minimum fixed charge coverage ratio and interest coverage ratio and a maximum leverage ratio. If the Company does not comply with its covenants under the Credit Agreement, the maturity date of its obligations under the Credit Agreement could be accelerated. In conjunction with the amendment, we made a payment of $7.5 million in the third quarter, which will be applied to all of our required forth quarter debt payment, approximately half of our first quarter of fiscal 2004 payment, with the balance to be applied pro-rata based on our payments over the remainder of the agreement. -8- ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion in conjunction with our financial statements and related notes appearing elsewhere in this Report on Form 10-Q. 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 in our Form 10-K for the period ended June 30, 2002. 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. OVERVIEW We provide product development and design services, precision metal and plastic part manufacturing, product assembly services and supply chain management. We provide our products and services to each of the following primary target markets: o Surgical instrumentation devices and components; o Electro-medical devices and components; o Interventional devices and components; and o Orthopedic devices 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. We began operations when we acquired seven companies during March 1999 and have subsequently completed six additional acquisitions, most recently HV Technologies, or HVT, in January 2002 and Cycam Inc. in September 2002. (The other four acquisitions were completed before our year ended June 30, 2001.) 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 and instruments, enhances our capabilities within plastic machining, propriety coating technology, clean room knitting and packaging along with multi axis machining. All of our acquisitions were accounted for using the purchase method of accounting. During June 2001, we completed a review of our manufacturing operations and support functions. Based on our evaluation of the unique and common characteristics of our various facilities, we determined that we could achieve over-all cost savings by closing or selling three of the facilities, thus improving capacity utilization and efficiency of the remaining facilities and recorded a charge of $11.5 million in connection with these closings. The Company recorded an additional $1.4 million of restructuring charges in the third quarter of fiscal 2003 because it ultimately closed or sold four facilities (and not three as originally intended). -9- In January 2003, we announced a restructuring initiative that will involve continuing consolidation of our operations network, resulting in a decrease in overall floor space and related overhead costs. Pre-tax charges related to the continuing restructuring efforts are projected to total approximately $15.0 million to $20.0 million and will be incurred through the end of fiscal 2005. As of March 30, 2003 we had recognized $0.5 million of costs associated with this initiative. RESULTS OF OPERATIONS REVENUES We recognize product revenues 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 three months ended March 30, 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 non-medical customers as a percentage of our total revenues have been decreasing over time. Sales to non-medical customers were less than 2% of our total revenues during the three and nine-month periods ended March 30, 2003. Historically, most of our revenues were derived from manufacturing 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. Recent competitive pressures, coupled with the fact that many of our customers' orders are increasingly based on engineering projects with ever longer pre-commercialization phases and device assembly projects that are engineering intensive, but cost sensitive, has put pressure on engineering resources, lengthened our time-to-revenue cycle and increased the demand we face for lower cost products and services. In order to address these competitive pressures, along with the nature of our customer orders described above, we announced a growth strategy and restructuring initiative during January 2003. The initiative is intended to focus additional resources on our medical device assembly and engineering services businesses. The initiative will involve the cost savings measures described below under "-- Cost and Expenses." Our top four customers accounted for 56% of our revenues for the nine months ended March 30, 2003, with three customers accounting for 27%, 13%, and 11% or our revenues respectively. We expect revenues from our largest customers to continue to constitute an increasing portion of our total revenues. We primarily derive our revenues from serving leading medical device companies. These customers are typically large companies with substantial market share in one or more of our four target markets, and we believe that expanding our relationships with these customers represents our most important revenue opportunity. As a result, we devote significant sales efforts to securing additional business from the business units and product lines of the leading medical device companies that we currently serve, as well as developing business with other business units and product lines of these customers. As we increasingly focus on serving leading medical device companies and expand our offerings to them by developing or acquiring additional engineering and manufacturing capabilities, we expect the -10- 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 after 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 selectively make 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. 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, and can result in slightly lower gross margins but with lower capital investment. Additionally, we are seeing an evolving environment resulting in greater demands from our customers and more competition within both our components and assembly business. As a result of these conditions, we have initiated a growth and restructuring plan (described below). 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. The restructuring initiative we announced in January 2003 will result in a decrease in overall floor space and related overhead costs. Once fully implemented, the growth and restructuring imitative should generate cost savings of $6 million to $8 million on an annual basis. Pre-tax charges related to the continuing restructuring efforts are projected to total approximately $15 million to $20 million and will be incurred through the end of fiscal 2005. THREE MONTHS ENDED MARCH 30, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002 Revenues for the three-month period ended March 30, 2003 totaled $44.5 million compared to $42.2 million for the same period of the prior year, an increase of 5.6%. The revenue increase was primarily due to our Cycam acquisition. Excluding the expected decline in shipments reported of non-medical products, -11- the June 2001 company restructuring and increased revenue from the Cycam acquisition, our base medical business increased 6.0% compared to the prior year. These revenue gains were driven by higher demand across all major market segments. Cost of products sold for the three-month period ended March 30, 2003 totaled $34.0 million compared to $31.5 million for the three-month period ended March 31, 2002. The increase in cost of products sold resulted principally from the increase in volume compared to the prior year period and competitive pricing pressure. Gross margin was 23.6% for the three months ended March 30, 2003, compared to 25.3% for the same period of the prior year. The decrease is a result of costs associated with the transfer of production of certain products to other company facilities to achieve long-term operational efficiencies. Selling, general, and administrative expense for the three-month period ended March 30, 2003 totaled $8.4 million, or 18.8% of revenues, compared to $8.3 million, or 19.7% of revenues, for the same period of the prior year. As a result of impairment indicators, the Company initiated a goodwill impairment assessment during the three-month period ended March 30, 2003. As a result of this assessment, a $30.0 million non-cash impairment charge was recorded in the third quarter. The non-cash impairment charge amount may be adjusted when the analysis is finalized during the fourth quarter of 2003. Net interest expense totaled $0.6 million for the three-month period ended March 30, 2003 and $2.4 million for the same prior year period. This was due to both lower debt and interest rates from the prior period as a result of the March 2002 Initial Public Offering (IPO) and the debt refinancing in April 2002. Net loss attributed to common shareholders totaled $30.4 million, or $1.10 per share, compared with a loss of $28.7 million, or $4.01 per share, for the same prior year period. NINE MONTHS ENDED MARCH 30, 2003 COMPARED TO NINE MONTHS ENDED MARCH 31, 2003 Revenues for the nine-month period ended March 30, 2003 totaled $130.1 million compared to $114.3 million for the same period of the prior year, an increase of 13.8%, of which 9.3% was due to acquisitions and 4.5% stemmed from internal growth. Internal growth was driven by increased shipments of products in all of the company's market segments - surgical instrumentation, electomedical implants, interventional medicine and orthopedics. Excluding the already noted expected decline in shipments reported of non-medical products, the June 2001 company restructuring and increased revenue from the HVT and Cycam acquisitions, our base medical business increased 6.0% compared to the prior year. Cost of products sold for the nine-month period ended March 30, 2003 totaled $98.0 million compared to $86.1 million for the nine-month period ended March 31, 2002. The increase in cost of products sold resulted principally from the increase in volume compared to the prior year period. Gross margin was 24.7% for the nine months ended March 30, 2003, and 24.7% for the same period of the prior year. Selling, general, and administrative expense for the nine-month period ended March 30, 2003 totaled $24.5 million, or 18.8% of revenues, compared to $22.6 million, or 19.7% of revenues, for the same period of the prior year. The $1.9 million increase in SG&A resulted primarily from the impact of acquisitions. -12- As a result of impairment indicators, the Company initiated a goodwill impairment assessment during the nine-month period ended March 30, 2003. As a result of this preliminary analysis, a $30.0 million non-cash impairment charge was recorded in the third quarter. The non-cash impairment charge amount may be adjusted when the analysis is finalized during the fourth quarter of 2003. Net interest expense totaled $1.8 million for the nine-month period ended March 30, 2003 and $7.2 million for the same prior year period. This was due to both lower debt and interest rates from the prior period as a result of the March 2002 IPO and the debt refinancing in April 2002. Net loss attributed to common shareholders for the nine-month period ended March 30, 2003 totaled $26.1 million, or $0.95 per share, compared with a loss of $35.6 million, or $6.06 per share, for the same prior year period. LIQUIDITY AND CAPITAL RESOURCES Our principal sources of liquidity are cash provided by operations and borrowings under our senior credit facility, which includes a $15 million unused revolving credit facility. To date, our principal uses of cash have been to finance capital expenditures, meet debt service requirements and finance acquisitions. We expect that these uses will continue in the future. On May 9, 2003, we amended our senior credit facility. The amendment contains certain convents, which require us to maintain, among other things, a minimum fixed charge coverage ratio and interest coverage ratio and a maximum leverage ratio. Consistent with credit facilities of this type, if we do not comply with the covenants in the credit facility, the maturity date of our obligations under the credit facility could be accelerated. In conjunction with the amendment, we made a payment of $7.5 million in the third quarter, which will be applied to all of our required forth quarter debt payment, approximately half of our first quarter of fiscal 2004 payment, with the balance to be applied pro-rata based on our payments over the remainder of the agreement. Management believes that current cash balances and cash generated from operations, combined with available borrowings under our senior credit facility, will be adequate to fund requirements for working capital, capital expenditures, and future expansion for the next 12 months. OPERATING ACTIVITIES Net cash provided by operating activities totaled $5.2 million for the nine months ended March 30, 2003 compared to $0.1 million for the prior year period. The increase in cash provided by operating activities over the prior year period was primarily the result of a $1.1 million loss on retirement of equipment, and a $2.0 million decrease in inventory, offset by a $1.8 million reduction in proceeds from the interest escrow fund received in the prior year period, which did not recur in the current period, as well as a $1.5 million increase in accounts receivable and a $3.2 million reduction in accounts payable and other accrued expenses. INVESTING ACTIVITIES Cash used in investing activities was $33.1 million for the nine months ended March 30, 2003, compared to $12.5 million for the prior year period. This increase was due to cash of $18.4 million used for the acquisition of Cycam. Cash paid for capital expenditures increased $2.5 million when compared to the prior year period. We expect capital expenditures in fiscal 2003 to be approximately $10 to $12 million. -13- FINANCING ACTIVITIES Cash provided by financing activities was $3.8 million for the nine months ended March 30, 2003, compared to $92.0 million for the prior year period. The decrease over the prior period was primarily the result of a $96.3 million decrease of proceeds received from the sale of Series E preferred stock and common stock, offset by proceeds of $8.0 million from the acquisition line under our senior credit facility, in connection with the acquisition of Cycam. CRITICAL ACCOUNTING POLICIES There has been no material change to the Critical Accounting Policies we disclosed in our annual report on Form 10-K for our year ended June 30, 2002. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE RISK Amounts outstanding under our senior credit facility bear interest at a floating rate. To reduce our exposure to interest rate risk, we entered into cap agreements to hedge our exposure to interest rate risk under this facility. Changes in the fair value of the caps will be recorded in Accumulated Other Comprehensive Loss in Stockholders' Equity. We had entered into a similar swap agreement in connection with amounts due under our old senior credit facility. The effect of a 10% increase in interest rates would have resulted in an immaterial increase in interest expense during our period ended March 30, 2003. FOREIGN CURRENCY RISK Most of our sales and purchases are denominated in United States dollars and as a result, we have relatively little exposure to foreign currency exchange risk with respect to our sales. Accordingly, we do not use forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instrument for trading or speculative purposes. The effect of a 10% change in exchange rates as of March 30, 2003 would not have had a material impact on our operating results for the fiscal year then ended. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we are required to filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management's control objectives. Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chairman of the Board and Chief Executive Officer and our Senior Vice President -- Finance and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the foregoing, our Chairman of the Board and Chief Executive Officer and our Senior Vice President -- Finance and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to MedSource (and its consolidated subsidiaries) required to be included in our Exchange Act reports. -14- CHANGES IN INTERNAL CONTROLS There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out the evaluation referred to above. -15- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS RECENT SALES OF UNREGISTERED SECURITIES During January 2003, we issued an aggregate of 46,923 shares of our common stock upon exercise of warrants issued to seven 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 each of the investors used a "cashless" exercise provision that enabled the investors 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 73 shares. We issued these securities in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933 and Rule 506 thereunder. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed herewith: Exhibit Number Description ------ ----------- 10.1 Waiver and Second Amendment to Credit Agreement dated as of May 9, 2003 among the registrant, its subsidiaries, Wachovia Bank, National Association and the lenders named therein 99.1 Certificate of Chief Executive Officer 99.2 Certificate of Chief Financial Officer (b) We did not file any reports on Form 8-K during the period covered by this quarterly report. -16- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: May 14, 2003 MEDSOURCE TECHNOLOGIES, INC. By: /s/ Richard J. Effress ----------------------------------- Richard J. Effress, Chairman and Chief Executive Officer By: /s/ William J. Kullback ----------------------------------- William J. Kullback Senior Vice President - Finance and Chief Financial Officer CERTIFICATION BY PRINCIPAL EXECUTIVE OFFICER I, Richard J. Effress, certify that: 1. I have reviewed this quarterly report on Form 10-Q of MedSource Technologies, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Richard J. Effress -------------------------------- Richard J. Effress Chairman of the Board and Chief Executive Officer CERTIFICATION BY PRINCIPAL FINANCIAL OFFICER I, William J. Kullback, certify that: 1. I have reviewed this quarterly report on Form 10-Q of MedSource Technologies, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ William J. Kullback -------------------------------- William J. Kullback Senior Vice President -- Finance and Chief Financial Officer EXHIBIT INDEX Exhibit Number Description ------ ----------- 10.1 Waiver and Second Amendment to Credit Agreement dated as of May 9, 2003 among the registrant, its subsidiaries, Wachovia Bank, National Association and the lenders named therein 99.1 Certificate of Chief Executive Officer 99.2 Certificate of Chief Financial Officer