10-K 1 a07-6001_110k.htm 10-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-K


x

 

ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the fiscal year ended December 31, 2006

 

 

 

or

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 333-130470

Accellent Inc.

(Exact name of registrant as specified in its charter)

Maryland

 

84-1507827

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

100 Fordham Road

Wilmington, Massachusetts  01887

(978) 570-6900

(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act   Yes o  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes o  No x

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 o

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 the registrant’s knowledge, in definitive proxy for information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o          Accelerated filer  o          Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

The aggregate market value of the voting stock held by nonaffiliates of the registrant as of June 30, 2006: not applicable

As of March 13, 2007, 1,000 shares of the Registrant’s common stock were outstanding.  The registrant is a wholly owned subsidiary of Accellent Holdings Corp.

 




TABLE OF CONTENTS

PART I

 

 

1. Business

 

 

1A. Risk Factors

 

 

1B. Unresolved Staff Comments

 

 

2. Properties

 

 

3. Legal Proceedings

 

 

4. Submission of Matters to a Vote of Security Holders

 

 

PART II

 

 

5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

6. Selected Financial Data

 

 

7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

7A. Quantitative and Qualitative Disclosures About Market Risk

 

 

8. Consolidated Financial Statements and Supplementary Data

 

 

9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

 

9A. Controls and Procedures

 

 

9B. Other Information

 

 

PART III

 

 

10. Directors and Executive Officers of the Registrant

 

 

11. Executive Compensation

 

 

12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

13. Certain Relationships and Related Transactions

 

 

14. Principal Accountant Fees and Services

 

 

PART IV

 

 

15. Exhibits, Financial Statement Schedules

 

 

Signatures

 

 

 

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CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE

SECURITIES LITIGATION REFORM ACT OF 1995

This annual report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended.  In some cases, these “ forward looking statements” can be identified by the use of words like “believes,” “estimates,” “anticipates,” “expects,” “intends,” “may,” “will” or “should” or, in each case, their negative or other variations or comparable terminology. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industry in which we operate.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate may differ materially from those made in or suggested by the forward-looking statements contained in this report. In addition, even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate are consistent with the forward-looking statements contained in this report, those results or developments may not be indicative of results or developments in subsequent periods.

Important factors that could cause our actual results, performance and achievements, or industry results to differ materially from the forward-looking statements are set forth in this report, including under the headings “Item 7—Management Discussion and Analysis of Financial Condition and Results of Operations” and “Item 1A—Risk Factors.”

We undertake no obligation to update publicly or publicly revise any forward-looking statement, whether as a result of new information, future events or otherwise.

OTHER INFORMATION

We maintain our principal executive offices at 100 Fordham Road, Wilmington, Massachusetts 01887, and our telephone number is (978) 570-6900.

We are required to file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other information with the Securities and Exchange Commission (the “SEC”).  You can obtain copies of these materials by visiting the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549, by calling the SEC at 1-800-SEC-0330, or by accessing the SEC’s Web site at www.sec.gov.

PART I

Item 1.  Business

Unless the context otherwise requires, references in this Form 10-K to “Accellent,” “we,” “our,” “us” and “the company” refer to Accellent Inc. and its consolidated subsidiaries, which were acquired pursuant to the Transaction (as described below).  Financial information reported in this Form 10-K include the financial results of each acquired company since each respective acquisition date.

Overview

We believe that we are the largest provider of outsourced precision manufacturing and engineering services in our target markets of the medical device industry. We focus on what we believe are three of the largest and fastest growing segments of the medical device market: cardiology, endoscopy and orthopaedics. Our customers include the leading medical device companies in the world, including Abbott Laboratories, Boston Scientific, Johnson & Johnson, Medtronic, Smith & Nephew, St. Jude, Stryker, Tyco and Zimmer. We provide our customers with reliable, high-quality, cost-efficient, integrated outsourcing solutions that span the complete supply chain spectrum.

Our design and engineering, precision component manufacturing, device assembly and supply chain management services provide multiple strategic benefits to our customers. We help speed our customers’ products to market, lower their manufacturing costs, provide capabilities that they do not possess internally, and enable our customers to concentrate resources on clinical education, research, sales and marketing.

We have developed long-term relationships with our largest customers and work closely with them in the designing, testing, prototyping, validation and production of their products. In many cases, we have been partnering with our key customers for over ten years. Based on discussions with our customers, we believe we are considered a preferred strategic supplier by a majority of our top ten customers, and often become the sole supplier of the manufacturing and engineering

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services that we provide to our customers. Many of the end products we produce for our customers are regulated by the FDA, which has stringent quality standards for manufacturers of medical devices. Complying with these requirements involves significant investments of money and time, which results in stronger relationships with our customers through the multiple validations of our manufacturing process required to ensure high quality and reliable production. The joint investment of time and process validation by us and our customers, along with the possibility of supply disruptions and quality fluctuations associated with moving a product line, often create high switching costs for transferring product lines once a product begins production. Typically, once our customers have begun production of a certain product with us, they do not move their products to another supplier. Further, validation requirements encourage customers to consolidate business with preferred suppliers such as us, whose processes have been validated in the past.

We generate significant recurring revenues from a diverse range of products that generally have long product life cycles. Moreover, the majority of our revenues are generated by high value, single use products that are either regulated for one-time use, implanted into the body or are considered too critical to be re-used. We currently work with our customers on over 10,000 stock keeping units, providing us with tremendous product diversity across our customer base.

Our opportunities for future growth are expected to come from a combination of factors, including market growth for cardiology, endoscopy and orthopaedic devices, increased outsourcing of existing and new products by our customers to us, and increasing our market share of the overall outsourcing market. This growing revenue base is made up of a diversified product mix with limited technology or product obsolescence risk. We manufacture many products that have been used in medical devices for over ten years, such as biopsy instruments, joint implants, pacemakers and surgical instruments. Even as our customers’ end market products experience new product innovation, we continue to supply the base products and services across end market product cycles. For the twelve months ended December 31, 2006, our net sales by end market were:

 

 

 

Cardiology

 

40

%

Endoscopy

 

35

%

Orthopaedic

 

17

%

Industrial

 

8

%

 

 

100

%

 

The Transaction

On November 22, 2005, we completed our merger with Accellent Acquisition Corp., or AAC, an entity controlled by affiliates of Kohlberg Kravis Roberts & Co. L.P., or KKR, pursuant to which Accellent Merger Sub Inc., a wholly-owned subsidiary of AAC, merged with and into Accellent Inc., with Accellent Inc. being the surviving entity (the “Merger”).

In connection with the Merger, entities affiliated with KKR and entities affiliated with Bain Capital (“Bain”) made an equity investment in Accellent Holdings Corp. of approximately $611 million, with approximately $30 million of additional equity rolled over by 58 members of management. Equity rolled over by management includes approximately $19 million of equity in stock options of Accellent, Inc. that was exchanged for stock options in Accellent Holdings Corp., approximately $1 million of after-tax stock option proceeds used by management to acquire common stock of Accellent Holdings Corp., and $10 million of preferred stock of Accellent Inc. exchanged for $10 million of common stock of Accellent Holdings Corp. The equity rolled over by management in the form of stock options included approximately $14 million of equity rolled over by our executive officers, which is comprised of eight individuals. In addition, in connection with the Merger, we:

·                  entered into a senior secured credit facility, consisting of a $400 million senior secured term loan facility and a $75 million senior secured revolving credit facility;

·                  issued $305 million aggregate principal amount of 10½% senior subordinated notes, resulting in net proceeds of approximately $301 million after an approximately $4 million original issue discount;

·                  repaid approximately $409 million of the indebtedness of our subsidiary, Accellent Corp., including pursuant to a tender offer for $175 million 10% senior subordinated notes due 2012; and

·                  paid approximately $73 million of transaction fees and expenses, including tender premiums.

The Merger and related financing transactions are referred to collectively as the “Transaction.”

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Acquisitions by the Company

On June 30, 2004, we acquired MedSource Technologies, Inc., or MedSource. As a result of the merger, we became the largest provider of manufacturing and engineering services to the medical device industry.  We have completed the operational integration and facilities rationalization of MedSource.

On September 12, 2005, we acquired substantially all of the assets of Campbell Engineering, Inc., or Campbell, a manufacturing and engineering firm. Campbell engaged in the business of design, analysis, precision fabrication, assembly and testing of primarily orthopaedic implants and instruments.

On October 6, 2005, we acquired 100% of the outstanding membership interests in Machining Technology Group, LLC, or MTG, a manufacturing and engineering company. MTG specialized in rapid prototyping and manufacturing of specialized orthopaedic implants and instruments.

The Campbell and MTG acquisitions are referred to collectively as the “2005 Acquisitions.”

The results of operations of the acquired companies are included in our results as of the date of each respective acquisition.

Industry Background

We focus on what we believe are three of the largest and fastest growing end markets within the medical device industry: cardiology, endoscopy and orthopaedics.  We believe that these end markets are attractive based on their large size, significant volume growth, relatively high customer profit margins, strong product pipelines, competitive environment and a demonstrated need for our high-quality manufacturing and engineering services.

We target these three end markets by focusing on medical device companies that operate in one or more of these markets. We believe these medical device companies will generate outsourcing opportunities similar to the end markets in which they operate.

We believe that this demand is being driven primarily as a result of:

·                       Aging Population.  The average age of the U.S. population is expected to increase significantly over the next decade. According to U.S. Census data, the total U.S. population is projected to grow approximately 4% from 2006 to 2011, while the number of individuals in the United States over the age of 55 is projected to grow approximately 14% during the same period. As the average age of the population increases, the demand for medical products and services, including medical devices, is expected to increase as well.

·                       Active Lifestyles.  As people are living longer, more active lives, the adoption of medical devices such as orthopaedic implants and arthroscopy devices has grown. In addition, in order to maintain this active lifestyle, patients demand more functional, higher technology devices.

·                       Advances in Medical Device Technology.  The development of new medical device technology is driving growth in the medical device market. Examples include neurostimulation, minimally invasive spinal repair, vascular stenting and innovative implantable defibrillators, which are experiencing increased adoption in the medical community because of the significant demonstrated patient benefits.

·                       Increased Global Utilization.  The global medical device market is largely concentrated in North America, Western Europe and Japan. As the United States is the major global supplier of medical devices, the aging of the European and Japanese populations and the increased global utilization of medical devices further add to medical device volume growth. Emerging countries in Asia, South America and Eastern Europe are also increasing their consumption of medical devices due to enhanced awareness and increasing financial flexibility.

·                       Increase in Minimally Invasive Technologies.  The medical device market is witnessing a major shift away from invasive or open surgical procedures to minimally invasive procedures and technologies. Minimally invasive procedures have been developed to reduce the pain, trauma, recovery time and overall costs resulting from open and more invasive procedures. The continued adoption of such minimally invasive technologies is expected to continue driving growth in the overall medical device market.

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The chart below provides examples of customer products in our targeted markets and the products and services that we provide for each of the customer end products.

Market

 

Customer Devices/Products

 

Our Products and Services

 

 

 

 

 

Cardiology

 

 

 

 

Interventional Cardiology

 

·  Stents

 

·  Stent tubing, stents, mandrels

 

 

·  Rotational artery clearing device

 

·  Ground guidewires, tubular drive components

 

 

·  Guidewires, delivery systems

 

·  Marker bands, catheter shafts, tooling mandrels, corewires, guidewire assemblies

Cardiac Rhythm Management

 

·  Pacemakers

 

·  Implantable electrodes, connector blocks, lugs

 

 

·  Implantable defibrillators

 

·  Electrodes & leads

Cardiac Surgery

 

·  Heart immobilization devices

 

·  Machined tubing

 

 

·  Heart valves

 

·  Machined valve bodies and leaflets

Interventional Neurology

 

·  Implantable coils

 

·  Wire coiling

 

 

·  Catheters/delivery systems

 

·  Guidewires

Peripheral Vascular

 

·  Stents/Delivery systems

 

·  Stents, stent tubing, guidewires, hypotubing

 

 

 

 

 

Endoscopy

 

 

 

 

Laparoscopy/Gynecology

 

·  Harmonic scalpel blades

 

·  Blade assemblies

 

 

·  Breast biopsy devices

 

·  Tubular components, stamped components

 

 

·  Trocars

 

·  Tubular components and complete assemblies

 

 

·  Birth control devices

 

·  Tubular machined components

 

 

 

 

·  Complete finished devices

Arthroscopy

 

·  Shaver blades

 

·  Blade assemblies

 

 

·  Arthroscopes

 

·  Arthroscope tubing

 

 

·  Suture anchors

 

·  Machined anchors, drivers

Urology

 

·  Stone retrieval baskets

 

·  Wire grinding

 

 

·  Thermal tumor shrinkage

 

·  Catheter design and fabrication

 

 

·  Bladder stapling devices

 

·  Finished goods

Gastrointestinal

 

·  Biopsy forceps

 

·  MIM jaws

 

 

 

 

·  Plastic catheters

 

 

 

 

·  Plastic injection molded assemblies

Ophthalmology

 

·  Ultrasonic tips

 

·  Micro tube drawing and machining

Drug Delivery

 

·  Drug pumps

 

·  Case stamping

 

 

 

 

·  Hypotube needle fabrication

Wound Closure

 

·  Stapling devices

 

·  Stamped components

 

 

 

 

·  MIM jaws and Anvils

 

 

 

 

·  Tubular components

Orthopaedics

 

 

 

 

Joint Replacement

 

·  Artificial hip, knee & extremity implants

 

·  Hip stems & sleeves, acetabular shells & liners, tibial trays, posts, inserts & wedges, femoral components, glenoids, shoulder stems, ankle, finger & toe components. Forgings, surface treatment & engineering services to

 

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support customer implant programs

 

 

·  Hip and knee trials

 

·  Same as implants above, but machined from plastic, aluminum and stainless steel. Used for sizing implants

 

 

·  Procedure specific instruments

 

·  Impactors, implant holders, reamers, drills, taps, tamps, alignment guides, cutting blocks, screw drivers, torque wrenches

Spinal

 

·  Fusion components, artificial discs, and dynamic stabilization system implants

 

·  Plates, screws, rods, cross-connectors, metal discs, polyurethane inserts, surface treatments

 

 

·  Procedure specific instruments

 

·  Screwdrivers, torque wrenches, gages, implant holders, reamers, cutting guides

 

 

·  Orthobiologics

 

·  Single use sterile delivery system design, manufacture & assembly & packaging, Machined synthetic bone substitutes and packaging

Trauma

 

·  Implants

 

·  Maxillofacial plates & screws, compression plates & screws, IM nail, fixation screws

 

 

·  External Fixation

 

·  Clamps, hooks, screws

 

 

·  Procedure specific instruments

 

·  Screwdrivers, drills, taps, reamers, alignment guides

 

Medical Device Companies in Our Key Target End Markets Are Outsourcing Manufacturing, Design and Engineering.  As medical devices have become more technically complex, the demand for precision manufacturing capabilities and related engineering services has increased significantly. Many of the leading medical device companies in our end markets are increasingly utilizing third-party manufacturing and engineering providers as part of their business and manufacturing strategies. Outsourcing allows medical device companies to take advantage of the manufacturing technologies, economies of scale and supply chain management expertise of third-party manufacturers.  In addition, outsourcing enables medical device companies to concentrate resources on clinical education, research, sales and marketing.

Medical device companies carefully select their manufacturing and engineering outsourcing partners primarily based on quality and reliability. Medical devices companies require stringent validation processes and manufacturing standards to ensure high quality production and reliable delivery. The validation and approval process for third-party manufacturing requires a significant amount of time and engineering resources that often result in long-term relationships. These processes may also include inspection by the FDA of the manufacturing facilities in connection with products undergoing pre-market regulatory review. As a result, we believe that medical device companies increasingly seek to reduce the number of suppliers they use by consolidating with a limited number of strategic partners with demonstrated track records. We believe that medical device companies are choosing their strategic outsourcing partners based on the partner’s ability to:

·                                          Provide comprehensive precision manufacturing and engineering capabilities

·                                          Deliver consistently high quality and highly reliable products at competitive prices

·                                          Assist in rapid time-to-market and time-to-volume manufacturing requirements

·                                          Manage a global supply chain

We believe our current target market will continue to increase due to both the growth in medical device end markets and an increase in outsourcing by medical device companies. Key factors driving increased penetration in outsourcing include:

·                       Desire to Accelerate Time-to-Market.  The leading medical device companies are focused on clinical education, research, sales and marketing in order to maximize the commercial potential from new products. For

7




 

                        these new products, the medical device companies are attempting to reduce development time in order to bring products to market faster and compete more effectively. Outsourcing enables medical device companies to accelerate time-to-market and clinical adoption.

·                       Increasing Complexity of Manufacturing Medical Device Products.  As medical device companies seek to provide additional functionality in their products, the complexity of the technologies and processes involved in producing medical devices has increased. Medical device outsourcing companies have invested in facilities with comprehensive services and experienced personnel to deliver precision manufacturing services for these increasingly complex products.  Medical device companies may also outsource because they do not possess the capabilities to manufacture their new products and/or manufacture them in a cost effective manner.

·                       Rationalization of Medical Device Companies’ Existing Manufacturing Facilities.  Medical device companies are continually looking to reduce costs and improve efficiencies within their organizations. As medical device companies rationalize their manufacturing base as a way to realize cost savings, they are increasingly turning to outsourcing. Through outsourcing, medical device companies can reduce capital investment requirements and fixed overhead costs, as well as benefit from the economies of scale of the third-party manufacturer.

·                       Increasing Focus on Clinical Education, Research, Sales and Marketing.  We believe medical device companies are increasingly focusing resources on clinical education, research, sales and marketing. Outsourcing enables medical device companies to focus greater resources on these areas while taking advantage of the manufacturing technologies, economies of scale and supply chain management expertise of third-party manufacturers.

·                       Reduced Product Development and Manufacturing Costs.  We provide comprehensive services, including design and development, raw material sourcing, component manufacturing, final assembly, quality control and sterilization, and warehousing and delivery, to our customers, often resulting in lower total product development costs.

Competitive Strengths

Our competitive strengths make us a preferred strategic partner for many of the leading medical device companies and position us for profitable growth. Our preferred provider status is evidenced through our long-term customer relationships, sole source agreements and/or by official designations.

·                  Market Leader.  We believe that we are the largest provider of outsourced precision manufacturing and engineering services in our target markets. We continue to invest in information technology and quality systems that enable us to meet or exceed the increasingly rigorous standards of our customers and differentiate us from our competitors.

·                  Strong Long-Term Strategic Partnerships With Targeted Customers.  Based on discussions with our customers, we believe we are considered a preferred strategic supplier to a majority of our top ten customers and often become the sole supplier of manufacturing and engineering services for a significant portion of the products we provide to our customers. We have a highly focused sales force dedicated to serving the leading medical device manufacturers, many of which we have had relationships with for at least ten years. Within these large customers, we generate diversified revenue streams across separate divisions and multiple products. As a result of our strong relationships, we are well-positioned to compete for a majority of our customers’ outsourcing needs and benefit as our customers seek to reduce their supplier base.

·                  Breadth of Manufacturing and Engineering Capabilities.  We provide a comprehensive range of manufacturing and engineering services, including design, testing, prototyping, production and device assembly, as well as global supply chain management services. We have approximately 200 engineers available to help design, prototype and test feasibility and manufacturability. We have made significant investments in precision manufacturing equipment, information technology and quality systems. Our facilities have areas of expertise and capabilities which allow us to provide proprietary manufacturing services. In addition, our internal R&D team has developed innovative automation techniques that create economies of scale that can reduce production costs and often enable us to manufacture products at lower costs than our customers and competitors.

·                  Reputation for Quality.  We believe that we have a reputation as a high quality manufacturer. Our manufacturing facilities follow a single uniform quality system and are ISO 13485 certified, a quality standard that is specific to medical devices and the most advanced level attainable. Due to the patient-critical and highly

8




 

                        regulated nature of the products our customers provide, strong quality systems are an important factor in our customers’ selection of a strategic manufacturing partner. As a result, our reputation and experience provide us with an advantage in winning new business as large medical device companies want to partner with successful, proven manufacturers who have the systems and capabilities necessary to deliver a high level of quality that is comparable to their own.

·                  Strategic Locations.  We believe that the location of our design, prototyping and engineering centers near our major customers and the location of certain of our facilities in advantageous manufacturing centers provide us with a competitive advantage. Our strategic locations allow us to facilitate speed to market, rapid prototyping, low cost assembly and overall customer familiarity. For example, our design, prototyping and engineering centers near Boston, Massachusetts, Minneapolis, Minnesota, and Memphis, Tennessee; our manufacturing centers in Galway, Ireland, and near Minneapolis, Minnesota are strategically located near our major customers. In addition, our Juarez, Mexico facility provides our customers with a low-cost manufacturing and assembly solution.

·                  Experienced and Committed Management Team.  We have a highly experienced management team at both the corporate and operational levels.  Members of our management team also have extensive experience in mergers, acquisitions and integrations.

Business Strategy

Our objective is to follow a focused and profitable growth strategy, and to strengthen our position as the leading provider of outsourced precision manufacturing and engineering services to our target markets through the following:

·                       Grow Our Revenues.  We are focused on increasing our share of revenues from the leading companies within our target markets, and gaining new customers within these markets. We believe the strength of our customer relationships and our customer-focused sales teams, in combination with our comprehensive engineering and operating capabilities put us in a preferred position to capture an increasing percentage of new business with existing customers, and gain new customers.

·                       Increase Manufacturing Efficiencies.   We are implementing  our “Lean Sigma Manufacturing” program focused on improving overall process control and cycle time reduction while substantially increasing our labor, equipment and facility efficiencies.  The program is aimed at reducing our overall manufacturing costs and improving our capital and facility utilization necessary to support our continued growth.  The program consists of standardized training for all Accellent employees in both lean and six sigma fundamentals including standard tools to support the identification and elimination of waste and variation.  We are also deploying customized training for specialized job functions to increase our population of Lean Sigma certified employees.

·                       Expand Design and Prototyping Capabilities and Presence.  We intend to grow revenues from design and prototyping services by continuing to invest in selected strategic locations and equipment. We currently have design facilities for cardiology near Minneapolis, Minnesota, endoscopy near Boston, Massachusetts, and orthopaedics near Memphis, Tennessee. We believe being involved in the initial design and prototyping of medical devices positions us favorably to capture the ongoing manufacturing business of these devices as they move to full production.

·                       Provide an Integrated Supply Chain Solution.  We are constantly adding strategic capabilities in order to provide a continuum of service for our customers throughout their product life cycles, thereby allowing them to reduce the number of vendors they deal with and focus their resources on speed to market. These capabilities range from concept validation and design and development, through manufacturing, warehousing and distribution.  We are also evaluating other low cost capabilities, including Far East sourcing.

·                       Selectively Pursue Complementary Acquisitions.  The fragmented nature of the medical device outsourcing industry presents opportunities for us to selectively pursue complementary acquisitions, which would allow us to expand our scope and scale to further enhance our offering to our customers.

Capabilities

As medical device companies’ outsourcing continues to grow, we believe that our customers’ reliance upon the breadth of our capabilities increases. Our capabilities include Design and Engineering, Precision Component Manufacturing, Device Assembly and Supply Chain Management.

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Design and Engineering.  We offer design and engineering services that include product design engineering, design for manufacturability, analytical engineering, rapid prototyping and pilot production. We focus on providing design solutions to meet our customers’ functional and cost needs by incorporating reliable manufacturing and assembly methods. Through our engineering design services, we engage our customers early in the product development to reduce their manufacturing costs and accelerate the development cycle.

Capability

 

Description & Customer Application

Product Design Engineering

 

Computer Aided Design (CAD) tool used to model design concepts which supports the design portion of the project, freeing the customer’s staff for additional research

Design for Manufacturability

 

Experience in manufacturing and process variation analysis ensures reliability and ongoing quality are designed in from the onset which eliminates customers’ need for duplicate quality assurance measures, provides for continuous improvement and assures long-term cost control objectives are met

Analytical Engineering

 

Finite Element Analysis (FEA) and Failure Mode and Effect Analysis (FMEA) tools verify function and reliability of a device prior to producing clinical builds which shortens the design cycle allowing products to reach the market faster and more cost effectively

Physical Models

 

Computer Aided Manufacturing (CAM), Stereolithography and “Soft Tooling” concepts which permit rapid prototyping to provide customers with assurance that they have fulfilled the needs of their clinical customers and confirms a transition from design to production

Pilot Production

 

Short run manufacturing in a controlled environment utilizing significant engineering support to optimize process prior to production transfer, which provides opportunity to validate manufacturing process before placement in a full scale manufacturing environment

 

Precision Component Manufacturing.  We utilize a broad array of manufacturing processes to produce metal and plastic based medical device components. These include metal forming, machining and molding and polymer molding, machining and extrusion processes.

Capability

 

Description & Customer Application

Tube Drawing

 

Process to manufacture miniature finished tubes or tubular parts used in stents, cardio catheters, endoscopy instruments & orthopaedic implants

Wire Drawing

 

Specialized clad wires utilized in a variety of cardiology and neurological applications

Wire Grinding & Coiling

 

Secondary processing of custom wires to create varying thicknesses, or shapes (springs) used in “guide-wires” and catheters for angioplasty and as components in neurological applications

Micro-Laser Cutting

 

Process involves using a laser to remove material in tubular components resulting in tight tolerances and the ability to create the “net like” shapes used in both cardiology and peripheral stents

CNC Swiss Machining

 

Machining process using a predetermined computer controlled path to remove metal or plastic material thereby producing a three dimensional shape. Used in orthopaedic implants such as highly specialized bone screws and miniature components used in cardiac rhythm management

High Speed CNC multi-axis Profile Machining

 

Machining process using a predetermined computer controlled path to remove metal or plastic material thereby producing a three dimensional shape. Used to produce orthopaedic implants where precise mating surfaces are required

Electrical Discharge Machining (EDM)

 

Machining process using thermal energy from an electrical discharge to create very accurate, thin delicate shapes and to manufacture complete components used in arthroscopy, laparoscopy and other surgical procedures

Plastic Injection Molding

 

Melted plastic flows into a mold which has been machined in the mirror image of the desired shape; process is used throughout the medical industry to create components of assemblies and commonly combined with metal components

Metal Injection Molding

 

Metal powders bound by a polymer are injected into a mold to produce a metal part of the desired shape; used in higher volume metal applications to reduce manufacturing costs in orthopaedics, endoscopy, arthroscopy and other procedures

Plastic Extrusion

 

Process that forces liquid polymer material between a shaped die and mandrel to produce a continuous length of plastic tubing; used in cardiology catheter applications

 

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Capability

 

Description & Customer Application

Alloy Development

 

Product differentiation in the medical device industry is commonly driven by the use of alternative materials; we work with our customers to develop application-specific materials that offer marketable features and demonstrable benefits

Forging

 

Process using heat and impact to “hammer” metal shapes and forms. Secondary processing needed to bring to finished form. Most often to fabricate surgical instruments within the medical industry

 

Device Assembly.  Device assembly is being driven by the medical device companies’ focus on more products being released in shorter timeframes. To fulfill this growing need, we provide contract manufacturing services for complete/finished medical devices at our U.S., Mexico and Ireland facilities. We provide the full range of assembly capabilities defined by our customers’ needs, including packaging, labeling, kitting and sterilization.

Capability

 

Description & Customer Application

Mechanical Assembly

 

Uses a variety of sophisticated attachment methods such as laser, plasma, ultrasonic welding, or adhesives to join components into complete medical device assemblies

Electro-Mechanical Assembly

 

Uses a combination of electrical devices such as printed circuit boards, motors and graphical displays with mechanical sub-assemblies to produce a finished medical device

Marking/Labeling & Sterile Packaging

 

Use of laser or ink jet marking, or pad printing methods for product identification, branding, and regulatory compliance; applying packaging methods such as form-fill-seal or pouch-fill-seal to package individual medical products for sterilization and distribution

 

Supply Chain Management.  Our supply chain management services encompass the complete order fulfillment process from raw material to finished devices for entire product lines. This category of capabilities is an umbrella for the capabilities listed above, not only including design and engineering, component manufacturing and device assembly but also raw materials sourcing, quality control/sterilization and warehousing and delivery, which are described below.

Capability

 

Description & Customer Application

Raw Materials Sourcing

 

Procurement and consulting on the choice of raw materials, allow design and materials suitability

Quality Control/Sterilization

 

The ability to design and validate quality control systems that meet or exceeds customer requirements. In addition, we provide validated sterilization services

Warehousing and Delivery

 

The ability to provide customer storage and distribution services, including end user distribution

 

Business Segments

We have three reporting units: cardiology, endoscopy and orthopaedics. We have determined our three reporting units meet the aggregation criteria of paragraph 17 of SFAS No. 131, and are treated as one reportable segment. See note 15 to our consolidated financial statements.

Cardiology.  Diseases involving disorders of the heart and blood vessels are one of the leading causes of death in developed countries. Interventional Cardiology, Electrophysiology and the Cardiac Rhythm Management (CRM) markets are the largest revenue generators in the cardiology segment. In response to these growing markets, medical device companies are developing innovative and often less invasive products such as cardiac resynchronization and drug eluting stents.

We have a long history of service to the cardiology market. We design, develop, manufacture and assemble implants and instruments for CRM, interventional cardiology, cardiac surgery and peripheral vascular markets. These precision products are typically produced from plastic materials, electronic components, specialized metals and precious metals. We provide a diverse range of products to this market, including stent tubing, guidewires & delivery systems, implantable pacemaker electrodes, marker bands, header assemblies for pacing and defibrillator units and machined heart valve assemblies.

Endoscopy.  The medical device market is shifting away from open surgical procedures to minimally invasive procedures and technologies to reduce pain, trauma and recovery time. The continued adoption of such minimally invasive technologies is expected to continue driving growth in the overall medical device market.

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In order to take advantage of these market trends, we design, develop, manufacture and assemble implants, instruments and equipment for use in minimally invasive procedures. Our experience encompasses the electrosurgical, laparoscopic, wound closure, opthalmic surgery, gynecology and arthroscopic markets. Endoscopy devices are produced from high quality materials suited for each individual device performance requirements and application, including precision metals and plastics processing technology. Our extensive design and development expertise, precision component manufacturing and advanced assembly competencies offer our customers comprehensive endoscopy device manufacturing services.

Orthopaedics.  Growth in the orthopaedic market is being driven by demographics and technological advances. The aging population and an accelerating interest in an active lifestyle are leading to an increased incidence of orthopaedic injuries. Additionally, innovation, especially in less invasive surgical techniques, has reduced the recovery time and minimized patient discomfort improving post-operative outcomes.

Orthopaedic companies are demanding more from their supply chain and we meet those challenges with a comprehensive portfolio of services aimed at addressing the critical needs of the orthopaedic industry. We develop, manufacture and assemble implants and instruments for the reconstructive, spinal, trauma, and sports medicine segments. Our capabilities include a forging facility as well as our proprietary CHEMTEX® surface treatment to facilitate bone in-growth. With multiple manufacturing sites and hundreds of CNC machines, we have the scale and resources to simplify our customers’ supply chain.

Sales and Marketing

We market and sell our products directly to our customers through our sales team of approximately 35 individuals; 32 individuals are based in the United States, and 3 individuals are based in Europe.  In addition, we have a network of independent manufacturer’s representative firms to sell our products primarily outside of the United States.

Our sales force targets the top medical device customers in each of the target markets that we serve. Each of these top accounts is assigned dedicated Corporate Account Teams based upon the target markets in which they participate. The primary mission of our sales force is to increase our market share with these top customers by expanding our relationships and securing new business. Our end market focus allows us to better understand our customers’ specific needs.

The engineering expertise of our sales force allows us to provide technical assistance and advice to our customers in the field. This assistance and advice strengthens our close working relationships between our sales personnel and our customers.

Customers

Our customers include the top worldwide medical device manufacturers that concentrate primarily in the cardiology, endoscopy and orthopaedics markets. We have built strong relationships with our customers by delivering highly customized and engineered components, assemblies and finished goods for their markets. For the twelve months ended December 31, 2006, approximately 92% of our net sales were derived from our medical device customers.

Our strategy is to focus on leading medical device companies, which we believe represent a substantial portion of the overall market opportunity. For the twelve months ended December 31, 2006, our 10 largest medical device customers accounted for approximately 59% of our net sales.  In particular, Boston Scientific, Johnson & Johnson and Medtronic each accounted for more than 10% of our net sales for the twelve months ended December 31, 2006. We provide a multitude of products and services to our customers across their various divisions.

We also have established customer relationships with companies outside of the medical device market. Our industrial customers service the electronic, computer, industrial equipment and consumer markets. We provide them with high quality, complex components for use in high density discharge lamps, fiber optics, motion sensors and power generation.

International Operations

For the twelve months ended December 31, 2006, approximately 14% of our sales were international sales. There are additional risks associated with our international sales than with domestic sales, including those resulting from currency fluctuations, duties and taxation, foreign legal and regulatory requirements, changing labor conditions and longer payment cycles.  See note 15 to our consolidated financial statements for revenues and long-lived assets by country.

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Information Technology

We are in the process of installing the Oracle 11i enterprise resource planning, or ERP, system across our facilities. Building upon a core existing deployment of Oracle ERP at several of our sites, this project will upgrade and deploy a full implementation of ERP functionality at all of our facilities.  We completed the implementation of the Oracle ERP system at four of our manufacturing locations during 2006, and we expect to complete further implementations at several other manufacturing locations during 2007.  We expect to complete the implementation of the Oracle ERP system at all of our locations by the end of 2008.  We believe our ERP platform and related information technology systems will enable us to better serve our customers by aiding us in predicting customer demand, utilizing latest production planning methodologies, taking advantage of economies of scale in purchasing, providing greater flexibility to move product from design to manufacturing at various sites and improving the accuracy of capturing and estimating our manufacturing and engineering costs. In addition, we utilize computer aided design, CAD, and computer aided manufacturing, or CAM, software at our facilities which allows us to improve our product quality and enhance the interactions between our engineers and our customers. We focus our systems to provide direct business benefits to us, our customers and our suppliers.

Quality

Due to the patient-critical and highly regulated nature of the products our customers provide, strong quality systems are an important factor in our customers’ selection of a strategic manufacturing partner. In order for our customers to outsource manufacturing to us, our quality program must meet or exceed customer requirements.

Our Quality Management System is based on the standards developed by the International Organization for Standardization (ISO) and the FDA’s Quality System Regulation. These standards specify the requirements necessary for a quality management system to consistently provide product that meets or exceeds customer requirements. Also included are requirements for processes to ensure continual improvement and continued effectiveness of the system. Compliance to ISO Standards is assessed by independent audits from an accredited third party (a Registrar) and through internal and customer audits of the quality system at each facility.

We have registered our facilities under a single Quality Management System which conforms to ISO 13485:2003, “Medical Devices—Quality management systems—Requirements for regulatory purposes.”

Additionally we are deploying our “lean manufacturing” program throughout the Company. The lean manufacturing program supports the quality system and drives continuous improvement by utilizing six sigma principles. The principles of the six sigma methodology (Define, Measure, Analyze, Improve and Control) allow the sources of variation in a process to be identified, systematically reduced and controlled to maintain the improvements.

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 most cases we have pass-through pricing arrangements with our customers that purchase precious metal components.

When manufacturing and assembling medical devices, we may subcontract manufacturing services that we cannot perform in-house. As we provide our customers with a fully integrated supply chain solution, we will continue to rely on third-party suppliers, subcontractors and outside sources for components or services that we cannot provide through our internal resources.

To date, we have not experienced any significant difficulty obtaining necessary raw materials or subcontractor services.

Intellectual Property

The products that we manufacture are made to order based on the customers’ specifications and may be designed using our design and engineering services. Generally, our customers retain ownership of and the rights to their products’ design while we retain the rights to any of our proprietary manufacturing processes.

We continue to develop intellectual property primarily in the areas of process engineering and materials development for the purpose of internal proprietary utilization. Our intellectual property enhances our production capabilities, and improves margins in our manufacturing processes while providing a competitive differentiator. Examples of technologies developed include improvements in micro profile grinding, polymer micro tube manufacturing, metal injection molding, and surface enhancement methods for surgical implants.

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We also continue to develop intellectual property for the purpose of licensing certain technologies to our medical device customers. Use of these technologies by our medical device customers in their finished design, component or material solution results in additional royalty revenues. Examples of licensed technologies include improvements to catheter based applications, gastrointestinal surgical devices, and vascular stents.

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 practice inventions in patents held by third parties in connection with precision metal injection manufacturing technology.

Competition

The medical device outsourced manufacturing and engineering services industry has traditionally been highly fragmented with several thousand companies that have limited manufacturing capabilities and limited sales and marketing expertise. We believe that very few companies offer the scope of manufacturing capabilities and services that we provide to medical device companies, however, we may compete in the future against companies that assemble broad manufacturing capabilities and related services. We compete with different companies depending on the type of product or service offered or the geographic area served. We are not aware of a single competitor that operates in all of our target markets or offers the same range of products and services that we offer.

Our existing or potential competitors include suppliers with different subsets of our manufacturing capabilities, suppliers that concentrate on niche markets, and suppliers that have, are developing, or may in the future develop, broad manufacturing capabilities and related services. We compete for new business at all phases of the product lifecycle, which includes development of new products, the redesign of existing products and transfer of mature product lines to outsourced manufacturers. Competition is generally based on reputation, quality, delivery, responsiveness, breadth of capabilities, including design and engineering support, price, customer relationships, and increasingly the ability to provide complete supply chain management rather than individual components.

Many of our customers also have the capability to manufacture similar products in house, if they so choose.

Government Regulation

Our business is subject to governmental requirements, including those federal, state and local environmental laws and regulations governing the emission, discharge, use, storage and disposal of hazardous materials and the remediation of contamination associated with the release of these materials at or from our facilities or off-site disposal locations. Many of our manufacturing processes involve the use and subsequent regulated disposal of hazardous materials. We monitor our compliance with all federal and state environmental regulations, and have in the past paid civil penalties and taken corrective measures for violations of environmental laws.  In anticipation of proposed changes to air emission regulations, we are planning to incorporate new air emission control technologies at one of our manufacturing sites which uses a regulated substance.  To date, such matters have not had a material adverse impact on our business or financial condition. We cannot assure you, however, that such matters will not have a material impact on us in the future.

In several instances, we have entered into settlements arising from alleged liability as potentially responsible parties for the off-site disposal or treatment of hazardous substances. None of those settlements have had a material adverse impact on our business or financial condition.

Environmental laws have been interpreted to impose strict, joint and several liability on owners and operators of contaminated facilities and parties that arrange for the off-site disposal or treatment of hazardous materials. Pursuant to such laws in 2001, the United States Environmental Protection Agency, or EPA, approved a Final Design Submission submitted by UTI Corporation (“UTI”), our wholly owned subsidiary, to the EPA in respect of a July 1988 Administrative Consent Order issued by the EPA. The Administrative Consent Order alleged that hazardous substances had been released into the environment from UTI’s Collegeville, Pennsylvania plant and required UTI to study and, if necessary, remediate the groundwater and soil beneath and around the plant. Since that time, UTI has implemented and is operating successfully a contamination treatment system approved by the EPA.  Other of our subsidiaries also operate or formerly operated facilities located on properties where environmental contamination may have occurred or be present.

At December 31, 2006, we have a long-term liability of $3.7 million related primarily to the Collegeville remediation.  We have prepared estimates of our potential liability for these properties, if any, based on available information. Changes in EPA standards, improvement in cleanup technology and discovery of additional information, however, could affect the estimated costs associated with these matters in the future.

We are a medical device and component manufacturing and engineering services provider. Some of the products that we manufacture may be considered by the FDA to be finished medical devices. The manufacturing processes used in the

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production of these finished medical devices are subject to FDA regulatory-inspection, and must comply with FDA regulations, including its Quality System Regulation, or QSR. The QSR requires manufacturers of finished medical devices to follow elaborate design, testing, control, documentation and other quality assurance procedures during the finished device manufacturing process. The QSR governs manufacturing activities broadly defined to include activities such as product design, manufacture, testing, packaging, labeling, distribution and installation. Some of our customers may also require by contractual agreement that we comply with the QSR when manufacturing their device components. Our FDA registered facilities are subject to FDA inspection at any time for compliance with the QSR and other FDA regulatory requirements. Failure to comply with these regulatory requirements may result in civil and criminal enforcement actions, including financial penalties, seizures, injunctions and other measures. In some cases, failure to comply with the QSR could prevent or delay our customers from gaining approval to market their products. Our products must also comply with state and foreign regulatory requirements.

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 U.S., 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 U.S., we will be subject to the medical device manufacturing regulations of those countries. Our Mexico facility must comply with U.S. FDA regulations, which we believe are more stringent than the local regulatory requirements our facility must also comply with. Some other countries may rely upon compliance with U.S. 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.

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.

Employees

As of December 31, 2006, we had 3,289 employees. We also employ a number of temporary employees to assist with various projects. Other than some employees at our facility in Aura, Germany, our employees are not represented by any union. We have never experienced a work stoppage or strike and believe that we have good relationships with our employees.

Item 1A.  Risk Factors

We may occasionally make forward-looking statements and estimates such as forecasts and projections of our future performance or statements of our plans and objectives.  These forward-looking statements may be contained in, among other things, SEC filings, including this annual report on Form 10-K, press releases made by us, and in oral statements made by our officers.  Actual results could differ materially from those contained in such forward-looking statements.  Important factors that could cause our actual results to differ from those contained in such forward-looking statements include, among other things, the risks described below.

We have a substantial amount of indebtedness which may adversely affect our cash flow and our ability to operate our business, remain in compliance with debt covenants and make payments on our indebtedness.

As of December 31, 2006, our total indebtedness was $701 million. We also have an additional $66 million available for borrowing under the revolving portion of our senior secured credit facility at December 31, 2006.  We also are permitted to incur up to an additional $100 million of senior secured debt under our senior secured term loan facility at the option of participating lenders subject to certain conditions.

Our substantial indebtedness could have important consequences, including:

·              making it more difficult for us to make payments on our senior subordinated notes;

·              increasing our vulnerability to general economic and industry conditions;

·                                          requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;

·                                          exposing us to the risk of increased interest rates as certain of our borrowings, including borrowings under our senior secured credit facility, will be at variable rates of interest;

·              restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;

 

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·                                          limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions and general corporate or other purposes; and

·              placing us at a disadvantage compared to our competitors who have less debt.

We and our subsidiaries may be able to incur substantial additional indebtedness in the future, subject to the restrictions contained in our senior secured credit facility and the indenture governing our senior subordinated notes. If new indebtedness is added to our current debt levels, the related risks that we now face could intensify.

Our debt agreements contain restrictions that limit our flexibility in operating our business.

Our senior secured credit facility and the indenture governing our senior subordinated notes contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our and our restricted subsidiaries’ ability to, among other things:

·                                          incur additional indebtedness;

·                                          pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments;

·                                          make certain investments;

·                                          sell certain assets;

·                                          create liens;

·                                          consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

·                                          enter into certain transactions with our affiliates.

In addition, under the senior secured credit facility, we are required to satisfy and maintain specified financial ratios and other financial condition tests. Our ability to meet those financial ratios and tests can be affected by events beyond our control. We may not be able to meet these ratios and tests in future periods. A breach of any of these covenants could result in a default under the senior secured credit facility. Upon the occurrence of an event of default under the senior secured credit facility, the lenders could elect to declare all amounts outstanding under the senior secured credit facility to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under the senior secured credit facility could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all of our assets as collateral under the senior secured credit facility. If the lenders under the senior secured credit facility accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay the senior secured credit facility and the notes.

Our debt agreements contain various covenants, including a maximum ratio of consolidated net debt to consolidated adjusted EBITDA (“Leverage Ratio”) and a minimum ratio of consolidated adjusted EBITDA to consolidated interest expense (“Interest Coverage Ratio”).  Both of these ratios are calculated at the end of each fiscal quarter based on our trailing twelve month financial results.  At December 31, 2006, our Leverage Ratio was 6.86 versus a required maximum of 7.25.  The required maximum Leverage Ratio under our debt agreements adjusts down to 6.50 for the quarter ended December 31, 2007.  At December 31, 2006, our Interest Coverage Ratio was 1.67 versus a required minimum of 1.50.  The required minimum Interest Coverage Ratio adjusts up to 1.60 for the quarter ended December 31, 2007.  We may not meet the Leverage Ratio or Interest Coverage Ratio in future periods.  Failure to meet these ratios could result in the requirement to repay all amounts outstanding under our senior secured credit facility, and also restrict our ability to incur additional indebtedness in accordance with the indenture governing the senior subordinated notes.

These covenants also may restrict our ability to pursue complementary acquisitions in the future, which has been a significant portion of our growth strategy. As a result, our business, operating results, financial condition or growth prospects could be adversely affected, particularly if other medical device companies consolidate to create new companies with greater market power.

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition

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and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.

During 2006, we consumed $5.9 million of our cash and cash equivalents and used $3.0 million of additional net borrowings on the revolving credit portion of our senior secured credit facility to fund our cash payment obligations.  If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. Our senior secured credit facility and the indenture governing our senior subordinated notes restrict our ability to dispose of assets and use the proceeds from the disposition. We may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them and these proceeds may not be adequate to meet any debt service obligations then due.

Repayment of our debt is dependent on cash flow generated by our subsidiaries.

We are a holding company, and all of our tangible assets are owned by our subsidiaries. Repayment of our indebtedness, is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, debt repayment or otherwise. Unless they are guarantors of our senior subordinated notes, our subsidiaries do not have any obligation to pay amounts due on such notes or to make funds available for that purpose. Our subsidiaries may not be able to, or be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each of our subsidiaries is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. While the indenture governing our senior subordinated notes limits the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make other intercompany payments to us, these limitations are subject to important qualifications and exceptions. In the event that we do not receive distributions from our subsidiaries, we may be unable to make required principal and interest payments on our indebtedness.

Quality problems with our processes, products and services could harm our reputation for producing high quality products and erode our competitive advantage.

Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Many of our customers require us to adopt and comply with specific quality standards, and they periodically audit our performance. Our quality certifications are critical to the marketing success of our products and services. If we fail to meet these standards, our reputation could be damaged, we could lose customers and our revenue could decline. Aside from specific customer standards, our success depends generally on our ability to manufacture to exact tolerances precision engineered components, subassemblies and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high quality components could be harmed, our competitive advantage could be damaged, and we could lose customers and market share.

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 and we are unable to reduce our expenses, our results of operations will be adversely affected.

Because a significant portion of our net sales comes from a few large customers, any decrease in sales to these customers could harm our operating results.

The medical device industry is concentrated, with relatively few companies accounting for a large percentage of sales in the cardiology, endoscopy and orthopaedic markets that we target. Accordingly, our net sales and profitability are highly dependent on our relationships with a limited number of large medical device companies. For the twelve months

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ended December 31, 2006, our top 10 customers accounted for approximately 59% of our net sales. In particular, Boston Scientific, Johnson & Johnson and Medtronic each accounted for more than 10% of our net sales for this period.  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 net sales to customers that have accounted for significant net sales 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.

We may not be able to continue to grow our business if the trend by medical device companies to outsource their manufacturing activities does not continue or if our customers decide to manufacture internally products that we currently provide.

Our design, manufacturing and assembly business has grown partly as a result of the increase over the past several years in medical device companies outsourcing these activities. We view the increasing use of outsourcing by medical device companies as an important component of our future growth strategy. While industry analysts expect the outsourcing trend to increase, our current and prospective customers continue to evaluate our capabilities against the merits of internal production. As previously discussed, Boston Scientific transferred a number of products assembled by us to its own assembly operation. Protecting intellectual property rights and maximizing control over regulatory compliance are among factors that may influence medical device companies to keep production in-house. Any substantial slowing of growth rates or decreases in outsourcing by medical device companies could cause our revenue to decline, and we may be limited in our ability or unable to continue to grow our business.

Our operating results may fluctuate, which may make it difficult to forecast our future performance.

Fluctuations in our operating results may cause uncertainty concerning our performance and prospects or may result in our failure to meet expectations. Our operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a variety of factors, which include, but are not limited to:

·              the fixed nature of a substantial percentage of our costs, which results in our operations being particularly sensitive to fluctuations in revenue;

·              changes in the relative portion of our revenue represented by our various products, which could result in reductions in our profits if the relative portion of our revenue represented by lower margin products increases;

·              introduction and market acceptance of our customers’ new products and changes in demand for our customers’ existing products;

·              the accuracy of our customers’ forecasts of future production requirements;

·              timing of orders placed by our principal customers that account for a significant portion of our revenues;

·              timing of payments by customers;

·              future price concessions as a result of pressure to compete;

·              cancellations by customers as a result of which we may recover only our costs;

·              availability of raw materials, including nitinol, elgiloy, tantalum, stainless steel, columbium, zirconium, titanium, gold, silver and platinum;

·              increased costs of raw materials, supplies or skilled labor;

·              effectiveness in managing our manufacturing processes; and

·              changes in competitive and economic conditions generally or in our customers’ markets.

Investors should not rely on results of operations in any past period as an indication of what our results will be for any future period.

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Our industry is very competitive. We may face competition from, and we may be unable to compete successfully against, new entrants and established companies with greater resources.

The market for outsourced manufacturing and engineering services to the medical device industry is very competitive and includes thousands of companies. As more medical device companies seek to outsource more of the design, prototyping and manufacturing of their products, we will face increasing competitive pressures to grow our business in order to maintain our competitive position, and we may encounter competition from and lose customers to other companies with design, technological and manufacturing capabilities similar to ours. Some of our potential competitors may have greater name recognition, greater operating revenues, larger customer bases, longer customer relationships and greater financial, technical, personnel and marketing resources than we have. If we are unsuccessful competing with our competitors for our existing and prospective customers’ business, we could lose business and our financial results could suffer.

As we rationalize manufacturing capacity and shift production to more economical facilities, our customers may choose to reallocate their outsource requirements among our competitors or perform such functions internally.

As we integrate acquired operations and rationalize manufacturing capability and shift production to more economical facilities, our customers may evaluate their outsourcing requirements and decide to use the services of our competitors or move design and production work back to their own internal facilities. For some customers, geographic proximity to the outsourced design or manufacturing facility may be an important consideration and our reallocation may cause them to no longer use our services for future work. If our customers reallocate work among outsourcing vendors or complete design or production in their own facilities, we would lose business, which could impair our growth and operating results. Further, unanticipated delays or difficulties in facility consolidation and rationalization of our current and future facilities could cause interruptions in our services which could damage our reputation and relationships with our customers and could result in a loss of customers and market share.

If we do not respond to changes in technology, our manufacturing, design and engineering processes may become obsolete and we may experience reduced sales and lose customers.

We use highly engineered, proprietary processes and highly sophisticated machining equipment to meet the critical specifications of our customers. Without the timely incorporation of new processes and enhancements, particularly relating to quality standards and cost-effective production, our manufacturing, design and engineering capabilities will likely become outdated, which could cause us to lose customers and result in reduced revenues or profit margins. In addition, new or revised technologies could render our existing 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 may expend resources on developing new technologies that do not result in commercially viable processes for our business, which could adversely impact our margins and operating results.

Inability to obtain sufficient quantities of raw materials and production feedstock could cause delays in our production.

Our business depends on a continuous supply of raw materials and production feedstock. Raw materials and production feedstock needed for our business are susceptible to fluctuations in price and availability due to transportation costs, government regulations, price controls, change in economic climate or other unforeseen circumstances. Failure to maintain our supply of raw materials and production feedstock could cause production delays resulting in a loss of customers and a decline in revenue. Due to the supply and demand fundamentals of raw material and production feedstock used by us, we have occasionally experienced extended lead times on purchases and deliveries from our suppliers. Consequently, we have had to adjust our delivery schedule to customers. In addition, fluctuations in the cost of raw materials and production feedstock may increase our expenses and affect our operating results. The principal raw materials and production feedstock used in our business include stainless steel, tantalum, columbium, zirconium, titanium, nitinol, elgiloy, gold, silver, platinum, hydrogen, natural gas and electricity. In particular, tantalum and nitinol are in limited supply. For wire fabrication, we purchase most of our stainless steel wire from an independent, third party supplier. Any supply disruptions from this supplier could interrupt production and harm our business.

Our international operations are subject to a variety of risks that could adversely affect those operations and thus our profitability and operating results.

We have international manufacturing operations in Europe and Mexico. We also receive a portion of our net sales from international sales, approximately two-thirds is generated by exports from our facilities in the United States and the remainder is generated by sales from our international facilities. Although we take measures to minimize risks inherent to our international operations, the following risks may have a negative effect on our profitability and operating results, impair the performance of our foreign operations or otherwise disrupt our business:

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·                                          fluctuations in the value of currencies could cause exchange rates to change and impact our profitability; changes in labor conditions and difficulties in staffing and managing foreign operations, including labor unions, could lead to delays or disruptions in production or transportation of materials or our finished products;

·                                          greater difficulty in collecting accounts receivable and longer payment cycles, which can be more common in our international operations, could adversely impact our operating results over a particular fiscal period; and

·                                          changes in foreign regulations, export duties, taxation and limitations on imports or exports could increase our operational costs, impose fines or restrictions on our ability to carry on our business or expand our international operations.

 

We may expand into new markets and products and our expansion may not be successful.

We may expand into new markets through the development of new product applications based on our existing specialized manufacturing, design and engineering capabilities and services. These efforts could require us to make substantial investments, including significant research, development, engineering and capital expenditures for new, expanded or improved manufacturing facilities which would divert resources from other aspects of our business. Expansion into new markets and products may be costly without resulting in any benefit to us. Specific risks in connection with expanding into new markets include the inability to transfer our quality standards into new products, the failure of customers in new markets to accept our products and price competition in new markets. If we choose to expand into new markets and are unsuccessful, our financial condition could be adversely affected and our business harmed.

We are subject to a variety of environmental laws that could be costly for us to comply with, and we could incur liability if we fail to comply with such laws or if we are responsible for releases of contaminants to the environment.

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 the manufacturing of our products. If we fail to comply with any present or future environmental laws, we could be subject to fines, corrective action, other liabilities or the suspension of production. We have in the past paid civil penalties for violations of environmental laws. To date, such matters have not had a material adverse impact on our business or financial condition. We cannot assure you, however, that such matters will not have a material impact on us in the future.

In addition, conditions relating to our operations may require expenditures for clean-up of releases of hazardous chemicals into the environment. For example, we were required and continue to perform remediation as a result of leaks from underground storage tanks at our Collegeville, Pennsylvania facility. In addition, we may have future liability with respect to contamination at our current or former properties or with respect to third party disposal sites. Although we do not anticipate that currently pending matters will have a material adverse effect on our results of operations and financial condition, we cannot assure you that these matters or others that arise in the future will not have such an effect.

Changes in environmental laws may result in costly compliance requirements or otherwise subject us to future liabilities. For example, in anticipation of proposed changes to air emission regulations, we are incorporating new air emission control technologies at one of our manufacturing sites which uses a regulated substance.  We expect to spend approximately $1.0 million in capital expenditures to implement this new air emission technology.  In addition, to the extent these changes affect our customers and require changes to their devices, our customers could have a reduced need for our products and services, and, as a result, our revenue could suffer.

Our inability to protect our intellectual property could result in a loss of our competitive advantage, and infringement claims by third parties could be costly and distracting to management.

We rely on a combination of patent, copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect our intellectual property. The steps we have taken or will take to protect our proprietary rights may not 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 our intellectual property rights, we may be unable to detect infringement of these rights and we may lose our competitive advantage associated with our intellectual property rights before we do so. If it becomes necessary for us to resort to litigation to protect our intellectual property rights, any proceedings could be burdensome and costly and we may not prevail. Although we do not believe that any of our products, services or processes infringe the intellectual property rights of third parties, historically, patent applications in the United States and some foreign countries have not been publicly disclosed until the patent is issued (or as of recently, until

20




 

publication, which occurs eighteen months after filing), and we may not be aware of currently filed patent applications that relate to our products or processes. If patents later issue on these applications, we may in the future be notified that we are infringing patent or other intellectual property rights of third parties and we may be liable for infringement at that time. In the event of infringement of patent or other intellectual property rights, we may not be able to obtain licenses on commercially reasonable terms, if at all, and we may end up in litigation. The failure to obtain necessary licenses or other rights or the occurrence of litigation arising out of infringement claims could disrupt our business and impair our ability to meet our customers’ needs which, in turn, could have a negative effect on our financial condition and results of operations. Infringement claims, even if not substantiated, could result in significant legal and other costs and may be a distraction to management. We also may be subject to significant damages or injunctions against development and sale of our products.

In addition, any infringement claims, significant charges or injunctions against our customers’ products that incorporate our components may result in our customers not needing or having a reduced need for our capabilities and services.

Our earnings and financial condition could suffer if we or our customers become subject to product liability claims or recalls. We may also be required to spend significant time and money responding to investigations or requests for information related to end-products of our customers, including for example, responding to the subpoena we received in the investigation of Guidant Corporation described below in which we have been informed we are a witness.

The manufacture and sale of products that incorporate components manufactured or assembled by us exposes us to potential product liability claims and product recalls, including those that may arise from misuse or malfunction of, or design flaws in, our components or use of our components with components or systems not manufactured or sold by us. Product liability claims or product recalls with respect to our components or the end-products of our customers into which our components are incorporated, whether or not such problems relate to the products and services we have provided and regardless of their ultimate outcome, could require us to pay significant damages or to spend significant time and money in litigation or responding to investigations or requests for information. We manufacture polyimide products for Guidant in accordance with Guidant’s design specifications. On October 25, 2005, Guidant publicly announced that the U.S. Attorney’s Office in Minneapolis, Minnesota had issued a subpoena to Guidant requesting documents relating to its Ventak Prizm 2 and Contak Renewal 1 and 2 defibrillator devices. We received a subpoena dated October 28, 2005 from the Minneapolis office of the U.S. Attorney in connection with this investigation. In response to the subpoena, we have provided documents relating to polyimide products which we manufacture for use in implanted medical devices and also documents regarding the risks related to the use of polyimide in any medical device implanted in the human body. We have been orally advised by the office of the U.S. Attorney in Minneapolis that we are providing this information as a witness to this investigation. We are cooperating fully with the government in connection with this matter.

We may also lose revenue from the sale of components if the commercialization of a product that incorporates our components or subassemblies is limited or ceases as a result of such claims or recalls. For example, two of MedSource’s products were subject to recalls in 2001 and 2002. As a result of such product recalls, our customer redesigned the manufacturing process and decided to manufacture the device internally, resulting in lost annual revenues of approximately $5.0 million and $2.0 million for 2001 and 2002, respectively. In addition, certain finished medical devices into which our components were incorporated have been subject to product recalls. Expenditures on litigation or damages, to the extent not covered by insurance, and declines in revenue could impair our earnings and our financial condition. Also, if, as a result of claims or recalls our reputation is harmed, we could lose customers, which would also negatively affect our business.

We cannot assure you that we will be able to maintain our existing insurance coverage, which is currently at an aggregate level of $25 million per year, or to do so at reasonable cost and on reasonable terms. In addition, if our insurance coverage is not sufficient to cover any costs we may incur or damages we may be required to pay if we are subject to product liability claims or product recalls, we will have to use other resources to satisfy our obligations.

We and our customers are subject to various political, economic and regulatory changes in the healthcare industry that could force us to modify how we develop and price our components, manufacturing capabilities and services and could harm our business.

The healthcare industry is highly regulated and is influenced by changing political, economic and regulatory factors. Federal and state legislatures have periodically considered programs to reform or amend the United States healthcare system at both the federal and state levels. Regulations affecting the healthcare industry in general, and the medical device industry in particular, are complex, change frequently and have tended to become more stringent over time. In addition, these regulations may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates or otherwise change the environment in which healthcare industry participants, including medical device companies, operate. While we are not aware of any legislation or regulations specifically targeting the medical device industry that are currently pending, any such regulations could impair our ability to operate profitably. In addition, any failure by us to comply with

21




 

applicable government regulations could also result in the cessation of portions or all of our operations, impositions of fines and restrictions on our ability to continue or expand our operations.

Consolidation in the healthcare industry could have an adverse effect on our revenues and results of operations.

Many healthcare industry companies, including medical device companies, are consolidating to create new companies with greater market power. As the healthcare industry consolidates, competition to provide products and services to industry participants will become more intense. These industry participants may try to use their market power to negotiate price concessions or reductions for medical devices that incorporate components produced by us. If we are forced to reduce our prices because of consolidation in the healthcare industry, our revenues would decrease and our business, financial condition and results of operations would suffer.

Our business is indirectly subject to healthcare industry cost containment measures that could result in reduced sales of medical devices containing our components.

Our customers and the healthcare providers to whom our customers supply medical devices 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 were to occur, sales of finished medical devices that include our components may decline significantly, and our customers may reduce or eliminate purchases of our components. The cost containment measures that healthcare providers are instituting, both in the United States and internationally, could harm our ability to operate profitably. For example, managed care organizations have successfully negotiated volume discounts for pharmaceuticals. While this type of discount pricing does not currently exist for medical devices, if managed care or other organizations were able to affect discount pricing for devices, it may result in lower prices to our customers from their customers and, in turn, reduce the amounts we can charge our customers for our design and manufacturing services.

Accidents at our facilities could delay production and could subject us to claims for damages.

Our business involves complex manufacturing processes and hazardous materials that can be dangerous to our employees. We employ safety procedures in the design and operation of our facilities; however, there is a risk that an accident or death could occur at our facilities. Any accident could result in significant manufacturing delays, disruption of operations or claims for damages resulting from injuries, which could result in decreased sales and increased expenses. To date, we have not incurred any such significant delays, disruptions or claims. The potential liability resulting from any accident or death, to the extent not covered by insurance, would require us to use other resources to satisfy our obligations and could cause our business to suffer.

A substantial amount of our assets represents goodwill, and our net income will be reduced if our goodwill becomes impaired.

As of December 31, 2006, our goodwill, net represented approximately $847.2 million, or 61.7%, 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. 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, which if significantly impaired, could materially and adversely affect our results of operations.

Our inability to access additional capital could have a negative impact on our growth strategy.

Our growth strategy will require additional capital for, among other purposes, completing acquisitions, managing acquired companies, acquiring new equipment and maintaining the condition of existing equipment. If cash generated internally is insufficient to fund capital requirements, or if funds are not available under our senior secured credit facility, 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 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. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Some of our operations are highly cyclical.

We have established customer relationships with companies outside of the medical device market.  These customers incorporate our products and services into their products such as high density discharge lamps, fiber optics, motion sensors and power generators. For the twelve months ended December 31, 2006 our industrial operations accounted for

22




 

approximately 8% of our net sales. Historically, net sales from these operations have been highly cyclical.  Additionally, a significant portion of our orthopaedic net sales are for instruments used in implant procedures.  Our net sales from orthopaedic instrumentation related products are directly related to the timing of product launches by our customers.  Delays in product releases by our orthopaedic customers can result in increased volatility in our net sales.   We cannot predict when volatility will occur from either of these products, and how severely it will impact our results of operations.

We face risks associated with the implementation of our new Enterprise Resource Planning System.

We are in the process of installing a third party enterprise resource planning system, or ERP System, across our facilities, which will enable the sharing of customer, supplier and engineering data across our company. The installation and integration of the ERP System may divert the attention of our information technology professionals and certain members of management from the management of daily operations to the integration of the ERP System. Further, we may experience unanticipated delays in the implementation of the ERP System, difficulties in the integration of the ERP System across our facilities or interruptions in service due to failures of the ERP System. Continuing and uninterrupted performance of our ERP System is critical to the success of our business strategy. Any damage or failure that interrupts or delays operations may dissatisfy customers and could have a material adverse effect on our business, financial condition, results of operations and cash flow.

We license the ERP software from a third party. If these licenses are discontinued, or become invalid or unenforceable, there can be no assurance that we will be able to develop substitutes for this software independently or to obtain alternative sources at acceptable prices or in a timely manner. Any delays in obtaining or developing substitutes for licensed software could have a material adverse effect on our operations.

The loss of the services of members of our senior management could adversely affect our business.

Our success depends upon having a strong senior management team. We cannot assure you that we would be able to find qualified replacements for the individuals who make up our senior management team if their services were no longer available.  Our CEO, Ron Sparks, retired effective December 31, 2006.  The loss of services of one or more members of our senior management team could have a material adverse effect on our business, financial condition and results of operations   We do not currently maintain key-man life insurance for any of our employees.

Our business may suffer if we are unable to recruit and retain the experienced engineers and management personnel that we need to compete in the medical device industry.

Our future success depends upon our ability to attract, develop and retain highly skilled engineers and management personnel. We may not be successful in attracting new engineers or management personnel or in retaining or motivating our existing personnel, which may lead to increased recruiting, relocation and compensation costs for such personnel. These increased costs may reduce our profit margins.  Some of our manufacturing processes are highly technical in nature. Our ability to maintain or expand existing business with our customers and provide additional services to our existing customers depends on our ability to hire and retain engineers with the skills necessary to keep pace with continuing changes in the medical device industry. We compete with other companies in the medical device industry to recruit engineers.

We depend on outside suppliers and subcontractors, and our production and reputation could be harmed if they are unable to meet our quality and volume requirements and alternative sources are not available.

Although our current internal capabilities are comprehensive, they do not include all elements that are required to satisfy all of our customers’ requirements. As we 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.

We have acquired several companies during the last several years as part of our growth strategy and may selectively pursue additional acquisitions in the future, but, because of the uncertainty involved, we may not be able to identify suitable acquisition candidates and may not successfully integrate acquired businesses into our business and operations.

We may selectively pursue complementary acquisitions. However, we may not be able to identify potential acquisition candidates that could complement our business or may not be able to negotiate acceptable terms for acquisition candidates we identify. As a result, we may not be able to realize this element of our growth strategy. In addition, even if we

23




are successful in acquiring any companies, we may experience material negative consequences to our business, financial condition or results of operations if we cannot successfully integrate the operations of acquired businesses with ours. The integration of companies that have previously been operated separately involves a number of risks, including, but not limited to:

·             demands on management related to the significant increase in the size of the business for which they are responsible;

·             diversion of management’s attention from the management of daily operations to the integration of operations;

·             management of employee relations across facilities;

·             difficulties in the assimilation of different corporate cultures and practices, as well as in the assimilation and retention of broad and geographically dispersed personnel and operations;

·             difficulties and unanticipated expenses related to the integration of departments, systems (including accounting systems), technologies, books and records, procedures and controls (including internal accounting controls, procedures and policies), as well as in maintaining uniform standards, including environmental management systems;

·             expenses related to any undisclosed or potential liabilities; and

·             ability to maintain strong relationships with our and our acquired companies’ customers after the acquisitions.

Successful integration of acquired operations depends on our ability to effectively manage the combined operations, realize opportunities for revenue growth presented by broader product offerings and expanded geographic coverage and eliminate redundant and excess costs. If our integration efforts are not successful, we may not be able to maintain the levels of revenues, earnings or operating efficiency that we and the acquired companies achieved or might achieve separately.

Our Sponsors control our decisions and may have interests that conflict with ours.

Affiliates of KKR and Bain, which we refer to collectively as our Sponsors, control our affairs and policies. Circumstances may occur in which the interests of the Sponsors could be in conflict with our interests. For example, the Sponsors and certain of their affiliates are in the business of making investments in companies and may from time to time in the future acquire interests in businesses that directly or indirectly compete with certain portions of our business or are suppliers or customers of ours. Further, if the Sponsors pursue such acquisitions or make further investments in our industry, those acquisition and investment opportunities may not be available to us. So long as the Sponsors continue to indirectly own a significant amount of our equity, even if such amount is less than 50%, they will continue to be able to influence or effectively control our decisions.

Item 1B.          Unresolved Staff Comments

Not applicable.

24




 

Item 2.           Properties

We have 20 leased facilities and 7 owned facilities. Our principal executive office is located at 100 Fordham Road, Building C, Wilmington, Massachusetts 01887. We believe that our current facilities are adequate for our operations. Certain information about our facilities is set forth below:

 

Location

 

Approximate
Square
Footage

 

Own/Lease

 

Arlington, Tennessee

 

29,000

 

Own

 

Arvada, Colorado

 

45,000

 

Lease

 

Brimfield, Massachusetts

 

30,000

 

Own

 

Brooklyn Park, Minnesota

 

117,000

 

Lease

 

Collegeville, Pennsylvania

 

179,000

 

Own

 

El Paso, Texas

 

20,000

 

Lease

 

Englewood, Colorado

 

40,000

 

Lease

 

Hamburg, New York

 

18,000

 

Lease

 

Huntsville, Alabama

 

44,000

 

Own

 

Laconia, New Hampshire

 

41,000

 

Lease

 

Minnetonka, Minnesota

 

7,000

 

Lease

 

Orchard Park, New York

 

48,000

 

Lease

 

Pittsburgh, Pennsylvania

 

68,000

 

Own

 

Salem, Virginia

 

66,000

 

Lease

 

South Plainfield, New Jersey

 

6,000

 

Lease

 

Sturbridge, Massachusetts

 

18,000

 

Lease

 

Trenton, Georgia

 

7,000

 

Lease

 

Trenton, Georgia

 

31,000

 

Own

 

Upland, California

 

50,000

 

Lease

 

Watertown, Connecticut

 

46,000

 

Lease

 

Wheeling, Illinois

 

48,000

 

Own

 

Wheeling, Illinois

 

51,000

 

Lease

 

Wilmington, Massachusetts

 

22,000

 

Lease

 

Aura, Germany

 

17,000

 

Lease

 

Galway, Ireland

 

17,000

 

Lease

 

Juarez, Mexico

 

101,000

 

Lease

 

Manchester, England

 

10,000

 

Lease

 

Total

 

1,176,000

 

 

 


 

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. Please see “Government Regulation” above for a description of certain environmental remediation matters which are incorporated by reference herein.

Item 4.           Submission of Matters to a Vote of Security Holders

Not applicable.

PART II

Item 5.           Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

There is no established public trading market for our common stock.  As of the date hereof, there was one stockholder of record of our common stock.  Accellent Acquisition Corp. owns 100% of our capital stock.  Accellent Holdings Corp. owns 100% of the capital stock of Accellent Acquisition Corp.

We do not maintain any equity compensation plans under which our equity securities are authorized for issuance.

25




 

No dividends have been declared on our common stock in fiscal year 2004, the period from January 1, 2005 to November 22, 2005, the period from November 23, 2005 to December 31, 2005, or fiscal year 2006.

On November 22, 2005, we completed an offering of $305.0 million in aggregate principal amount of 10½% senior subordinated notes due 2013 (the “Notes”), which was exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”).  The net proceeds from the issuance of the Notes of approximately $301 million after an approximately $4 million original issue discount were used primarily to finance the Transaction.  See Item 1 “The Transaction” for a description of the Transaction.  We sold the Notes to Credit Suisse First Boston LLC, JP Morgan Securities Inc. and Bear, Stearns & Co. Inc. (collectively, the “Initial Purchasers”) pursuant to Section 4(2) of the Securities Act. The Initial Purchasers subsequently resold the Notes to qualified institutional buyers pursuant to Rule 144A under the Securities Act, and to non-U.S. persons outside the United States under Regulation S under the Securities Act.   On March 29, 2006, the Notes were exchanged for an equal aggregate principal amount of substantially identical registered notes (the “Exchange Notes”) pursuant to a registration statement on Form S-4, which was declared effective by the Securities and Exchange Commission on February 14, 2006.   Our senior secured credit facility and the indenture dated November 22, 2005 governing the Notes and Exchange Notes limit our ability to pay dividends. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” and Note 6 to the accompanying financial statements included in Item 8 of this Form 10-K.

Item 6.           Selected Financial Data

As a result of the Transaction, our selected historical consolidated financial data are presented in two periods, the Predecessor Period, which refers to the three years ended December 31, 2004 and the period from January 1, 2005 up to the date of the Transaction, or November 22, 2005.  The Successor Period refers to the period subsequent to the Transaction and ending December 31, 2005 and the year ended December 31, 2006.  We refer to the period from January 1, 2005 to November 22, 2005 as the “2005 Predecessor Period,” and the period from November 23, 2005 to December 31, 2005 as the “2005 Successor Period.” The operating data for the year ended December 31, 2004, the 2005 Predecessor Period, the 2005 Successor Period and the year ended December 31, 2006 were derived from our audited consolidated financial statements included elsewhere in this Form 10-K. The balance sheet data as of December 31, 2005 and 2006 were derived from our audited consolidated balance sheets included elsewhere in this Form 10-K.  The balance sheet data as of December 31, 2002, 2003 and 2004 were derived from our audited financial statements that are not included in this Form 10-K. The results of operations for any period are not necessarily indicative of the results to be expected for any future period.

The information presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes thereto included elsewhere in this Form 10-K.

26




 

 

 

 

Predecessor

 

 

 

Successor

 

 

 

Twelve Months Ended December 31,

 

Period From
January 1 to
November 22,

 

 

 

Period From
November 23
to December 31,

 

Twelve 
Months Ended
December 31,

 

 

 

2002

 

2003

 

2004

 

2005

 

 

 

2005

 

2006

 

 

 

(In thousands)

 

 

 

 

 

 

 

STATEMENT OF OPERATIONS DATA(1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

135,841

 

$

174,223

 

$

320,169

 

$

411,734

 

 

 

$

49,412

 

$

474,134

 

Cost of sales

 

96,740

 

121,029

 

234,396

 

283,029

 

 

 

44,533

 

337,043

 

Gross profit

 

39,101

 

53,194

 

85,773

 

128,705

 

 

 

4,879

 

137,091

 

Selling, general and administrative expenses

 

23,548

 

28,612

 

45,912

 

71,520

 

 

 

7,298

 

58,458

 

Research and development expenses

 

2,380

 

2,603

 

2,668

 

2,655

 

 

 

352

 

3,607

 

Restructuring and other charges(2)

 

2,440

 

1,487

 

3,600

 

4,154

 

 

 

311

 

5,008

 

Merger related costs(3)

 

 

 

 

47,925

 

 

 

8,000

 

 

Impairment of goodwill and intangibles(4)

 

21,725

 

 

 

 

 

 

 

 

Amortization of intangibles

 

4,703

 

4,828

 

5,539

 

5,730

 

 

 

1,839

 

17,205

 

Income (loss) from operations

 

(15,695

)

15,664

 

28,054

 

(3,279

)

 

 

(12,921

)

52,813

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

(16,923

)

(16,587

)

(26,879

)

(43,233

)

 

 

(9,301

)

(65,338

)

Other(5)

 

61

 

(9

)

(3,312

)

(29,985

)

 

 

198

 

(727

)

Total other expense

 

(16,862

)

(16,596

)

(30,191

)

(73,218

)

 

 

(9,103

)

(66,065

)

Income (loss) before income taxes

 

(32,557

)

(932

)

(2,137

)

(76,497

)

 

 

(22,024

)

(13,252

)

Income tax expense (benefit)

 

(5,145

)

13,872

 

3,483

 

5,816

 

 

 

478

 

5,307

 

Net loss

 

$

(27,412

)

$

(14,804

)

$

(5,620

)

$

(82,313

)

 

 

$

(22,502

)

$

(18,559

)

OTHER FINANCIAL DATA(1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows provided by (used in):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating activities

 

$

14,022

 

$

14,392

 

$

22,231

 

$

34,729

 

 

 

$

(81,961

)

$

26,833

 

Investing activities

 

(9,446

)

(20,370

)

(227,376

)

(74,418

)

 

 

(802,852

)

(30,284

)

Financing activities

 

(1,517

)

3,977

 

217,071

 

38,032

 

 

 

879,342

 

(2,642

)

Capital expenditures

 

6,218

 

6,371

 

13,900

 

22,896

 

 

 

6,265

 

30,744

 

Depreciation and amortization

 

10,858

 

11,591

 

16,152

 

20,047

 

 

 

3,057

 

34,173

 

EBITDA(6)

 

 

 

 

 

40,894

 

(13,217

)

 

 

(9,666

)

86,259

 

Adjusted EBITDA(6)

 

 

 

 

 

79,652

 

96,144

 

 

 

9,321

 

101,661

 

Ratio of earnings to fixed charges(7)

 

 

 

 

 

 

 

 

 

Deficiency of earnings to fixed charges

 

32,557

 

932

 

2,137

 

76,497

 

 

 

22,024

 

13,252

 

BALANCE SHEET DATA (at period end)(1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

5,877

 

$

3,974

 

$

16,004

 

 

 

 

 

$

8,669

 

$

2,746

 

Total assets

 

235,775

 

279,135

 

600,229

 

 

 

 

 

1,408,448

 

1,373,594

 

Total debt

 

144,411

 

136,246

 

368,052

 

 

 

 

 

701,092

 

700,529

 

Redeemable and convertible preferred stock

 

540

 

12,593

 

30

 

 

 

 

 

 

 

Total stockholder’s equity

 

64,219

 

56,813

 

137,461

 

 

 

 

 

618,800

 

586,260

 


(1)          We acquired Venusa, Ltd and Venusa de Mexico, S.A. de C.V. (together, “Venusa”) on February 28, 2003, MedSource on June 30, 2004, Campbell on September 12, 2005 and MTG on October 6, 2005. All acquisitions were accounted for using the purchase method of accounting. Accordingly the assets acquired and liabilities assumed were recorded in our financial statements at their fair market values and the operating results of the acquired companies are reflected beginning on the date of acquisition.

27




 

(2)          During 2002, we implemented two restructuring plans focused on consolidating our U.S. operations. During the second quarter of 2002, we announced the relocation of the majority of operations in our South Plainfield, New Jersey facility to the Collegeville, Pennsylvania facility. A restructuring charge of $0.5 million was recognized that consisted of $0.1 million related to severance and $0.4 million associated with the write-down of assets and other closure costs at the South Plainfield, New Jersey facility.

During the fourth quarter of 2002, we announced the consolidation of our machining capabilities into our Wheeling, Illinois facility and the closing of our Miramar, Florida plant. As a result, we recognized a restructuring charge of $1.4 million consisting of: $0.1 million related to stay-on bonuses earned through December 31, 2002; $0.5 million related to the write-down of assets; and $0.8 million related to lease obligations. In 2003, the relocation was completed and we recognized a restructuring charge of $1.8 million consisting of $0.5 million related to stay-on and relocation bonuses earned through the relocation date; $0.3 million related to the relocation of equipment and plant clean-up; $0.7 million of other exit costs; and $0.3 million related to excess inventory discarded (included in cost of sales in the consolidated statements of operations).

During the third quarter of 2002, we decided not to proceed with the construction of a new technology center and recognized a loss of $0.5 million related to the write-down of previously capitalized costs.

In connection with the MedSource acquisition, we identified $9.3 million of costs associated with eliminating duplicate positions and plant consolidations, which is comprised of $8.6 million in severance payments, and $0.6 million in lease and other contract termination costs. Severance payments relate to approximately 370 employees in manufacturing, selling and administration which are expected to be paid by the end of 2007. The cost of these plant consolidations was reflected in the purchase price of MedSource in accordance with the FASB Emerging Issues Task Force (“EITF”) No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination.

In connection with the Merger, we identified $0.4 million of costs associated with reductions in staffing levels.  These costs are comprised primarily of severance payments.  Severance payments relate to approximately 40 employees in manufacturing, selling and administration and are expected to be paid by the end of 2007.  The costs of this restructuring plan was reflected in the purchase price of us by KKR and Bain in accordance with the FASB Emerging Issues Task Force (“EITF”) No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. These are subject to change based on the actual costs incurred.

We recognized $3.6 million of restructuring charges and acquisition integration costs during fiscal year 2004, including $1.7 million of severance, facility closure and relocation costs incurred as part of a MedSource manufacturing facility closure plan which existed at the time of the acquisition, and $1.0 million of salary related costs due to the elimination of positions we deemed to be redundant as a result of the MedSource acquisition. In addition to the $2.7 million in restructuring charges incurred during fiscal year 2004, we incurred $0.9 million of costs for the integration of MedSource comprised of outside professional services and salary related cost and incentive compensation earned by members of an integration team.

We recognized $4.5 million of restructuring charges and MedSource integration costs during the twelve months ended December 31, 2005, including $1.3 million of severance costs and $2.4 million of other exit costs including costs to move production processes from five facilities that were closed to our other production facilities. In addition, we incurred $0.8 million of costs for the integration of MedSource.

The Company recognized $5.0 million of restructuring charges during 2006, including $4.3 million of severance costs and $0.7 million of other exit costs.  Severance costs include $2.4 million for the elimination of 111 positions throughout our manufacturing operations as we downsized certain operations and consolidated various administrative functions, $1.0 million for the elimination of 18 corporate staff positions in an effort to streamline our management structure, $0.7 million for the elimination of 317 manufacturing positions at the Juarez, Mexico facility due to the expiration of a customer contract, and $0.2 million to record retention bonuses related to facility closures.  Other exit costs relate primarily to the cost to transfer production from former MedSource facilities that were closed to other existing facilities of the Company.

28




 

The following table summarizes the recorded accruals and activity related to the restructuring and other charges (in thousands):



 

Employee
Costs

 

Other Exit
Costs

 

Total

 

Restructuring and other charges

 

$

230

 

$

2,210

 

$

2,440

 

Less: cash payments

 

(80

)

(143

)

(223

)

Less: non-cash Items

 

 

(1,262

)

(1,262

)

Balance as of December 31, 2002

 

150

 

805

 

955

 

Restructuring charge

 

471

 

1,016

 

1,487

 

Inventory discarded

 

 

322

 

322

 

Less: cash payments

 

(613

)

(1,559

)

(2,172

)

Balance as of December 31, 2003

 

8

 

584

 

592

 

Restructuring charge

 

1,307

 

2,293

 

3,600

 

Plant closure and severance costs for MedSource integration

 

11,559

 

9,927

 

21,486

 

Less: cash payments

 

(5,110

)

(2,891

)

(8,001

)

Balance as of December 31, 2004

 

7,764

 

9,913

 

17,677

 

Adjustment for change in estimate for previously recorded restructuring accruals

 

(1,478

)

(2,888

)

(4,366

)

Elimination of positions in connection with the Merger

 

581

 

34

 

615

 

Restructuring and integration charges incurred

 

1,275

 

2,879

 

4,154

 

Less: cash payments

 

(4,513

)

(3,381

)

(7,894

)

Balance November 22, 2005

 

3,629

 

6,557

 

10,186

 

Restructuring and integration charges incurred

 

61

 

250

 

311

 

Less: cash payments

 

(49

)

(267

)

(316

)

Balance December 31, 2005

 

3,641

 

6,540

 

10,181

 

Adjustment for change in estimate for previously recorded restructuring accruals

 

(1,905

)

(6,072

)

(7,977

)

Restructuring and integration charges incurred

 

4,334

 

674

 

5,008

 

Less: cash payments

 

(4,333

)

(951

)

(5,284

)

Balance December 31, 2006

 

$

1,737

 

$

191

 

$

1,928

 

 

The adjustment to restructure accruals of $8.0 million recorded during the twelve months ended December 31, 2006 is primarily due to a change in estimate for acquisition-related restructuring accruals resulting in a corresponding reduction to goodwill.

(3)          In connection with the Transaction, we incurred investment banking and equity sponsor related fees of $28.6 million, management bonuses of $16.7 million, legal and accounting fees of $1.1 million and other costs of $1.5 million during the 2005 Predecessor Period.  During the 2005 Successor Period, we recorded an $8.0 million charge for in-process research and development acquired in the Transaction.

(4)          As a result of a loss of significant customers during 2002, goodwill impairment was determined to exist in one of our three reporting units.  Accordingly, an impairment of goodwill charge of $17.5 million was recognized. In addition, related intangible assets of developed technology and know how and customer base were reduced to their estimated fair value based on projected cash flow by $2.2 million and $2.0 million, respectively.

(5)          For the year ended December 31, 2004 other income (expense) includes $3.3 million of pre-payment fees associated with the retirement of our subsidiaries old senior subordinated indebtedness and our senior indebtedness.  For the 2005 Predecessor Period other income (expense) includes $29.9 million of pre-payment fees in connection with the retirement of our subsidiaries $175.0 million senior subordinated notes due 2012.

(6)          We define EBITDA as net income (loss) before net interest expense, income tax expense (benefit), depreciation and amortization. Since EBITDA may not be calculated the same by all companies, this measure may not be comparable to similarly titled measures by other companies.  Adjusted EBITDA is defined as EBITDA further adjusted to give effect to unusual items, non-cash items and other adjustments, all of which are required in calculating covenant ratios and compliance under the indenture governing the senior subordinated notes and under our senior secured credit facility.  We use EBITDA and Adjusted EBITDA to provide additional information to investors about the calculation of certain financial covenants in the indenture governing the senior subordinated notes and under our senior secured credit facility, as well as a supplemental measure of our performance. EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation, or as a substitute for analysis of our results as reported under

29




GAAP. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Other Key Indicators of Financial Condition and Operating Performance” for a discussion of our use of EBITDA and Adjusted EBITDA, certain limitations of EBITDA and Adjusted EBITDA as financial measures, for a reconciliation of net income to EBITDA and a reconciliation of EBITDA to Adjusted EBITDA.

(7)          For purposes of calculating the ratio of earnings to fixed charges, earnings consist of income before income taxes plus fixed charges. Fixed charges include: interest expense, whether expensed or capitalized; amortization of debt issuance cost; and the portion of rental expense representative of the interest factor.

Item 7.           Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described under “Item 1A. Risk Factors.” Our actual results may differ materially from those contained in any forward-looking statements.

Overview

We believe that we are the largest provider of outsourced precision manufacturing and engineering services in our target markets of the medical device industry. We offer our customers design and engineering, precision component manufacturing, device assembly and supply chain management services. We have extensive resources focused on providing our customers with reliable, high quality, cost-efficient, integrated outsourced solutions. Based on discussions with our customers, we believe we often become the sole supplier of manufacturing and engineering services for the products we provide to our customers.

We primarily focus on leading companies in three large and growing markets within the medical device industry: cardiology, endoscopy and orthopaedics. Our customers include many of the leading medical device companies, including Abbott Laboratories, Boston Scientific, Johnson & Johnson, Medtronic, Smith & Nephew, St. Jude Medical, Stryker, Tyco International and Zimmer. While net sales are aggregated by us to the ultimate parent of a customer, we typically generate diversified revenue streams within these large customers across separate divisions and multiple products.  During 2006, our top 10 customers accounted for approximately 58.5% of net sales with three customers each accounting for greater than 10% of net sales.  Although we expect net sales from our largest customers to continue to constitute a significant portion of our net sales in the future, Boston Scientific has transferred a number of products assembled by us to its own assembly operation.  This transfer was complete as of the end of the second quarter of 2006.  Our net sales to Boston Scientific decreased by approximately $30 million in 2006 as compared to 2005 and we expect our 2007 net sales to decrease by an additional $11 million.  While we believe that the transferred business can be replaced with new business from existing and potential new customers to offset the loss, there is no assurance that we will replace such business and that the loss will not adversely affect our operating results in 2007 and thereafter.

Accounting Policy Overview

We recognize net sales in compliance with SAB 104, “Revenue Recognition,” which requires that the following criteria are met:  (a) persuasive evidence of an arrangement exists, (b) delivery has occurred or services have been rendered, (c) the price from the buyer is fixed or determinable, and (d) collectibility is reasonably assured.  We recognize revenue based on written arrangements or purchase orders with the customer, and upon transfer of title of the product or rendering of the service.  A sale for product sold on consignment is recognized when our customer uses the product.  Amounts billed for shipping and handling fees are classified as net sales in our consolidated statement of operations.  Costs incurred for shipping and handling fees are classified as cost of sales.  We provide a reserve for estimated future returns against net sales in the period net sales are recorded.  The estimate of future returns is based on such factors as known pending returns and historical return data. We primarily generate our net sales domestically.  For the twelve months ended December 31, 2006, approximately 86% of our net sales were sold to customers located in the United States. Since a substantial majority of the leading medical device companies are located in the United States, we expect our net sales to U.S.-based companies to remain a high percentage of our net sales in the future.

Our operations are based on purchase orders that typically provide for 30 to 90 days delivery from the time the purchase order is received, but which can provide for delivery within 30 days or up to 180 days, depending on the product and the customer’s ability to forecast requirements.

Cost of goods sold includes raw materials, labor and other manufacturing costs associated with the products we sell.

30




Some products incorporate precious metals, such as gold, silver and platinum. Changes in prices for those commodities are generally passed through to our customers.

Selling, general and administrative expenses include salaries, sales commissions, and other selling and administrative costs.

Amortization of intangible assets up to the date of the Transaction was primarily related to our acquisitions of G&D, Inc. d/b/a Star Guide, Noble-Met, Ltd., UTI, American Technical Molding, Inc., Venusa, Ltd. and Venusa de Mexico, S.A. de C.V. (together with Venusa, Ltd., “Venusa”), MedSource and Campbell Engineering, Inc.   Amortization of intangible assets subsequent to the date of the Transaction relates to the acquisition of us by KKR and Bain.

Interest expense up to the date of the Transaction was primarily related to indebtedness incurred to finance our acquisitions.  Interest expense subsequent to the date of the Transaction relates to the financing of the acquisition of us by KKR and Bain.

Concurrent with our acquisition of MedSource on June 30, 2004, we aligned our management by the three medical device markets which we serve: cardiology, endoscopy, and orthopaedics. We have determined that our three reporting units meet the segment aggregation criteria of paragraph 17 of SFAS No. 131, and are treated as one reportable segment.

In connection with the MedSource acquisition, we identified $9.3 million of costs associated with eliminating duplicate positions and plant consolidations, which is comprised of $8.6 million in severance payments and $0.7 million in lease termination and other contract termination costs. Severance payments relate to approximately 370 employees in manufacturing, selling and administration and are expected to be paid by the end of 2007.  The costs of these plant consolidations were reflected in the purchase price of MedSource in accordance with the FASB Emerging Issues Task Force (“EITF”) No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. These costs include estimates to close facilities and consolidate manufacturing capacity, and are subject to change based on the actual costs incurred to close these facilities.

The adjustment to restructure accruals of $8.0 million recorded during the twelve months ended December 31, 2006 is primarily due to a change in estimate for acquisition-related restructuring accruals resulting in a corresponding reduction to goodwill.

In connection with the Merger, we identified $0.4 million of costs associated with eliminating duplicate positions which is comprised primarily of severance payments.  Severance payments relate to approximately 40 employees in manufacturing, selling and administration and are expected to be paid by the end of fiscal year 2007.  The costs of this restructuring plan was reflected in the purchase price of us by KKR and Bain in accordance with the FASB Emerging Issues Task Force (“EITF”) No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. These are subject to change based on the actual costs incurred.

31




 

The following table summarizes the recorded accruals and activity related to the restructuring activities (in thousands):

 

 

Employee costs

 

Other costs

 

Total

 

Balance as of December 31, 2003

 

$

8

 

$

584

 

$

592

 

Restructuring charge

 

1,307

 

2,293

 

3,600

 

Plant closure and severance costs for MedSource integration

 

11,559

 

9,927

 

21,486

 

Less: cash payments

 

(5,110

)

(2,891

)

(8,001

)

Balance as of December 31, 2004

 

7,764

 

9,913

 

17,677

 

Adjustment for change in estimate forpreviously recorded restructuring accruals

 

(1,478

)

(2,888

)

(4,366

)

Elimination of positions in connection with the Merger

 

581

 

34

 

615

 

Restructuring and integration charges incurred

 

1,275

 

2,879

 

4,154

 

Less: cash payments

 

(4,513

)

(3,381

)

(7,894

)

Balance November 22, 2005

 

3,629

 

6,557

 

10,186

 

Restructuring and integration charges incurred

 

61

 

250

 

311

 

Less: cash payments

 

(49

)

(267

)

(316

)

Balance December 31, 2005

 

3,641

 

6,540

 

10,181

 

Adjustment for change in estimate for previously recorded restructuring accruals

 

(1,905

)

(6,072

)

(7,977

)

Restructuring and integration charges incurred

 

4,334

 

674

 

5,008

 

Less: cash payments

 

(4,333

)

(951

)

(5,284

)

Balance December 31, 2006

 

$

1,737

 

$

191

 

$

1,928

 

 

Results of Operations

Our accounting for the Merger follows the requirements of Staff Accounting Bulletin (“SAB”) 54, Topic 5-J, and Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” which require that purchase accounting treatment of the Merger be “pushed down,” resulting in the adjustment of all of our net assets to their respective fair values as of the Merger date.  Although we continued as the same legal entity after the Merger, the application of push down accounting represents the termination of the old accounting entity and the creation of a new one.  As a result, our consolidated financial statements are presented for two periods:  Predecessor and Successor, which relate to the period preceding the Merger and the period succeeding the Merger, respectively.  We have prepared our discussion of the results of operations by comparing the mathematical combination of the Predecessor Period from January 1, 2005 to November 22, 2005 and the 2005 Successor Period from November 23, 2005 to December 31, 2005 with the twelve month period ended December 31, 2006, and with the twelve month period ended December 31, 2004.  We refer to the twelve months ended December 31, 2005 as the 2005 Combined Period.  Although this presentation does not comply with generally accepted accounting principles “(GAAP)”, we believe the combination of the 2005 periods provides a meaningful comparison to the 2006 and 2004 periods.  The combined operating results have not been prepared as pro forma results under applicable regulations and may not reflect the actual results we would have achieved absent the Merger and may not be predictive of future results of operations.

32




 

The following table sets forth the amounts from our consolidated statements of operations for both the 2005 Predecessor Period and 2005 Successor Period and arrives at the combined results of operations for the twelve months ended December 31, 2005:

 

 

 

Predecessor

 

 

 

Successor

 

Combined

 

 

 

Period
From
January 1 to
November
22,

 

 

 

Period
From
November
23 to
December
31,

 

Twelve
Months
Ended
December 31,

 

 

 

2005

 

 

 

2005

 

2005

 

Net sales

 

$

411,734

 

 

 

$

49,412

 

$

461,146

 

Cost of sales

 

283,029

 

 

 

44,533

 

327,562

 

Gross profit

 

128,705

 

 

 

4,879

 

133,584

 

Selling, general and administrative expenses

 

71,520

 

 

 

7,298

 

78,818

 

Research and development expenses

 

2,655

 

 

 

352

 

3,007

 

Restructuring and other charges

 

4,154

 

 

 

311

 

4,465

 

Merger related costs

 

47,925

 

 

 

8,000

 

55,925

 

Amortization of intangible assets

 

5,730

 

 

 

1,839

 

7,569

 

Loss from operations

 

(3,279

)

 

 

(12,921

)

(16,200

)

 

 

 

 

 

 

 

 

 

 

Other income (expense): Interest expense, net

 

(43,233

)

 

 

(9,301

)

(52,534

)

Other income (expense), including debt prepayment penalty of $3,295 in 2004 and $29,914 for the period ended November 22, 2005

 

(29,985

)

 

 

198

 

(29,787

)

Total other expense

 

(73,218

)

 

 

(9,103

)

(82,321

)

Loss before income taxes

 

(76,497

)

 

 

(22,024

)

(98,521

)

Income tax expense

 

5,816

 

 

 

478

 

6,294

 

Net loss

 

$

(82,313

)

 

 

$

(22,502

)

$

(104,815

)

 

The following table sets forth percentages derived from the consolidated statements of operations for the years ended December 31, 2004, the 2005 Predecessor Period, the 2005 Successor Period, the 2005 Combined Period and the year ended December 31, 2006 presented as a percentage of net sales:

 

 

 

Predecessor

 

 

 

Successor

 

Combined

 

 

 

 

 

Twelve Months
Ended
December 31,

 

Period From
January 1 to
November 22,

 

 

 

Period From
November 23
to December
31,

 

Twelve Months
Ended
December 31,

 

Twelve Months
Ended
December 31,

 

 

 

2004

 

2005

 

 

 

2005

 

2005

 

2006

 

STATEMENT OF OPERATIONS DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales

 

100.0

%

100.0

%

 

 

100.0

%

100.0

%

100.0

%

Cost of Sales

 

73.2

 

68.7

 

 

 

90.1

 

71.0

 

71.1

 

Gross Profit

 

26.8

 

31.3

 

 

 

9.9

 

29.0

 

28.9

 

Selling, General and Administrative Expenses

 

14.4

 

17.4

 

 

 

14.8

 

17.1

 

12.3

 

Research and Development Expenses

 

0.8

 

0.7

 

 

 

0.7

 

0.7

 

0.8

 

Merger costs

 

 

11.6

 

 

 

 

10.4

 

 

In-Process Research and Development Charge

 

 

 

 

 

16.2

 

1.7

 

 

Restructuring and Other Charges

 

1.1

 

1.0

 

 

 

0.6

 

1.0

 

1.1

 

Amortization of Intangibles

 

1.7

 

1.4

 

 

 

3.7

 

1.6

 

3.6

 

Income (Loss) from Operations

 

8.8

 

(0.8

)

 

 

(26.1

)

(3.5

)

11.1

 

 

33




 

Twelve Months Ended December 31, 2006 Compared to the 2005 Combined Period

Net Sales

Net sales for 2006 were $474.1 million, an increase of $13.0 million or 3% compared to net sales of $461.1 million for the 2005 Combined Period.  The increase in net sales was due to having a full year of sales in 2006 related to the 2005 Acquisitions, which increased net sales by $13.2 million.  This increase was partially offset by a $0.2 million reduction in the volume of net shipments, which includes the negative impact of the Boston Scientific transfers totaling $30.5 million, our facility rationalization program, which included the closing or sale of select facilities, resulting in a reduction in net sales attributable to former MedSource facilities of $5.3 million, partially offset by higher unit volume of shipments of $35.6 million. Three customers, Boston Scientific, Johnson & Johnson and Medtronic each accounted for greater than 10% of net sales for both 2006 and the 2005 Combined Period.

Gross Profit

Gross profit for 2006 was $137.1 million as compared to $133.6 million for the 2005 Combined Period.   The $3.5 million increase in gross profit was a result of the 2005 Acquisitions, which increased gross profit by $3.1 million, and a $4.5 million decrease in charges for the sell through of acquired inventories related primarily to the Merger.  These increases were partially offset by a less favorable product mix in 2006 as compared to the 2005 Combined Period.

Gross margin was 28.9% of net sales for 2006 as compared to 29.0% of net sales for the 2005 Combined Period.  The decrease in gross margin was primarily due to a less favorable product mix in 2006 as compared to the 2005 Combined Period.  This decrease in gross margin was partially offset by reduced charges for the sell through of inventory stepped-up in the Transaction and 2005 Acquisitions.

Selling, General and Administrative Expenses

SG&A expenses were $58.5 million for 2006 compared to $78.8 million for the 2005 Combined Period. The decrease in SG&A costs was due to a $15.6 million reduction in non-cash stock-based compensation charges, a $5.3 million reduction in provisions for annual cash-based incentive compensation payments and a $2.0 million reduction in salary costs due to cost reduction initiatives.  These decreases in SG&A costs were partially offset by $2.0 million of consulting costs for Merger integration and $1.2 million due to having a full year of SG&A expenses related to the 2005 Acquisitions.  SG&A expenses were 12.3% of net sales for 2006 as compared to 17.1% of net sales for the 2005 Combined Period.  The reduction was primarily a result of the lower non-cash stock-based compensation expenses which amounted to 3.3% of net sales and the reduction in annual cash-based inventive compensation payments which amount to 1.1% of net sales.

During the 2005 Combined Period, we recorded $16.7 million of non-cash stock-based compensation expense which were all incurred during the 2005 Predecessor Period.  These charges were due to the grant of restricted stock during the 2005 Predecessor Period for which we incurred a charge of $10.0 million, a charge of $3.7 million for the granting of stock options during the 2005 Predecessor Period which were determined to be granted at an exercise price below fair value, a $2.7 million increase in our liability for phantom stock plans as a result of an increase in the value of our common stock and other stock option related charges of $0.2 million. All of our Predecessor stock options, restricted stock and phantom stock plans were settled upon the closing of the Transaction.  Our non-cash stock-based compensation expense for 2006 was $1.1 million, and relates to stock options granted subsequent to the Merger for which we are recording compensation in accordance with the requirements of  SFAS No. 123R (“SFAS 123R”).

Research and Development Expenses

R&D expenses for 2006 were $3.6 million or 0.8% of net sales, compared to $3.0 million or 0.7% of net sales for the 2005 Combined Period.  The increase in R&D expenses was primarily due to an increase in project costs.

Restructuring and Other Charges

We recognized $5.0 million of restructuring charges during 2006, including $4.3 million of severance costs and $0.7 million of other exit costs.  Severance costs include $2.4 million for the elimination of 111 positions throughout our manufacturing operations as we downsized certain operations and consolidated various administrative functions, $1.0 million for the elimination of 18 corporate staff positions in an effort to streamline our management structure, $0.7 million for the elimination of 317 manufacturing positions in our Juarez, Mexico facility due to the expiration of a customer contract and $0.2

34




 

million to record retention bonuses related to facility closures.  Other exit costs relate primarily to the cost to transfer production from former MedSource facilities to our other existing facilities.

Amortization

 Amortization of intangible assets was $17.2 million for 2006 compared to $7.6 million for the 2005 Combined Period.  The increase was primarily due to the effects of the Transaction, which required the revaluation of all of our intangible assets as of the closing date.

Interest Expense, net

Interest expense, net, increased $12.8 million to $65.3 million for 2006 as compared to $52.5 million for the 2005 Combined Period.  This increase was due to the increased debt incurred in connection with the Transaction, which increased interest expense by $24.7 million; increased debt to acquire Campbell and MTG, which increased interest expense by $2.1 million; higher interest rates, which increased interest expense by $2.4 million; and new borrowings under our revolving credit facility, which increased interest expense by $0.4 million.  The increases in interest expense were partially offset by certain one-time charges included in the 2005 Combined Period including $14.4 million to write off deferred financing costs due to the refinancing which occurred as a result of the Transaction, and $2.4 million of bridge loan fees incurred upon the closing of the Transaction.

Interest expense, net includes interest income of approximately $192,000 and $87,000 for 2006 and the 2005 Combined Period, respectively.

Other expense, net

Other expense was $0.7 million for 2006 compared to $29.8 million for the 2005 Combined Period.  Other expense, net for 2006 includes $0.8 million of non-cash charges for currency translation.  Other expense for the 2005 Combined Period includes $29.9 million of debt prepayment penalties incurred due to the prepayment of our subsidiary’s senior subordinated notes in connection with the Transaction.

Income Tax Expense

Income tax expense for 2006 was $5.3 million and included $3.1 million of deferred income taxes for the different book and tax treatment for goodwill, $1.3 million of foreign income taxes and $0.9 million of state income taxes.  Income tax expense for the 2005 Combined Period was $6.3 million and included $2.9 million of state income taxes, $2.1 million of non-cash deferred income taxes for the different book and tax treatment for goodwill and $1.3 million of foreign income taxes.   We have not provided for any domestic federal income taxes due to net operating losses incurred.  We have net operating loss carryforwards of approximately $243.7 million to offset future domestic federal income taxes.  The future utilization of our net operating loss carryforwards may be limited in future years by the provisions of Internal Revenue Code section 382.  We have incurred, and expect to continue to incur certain state and foreign income taxes in jurisdictions where we cannot offset our taxable income with losses or expenses incurred in other jurisdictions.

We have assessed the positive and negative evidence bearing upon the realizability of our deferred tax assets.  As a result of these assessments, we established a valuation allowance against the net deferred tax assets.  At the end of 2006, we again assessed our ability to realize our deferred tax assets and continue to believe that it is more likely than not that we will not recognize the benefits of our federal and state deferred tax assets. As a result, we continue to provide a full valuation reserve.

2005 Combined Period Compared to Twelve Months Ended December 31, 2004

Net Sales

Net sales for the 2005 Combined Period were $461.1 million, an increase of $140.9 million or 44% compared to net sales of $320.2 million for 2004. Higher net sales were due to the acquisition of MedSource and the 2005 Acquisitions, which increased net sales by $97.4 million, and higher unit volume of shipments totaling $60.1 million. These increases were partially offset by our facility rationalization program, which included the closing or sale of select facilities, resulting in a reduction in net sales attributable to former MedSource facilities of $16.6 million for the 2005 Combined Period. Three customers, Boston Scientific, Johnson & Johnson and Medtronic each accounted for greater than 10% of net sales for the 2005 Combined Period. Two customers, Boston Scientific and Johnson & Johnson each accounted for greater than 10% of net sales for 2004.

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Gross Profit

Gross profit for the 2005 Combined Period was $133.6 million compared to $85.8 million for 2004. The $47.8 million increase in gross profit was caused by unit volume increases which increased gross margin by $27.0 million, and the acquisitions of MedSource and the 2005 Acquisitions which increased gross profit by $26.4 million.  Additionally, gross profit for 2004 included a $3.4 million write off of the step-up of inventory related to the acquisition of MedSource and a $1.9 million charge to reduce the value of inventories acquired from MedSource.  These increases in gross profit were partially offset by the write off of the step-up of acquired inventory during the 2005 Combined Period.  In connection with the 2005 Acquisitions, we recorded a $0.9 million step-up in the value of inventories acquired, and charged that step-up to cost of sales during the 2005 Combined Period.  In connection with the Merger, we recorded a $16.4 million step-up in the value of our inventory acquired by KKR and Bain, and charged $10.0 million of that step-up to cost of sales during the 2005 Combined Period.  The remaining step-up of inventory of $6.4 million recorded as a result of the Merger was charged to our cost of sales during our first quarter of 2006.

Gross margin was 29.0% of net sales for the 2005 Combined Period compared to 26.8% of net sales for 2004. The increase in gross margins is due to increased sales, which lead to improved leverage of our fixed cost of sales.  Also, gross margin for 2004 included the write-off of the step-up of inventory related to the acquisition of MedSource which reduced gross margin by 1.1%, and charges to write-down inventory acquired from MedSource which further reduced gross margin by 0.6%.  These improvements in gross margin were partially offset by the write-off of the step up of inventory related to the 2005 Acquisitions and the Merger, which reduced our 2005 Combined Period gross margin by 2.4%.

Selling, General and Administration Expenses

SG&A expenses were $78.8 million for the 2005 Combined Period compared to $45.9 million for 2004. The increase in SG&A costs was caused by a $16.4 million increase in charges for stock-based compensation, and the MedSource acquisition and 2005 Acquisitions which increased SG&A cost by $15.6 million. The increase in stock-based compensation is due to $13.7 million of amortization of deferred compensation associated with the restricted stock and stock options granted during the third quarter of 2005 for which we accelerated vesting due to the change of control occurring in connection with the Merger, and stock-based compensation charges of $2.7 million relating to our increased liability for phantom stock plans due to the increase in value of our common stock.

SG&A expenses were 17.1% of net sales for the 2005 Combined Period versus 14.4% of net sales for 2004. The higher 2005 percentage was impacted by increased charges for stock-based compensation in the 2005 period, which amounted to 3.6% of net sales for the 2005 Combined Period as compared to 0.1% in the 2004 period.

Research and Development Expenses

R&D expenses for the 2005 Combined Period were $3.0 million or 0.7% of net sales, compared to $2.7 million or 1.0% of net sales for 2004. The lower 2005 percentage was driven by sales growth, which lead to improved leverage of our fixed R&D costs.

Restructuring and Other Charges

We recognized $4.5 million of restructuring charges and acquisition integration costs during the 2005 Combined Period, including $1.3 million of severance costs and $2.4 million of other exit costs including costs to move production processes from five facilities that were closed to our other production facilities.  In addition to the $3.7 million in restructuring charges incurred during the 2005 Combined Period, we incurred $0.8 million of costs for the integration of MedSource.

Merger Related Costs

During the 2005 Combined Period, we incurred $55.9 million of merger related costs including incurred investment banking and equity sponsor related fees of $28.6 million, management bonuses of $16.7 million, and $8.0 million charge for in-process research and development, legal and accounting fees of $1.1 million and other costs of $1.5 million.

We allocated $8.0 million of the purchase price in the Transaction to in-process research and development (“IPR&D”) projects that have not yet reached technological feasibility and have no future alternative use.  Our IPR&D projects focus on the utilization of new materials, including biomaterials, and new methods for fabricating metals, polyimide and other materials.  The valuation of each project was based on an income approach which discounts the future net cash flows attributable to each project to determine the current value.  Projects were broken into three categories:  Incremental, Platform and Breakthrough.   Incremental IPR&D is comprised of 14 individual projects which are estimated to be complete by 2009.  Costs to complete Incremental IPR&D were estimated to be $2.8 million as of the date of the Merger.  Costs to complete Incremental IPR&D are estimated to be $1.0 million at December 31, 2006.  Net cash flows from Incremental

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IPR&D are estimated to be positive by 2008.   Platform IPR&D is comprised of 13 individual projects which are estimated to be complete by 2009.  Costs to complete the Platform IPR&D were estimated to be $6.4 million as of the date of the Merger.  Costs to complete Platform IPR&D are estimated to be $4.9 million at December 31, 2006.  Net cash flows from Platform IPR&D are estimated to be positive by 2009.  Breakthrough IPR&D is comprised of 4 individual projects which are estimated to be complete by 2010.  Costs to complete the Breakthrough IPR&D were estimated to be $4.0 million as of the date of the Merger.  Costs to complete Platform IPR&D are estimated to be $2.7 million at December 31, 2006.  Net cash flows from Breakthrough IPR&D are estimated to be positive by 2010.

Amortization

Amortization was $7.6 million for the 2005 Combined Period compared to $5.5 million for 2004. The higher amortization was due to the Merger, which increased amortization expense by $1.2 million for the 2005 Combined Period, and the acquisition of MedSource which increased amortization expense by $0.7 million for the 2005 Combined Period.

Interest Expense, net

Interest expense, net was $52.5 million for the 2005 Combined Period as compared to $26.9 million for 2004. The increase for the 2005 Combined Period was due to the write-off of $14.4 million of deferred financing fees due to the refinancing done in connection with the Transaction, increased debt incurred to acquire MedSource which increased interest expense by $7.8 million, increased debt in connection with the Transaction which increased interest expense by $3.1 million, one-time bridge loan charges of $2.4 million incurred in connection with the Transaction, higher interest rates on variable rate debt which increased interest expense by $1.4 million and increased debt incurred in connection with the 2005 Acquisitions which increased interest expense by $0.7 million. This increase was partially offset by $4.5 million of accelerated amortization of debt discounts and deferred financing costs incurred during 2004 due to the refinancing of our and our subsidiary’s indebtedness in connection with the MedSource acquisition.

Interest expense, net includes interest income of approximately $87,000 and $94,000 for the 2005 Combined Period and 2004, respectively.

Other expense

Other expense was $29.8 million for the 2005 Combined Period compared to $3.3 million for 2004.  Other expense for the 2005 Combined Period includes $29.9 million of debt prepayment penalties incurred due to the prepayment of our subsidiary’s senior subordinated notes in connection with the Transaction.  Other expense for 2004 includes $3.3 million of debt prepayment penalties incurred due to the prepayment of debt in connection with the MedSource acquisition.

Income Tax Expense

Income tax expense for the 2005 Combined Period was $6.3 million and includes $2.9 million of state income taxes, $2.1 million of non-cash deferred income taxes for the different book and tax treatment for goodwill and $1.3 million of foreign income taxes.  Income tax expense for 2004 was $3.5 million and includes $1.5 million of non-cash deferred income taxes due to the different book and tax treatment for goodwill, $1.2 million of state income taxes and $0.8 million of foreign income taxes.

Liquidity and Capital Resources

Our principal source of liquidity is our cash flows from operations and borrowings under our senior secured credit facility, entered into in conjunction with the Transaction, which includes a $75.0 million revolving credit facility and a seven-year $400.0 million term facility. Additionally, we are able to borrow up to $100.0 million in additional term loans, with the approval of participating lenders.

At December 31, 2006, we had $6.0 million of letters of credit outstanding and $3.0 million of outstanding loans which reduced the amounts available under the revolving credit portion of our senior secured credit facility resulting in $66.0 million available under the revolving credit facility.

Cash provided by operations was $26.8 million for 2006, as compared to cash used in operations of $47.2 million for the 2005 Combined Period.   Cash provided by operations for 2006 was negatively impacted by a $22.8 million increase in interest expense payments as a result of higher debt incurred to fund the Transaction and $2.1 million in payments to purchase stock options from terminating employees.  These decreases were partially offset by lower investments in working capital of $15.5 million and reduced restructuring related payments of $3.5 million. Cash used in operations for the 2005 Combined Period

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includes $80.2 million of cash expenses incurred for the Transaction including Merger related costs of $47.9 million, debt prepayment penalties of $29.9 million and a bridge loan fee of $2.4 million.

Cash used in investing activities was $30.3 million for 2006 as compared to $877.3 million for the 2005 Combined Period.  This decrease is a result of the following payments during the 2005 Combined Period:  $796.2 million in consideration to our former stockholders as part of the Transaction, the 2005 Acquisitions, for which we paid $49.5 million and a $2.2 million earn-out payment relating to our acquisition of Venusa.  This decrease was partially offset by $1.6 million in higher capital expenditures in 2006, which grew to $30.7 million for 2006 as compared to $29.2 million for the 2005 Combined Period.  Capital expenditures during 2006 included $4.5 million for the implementation of the Oracle enterprise resource planning system, or ERP system, with the balance consisting primarily of the purchase of production equipment to meet customer demand for certain of our products.

 During 2006, cash used in financing activities was $2.6 million compared to $917.4 million of cash provided by financing activities for the 2005 Combined Period.  The decrease in cash provided by financing activities was due to the effects of the Transaction during the 2005 Combined Period, which resulted in net proceeds from debt and equity issuances of $879.3 million and additional debt proceeds of $42.0 million used to fund the 2005 Acquisitions.

Cash used in operations for the 2005 Combined Period was $47.2 million as compared to $22.2 million of cash provided by operations for 2004.  This decrease was due to the following increases in cash payments for the 2005 Combined Period:  $80.2 million of cash expenses incurred for the Transaction, higher interest payments of $30.6 million, increased investments in working capital of $16.1 million and $3.6 million of higher restructuring related payments.   These decreases were partially offset by $61.1 million of increased profitability from our operations as a result of increased demand for our products and a full year of the MedSource acquisition.

During the 2005 Combined Period, cash used in investing activities totaled $877.3 million compared to $227.4 million for 2004. The increase in cash used in investing activities is attributable to the payment of $796.7 million in consideration to our former stockholders upon the consummation of the Merger, the 2005 Acquisitions for $49.5 million net of cash acquired, increased capital spending of $15.3 million due to increased demand for our products and a full year of the MedSource acquisition and a $2.2 million final earn-out payment relating to our acquisition of Venusa.  Cash used in investing activities in 2004 included the acquisition of MedSource, which used $205.4 million of cash during 2004, and an earn-out payment relating to our acquisition of Venusa, which used $9.6 million of cash during the first nine months of 2004.

During the 2005 Combined Period, cash provided by financing activities was $917.4 million and consisted of the following:

·                  Proceeds from our senior secured credit facility of $400.0 million and proceeds of $300.9 million from our senior subordinated notes due 2013.  We paid $24.0 million in debt issuance costs for these debt instruments.

·                  Equity contributed from our parent company in connection with the Merger of $611.0 million.

·                  Proceeds from borrowings under our subsidiary’s senior secured credit facility of $42.0 million to fund our acquisitions of Campbell and MTG.  We incurred debt issuance costs of $0.9 million on our subsidiary’s senior secured credit facility, including $0.8 million of costs incurred to amend this facility during the quarter ended March 31, 2005, and $0.1 million of costs incurred in connection with additional term loans drawn to fund the acquisition of MTG.

·                  The repayment by our subsidiary of $408.6 million of existing indebtedness upon the closing of the Transaction, as well as other scheduled payments under our subsidiary’s senior secured credit facility of $1.5 million prior to the Transaction.

·                  The repayment of $1.7 million of MTG’s indebtedness upon our acquisition of MTG.

Cash provided by financing activities was $217.1 million for 2004 and relates to the following financing transactions, which took place in conjunction with our June 30, 2004 acquisition of MedSource:

·                  The issuance of $369.0 million of indebtedness consisting of Accellent Corp.’s previous senior secured credit facility, which was a $194.0 million six-year term facility, and $175.0 million of Accellent Corp.’s previous 10% senior subordinated notes due July 15, 2012. Our subsidiary incurred $17.1 million of fees related to this debt.

·                  The repayment of all previously outstanding debt, which included our subsidiary’s credit facility of $83.5 million, our subsidiary’s senior subordinated notes of $21.5 million and our senior notes of $38.3 million.

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·                  The repayment of all MedSource debt and capital leases totaling $36.1 million.

·                  The payment of $22.2 million of dividends.

·                  The repurchase of $18.8 million of our Class C Redeemable Preferred Stock.

·                  The issuance of 7,568,980 shares of our Class A-8 5% Convertible Preferred stock for approximately $88.0 million, net of $1.8 million of fees.

Capital Expenditures.  We anticipate that capital expenditures will approximate $28 million to $32 million in 2007. Our senior secured credit facility contains restrictions on our ability to make capital expenditures. We may make capital expenditures in each fiscal year in an amount not exceeding the greater of (i) 6% of consolidated net sales for such fiscal year and (ii) for the period November 23, 2005 to December 31, 2006, $39,000,000; for the 2007 fiscal year, $40,000,000; for the 2008 fiscal year, $42,500,000; for the 2009 fiscal year, $45,000,000; for the 2010 fiscal year, $47,500,000; for the 2011 fiscal year, $52,500,000; and for the 2012 fiscal year, $55,000,000. The senior secured credit facility also allows us to carry forward unused amounts and to carry back future permitted amounts, in each case on a limited basis. Based on current estimates, our management believes that the amount of capital expenditures permitted to be made under our senior secured credit facility will be adequate to grow our business according to our business strategy and to maintain our continuing operations.  We expect to finance our 2007 capital expenditures with cash flow from operations, and if needed, available borrowings under our senior secured credit facility.

Other Expenditures.  In connection with our acquisition of Venusa in February of 2003, we were obligated to pay contingent consideration based on agreed upon earnings targets for fiscal years 2002, 2003 and 2004. During the second quarter of 2005, we paid $2.2 million in cash, $3.6 million in our Class A-7 5% Convertible Preferred Stock and $0.2 million in our phantom stock in connection with Venusa achieving fiscal year 2004 earn out targets. During the second quarter of 2004, we paid $9.6 million in cash, $26.0 million in our Class A-7 5% Convertible Preferred Stock, and $1.3 million in our phantom stock in connection with Venusa achieving fiscal year 2002 and 2003 earnout targets.  We are not obligated to make any additional payments in connection with any of our acquisitions as of December 31, 2006.

Other Long-Term Liabilities.  Other long-term liabilities increased $11.1 million from $28.1 million at December 31, 2005 to $39.2 million at December 31, 2006.  The increase was due to the classification of our roll-over stock options from stockholder’s equity to a $19.6 million liability upon the adoption of SFAS 123R and a $3.0 million increase in our liability for deferred taxes.  These increases were partially offset by a $8.1 million reduction in the long-term portion of our costs to close certain MedSource facilities and $2.1 million in payments to repurchase roll-over stock options from terminating employees.  Other long-term liabilities increased $4.5 million from $23.7 million at December 31, 2004 to $28.1 million at December 31, 2005. The increase was due to an $8.8 million increase in our deferred tax liability, which was partially offset by a $3.0 million reduction in the long-term portion of our estimated costs to close certain MedSource facilities and a $1.5 million decrease in our phantom stock liability due to the purchase of all of our equity instruments in connection with the Merger.  The increase in our deferred tax liability was due to $2.1 million in provisions for deferred taxes during the 2005 Combined Period and $6.7 million of deferred taxes recorded in connection with the allocation of the purchase price paid to acquire us in the Merger to the fair value of all of our assets and liabilities.

As of December 31, 2006, we have provided a liability of $3.7 million for environmental clean up matters. The United States Environmental Protection Agency, or EPA, issued an Administrative Consent Order in July 1988 requiring UTI, our subsidiary, to study and, if necessary, remediate the groundwater and soil beneath and around its plant in Collegeville, Pennsylvania. Since that time, UTI has implemented and is operating successfully a contamination treatment system approved by the EPA. We expect to incur approximately $0.2 million of ongoing operating costs during fiscal year 2007 relating to the Collegeville remediation effort. Our environmental accrual at December 31, 2006 includes $3.6 million related to Collegeville.  The remaining environmental accrual which relates to our other subsidiaries was $0.1 million at December 31, 2006.  Also, in anticipation of proposed changes to air emission regulations, we are planning to incorporate new air emission control technologies at one of our manufacturing sites which uses a regulated substance.  We currently estimate that we will incur $1.0 million of capital expenditures during 2007 to implement the new air emission control technologies.  We believe that the disposition of these identified environmental matters will not have a material adverse effect upon our liquidity, capital resources, business or consolidated financial position. However, one or more of such environmental matters could have a significant negative impact on our consolidated financial results for a particular reporting period.

Our ability to make payments on our indebtedness and to fund planned capital expenditures, other expenditures and long-term liabilities, and necessary working capital will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our

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control. For example, during 2006 Boston Scientific transferred a number of products assembled by us to its own assembly operation. Based on our current level of operations, we believe our cash flow from operations and available borrowings under our senior secured credit facility will be adequate to meet our liquidity requirements for the next 12 months. However, no assurance can be given that this will be the case.  As noted below, we are required to maintain certain financial ratios in connection with our debt agreements. Failure to maintain those ratios would prevent us from accessing additional borrowings under our senior secured credit facility and could also result in the requirement to repay all amounts outstanding under that facility, each of which would have a material impact on our liquidity and financial condition.

Our debt agreements contain various covenants, including a maximum ratio of consolidated net debt to consolidated adjusted EBITDA (“Leverage Ratio”) and a minimum ratio of consolidated adjusted EBITDA to consolidated interest expense (“Interest Coverage Ratio”).  Both of these ratios are calculated at the end of each fiscal quarter based on our trailing twelve month financial results.  At December 31, 2006, our Leverage Ratio was 6.86 versus a required maximum of 7.25.  The required maximum Leverage Ratio under our debt agreements adjusts down to 6.50 for the quarter ended December 31, 2007.  At December 31, 2006, our Interest Coverage Ratio was 1.67 versus a required minimum of 1.50.  The required minimum Interest Coverage Ratio adjusts up to 1.60 for the quarter ended December 31, 2007.  We may not meet the Leverage Ratio or Interest Coverage Ratio in future periods.  Failure to meet these ratios could result in the requirement to repay all amounts outstanding under our senior secured credit facility, and also restrict our ability to incur additional indebtedness in accordance with the indenture governing the senior subordinated notes.

Indebtedness.  The following is a description of our material indebtedness as of December 31, 2006:

10½% Senior Subordinated Notes Due 2013

On November 22, 2005, we issued $305.0 million in aggregate principal amount of 10½% senior subordinated notes due 2013. The notes were initially purchased by Credit Suisse First Boston LLC, JPMorgan Securities Inc. and Bear, Stearns & Co. Inc. and were resold to various qualified institutional buyers and non-U.S. persons pursuant to Rule 144A and Regulation S, respectively, under the Securities Act. Interest on the notes is payable semi-annually on June 1st and December 1st of each year beginning on June 1, 2006, and the notes mature on December 1, 2013.  The notes are guaranteed by all of our existing domestic subsidiaries and by all of our future domestic subsidiaries that are not designated as unrestricted subsidiaries.

We have the option to redeem the notes, in whole or in part, at any time on or after December 1, 2009, at redemption prices declining from 105.25% of their principal amount on December 1, 2009 to 100% of their principal amount on December 1, 2011, plus accrued and unpaid interest.  At any time on or prior to December 1, 2008, we may also redeem up to 35% of the aggregate principal amount of the notes at a redemption price of 110.5% of their principal amount, plus accrued and unpaid interest, within 90 days of the closing of an underwritten public equity offering. Upon a change of control, as defined in the indenture pursuant to which the notes were issued, we are required to offer to repurchase the notes at a purchase price equal to 101% of their principal amount, plus accrued and unpaid interest.

The indenture limits our and our subsidiaries’ ability to, among other things:

·                                          pay dividends;

·                                          redeem capital stock and make other restricted payments and investments;

·                                          incur additional debt or issue preferred stock;

·                                          enter into agreements that restrict our subsidiaries from paying dividends or other distributions;

·                                          make loans or otherwise transfer assets to us or to any other subsidiaries;

·                                          create liens on assets;

·                                          engage in transactions with affiliates;

·                                          sell assets, including capital stock of subsidiaries; and

·                                          merge, consolidate or sell all or substantially all of our assets and the assets of our subsidiaries.

The indenture contains customary events of default including, but are not limited to:

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·                                          failure to pay any principal, interest, fees or other amounts when due;

·                                          material breach of any representation or warranty;

·                                          covenant defaults;

·                                          events of bankruptcy;

·                                          cross defaults to other material indebtedness;

·                                          invalidity of any guarantee; and

·                                          unsatisfied judgements.

Senior Secured Credit Facility

In connection with the Transaction on November 22, 2005, we entered into a senior secured credit facility with JPMorgan Chase Bank, N.A., as administrative agent, consisting of a term loan facility and a revolving credit facility, with a syndicate of lenders. The terms of the senior facility are set forth below. This description of the senior facility does not purport to be complete.

Borrowings

The senior facility provides for a $400 million term loan facility and a $75 million revolving credit facility, which includes a letter of credit subfacility. The proceeds of the term loan were used to fund a portion of the Merger, to repay all outstanding indebtedness under Accellent Corp.’s old senior secured credit facility and to pay certain fees, expenses and other costs associated with the Merger. The proceeds of the revolving credit facility and the letters of credit will be used for general corporate purposes.

The full amount of the term loans was borrowed on the closing date. The term loans will amortize in 27 quarterly installments of 0.25% of the original principal amount of the term loans, with the balance payable on the seventh anniversary of the closing date. Amounts prepaid or repaid with respect to the term loans may not be re-borrowed. The senior facility provides that up to $100 million of additional term loans may be incurred under the term facility, with the average life to maturity and final maturity date of such additional term loans to be no earlier than the average life to maturity and final maturity date, respectively, of the initial term loans and with pricing to be agreed.

Revolving loans may be borrowed, repaid and re-borrowed after the closing date until the sixth anniversary of the closing date, and any revolving loans outstanding on the sixth anniversary of the closing date shall be repaid on such date. Approximately $66.0 million of the revolving facility was available as of December 31, 2006.

Voluntary prepayments of the term loans and revolving commitment reductions are permitted in whole or in part, subject to minimum prepayment requirements. Voluntary prepayments of LIBOR loans on a date other than the last day of the relevant interest period are also subject to payment of customary breakage costs, if any. We are required to prepay the loans with the net proceeds of certain incurrences of indebtedness, a certain percentage of excess cash flow and, subject to certain reinvestment rights, certain asset sales.

Interest

The interest rates under the senior facility are based in the case of the term loans, at our option, on either LIBOR plus 2.00% or the alternative base rate plus 1.00%, and, in the case of the revolving loans, at our option, on either LIBOR plus 2.25% or the alternate base rate plus 1.25%, which applicable margins are in each case subject to reduction based upon the attainment of certain leverage ratios. The interest rate on the secured facility at December 31, 2006 was 7.37%.  Overdue principal bears interest at a rate per annum equal to 2.0% above the rate then applicable to such principal amount. Overdue interest and other amounts bear interest at a rate per annum equal to 2.0% above the rate then applicable to alternate base rate loans under the term facility. With respect to LIBOR loans, each interest period will have a duration of, at our option, either one, two, three or six months, or, if available to all relevant lenders, nine or twelve months, and interest is payable in arrears at the end of each such interest period and, in any event, at least every three months. With respect to alternate base rate loans, interest is payable quarterly in arrears on the last day of each calendar quarter. Calculations of interest are based on a 360-day year (or 365/366 days, in the case of certain base rate loans) for actual days elapsed.

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Fees

The senior facility provides for the payment to the lenders of a commitment fee equal to 0.50% per annum on the average daily unused portion of the available commitments under the revolving credit facility, payable quarterly in arrears and upon termination of the commitments, which commitment fee is subject to reduction based upon the attainment of a certain leverage ratio. The senior facility also provides for the payment to the lenders of a letter of credit fee on the average daily stated amount of all outstanding letters of credit equal to the then-applicable spread for LIBOR loans under the revolving credit facility, and a payment to JPMorgan Chase Bank, N.A., as letter of credit issuer, of a letter of credit fronting fee on the average daily stated amount of all outstanding letters of credit at 0.125% per annum, in each case payable quarterly in arrears and upon termination of the commitments under the revolving facility.

Collateral and guarantees

The loans under the senior facility and certain hedging obligations owing to senior facility lenders or their affiliates are guaranteed by Accellent Acquisition Corp. and by all of our existing and future direct and indirect wholly-owned domestic subsidiaries. The loans, the guarantees and such hedging arrangements are secured by a first priority perfected lien, subject to certain exceptions, on substantially all of our and the guarantors’ existing and future properties and tangible and intangible assets, including a pledge of all of the capital stock held by such persons (other than certain capital stock of foreign subsidiaries).

Representations, warranties and covenants

The senior facility contains certain customary representations and warranties. In addition, we are required to maintain certain ratings in effect with respect to the senior facility, and the senior facility contains customary covenants restricting the ability our and certain of our subsidiaries’ ability to, among other things:

·                                          declare dividends and redeem capital stock;

·                                          incur additional indebtedness (including guarantees of indebtedness);

·                                          create liens;

·                                          engage in mergers, consolidations, acquisitions and asset sales;

·                                          change the nature of our business;

·                                          make investments, loans and advances;

·                                          enter into sale-leaseback transactions;

·                                          engage in certain transactions with affiliates;

·                                          make prepayments of subordinated debt and amend subordinated debt documents;

·                                          change our fiscal year; and

·                                          make capital expenditures.

In addition, the senior facility requires us to maintain a maximum ratio of consolidated net debt to consolidated adjusted EBITDA and a minimum ratio of consolidated adjusted EBITDA to consolidated interest expense.

Events of Default

Events of default under the senior facility include but are not limited to:

·                                          failure to pay principal, interest, fees or other amounts when due;

·                                          material breach of any representation or warranty;

·                                          covenant defaults;

·                                          cross defaults to other material indebtedness;

42




 

·                                          events of bankruptcy;

·                                          invalidity of any guarantee or security interest;

·                                          a change of control; and

·                                          other customary events of default.

Other Long-Term Debt

As of December 31, 2006, our obligations under capital leases totaled $21,000.

As of December 31, 2006, we were in compliance with the covenants under our senior secured credit facility and our senior subordinated notes.

Other Key Indicators of Financial Condition and Operating Performance

EBITDA, Adjusted EBITDA and the related ratios presented in this Form 10-K are supplemental measures of our performance that are not required by, or presented in accordance with GAAP. EBITDA and Adjusted EBITDA are not measurements of our financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as an alternative to cash flow from operating activities as a measure of our liquidity.

EBITDA represents net income (loss) before net interest expense, income tax expense (benefit), depreciation and amortization. Adjusted EBITDA is defined as EBITDA further adjusted to give effect to unusual items, non-cash items and other adjustments, all of which are required in calculating covenant ratios and compliance under the indenture governing the senior subordinated notes and under our senior secured credit facility.

We believe that the inclusion of EBITDA and Adjusted EBITDA in this Form 10-K is appropriate to provide additional information to investors and debt holders about the calculation of certain financial covenants in the indenture governing the senior subordinated notes and under our senior secured credit facility. Adjusted EBITDA is a material component of these covenants. For instance, the indenture governing the senior subordinated notes and our senior secured credit facility contain financial covenant ratios, specifically total leverage and interest coverage ratios that are calculated by reference to Adjusted EBITDA. Non-compliance with the financial ratio maintenance covenants contained in our senior secured credit facility could result in the requirement to immediately repay all amounts outstanding under such facility, while non-compliance with the debt incurrence ratios contained in the indenture governing the senior subordinated notes would prohibit us from being able to incur additional indebtedness other than pursuant to specified exceptions.

We also present EBITDA because we consider it an important supplemental measure of our performance and believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of high yield issuers, many of which present EBITDA when reporting their results. Measures similar to EBITDA are also widely used by us and others in our industry to evaluate and price potential acquisition candidates. We believe EBITDA facilitates operating performance comparison from period to period and company to company by backing out potential differences caused by variations in capital structures (affecting relative interest expense), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses) and the age and book depreciation of facilities and equipment (affecting relative depreciation expense).

In calculating Adjusted EBITDA, as permitted by the terms of our indebtedness, we eliminate the impact of a number of items. For the reasons indicated herein, you are encouraged to evaluate each adjustment and whether you consider it appropriate. In addition, in evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses similar to the adjustments in the presentation of Adjusted EBITDA. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.

EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

·                                          they do not reflect our cash expenditures for capital expenditure or contractual commitments;

·                                          they do not reflect changes in, or cash requirements for, our working capital requirements;

·                                          they do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our indebtedness;

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·                                          although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect cash requirements for such replacements;

·                                          Adjusted EBITDA does not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations, as discussed in our presentation of “Adjusted EBITDA” in this report; and

·                                          other companies, including other companies in our industry, may calculate these measures differently than we do, limiting their usefulness as a comparative measure.

Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business or reduce our indebtedness. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA and Adjusted EBITDA only supplementally. For more information, see our consolidated financial statements and the notes to those statements included elsewhere in this report.

The following table sets forth a reconciliation of net income to EBIDTA for the periods indicated:

 

 

 

Predecessor

 

 

 

Successor

 

 

 

Twelve Months
Ended
December 31,

 

Period From
January 1 to
November 22,

 

 

 

Period From
November 23
to December
31,

 

Twelve Months
Ended
December 31,

 

 

 

2004

 

2005

 

 

 

2005

 

2006

 

RECONCILIATION OF NET INCOME
TO EBITDA:

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(5,620

)

$

(82,313

)

 

 

$

(22,502

)

$

(18,559

)

Interest expense, net

 

26,879

 

43,233

 

 

 

9,301

 

65,338

 

Provision for income taxes

 

3,483

 

5,816

 

 

 

478

 

5,307

 

Depreciation and amortization

 

16,152

 

20,047

 

 

 

3,057

 

34,173

 

EBITDA

 

$

40,894

 

$

(13,217

)

 

 

$

(9,666

)

$

86,259

 

 

44




 

The following table sets forth a reconciliation of EBITDA to Adjusted EBITDA for the periods indicated:

 

 

Predecessor

 

 

 

Successor

 

 

 

Twelve Months
Ended
December 31,

 

Period From
January 1 to
November 22,

 

 

 

Period From
November 23
to December
31,

 

Twelve Months
Ended
December 31,

 

 

 

2004

 

2005

 

 

 

2005

 

2006

 

EBITDA

 

$

40,894

 

$

(13,217

)

 

 

$

(9,666

)

$

86,259

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

Acquired Adjusted EBITDA (a)

 

22,751

 

7,165

 

 

 

 

 

Restructuring and other charges(b)

 

3,600

 

4,154

 

 

 

311

 

5,008

 

Stock-based compensation(c)

 

266

 

16,676

 

 

 

 

1,138

 

Severance(d)

 

232

 

384

 

 

 

248

 

35

 

Relocation(d)

 

67

 

506

 

 

 

 

530

 

Write-off of step-up of acquired
inventory at date of acquisitions(e)

 

3,397

 

522

 

 

 

10,352

 

6,422

 

Write off acquired A/R and
inventory(f)

 

2,478

 

(336

)

 

 

 

 

Losses incurred by closed facilities(g)

 

2,046

 

872

 

 

 

97

 

 

Gain on sale of property and equipment(h)

 

(74

)

179

 

 

 

(104

)

186

 

Management fees to existing
stockholders(i)

 

700

 

827

 

 

 

83

 

1,042

 

Debt prepayment penalty(j)

 

3,295

 

29,914

 

 

 

 

 

Currency exchange gain(k)

 

 

 

 

 

 

641

 

Acquisition expenses(l)

 

 

 

 

 

 

 

479

 

Gain on derivative instruments(m)

 

 

 

 

 

 

(79

)

Costs related to the Transaction(n)

 

 

48,498

 

 

 

8,000

 

 

Adjusted EBITDA

 

$

79,652

 

$

96,144

 

 

 

$

9,321

 

$

101,661

 


(a)          Under the applicable debt agreements, Adjusted EBITDA is permitted to be calculated by giving pro forma effect to acquisitions as if they had taken place at the beginning of the periods covered by the covenant calculation.  We acquired MedSource on June 30, 2004, Campbell on September 12, 2005 and MTG on October 6, 2005.  The Adjusted EBITDA for the year ended December 31, 2004 and the period from January 1, 2005 to November 22, 2005 have been adjusted to reflect the pre-acquisition amount of Adjusted EBITDA earned.

(b)         Set forth below is a reconciliation of restructuring and other charges as shown on the selected historical consolidated financial data to the amount shown above as an adjustment to EBITDA:

 

Predecessor

 

 

 

Successor

 

 

 

Twelve Months
Ended
December 31,

 

Period From
January 1 to
November 22,

 

 

 

Period From
November 23
to December
31,

 

Twelve Months
Ended
December 31,

 

 

 

2004

 

2005

 

 

 

2005

 

2006

 

Restructuring charges

 

$

2,691

 

$

3,388

 

 

 

$

311

 

$

5,008

 

MedSource integration costs

 

909

 

766

 

 

 

 

 

 

 

$

3,600

 

$

4,154

 

 

 

$

311

 

$

5,008

 

(c)          We have incurred non-cash charges for stock-based compensation relating to stock options granted during the twelve months ended December 31, 2000 and 2001, non-cash dividends on phantom stock issued to employees in connection with certain acquisitions, an increase in the value of phantom stock, charges for restricted stock and stock options granted to employees in July 2005, and charges for stock options granted in September 2005.  All non-cash charges for stock-based compensation recorded during the twelve months ended December 31, 2006 were recorded to comply with the requirements of SFAS 123R, which the Company adopted on January 1, 2006.  The table below summarizes non-cash stock-based compensation for the amounts shown above as an adjustment to EBITDA:

45




 

 

 

Predecessor

 

 

 

Successor

 

 

 

Twelve Months Ended
December 31,

 

Period From
January 1 to
November 22,

 

 

 

Period From
November 23
to December
31,

 

Twelve Months Ended
December 31,

 

 

 

2004

 

2005

 

 

 

2005

 

2006

 

2000 & 2001 stock options

 

$

170

 

$

206

 

 

 

$

 

$

 

Phantom stock market value adjustment

 

 

2,747

 

 

 

 

 

Award of redeemable preferred stock

 

20

 

 

 

 

 

 

July 2005 stock options and restricted stock

 

 

12,201

 

 

 

 

 

September 2005 stock options

 

 

1,489

 

 

 

 

 

Phantom stock non-cash dividends

 

76

 

33

 

 

 

 

 

SFAS 123R compensation on stock options

 

 

 

 

 

 

1,138

 

 

 

$

266

 

$

16,676

 

 

 

$

 

$

1,138

 

 

(d)            Our credit agreements provide for the adjustment of EBITDA for non-recurring expenses, including employee severance and relocation expenses.

(e)             We record the assets and liabilities of acquired companies at their respective fair values upon the date of acquisition. Inventories are recorded at fair value at the acquisition date, with the difference between the cost of the inventory and fair value charged to cost of sales as the inventory is sold. During the twelve months ended December 31, 2004, we incurred $3.4 million of costs to write off the step-up of inventory acquired from MedSource. During the period from January 1, 2005 to November 22, 2005, we incurred $0.5 million of costs related to the step-up of inventory acquired from Campbell and MTG.  For the period from November 23, 2005 to December 31, 2005, we incurred $0.4 million of costs related to the step-up of inventory acquired from Campbell and MTG, and $10.0 million of costs to write off the step-up of inventory acquired in the acquisition of us by KKR and Bain.  For the twelve months ended December 31, 2006, we incurred $6.4 million of costs to write off the step up of inventory acquired in the acquisition of us by KKR and Bain.

(f)               We incurred charges of $2.5 million in the fourth quarter of 2004 to write down $1.9 million of inventory and $0.6 million of receivables acquired from MedSource. During our first quarter of 2005, we settled a $0.3 million MedSource receivable that had previously been written off, and, as a result, recorded a reduction of the original EBITDA adjustment.

(g)            In connection with our acquisition of MedSource, we implemented a plan to close certain MedSource facilities. We closed the Newton, Massachusetts facility in January 2005, sold the Norwell, Massachusetts facility in February 2005, and closed the Navojoa, Mexico facility in April 2005. We have added back operating losses, net of depreciation expense incurred by these facilities during the twelve months ended December 31, 2004, the period from January 1, 2005 to November 22, 2005 and the period from November 23, 2005 to December 31, 2005 of $2.0 million, $0.9 million and $0.1 million, respectively.

(h)            Our credit agreements require that we adjust EBITDA for all gains and losses from sales of our property, plant and equipment.

(i)                Prior to the Transaction, we incurred management fees to one of our equity sponsors, KRG Capital Partners, LLC of $0.5 million per year. Effective July 1, 2004, we began to incur an additional management fee to another equity sponsor, DLJ Merchant Banking of $0.4 million annually. In connection with the Transaction, such arrangements were terminated and we entered into a management services agreement with KKR that provides for a $1.0 million annual payment, such amount to increase by 5% per year.  See Item 13-”Certain Relationships and Related Party Transactions.”

(j)                In connection with the MedSource acquisition on June 30, 2004, we repaid existing indebtedness and as a result incurred $3.3 million of prepayment penalties.  In connection with the Transaction on November 22, 2005, we repaid existing indebtedness and as a result incurred $29.9 million of prepayment penalties.

(k)          Our credit agreements provide for the adjustment of EBITDA for non operating currency transaction gains and losses.

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(l)             During the twelve months ended December 31, 2006, we incurred costs relating to an acquisition that will not be consummated.

(m)       We have entered into interest rate swap and collar agreements to hedge our exposure to variable interest rates on our senior secured credit facility.  We record realized and unrealized gains and losses on the swap and collar.  Effective November 30, 2006, we documented the hedging relationship between our swap agreement and the underlying debt instrument.  From December 1, 2006 through the maturity date of the swap agreement, we expect future realized gains and losses on the swap agreement to be recorded as interest expense, and unrealized gains and losses to be recorded as adjustments to other comprehensive income (loss).

(n)         In connection with the Transaction, we incurred the following expenses during the periods indicated: