10-K 1 primetenk.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 2003 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------- ------------- Commission File Number: 0-14961 PRIMESOURCE HEALTHCARE, INC. (Exact name of registrant as specified in its charter) Massachusetts 04-2741310 (State or other jurisdiction of (I.R.S. Employer incorporation or organizatio Identification No.) 3700 East Columbia Street - Tucson, Arizona - 85714 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (520) 512-1100 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share (Title of class) Indicate by checkmark 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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes |_| No |X| The estimated aggregate market value of the voting common stock held by non-affiliates of the registrant was $1,978,880 as of September 1, 2003. Because PrimeSource's common stock is not listed or quoted on an exchange, this computation is based on an estimated market value of $.32 per share of common stock as of September 1, 2003. As of September 1, 2003, 22,375,094 shares of common stock, $.01 par value, were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: None. 2
TABLE OF CONTENTS Part I Item 1. Business......................................................................... 4 Item 2. Properties....................................................................... 15 Item 3. Legal Proceedings................................................................ 16 Item 4. Submission of Matters to a Vote of Security Holders.............................. 16 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............ 17 Item 6. Selected Financial Data.......................................................... 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Item 7A. Quantitative and Qualitative Disclosures About Market Risk....................... 34 Item 8. Financial Statements and Supplementary Data...................................... 36 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 64 Item 9A. Controls and Procedures.......................................................... 64 Part III Item 10. Directors and Executive Officers of the Registrant............................... 64 Item 11. Executive Compensation........................................................... 66 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.............................................................. 70 Item 13. Certain Relationships and Related Transactions................................... 73 Part IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................. 74 Signatures ............................................................................................ 82 Index to Exhibits ............................................................................................ 88
3 PART I When we refer to "we," "us", "our," or "PrimeSource," we mean PrimeSource Healthcare, Inc., a Massachusetts corporation formerly known as Luxtec Corporation, and its consolidated subsidiaries. This document includes various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Sections 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs concerning future events. Statements containing expressions such as "believes," anticipates" or "expects" used in our press releases and periodic reports on Forms 10-K and 10-Q filed with the Securities and Exchange Commission are intended to identify forward-looking statements. All forward-looking statements involve risks and uncertainties. Although we believe our expectations are based upon reasonable assumptions within the bounds of our knowledge and operations, there can be no assurances that actual results will not materially differ from expected results. We caution that these and similar statements included in this report and in previously filed periodic reports, including reports filed on Forms 10-K and 10-Q are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. Such factors include, without limitation, those listed under Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," under the subheading "Risk Factors." We caution readers not to place undue reliance on forward-looking statements, which speak only as of the date thereof. We undertake no obligation to publicly release any revisions to such forward-looking statements to reflect events or circumstances after the date hereof. ITEM 1. BUSINESS GENERAL We are a leading specialty medical products sales, marketing, manufacturing and service company. We sell a broad portfolio of specialty medical products, some of which we manufacture, to hospitals and surgery centers nationwide through a dedicated organization of sales and marketing professionals. We have expanded rapidly through the acquisition and integration of a number of leading regional specialty sales and marketing organizations and select specialty medical products manufacturing companies. Today, we have two primary businesses: Specialty Medical Distribution and the Manufactured Products Division or Manufactured Products. As of June 30, 2003, we had 142 employees and generated total revenue of $46.4 million for the fiscal year ending June 30, 2003. On March 2, 2001, we completed a merger with PrimeSource Surgical, Inc., or PrimeSource Surgical, resulting in PrimeSource Surgical becoming our wholly owned subsidiary. Subsequent to the merger with PrimeSource Surgical, we changed our name from "Luxtec Corporation," or Luxtec, to "PrimeSource Healthcare, Inc." In October 2001, we engaged Corporation Revitalization Partners as a restructuring agent to evaluate our operations for possible reorganization. In November 2001, we commenced with a restructuring plan which involved narrowing the focus of our operations, consolidation of certain under performing sales regions, reduction of corporate overhead through workforce reductions and facility consolidation, restructuring of our balance sheet through the recapitalization of equity and refinancing of our senior bank debt and reduction of debt levels through cost reductions and improved efficiency of operations. 4 On September 20, 2002, Ruby Merger Sub, Inc., the Company's indirect wholly owned subsidiary ("Ruby"), sold all of the assets of the former Professional Equipment Co., Inc. ("PEC") line of business in exchange for the cancellation of previously issued stock to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business. On June 30, 2003, PrimeSource Surgical, Inc. ("PrimeSource"), a subsidiary of PrimeSource Healthcare, Inc. ("the Company"), sold all of the issued and outstanding capital stock of Ruby for cash proceeds of $1,000,000 to New England Medical Specialties, Inc., a newly formed entity ("NMSI"). Peter Miller, a stockholder of NMSI, was the Regional Manager of Ruby prior to the disposition of the capital stock of Ruby. In connection with the sale of the capital stock of Ruby, Mr. Miller concluded his employment relationship with PrimeSource. The cash proceeds were used to payoff the PrimeSource Term Note and reduce the revolving line of credit with Citizens Bank of Massachusetts ("Citizens"). The loss on the disposal of the operation of $73,830 was included as discontinued operations in the fourth quarter of 2003, and the related results of operations for the operation were re-classified as discontinued operations. BUSINESS STRATEGY Our goal is to be one of the nation's leading suppliers of specialty medical products to hospitals and surgery centers. We intend to continue to grow by: o hiring experienced territory sales representatives; o securing additional specialty product lines to our product offerings; and o selectively acquiring specialty medical products manufacturers. We expect to benefit from the acquisition of select specialty medical products manufacturers by increasing sales of acquired product lines through use of our direct specialty medical products sales force. Our Manufactured Products Division continues to lead the surgical headlamp illumination industry and focuses its research and development budget on new, innovative products. We believe we are well positioned to continue our growth within the specialty medical products industry. We expect to experience sales growth in the specialty medical products industry as a result of: o favorable industry demographics; o sustaining or increasing our market share; o the acquisition of other specialty medical products manufacturers; o further penetration of existing customer accounts due to our introduction of new products and services; and o entrance into new specialty markets and expansion into international markets. 5 INDUSTRY The medical products industry has grown in recent years due to the aging of the population and the development of new medical products and technologies that create new product opportunities for manufacturers and suppliers. Healthcare industry analysts estimate that the overall market for medical products and supplies in the United States is in excess of $45 billion. An estimated $15 billion is distributed by the larger medical and surgical, or med-surg distributors, such as Owens & Minor, Cardinal Health and McKesson HBOC. These distributors primarily market commodity products and supplies to group purchasing organizations ("GPOs") and integrated delivery networks ("IDNs"). It is estimated that an additional $25 billion in medical product sales is sold directly by medical device manufacturers to end customers. Local and regional distributors account for an estimated $5 billion of specialty medical products sold to hospitals, clinics and physicians. PrimeSource competes within this highly fragmented segment of the medical products and supplies market. Historically, the specialty medical products industry has been highly fragmented. During the past decade, healthcare providers have consolidated into larger and more IDNs in an effort to reduce costs. In addition, in order to gain purchasing power, buyers of medical products and supplies have consolidated their purchases through large, national GPOs. In addition to our traditional customer base, composed primarily of hospitals and surgery centers, we also market (on a limited basis) to IDNs and GPOs. IDNs and GPOs purchase a significant percentage of medical products and supplies for hospitals. GPO contractors typically require purchasing volume of at least $10 million when structuring purchasing contracts with distributors. By aggregating specialty products, we have created an opportunity for GPOs to capture additional administrative fees by bringing in non-contracted specialty medical products. Furthermore, because of our access to IDNs and GPOs, we have established a compelling advantage with small product manufacturers (which cannot easily access the IDN and GPO customer base) over smaller competitors who are unable to satisfy IDN and GPO minimum volume purchasing requirements. We believe that we are well positioned within our industry because we: o provide a consultative, specialty-focused sales approach through a network of highly trained sales professionals; o operate in a complementary niche outside the volume-driven model of large, national med-surg distributors; and o offer a broader range of products, services, and solutions exceeding those of any single specialty medical product manufacturer's direct sales force. o reach a national customer base of GPOs and IDNs that is beyond the scope of local and regional specialty medical products distributors. We believe that customers seek to consolidate their purchases of products and services in the highly fragmented specialty medical products and services market in order to reduce their procurement costs. We help customers reduce the number of vendors that they work with, thereby reducing the overall costs of products and services. 6 PRODUCTS AND SERVICES SPECIALTY MEDICAL DISTRIBUTION Within the Specialty Medical Distribution business, we divide our business into PrimeSource Surgical, or Surgical, and PrimeSource Critical Care, or Critical Care. The Surgical segment is a regional sales and marketing organization that markets and sells a large number of surgical products primarily to hospitals and surgery centers in the midwestern, mid-atlantic and southeastern United States. The Critical Care segment is a regional sales and marketing organization that sells a large number of products primarily to hospitals and surgery centers in the southeastern and northeastern United States. Within the Surgical segment, the primary specialties are: o Cardio Vascular; o Endoscopy; o General Surgery; and o Gynecology. Within the Critical Care segment, the primary specialties are: o Neonatal Intensive Care; and o Maternal and Child Care. Our products and services are primarily used in hospital operating rooms and intensive care units, outpatient surgery centers and to a lesser degree doctors' offices. Most of our products are technologically innovative medical products, or specialty products, that require hands-on training of clinicians and medical personnel. We continue to expand our product base to include additional instruments and equipment thereby allowing customers to use us as a source for a greater percentage of their specialty products needs. The sale of specialty disposable products and capital equipment account for the majority of our revenues. Our capital equipment products are typically complex and require significant consultative selling and training of medical staff personnel. Our specialty disposable products are often sold to support the growing base of installed capital equipment products and offer a recurring and stable source of revenue. THE MANUFACTURED PRODUCTS DIVISION We operate the Manufactured Products business through our Luxtec division, which designs, manufactures and markets fiber optic headlight and video camera systems, light sources, cables, retractors and surgical and other custom-made equipment for the medical and dental industries. Luxtec has developed a 7 proprietary, fiber optic drawing system designed to manufacture optical glass to a specified diameter. The fibers are utilized in fiber optic cables, which are incorporated with Luxtec's surgical headlight systems and video camera systems, as well as into an array of fiber optic transilluminators utilized with Luxtec's surgical instruments. Luxtec also markets replacement fiber optic cables, bulbs, and light sources for use with other manufacturers' products, including various endoscopic systems used in minimally invasive surgical procedures. Fiber optics allow for the transmission of a light or image from one place to another through a flexible conduit of optical glass rods and tubes. The flexible conduit provides for an improved ability to bend and transmit light and images to and from places with limited or difficult access. The technology used by Luxtec to provide illumination directly to the surgical site is facilitated by fiber optic cables transmitting light to an adjustable headlight composed of a series of lenses and mirrors mounted on a headband. These lenses then focus the light directly on the surgical site when worn by the surgeon. This provides a lightweight, low temperature illumination source to enhance visualization for microsurgical and deep cavity illumination. A summary of the Luxtec division's specific product offerings is as follows: HEADLIGHT SYSTEMS: Luxtec designs and manufactures a proprietary line of fiber optic headlight systems that assist surgeons by brightly illuminating the surgical site. Designed to provide maximum performance and comfort, Luxtec's patented headlight systems are lightweight and provide the surgeon with a virtually unobstructed view of the surgical area. LIGHT SOURCES: Luxtec manufactures a product line of high quality, solid state xenon and halogen fiber optic light sources. Luxtec's light sources offer a wide range of light intensities in order to serve the varying requirements in illuminating surgical and diagnostic procedures. The lamps illuminate the end surface of the fiber optic cable through which the light is transmitted, without transmitting heat. Luxtec's light sources are designed and manufactured to comply with Underwriters Laboratories 544 medical safety standards and are listed domestically with ETL Laboratories. Internationally, Luxtec strives to achieve compliance with all applicable international standards to compete effectively on a worldwide basis (including the CE mark, which has been attained on the present product line). FIBER OPTIC CABLES: Luxtec designs and manufactures a complete range of fiber optic cables and holds patents on certain fiber optic cable assemblies. See "Patents and Trademarks." Luxtec offers surgeons a range of fiber bundle diameters in order to optimize the use of surgical instruments. Luxtec employs a proprietary technology that enables the fiber optic interface to withstand significantly higher temperatures and permits the use of higher output light sources. In addition, all of Luxtec's fiber optic cables are adaptable to light sources made by other manufacturers. FIBER OPTIC HEADLIGHT AND VIDEO CAMERA SYSTEMS: Luxtec manufactures and markets a series of video products that are currently being used in the United States and in over 25 countries around the world. Luxtec's Microlux headlight camera systems are designed to televise surgical procedures. The system is a very small, lightweight, solid state television camera mounted at the front of a headband, manufactured by Luxtec, and integrated with fiber optic illumination. 8 SALES AND MARKETING We sell our products and services to hospitals, IDNs, surgery centers and physician offices. In fiscal year ended June 30, 2003, within the Surgical Medical Distribution business, we sold specialty medical products to over 3,000 customers, primarily in the United States. We are not dependent on any single customer or geographic group of customers. Our largest customer accounted for 3.3% of our gross profit during our fiscal year ended June 30, 2003. We maintain an extensive sales organization that is highly experienced and skilled in representing clinical products and services. Our sales representatives serve as a service and educational resource to the marketplace. They assist clinicians in selecting and purchasing products, help customers better manage inventories of specialty medical products and direct the appropriate utilization of our clinically focused products. Each sales representative works within an assigned sales territory under the supervision of a dedicated regional sales manager. Our sales representatives are primarily compensated on a commission basis. Within the surgical illumination business, Luxtec is the domestic market leader in surgical headlight systems with over 50,000 surgeons using their products on a worldwide basis. Within the United States, the Luxtec fiber optic and illumination products are primarily distributed through PrimeSource Surgical's sales force, supported by Luxtec field specialists and a customer support team located in our West Boylston facility. Luxtec also distributes domestically through a number of other regional specialty medical distributors. Internationally, Luxtec distributes through a network of local distributors. Our external sales, based upon the customer's country of origin by geographic area for the year ended June 30, 2003, 2002 and 2001, totaled $44,015,000, $51,688,000 and $47,771,000, respectively, for sales in the United States and $2,345,000, $2,008,000 and $631,000, respectively, for sales to foreign companies. DISTRIBUTION We believe that responsive delivery of quality specialty medical products and supplies is a key element to providing complete customer satisfaction. Our customers place orders for medical products and supplies by telephone, facsimile or via EDI. All orders are routed through our centralized computer ordering, shipping and inventory management system, which is linked to our distribution centers. Rapid and accurate order fulfillment is a principal component of our value-added approach. In order to assure the availability of our broad product lines for prompt delivery to customers, we must maintain sufficient inventories at our distribution centers. Our inventory levels are centralized with and managed by a purchasing department using an integrated inventory control system. Our inventory consists primarily of medical products and supplies. MANUFACTURING AND SUPPLIERS Manufacturer relationships are an integral part of our businesses. Our Specialty Medical Distribution business represents more than 125 manufacturers with over 90% of sales concentrated among approximately 30 of these manufacturers. A majority of the business is comprised of stocking relationships whereby we stock the vendor's products and provide substantially all fulfillment services (i.e., customer service, shipping, returns, etc.). The remainder of the revenue is 9 received on an "agency" basis whereby we do not stock the vendor's products and do not provide fulfillment services. In the case of an agency sale, the manufacturer provides substantially all fulfillment services for customers and we provide sales and marketing support in helping facilitate the sale of the vendor's product. For providing the sales and marketing support, we are paid a sales commission on each sale of the vendor's products. Within the Manufactured Products business, Luxtec purchases components and materials from more than 200 vendors and believes it can purchase substantially all of its product requirements from other competing vendors under similar terms. Luxtec has no long-term contract with any supplier but does maintain long-standing relationships with certain vendors. Our Specialty Medical Distribution business aggressively pursues the opportunity to market and sell medical equipment and supplies on an exclusive basis. Manufacturers of specialty medical products and supplies typically offer distribution rights only to a selected group of distributors and are increasingly seeking to reduce the number of distributors selling their products to end users in an effort to reduce the overall costs associated with selling and marketing their products. We have been successful in assisting manufacturers in their development and marketing plans and in obtaining the exclusive rights to sell certain products. We believe that our ability to capture and retain such distribution rights represents a barrier to the entry of competitors. Within the Specialty Medical Distribution business, our network of manufacturers is continually seeking representation or market introduction for their products, resulting in a growth pipeline of attractive, innovative products accretive to our portfolio of distributed products. Moreover, we have been able to enter into contractual relationships with certain manufacturers that are typically exclusive in nature, extend for several years in duration, and include a right of first refusal on new product introductions. INFORMATION SYSTEMS Our Specialty Medical Distribution business employs a single, centralized, enterprise management information system utilized across all business units via a wide-area data network. This approach yields significant benefits including: o increased inventory utilization; o greater visibility as to sales performance; and o the coordination necessary to address the needs and requirements of an increasing number of IDNs and GPOs whose members are geographically dispersed. In addition to employing traditional e-business technologies such as electronic data interchange to achieve greater efficiencies, we also use the inherent strengths of the Internet to enhance relationships with both customers and manufacturers. Since early 2000, we have offered our web-based Surg-E-Track (TM) system to our direct sales force as well as select manufacturer partners. Surg-E-Track provides sales personnel and manufacturer partners with comprehensive customer purchasing data in a variety of formats. Through the Surg-E-Track system we have increased our sales representative productivity and customer service levels and have helped our manufacturer partners more effectively manage their businesses. 10 COMPETITION We compete with a variety of companies including manufacturers that utilize direct sales forces, national specialty distributors and a number of significantly smaller local and regional specialty distributors. We compete to a lesser degree with national med-surg distribution companies such as Cardinal Health, Inc., McKesson HBOC, Inc. and Owens & Minor, Inc. A brief discussion of each of the Company's competitors is as follows: o PRODUCT MANUFACTURERS' DIRECT SALES FORCES. Product manufacturers' direct, internal sales forces offer manufacturers direct access to healthcare providers. Manufacturers, however, periodically outsource the sales and marketing of some of their products to specialty sales and marketing organizations such as PrimeSource. o NATIONAL SPECIALTY DISTRIBUTORS. Several companies serve the national specialty medical products market. These national specialty distributors tend to focus and specialize within a particular segment of the specialty medical products market. o REGIONAL SPECIALTY DISTRIBUTORS. Regional specialty distributors represent our primary competition in the specialty medical products market, but they are unable to match the national scope or breadth of products that we offer. o NATIONAL MED-SURG DISTRIBUTORS. In most respects, we complement, rather than compete, with national med-surg distributors. These larger supply companies, such as McKesson HBOC, Inc., Owens & Minor, Inc., and Cardinal Health, Inc., have historically focused on distributing a broad array of lower-margin, later-stage products, aiming to give healthcare providers aggressive pricing and the convenience of one-stop shopping. As a result, their core expertise does not reside in creating a market for complex specialty products, which often require important services such as on-site training and product support. In addition, these suppliers are generally not viewed by their customers as experts within specific specialty areas. As a result, specialty product manufacturers tend to outsource sales and marketing services to specialists rather than national med/surg distributors. Within the Manufactured Products business, Luxtec competes with a number of manufacturers of proprietary light source systems. Competitors within the United States include the Cogent division of Welch Allyn, Cuda FiberOptics and Isolux. Some of Luxtec's competitors have historically relied on metal halide technology rather than the state-of-the-art xenon technology offered by Luxtec. The xenon technology is more widely accepted and provides a broader color spectrum than metal halide technology. Foreign competitors include Richard Wolfe, Scholly GMBH and those companies previously mentioned above. 11 PATENTS AND TRADEMARKS We maintain a policy of seeking patent and trademark protection in connection with certain elements of its technology and brand names. We own the following U.S. Patents and Trademarks: Patents ------- o Patent No. 4516190 for Surgical Headlight issued May 7, 1985. o Patent No. 4616257 for Headlight Camera System issued October 7, 1986. o Patent No. 4653848 for 45 degree and 90 degree Fiber Optic Cables issued March 31, 1987. o Patent No. 4797736 for Videolux Television Fiber Optic Headlight Camera System issued January 10, 1989. o Patent No. 5003605 for an electronically augmented stethoscope with timing sound issued March 26, 1991. o Patent No. 5220453 for telescopic spectacles with coaxial illumination issued June 15, 1993. o Patent No. 5295052 for a light source assembly issued March 15 1994. o Patent No. D345368 for surgical telescopes issued March 22, 1994. o Patent No. 5331357 for an illumination assembly issued July 19, 1994. o Patent No. D349123 for spectacles having integral illumination issued July 26, 1994. o Patent No. D350760 for an eyeglass frame temple issued September 20, 1994. o Patent No. 5392781 for blood pressure monitoring in noisy environments issued February 28, 1995. o Patent No. D415285 for Pinhole Headlamp Video Camera for Medical and Surgical Applications issued October 12, 1999. o Patent No. D398403 for Headband for Surgeons with Removable Headboard Hanger issued September 15, 1998. o Patent No. 6258037 for blood pressure monitoring in noisy environments issued July 10, 2001. Trademarks ---------- o LUXTEC, U.S. federal trademark registration number 1,453,098, registered August 18, 1987. o LUXTEC (and design), U.S. federal trademark registration number 1,476,726, registered February 16, 1988. o LUXTEC (stylized), U.S. federal trademark registration number 1,758,176, registered March 16, 1993. o LUXTEC, U.S. federal trademark registration number 1,956,027, registered February 13, 1996. o Luxtec is also the owner of the following foreign trademark registrations for its LUXTEC trademark: (i) Chile, registration number 452.314, registered October 31, 1995; and (ii) Peru, registration number 016214, registered June 14, 1995. o BIMECO, U.S. federal trademark registration number 1,190,584, registered February, 23 1981 o MegaTech Medical, U.S. federal trademark registration number 1,930,021, registered October 24, 1995 o TMC 12 o Clearfield o ValueFlex o PrimeSource Healthcare o PrimeSource Surgical We terminated our agreement with InterMed, Inc. in May 2002, pursuant to which we were previously granted an exclusive license agreement for the rights to Patent No. 5222949 ("In-Vivo Hardenable Catheter") and No. 5334171 ("Flexible, Noncollapsible Catheter Tube with Hard and Soft Regions"). The agreement allowed Luxtec to develop a product line of catheters incorporating fiber optics to facilitate several potential specialized applications. In general, we rely on our development and manufacturing efforts, rather than patent protection, to establish and maintain our industry position. We treat our design and technical data as confidential and rely on nondisclosure agreements, trade secrets laws and non-competition agreements to protect our proprietary position. We cannot assure that these measures will adequately protect our proprietary technologies. GOVERNMENT REGULATION The manufacturing, marketing, distribution and sale of specialty medical products sold by us are subject to government regulation in the United States and other countries. Among the federal laws which impact us are the Federal Food, Drug and Cosmetic Act, which regulates the advertising, record keeping, labeling, handling, storage and distribution of drugs and medical devices, and which requires us to be registered with the Federal Food and Drug Administration, and the Safe Medical Devices Act of 1990, which imposes certain reporting requirements on distributors in the event of an incident involving serious illness, injury or death caused by a medical device. In addition, in order to clinically test, produce and market products for human diagnostic or therapeutic use, we must comply with mandatory procedures and safety standards established by the United States Food and Drug Administration ("FDA") and comparable state and foreign regulatory agencies. Typically, products must meet regulatory standards as safe and effective for their intended use prior to being marketed for human applications. The clearance process is expensive and time consuming, and no assurance can be given that any agency will grant clearance for the sale of our products or that the length of time the process will require will not be extensive. We believe that we are in substantial compliance with all of the foregoing laws and that we possess all licenses required in the conduct of our business. EMPLOYEES As of September 1, 2003, we had 142 employees, of which approximately 46 are engaged in the Surgical segment, approximately 18 in the Critical Care segment, approximately 56 in the Manufactured Products business and approximately 22 in corporate and shared services. We believe that our continued success depends on our ability to attract and retain highly qualified personnel. None of our employees are covered by a collective bargaining agreement. 13 EXECUTIVE OFFICERS AND KEY MANAGEMENT PERSONNEL Following are the names and ages, as of September 1, 2003, of our executive officers and key management personnel, their positions and summaries of their backgrounds and business experience.
Name Age Position ---- --- -------- Joseph H. Potenza 56 President Shaun D. McMeans 41 Chief Operating Officer and Chief Financial Officer Samuel M. Stein 63 Vice President & General Manager, Manufacturing Division Mark A. Jungers 51 Regional Vice President, Distribution Division Bruce R. Hoadley 44 Regional Vice President, Distribution Division Scott F. Billman 47 Regional Vice President, Distribution Division Jason M. Fowler 32 Treasurer & Vice President
JOSEPH H. POTENZA, PRESIDENT: Prior to joining PrimeSource in February 2001, Mr. Potenza held senior management positions with McKesson HBOC as Vice President of the Corporate Program and with Medibuy where he was responsible for the National Accounts and Corporate Program. From 1977 to 1997, Mr. Potenza developed his career with American Hospital Supply Corporation/Baxter Healthcare Corporation, culminating as Eastern Region President, running a $750 million distribution business with 650 employees and seven distribution facilities. He received a Bachelor of Arts degree in English from Norwich University and a Master of Arts degree in Management from Central Michigan University. SHAUN D. MCMEANS, CHIEF OPERATING OFFICER & CHIEF FINANCIAL OFFICER: Mr. McMeans has 20 years of experience in manufacturing and distribution businesses, specializing in operations, accounting and financial management. Prior to becoming the Company's Chief Financial Officer, he served as Vice President of Operations and Corporate Controller. Prior to joining the Company in April 2000, Mr. McMeans held operational and financial management positions with Burnham Corporation, a leading domestic manufacturer and distributor of residential and commercial boilers. Mr. McMeans earned a Bachelor of Science degree in accounting from The Pennsylvania State University and is a certified public accountant. He began his career in public accounting with the former Peat, Marwick, Mitchell and Company. SAMUEL M. STEIN, VICE PRESIDENT & GENERAL MANAGER, MANUFACTURING DIVISION: Mr. Stein's career has focused on high growth technology companies. Prior to becoming General Manager of the Company's Luxtec Division, Mr. Stein served as Luxtec's Chief Financial Officer. Prior to joining Luxtec in 1993, Mr. Stein served as Chief Operating and Chief Financial Officer of Mitrol, Inc. of which he was also co-founder. He has served as Chief Financial Officer with companies ranging from start-ups to subsidiaries of Fortune 500 corporations. Mr. Stein earned a Bachelor of Science degree in Business Administration from the University of Toledo and a Master of Science degree from Rensselaer Polytechnic Institute. MARK A. JUNGERS, REGIONAL VICE PRESIDENT - DISTRIBUTION DIVISION: Mr. Jungers has an extensive background in med-surg and critical care product sales and management. Mr. Jungers joined PrimeSource through its 1999 acquisition of Bimeco, a leading distributor of specialty medical products to the critical care market in the southeastern United States, where he served as a Sales Manager. 14 Prior to joining Bimeco in 1979, he held sales and marketing positions with the Extracorporeal Medical Division of Johnson & Johnson. Mr. Jungers earned a Bachelor of Science degree in Business Administration from Marquette University. BRUCE R. HOADLEY, REGIONAL VICE PRESIDENT - DISTRIBUTION DIVISION: Mr. Hoadley has worked for 20 years in the sales and management of specialty surgical products. He was the Sales Manager for Futuretech, a leading distributor of specialty medical products to the surgical market in the southeastern United States, from 1991 until its acquisition by PrimeSource in 1999. Prior to joining Futuretech, Mr. Hoadley held sales management positions with Kendall Healthcare and Devon. He earned a Bachelor of Arts degree in Marketing from the University of Alabama. SCOTT F. BILLMAN, REGIONAL VICE PRESIDENT - DISTRIBUTION DIVISION: Mr. Billman has spent his entire career in sales, marketing, and operations management. He has worked for nearly 20 years in the healthcare industry, holding several management positions primarily focused on the sales and marketing of surgical products. He most recently served as Senior Vice President of Product Marketing for Medi-buy, Inc. Mr. Billman earned a Bachelor of Science degree in Business Administration and an MBA from Bowling Green State University. JASON M. FOWLER, TREASURER & VICE PRESIDENT: Mr. Fowler has a diverse background in corporate finance, consulting, and mergers and acquisitions. Prior to joining PrimeSource, Mr. Fowler was a Senior Financial Analyst and Production Manager for TouchStar Technologies, a division of The Williams Companies. At Williams, he worked in mergers and acquisitions and managed divisional operations in the U.S., England, Poland, and Australia. In 1996-97, he also served as a U.S. government-sponsored consultant in Poland. Mr. Fowler earned a Master of International Management degree from Thunderbird as well as Bachelor of Arts and MBA degrees from the University of Arizona. ITEM 2. PROPERTIES PrimeSource's corporate headquarters is located at 99 Hartwell Street, West Boylston, Massachusetts. All of our facilities are leased and located in the United States. A summary of the Company's facilities, as of September 1, 2003, and offices is as follows: Square Lease City, State Feet Expiration Date ----------- ---- --------------- Tucson, Arizona.............................. 25,544 02/28/05 Birmingham, Alabama.......................... 18,356 11/30/06 Atlanta, Georgia............................. 2,950 09/30/04 West Boylston, Massachusetts................. 31,689 10/31/05 ------- 78,539 ======= We believe that the all of our facilities are in satisfactory condition and suitable for the particular purposes for which they were acquired or constructed and are sufficient for the Company's current operations. The Company is in the process of either sub-leasing a portion of its Tucson facility (approximately 16,500 square feet of idle warehouse and office space) or renegotiating the current lease for only a portion of the current facility. A portion of this space became vacant subsequent to the 2002 restructuring. 15 ITEM 3. LEGAL PROCEEDINGS We are subject to claims and suits arising in the ordinary course of our business. We believe that ordinary course legal proceedings will not have a material adverse effect on our financial position, results of operations or liquidity. On September 5, 2002, John F. Rooney and Michael K. Bayley, each former executive officers and directors of PrimeSource, filed a complaint against us in Arizona Superior Court, County of Pima. The complaint alleges a breach by us of the severance agreements with each of Messrs. Rooney and Bayley and seeks an aggregate of at least $1.2 million in compensatory damages. We believe that we have meritorious defenses and we intend to defend our position with respect to this complaint. During the quarter ended September 30, 2002, the Company resolved an outstanding matter relating to alleged non-compete violations with a former employee. Pursuant to the terms of the settlement, the former employee paid the Company a cash settlement in the amount of $168,099, net of costs of $71,901, and returned for cancellation 132,963 shares of Company common stock valued at $42,548. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Our annual meeting of stockholders was held on December 17, 2002. At the meeting, the following items were submitted to a vote of the stockholders: (1) the election of two Class II directors for a three-year term was approved with the election of Larry H. Coleman receiving 16,024,720 votes in favor, 0 votes against, 38,411 votes withheld and 0 broker non-votes and the election of Bradford C. Walker receiving 16,024,635 votes in favor, 0 votes against, 38,496 votes withheld and 0 broker non-votes. (2) an amendment to our Articles of Organization increasing the authorized number of shares of common stock from 50,000,000 to 75,000,000 was approved with 15,681,817 votes in favor, 375,134 votes against, 6,180 abstentions and 0 broker non-votes; (3) an amendment to our Tucson Medical Corporation 1997 Stock Option/Stock Issuance Plan, as amended, was ratified with 14,728,539 votes in favor, 440,940 votes against, 119,707 abstentions and 773,945 broker non-votes; and (4) the appointment by our Board of Directors of Deloitte & Touche LLP, our independent auditors, was ratified with 16,017,262 votes in favor, 41,180 votes against, 4,689 abstentions and 0 broker non-votes. 16 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock was listed on the American Stock Exchange (the "AMEX") under the AMEX symbol "LXU.EC") from April 20, 1994 through November 17, 2000, at which time it was delisted by the AMEX because it no longer continued to satisfy the AMEX's listing requirements. On November 16, 2000, the trading day immediately before our common stock was delisted by the AMEX, the closing price was $1.00. Our common stock is not currently listed on any public exchange or market. There is no established public trading market for our common stock and we cannot assure that we will ever be able to establish trading of our common stock on a public market or exchange. As of September 1, 2003, there were approximately 532 registered holders of record of our common stock. We estimate that there are approximately 378 beneficial holders of our common stock. We have not paid any cash dividends on our common stock since our inception and the Board of Directors does not contemplate doing so in the near future. The Board of Directors currently intends to retain any future earnings for use in expanding our business. We are limited in our ability to pay dividends. In addition, we may not declare or pay any dividend without the consent of lenders and our preferred stockholders. On August 6, 2002, the Company created a new series of preferred stock, Series G Convertible Redeemable Preferred Stock, no par value (the "Series G Stock"), and the Company issued and sold 70,452 shares of Series G Stock on that date for proceeds of $1,866,037, net of costs of $388,429. The Series G Stock has 230,000 authorized shares. In connection with the issuance of the Series G Stock, the Company issued warrants to purchase an aggregate of 3,300,000 shares of common stock at $.01 per share. These warrants became exercisable on December 31, 2002 and expire on August 6, 2012. In addition, on September 15, 2002, November 15, 2002, January 15, 2003 and June 30, 2003, the Company issued and sold an additional aggregate 50,485.5 shares of Series G Stock for proceeds of $1,497,994, net of costs of $117,542. Each share of Series G Stock is convertible into 100 shares of common stock, subject to adjustment, at the option of the holder. Each share of Series G Stock has one vote for each share of common into which it would be convertible. In addition, Series G Stock ranks senior to all other outstanding stock of the Company. Series G Stock accrues dividends at the rate of 8% per year of the original issuance price of $32.00 per share and has a liquidation preference equal to $64.00 per share plus an amount equal to all accrued but unpaid dividends. The Series G Stock has a mandatory redemption date of June 3, 2005, and is redeemable at the original issue price of $32.00 per share plus accrued but unpaid dividends. The Series G Stock also has special consent rights to certain of the Company's activities, including, but not limited to, amendment of the Company's articles or bylaws and merger or consolidation of the Company. As noted above, in connection with the Series G Stock issuance, the Company issued warrants to purchase an aggregate of 3,300,000 shares of common stock with an exercise price of $.01 per share and a 10-year life. The value of these warrants was calculated using the Black-Scholes method, an expected life of 7 years, volatility of 50% and a zero-coupon bond rate of 4.09%. The resulting value of $1,031,000 was recorded as additional 17 paid-in capital on August 6, 2002 in connection with the sale of the Series G Stock. The resultant beneficial conversion feature of $1,031,000 was recorded directly to additional paid-in capital in December 2002 when the Series G Stock became convertible. On August 6, 2002 and prior to the issuance and sale of the Series G Stock, the Company recapitalized its equity structure. Each outstanding share of Series C Convertible Preferred Stock, par value $1.00 per share (the "Series C Stock"), was converted into 27.5871 shares of the Company's common stock. In connection with the conversion of the Series C Stock, the Company issued the former holders of the Series C Stock warrants to purchase an aggregate of 7,390,613 shares of our common stock with an exercise price of $.01 per share and a 10-year life. These warrants became exercisable on December 31, 2002 and expire on August 6, 2012. Additionally, exercise prices on warrants to purchase an aggregate of 140,330 shares of our common stock previously issued to certain former holders of the Series C Stock were repriced from $1.68 per share to $.01 per share. The value of the warrants issued and the warrants which were repriced was recorded as additional paid-in capital. The value of these warrants totaled $2,359,000 and was calculated using the Black-Scholes method, an expected life of 7 years, volatility of 50% and a zero coupon rate of 4.09%. Simultaneously with the conversion of the Series C Stock, each outstanding share of Series F Convertible Redeemable Preferred Stock, no par value (the "Series F Stock"), was converted into one share of common stock. In connection with the conversion of the Series F Stock, the Company issued the former holders of the Series F Stock warrants to purchase an aggregate of 1,614,560 shares of Company common stock with an exercise price of $.01 per share and a 10-year life. The warrants became exercisable on December 31, 2002 and expire on August 6, 2012. Additionally, the exercise price on previously issued warrants to purchase an aggregate of 1,751,130 shares of common stock was adjusted from $1.00 per share to $.01 per share. The value of the warrants issued and the warrants which were repriced was recorded as additional paid-in capital. The value of these warrants totaled $1,052,000 and was calculated using the Black-Scholes method, an expected life of 7 years, volatility of 50% and a zero coupon rate of 4.09%. On August 6, 2002 and subsequent to the conversion of the Series C Stock and Series F Stock, each outstanding share of Series E Convertible Preferred Stock, no par value (the "Series E Stock"), was exchanged for .3125 shares of Series G Stock. In connection with the exchange of the Series E Stock, the Company issued the former holders of the Series E Stock warrants to purchase an aggregate of 817,000 shares of Company common stock with an exercise price of $.01 per share. These warrants became exercisable on December 31, 2002 and expire on August 6, 2012. Additionally, in accordance with their terms, exercise prices on 1,625,000 warrants to purchase common stock previously issued to certain Series E Stockholders were repriced from $1.00 per share to $.01 per share. The value of the warrants issued and the warrants which were repriced were recorded as additional paid-in capital. The value of these warrants totaled $763,000 and was calculated using the Black-Scholes method, expected life of seven years, volatility of 50% and a zero coupon rate of 4.09%. Under the restructuring, former holders of Series C Stock, Series F Stock and Series E Stock received consideration totaling approximately $10,183,000, including common stock, Series G Stock, new warrants and the repricing of certain existing warrants, in exchange for the retirement of Series C Stock, Series F Stock and Series E Stock with a carrying value of approximately $21,993,000. The difference of $11,809,741 has been credited to retained earnings. 18
EQUITY COMPENSATION PLAN INFORMATION ------------------------------------ JUNE 30, 2003 NUMBER OF SECURITIES NUMBER OF SECURITIES REMAINING AVAILABLE FOR TO BE ISSUED WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER UPON EXERCISE OF EXERCISE PRICE OF EQUITY COMPENSATION PLANS OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)) PLAN CATEGORY (a) (b) (c) Equity compensation plans approved by security holders...... 25,440,818 $0.1965 2,097,736 Equity compensation plans not approved by security holders (1) 7,500 $16.00 0 ---------- ------- --------- Total....... 25,448,318 $0.2012 2,097,736 ========== ======= =========
(1) On August 6, 2002, we granted Bradford C. Walker an option to purchase 7,500 shares of our Series G Convertible Redeemable Preferred Stock at an exercise price of $16.00 per share. This option became fully vested and exercisable on the first anniversary of the grant date and expires upon the tenth (10th) anniversary of the grant date. The stock option agreement provides that if Mr. Walker is terminated for any reason other than misconduct, the option, to the extent vested on the termination date, becomes exercisable at any time prior to the earlier of (i) five (5) years following the date he ceases to provide any service to PrimeSource or (ii) one (1) year following the registration of the option shares under the Securities Act of 1933. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data presented below has been derived from our historical audited consolidated financial statements of PrimeSource for each of the five years in the period ended June 30, 2003. The following data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the notes thereto. Data is in thousands except per share data.
FISCAL YEAR OPERATING DATA: ENDED JUNE 30 --------------------------------------------------------------------------- 2003(1)(2) 2002(3)(4) 2001(5) 2000(6)(7) 1999(8) ---------- ---------- ---------- ---------- ---------- NET SALES...................... $ 46,360 $ 53,696 $ 48,402 $ 54,411 $ 15,114 NET LOSS....................... $(3,629) $(6,191) $ (4,382) $ (1,384) $ (744) NET INCOME (LOSS) PER $0.33 $ (1.11) $ (1.37) $ (0.69) $ (0.17) SHARE - BASIC.................. BALANCE SHEET DATA: TOTAL ASSETS................... $ 31,665 $ 37,587 $ 45,450 $ 31,297 $ 30,380 LONG-TERM OBLIGATIONS.......... $ 5,826 $ 23,285 $ 20,335 $ 15,968 $ 1,516 STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY).................... $ 10,686 $(5,349) $ (562) $ (567) $ 2,622
19 (1) In accordance with the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 142, the Company completed the transitional test for impairment in March 2003 and concluded that consolidated goodwill was impaired in the amount of $4,454,656. The Company recorded a non-cash charge of $4,454,656 to reduce the carrying value of its goodwill. This charge is non-operational in nature and is reflected as a cumulative effect of a change in accounting principle, effective July 1, 2002, in the accompanying Consolidated Statements of Operations. (2) On June 30, 2003, PrimeSource sold all of the issued and outstanding capital stock of Ruby to NMSI. The Company recognized a loss on the transaction totaling $73,830 in the fiscal year ending June 30, 2003, which is included in discontinued operations. (3) In the fiscal year ended June 30, 2002, PrimeSource approved plans for restructuring of operations involving narrowing the focus of its operations, consolidation of certain under performing sales regions, reduction of corporate overhead through workforce reductions, restructuring of its balance sheet through the refinancing of PrimeSource Healthcare's and PrimeSource Surgical's senior bank debt and the reduction of debt levels through cost reductions and improved efficiency of operations. The related costs of the restructuring, excluding the $1,038,823 discussed below, included charges of $2,915,675. (4) On September 20, 2002, in connection with the restructuring, Ruby sold all of the assets of its former PEC line of business in exchange for the cancellation of stock previously issued to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business. The Company recognized a loss on the transaction totaling $1,038,823 in the fiscal year ending June 30, 2002, as the assets were held for sale and deemed impaired at that date. (5) Effective March 2, 2001, PrimeSource Surgical completed a merger with Luxtec Corporation with aggregate consideration exchanged of approximately $4,791,000, where PrimeSource Surgical assumed liabilities, net of assets acquired and costs of approximately $3,931,000. The acquisition was accounted for using the purchase method of accounting and the results of operations of Luxtec have been included in the financial statements of PrimeSource Surgical as of the date of acquisition. In December 2000, the Company acquired two entities, PEC and NEM, for aggregate consideration of $1,310,000. The acquisition was accounted for using the purchase method of accounting and the results of operations of the acquired entities have been included in the consolidated financial statements from the date of acquisition through date of sale, as discussed above. (6) In June 2000, PrimeSource Surgical sold an entity for approximately $398,000, which resulted in a recorded loss of approximately $732,000. In addition, in April 2000, PrimeSource Surgical acquired an entity for $405,000. The acquisition was accounted for using the purchase method of accounting and the results of operations are included in the consolidated financial statements from the date of acquisition. 20 (7) In the fiscal year ended June 30, 2000, PrimeSource Surgical approved plans for a major restructuring of its operations with the goal of centralizing distribution facilities, eliminating unprofitable divisions and reducing costs. The aggregate costs of the restructuring included total charges of $1,031,000. (8) In June 1999, PrimeSource Surgical acquired four entities for $17,000,000. In March 1999, PrimeSource Surgical acquired an entity for approximately $196,000. Each of the acquisitions were accounted for using the purchase method of accounting and the results of operations of the acquired entities have been included in the consolidated financial statements from the dates of acquisition. 21 OPERATING DATA: The following table sets forth unaudited quarterly consolidated operating results for each of our last eight quarters. We have prepared this information on a basis consistent with our audited consolidated financial statements and included all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of the data. These quarterly results are not necessarily indicative of future results of operations. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the notes thereto. Data is in thousands, except per share data.
Sep-30, Dec-31, Mar-31, Jun-30, Sep-30, Dec-31, Mar-31, Jun-30, 2001 2001(1)(2) 2002(2) 2002(1)(2) 2002(3) 2002 2003 2003(4)(5) --------- ---------- --------- ---------- --------- --------- --------- --------- Net sales $14,732.1 $ 13,672.3 $13,314.7 $ 11,976.6 $ 11,789.8 $11,587.6 $11,127.0 $11,855.6 Cost of sales 9,205.8 9,853.0 8,707.9 7,562.4 7,498.9 7,307.1 6,885.2 7,606.4 --------- ---------- --------- ---------- ---------- --------- --------- --------- Gross profit $ 5,526.3 $ 3,819.3 $ 4,606.8 $ 4,414.2 $ 4,290.9 $ 4,280.5 $ 4,241.8 $ 4,249.2 ========= ========== ========= ========== ========== ========= ========= ========= Net income (loss) $ (257.0) $(5,039.9) $ (540.2) $ (353.5) $(3,970.5) $ 416.1 $ (3.0) $ (71.4) ========= ========== ========= ========== ========== ========= ========= ========= Net income (loss) per share-basic $ (.13) $ (.73) $ (.12) $ (.13) $ .45 $ .01 $ (.02) $ (.02) ========= ========== ========= ========== ========== ========= ========= =========
COMPUTED AS DESCRIBED IN OUR HISTORICAL CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES INCORPORATED BY REFERENCE INTO THIS FORM 10-K. Our results of operations historically have fluctuated on a quarterly basis and can be expected to continue to be subject to quarterly fluctuations. (1) PrimeSource Healthcare, in connection with restructuring, discontinued an operational division of the Critical Care segment, which resulted in a recorded loss of approximately $658,000 in quarter ended December 31, 2001 and $381,000 in quarter ended June 30, 2002. (2) PrimeSource Healthcare approved plans for a major restructuring of its operations resulting in total charges of approximately $2,463,000 in quarter ended December 31, 2001, $341,000 in quarter ended March 31, 2002 and $112,000 in quarter ended June 30, 2002. (3) In accordance with SFAS No. 142, the Company recorded a non-cash charge of $4,454,656 to reduce the carrying value of its goodwill. This charge is non-operational in nature and is reflected as a cumulative effect of a change in accounting principle, effective July 1, 2002. (4) On June 30, 2003, PrimeSource sold all of the issued and outstanding capital stock of Ruby to NMSI. The Company recognized a loss on the transaction totaling $73,830 in the fiscal year ended June 30, 2003. (5) On June 30, 2003, PrimeSource recorded a reserve for severance of the former President of $195,507 and other restructuring expenses of $150,000. 22 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This analysis of our financial condition, capital resources and results of operations should be read in conjunction with the accompanying consolidated financial statements, including the notes thereto. APPLICATION OF CRITICAL ACCOUNTING POLICIES Our discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. During preparation of these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, goodwill and other intangible assets and income taxes. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances. The results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The following critical accounting policies require us to make significant judgments and estimates used in the preparation of our financial statements. ALLOWANCE FOR DOUBTFUL ACCOUNTS We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We determine the adequacy of this allowance by regularly evaluating individual customer receivables and considering a customer's financial condition, credit history, and current economic conditions. If the financial condition of our customers were to deteriorate, additional allowances may be required. Our accounts receivable are written off once an account is deemed uncollectible. This typically occurs once we have exhausted all efforts to collect the account, which includes collection attempts by company employees and outside collection agencies. INVENTORY RESERVES FOR OBSOLESCENCE We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions prove to be less favorable than those projected by management, additional inventory write-downs may be required. GOODWILL AND OTHER INTANGIBLE ASSETS We evaluate goodwill and other intangible assets for impairment at least annually, in accordance with SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. For goodwill, we first compare the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds the fair value of a reporting unit, additional tests would be used to 23 measure the amount of impairment loss, if any. We use a present value technique to measure reporting unit fair value. If the carrying amount of any other intangible asset exceeds its fair value, we would recognize an impairment loss for the difference between fair value and the carrying amount. We recognized impairment losses in the year ended June 30, 2002 upon the disposition of PEC and an impairment loss effective July 1, 2002 upon completion of SFAS No. 142 implementation. If other events occur and circumstances change, causing the fair value of a reporting unit to fall below its carrying amount, impairment losses may be recognized in the future. DEFERRED TAX ASSETS We estimate our actual current tax exposure obligations together with the temporary differences that have resulted from the differing treatment of items dictated by generally accepted accounting principles versus U.S. tax laws. These temporary differences result in deferred tax assets and liabilities. On an on-going basis, we then assess the likelihood that our deferred tax assets will be recovered from future taxable income. If we believe the recovery to be less than likely, we establish a valuation allowance against the deferred tax asset and charge the amount as an income tax expense in the period in which such a determination is made. STOCK-BASED COMPENSATION The Company accounts for stock-based awards to employees using the intrinsic-value method in accordance with Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and elected the disclosure-only alternative under SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. Common stock of the Company has been delisted since November 17, 2000 and does not trade on any exchange and is not quoted on any quotation system. Fair value of the Company's common stock is determined by the Company's Board of Directors based upon the most recent significant capital stock transaction adjusted by current major events affecting the Company's financial condition. Certain equity-based compensation cost is included in net income (loss), as certain options granted during periods presented had an exercise price below the market value of the stock on the date of grant. In accordance with SFAS No. 148, ACCOUNTING FOR STOCK BASED COMPENSATION - TRANSITION AND DISCLOSURE, the Company will continue to disclose the required pro-forma information in the notes to the consolidated financial statements and will disclose the required information in quarterly unaudited consolidated financial statements. SALES RECOGNITION POLICY Sales are recorded upon shipment of products to customers. RESULTS OF OPERATIONS The following table sets forth certain consolidated financial data as a percentage of net revenues for the fiscal years ended June 30, 2003, 2002 and 2001.
2003 2002 2001 ----------------- ------------------ ------------------ NET SALES 100.0% 100.0% 100.0% COST OF SALES 63.2% 65.8% 69.2% GROSS PROFIT 36.8% 34.2% 30.8% SELLING EXPENSES 16.1% 16.6% 16.9% GENERAL AND ADMINISTRATIVE EXPENSES 15.1% 16.1% 17.2% DEPRECIATION AND AMORTIZATION EXPENSES 1.8% 4.6% 3.4% RESTRUCTURING EXPENSES 0.7% 7.4% INTEREST EXPENSE 1.8% 1.3% 1.9% NET LOSS (7.8%) (11.5%) (9.1%)
24 FISCAL YEAR ENDED JUNE 30, 2003 COMPARED WITH FISCAL YEAR ENDED JUNE 30, 2002 NET SALES: Net sales of $46,360,019 for fiscal 2003 were $7,335,698 or 13.7% lower than the $53,695,717 reported for fiscal 2002. The decrease in net sales in fiscal year 2003 was primarily due to the closure of the Company's western sales territory as a result of the Company's restructuring plan initiated in November 2001 and the divesture of PEC in June 2002. Remaining decreases are due to a shift in the company's distribution sales mix from stocking to agency-based sales, lost lines and other effects of the 2002 restructuring. The western sales territory closure resulted in approximately $2,542,000 of the decrease and the divesture of PEC resulted in approximately $1,327,000 of the decrease. COST OF SALES: Cost of sales decreased to $29,297,572 for fiscal 2003 from $35,329,128 for fiscal 2002. The cost of sales for fiscal 2003 was 63.2% of net sales compared to 65.8% of net sales for fiscal 2002. The decrease in cost of sales of $6,031,556, or 17.1% was primarily due to lower sales levels related to the closure of the western sales territory and the divesture of PEC. The remaining decreases are due to a shift in the Company's distribution sales mix from stocking to agency-based sales, lost lines and other effects of the 2002 restructuring. The western sales territory closure resulted in approximately $1,810,000 of the decrease and the divesture of PEC resulted in approximately $683,000 of the decrease. The decrease in cost of sales as a percentage of net sales in 2003 compared to 2002 is due to the difference in the product mix sold and the non-recurring prior year inventory reserve adjustments. GROSS PROFIT: Gross profit decreased to $17,062,447, or 36.8% of net sales for fiscal 2003, from $18,366,589, or 34.2% of net sales, for fiscal 2002. The $1,304,142 decrease in gross profit was primarily due to lower sales levels related to the closure of the western sales territory and the divesture of PEC. The western sales territory closure resulted in approximately $732,000 of the decrease and the divesture of PEC resulted in approximately $644,000 of the decrease. The increase in gross profit margins is due to a favorable in product mix and the non-recurring prior year inventory reserve adjustment from 2002 which caused a higher cost of goods sold. SELLING EXPENSES: Selling expenses decreased to $7,450,394 for fiscal 2003, from $8,890,380 for fiscal 2002, a decrease of $1,439,986, or 16.2%. The decrease in selling expense in fiscal 2003 is primarily due to the closure of the western sales territory as a result of the Company's restructuring plan initiated in November 2001 and the divesture of PEC in June 2002. Decreased salaries, commissions, benefits and travel expenses related to the western sales territory account for approximately $502,000 of the decrease and the PEC divesture resulted in approximately $500,000 of the decrease. 25 GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses decreased to $7,015,217 for fiscal 2003, from $8,625,555 for fiscal 2002, a decrease of $1,610,338, or 18.7%. The decrease is primarily a result of the Company's restructuring plan initiated in November 2001 and the divesture of PEC in June 2002. The restructuring plan decreased general and administrative expenses by narrowing the focus of the Company's operations and reducing corporate overhead through workforce reductions. Non-recurring reserve adjustments for inventory and accounts receivable recorded in December 2001 of approximately $474,000 also contributed to the decrease. The PEC divesture resulted in approximately $268,000 of the decrease. DEPRECIATION AND AMORTIZATION EXPENSES: Depreciation and amortization expenses decreased to $843,500 for fiscal 2003, from $2,455,081 for fiscal 2002, a decrease of $1,611,581, or 65.6%. The decrease in depreciation and amortization expense in fiscal 2003 is primarily due to the implementation of SFAS No. 142 GOODWILL AND OTHER INTANGIBLE ASSETS effective July 2002. As a result of this adoption goodwill was no longer amortized in fiscal 2003. RESTRUCTURING EXPENSES: Restructuring expense decreased to $345,507 for fiscal 2003, from $3,954,498 for fiscal 2002. Fiscal 2003 restructuring expenses include a reserve recorded for the former President's severance agreement for $195,507 and other restructuring expenses of $150,000. Fiscal 2002 restructuring expenses relate to the restructuring plan which began in early November 2001, involving narrowing the focus of our operations, the consolidation of certain under performing sales regions, the reduction of corporate overhead through workforce reductions, the restructuring of our balance sheet through a recapitalization and refinancing of the PrimeSource Healthcare and the PrimeSource Surgical senior bank debt and a reduction of debt levels through projected improved earnings and potential asset sales. From November 2001 through August 2002 significant aspects of our new business model, including a reduction in workforce and executive staff, exit of the western sales region, recapitalization of equity and a refinancing of our existing debt were completed. As a result of this, restructuring expense of $2,915,675 was recorded for fiscal 2002. In addition, during 2002, a decision was made to dispose of the PEC division, and the write-off of PEC goodwill and other impaired assets totaled $1,038,823. INTEREST EXPENSE: Interest expense increased to $839,243 during fiscal 2003, compared to $679,244 during fiscal 2002, an increase of $159,999, or 23.6%. Our interest cost increased as a result of increased interest rates and fees incurred related to the restructuring of the PrimeSource Healthcare and PrimeSource Surgical debt. INCOME TAX BENEFIT: Income tax benefit decreased to $19,700 during fiscal 2003, compared to $61,700 during fiscal 2002. The decrease is the result of decreased taxable net income (loss) at state levels. NET LOSS: Our net loss decreased to $3,628,799 during fiscal 2003, compared to $6,190,563 during fiscal 2002, a decrease of $2,561,764, or 41.4%. The decrease in net loss resulted primarily from expense reductions related to our fiscal 2002 restructuring and decreased amortization expense. These expense decreases were offset by goodwill impairment expense of $4,454,656 recorded in fiscal 2003, resulting from the Company's implementation of SFAS No. 142 in July 2002. 26 FISCAL YEAR ENDED JUNE 30, 2002 COMPARED WITH FISCAL YEAR ENDED JUNE 30, 2001 NET SALES: Net sales of $53,695,717 for fiscal 2002 were $5,293,248 or 10.9% higher than the $48,402,469 reported for fiscal 2001. The increase in net sales in fiscal year 2002 was primarily a result of recognizing a full year of sales contribution from the merger with Luxtec in March 2001 and the acquisition of NEMS and PEC in December 2000. In addition, we shifted our focus to implementing key measures to grow and strengthen the existing core business which contributed to our increase in net sales in fiscal 2002. COST OF SALES: Cost of sales increased to $35,329,128 for fiscal 2002 from $35,475,261 for fiscal 2001. The cost of sales for fiscal 2002 was 65.8% of net sales compared to 69.2% of net sales for fiscal 2001. The increase in cost of sales is primarily due to higher sales levels with the addition of full year Luxtec, NEMS and PEC results. The decrease in cost of sales as a percentage of net sales is primarily due to the full year addition of Luxtec's higher margin sales in our consolidated financial results in 2002 compared to only three months in 2001. GROSS PROFIT: Gross profit increased to $18,366,589, or 34.2% of net sales for fiscal 2002, from $14,927,208, or 30.8% of net sales, for fiscal 2001. The increase in gross profit is primarily due to higher, full year sales levels with the addition of the Luxtec, NEMS and PEC. The increase in gross profit margins is primarily due to the addition of a full year of Luxtec's financials results in our consolidated financial results in 2002 compared to only three months in 2001. SELLING EXPENSES: Selling expenses increased to $8,890,380 for fiscal 2002, from $8,188,831 for fiscal 2001, an increase of $701,549, or 8.6%. The increase in expenses in fiscal 2002 is primarily due to increased sales as a result of recognizing a full year of sales contribution from the merger with Luxtec in March 2001 and the acquisition of NEMS and PEC in December 2000. GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses increased to $8,625,555 for fiscal 2002, from $8,341,048 for fiscal 2001, an increase of $284,507, or 3.4%. The increase in expenses in fiscal 2002 is primarily due to increases in the allowance for doubtful accounts and inclusion of partial year results in 2001 due to the acquisition of Luxtec in March 2001 and the acquisition of NEMS and PEC in December 2000. The results of operations for Luxtec, NEMS and PEC were not included in our consolidated general and administrative expense for the entire fiscal year ended June 30, 2001. DEPRECIATION AND AMORTIZATION EXPENSES: Depreciation and amortization expenses increased to $2,455,081 for fiscal 2002, from $1,637,648 for fiscal 2001, an increase of $817,433, or 49.9%. The increase in depreciation and amortization expenses in fiscal 2002 is primarily due to a full year of amortizing Luxtec's goodwill in fiscal 2002 compared to three months in fiscal 2001. RESTRUCTURING EXPENSE: Fiscal 2002 restructuring expenses relate to the restructuring plan which began in early November 2001, involving narrowing the focus of our operations, the consolidation of certain under performing sales 27 regions, the reduction of corporate overhead through workforce reductions, the restructuring of our balance sheet through a recapitalization and refinancing of the PrimeSource Healthcare and the PrimeSource Surgical senior bank debt and the reduction of debt levels through projected improved earnings and potential asset sales. From November 2001 through August 2002 significant aspects of our new business model, including a reduction in workforce and executive staff, exit of the western sales region, recapitalization of equity and a refinancing of our existing debt were completed. As a result of this, restructuring expense of $2,915,675 was recorded for fiscal 2002. In addition, during 2002, a decision was made to dispose of the PEC division, and the write-off of PEC goodwill and other impaired assets totaled $1,038,823. INTEREST EXPENSE: Interest expense decreased to $679,244 during fiscal 2002, compared to $917,785 during fiscal 2001, a decrease of $238,541, or 26.0%. Our interest cost decreased primarily as the result of a reduction in interest rates during fiscal 2002. NET LOSS: Our net loss increased to $6,190,563 during fiscal 2002, compared to $4,382,164 during fiscal 2001, an increase of $1,808,399, or 41.3%. Our net loss increased in fiscal 2002 primarily as a result of the costs incurred related to our restructuring process. LIQUIDITY AND CAPITAL RESOURCES At June 30, 2003, we had a working capital deficit of $793,154 compared to a deficit of $5,202,638 at June 30, 2002. The decrease in our working capital deficit is primarily the result of decreased accounts receivable balances, offset by decreased total current liabilities. On March 2, 2001, we entered into an Amended and Restated Security and Loan Agreement (the "Luxtec Credit Agreement") for a $2,500,000 line of credit (the "Luxtec Line of Credit") with ARK CLO 2000-1 LIMITED ("ARK"). On August 6, 2002, we amended the Luxtec Credit Agreement. Pursuant to the amendment to the Luxtec Credit Agreement, ARK waived and amended certain provisions under the Luxtec Credit Agreement. Under the amendment, as of June 30, 2003, the maximum amount available to borrow under the Luxtec Line of Credit was limited to the lesser of $1,275,000 or a certain percentage of accounts receivable and inventory, as defined ($1,271,585 at June 30, 2003). As of June 30, 2003, borrowings bore interest at ARK's prime rate plus 3.0% (7.00% at June 30, 2003). Unused portions of the Luxtec Line of Credit accrue a fee at an annual rate of 1.00%. Borrowings are secured by substantially all of PrimeSource Healthcare's assets, excluding the capital stock of, and assets held by, PrimeSource Surgical. At June 30, 2003, there was no availability for additional borrowings under the Luxtec Line of Credit. Borrowings under the Luxtec Line of Credit are payable upon maturity on December 31, 2003. On March 2, 2001, as part of the Luxtec Credit Agreement, we executed an Amended and Restated Term Note (the "Luxtec Term Note") in the amount of $300,000 with ARK. The Luxtec Term Note bore interest at prime plus 0.5% and was secured by substantially all of PrimeSource Healthcare's assets, excluding the capital stock of, and assets held by, PrimeSource Surgical. The Luxtec Term Note required monthly principal payments of $10,000 commencing on March 31, 2001. The Luxtec Term Note was scheduled to mature on March 31, 2002 with a balloon 28 payment of $150,000 on that date. ARK granted us an extension on the payment of the Luxtec Term Note until May 31, 2002. On August 6, 2002, we paid off the entire outstanding balance of the Luxtec Term Note in connection with the Luxtec Credit Agreement amendment. The Luxtec Credit Agreement contains covenants that require the maintenance of defined financial ratios and income levels and limit additional borrowings and capital expenditures. The Company was in compliance with these financial covenants as of June 30, 2003. On June 14, 1999, the Company's wholly owned subsidiary, PrimeSource Surgical, entered into an Amended and Restated Credit Agreement (the "PrimeSource Surgical Credit Agreement") with Citizens for a line of credit (the "PrimeSource Surgical Line of Credit"). On August 6, 2002, PrimeSource Surgical amended the PrimeSource Surgical Credit Agreement, pursuant to which the maturity date of the revolving line of credit under the PrimeSource Surgical Credit Agreement was extended to March 31, 2004, the maturity date of the term loan was extended to December 31, 2003, and certain other changes were made including modifications to interest rates and covenant requirements. Under the amendment, as of June 30, 2003 the maximum amount available to borrow under the PrimeSource Surgical Line of Credit is limited to the lesser of $8,000,000 or a certain percentage of accounts receivable and inventory, as defined by the PrimeSource Surgical Credit Agreement ($5,281,805 at June 30, 2003). As of June 30, 2003, borrowings bore a variable step interest rate at Citizens' prime rate plus 4.50% (8.50% at June 30, 2003). Unused portions of the PrimeSource Surgical Line of Credit accrue a fee at an annual rate of 0.375%. Borrowings are secured by substantially all of the assets directly held by PrimeSource Surgical. At June 30, 2003, there was $627,369 of availability under the PrimeSource Surgical Line of Credit. Borrowings under the PrimeSource Surgical Line of Credit are payable upon maturity in March 31, 2004. On June 14, 1999, as part of the PrimeSource Surgical Credit Agreement, PrimeSource Surgical executed an Amended and Restated Term Note (the "PrimeSource Surgical Term Loan") in the original amount of $5,000,000 with Citizens. On June 30, 2003, we paid off the entire outstanding balance of the PrimeSource Surgical Term Loan in connection with the sale of Ruby and the funding of the last Preferred Series G round. The PrimeSource Surgical Term Loan was collateralized by substantially all the assets directly held by PrimeSource Surgical. In connection with the August 6, 2002 amendment to the PrimeSource Surgical Credit Agreement, previously deferred payments of $675,000 were paid, the interest rate was modified to a variable step interest rate and the required PrimeSource Surgical Term Loan monthly principal payments were changed to $50,000 between August 2002 and January 2003, $75,000 between February 2003 and July 2003. The PrimeSource Surgical Term Loan was also subject to a term loan facility fee. PrimeSource Surgical accrued a $75,000 fee on August 6, 2002, in connection with the amendment to the PrimeSource Surgical Credit Agreement. PrimeSource Surgical was obligated to pay additional $75,000 fees under the PrimeSource Surgical Term Loan on the last day of each calendar quarter, beginning on September 30, 2002 and for every quarter thereafter until the earlier of payment in full of the PrimeSource Surgical Term Loan or December 31, 2003. The accrued term loan facility fees were reduced by 40% because on June 30, 2003, we paid off the entire outstanding balance of the PrimeSource Surgical Term Loan in connection 29 with the sale of Ruby and the funding of the most recent Preferred Series G round. In connection with the PrimeSource Surgical Term Loan payoff on June 30, 2003, the amount outstanding under this term loan facility fee is $180,000, which is included in accrued expense and is due on or before December 31, 2003. The PrimeSource Surgical Term Loan was also subject to an additional repayment obligation. Commencing with the three-month period ending December 31, 2002, and for each three-month period thereafter, fifty percent (50%) of excess cash flow (as defined in the PrimeSource Credit Agreement) generated during the three-month period was applied to the principal amount of the PrimeSource Surgical Term Loan. At December 31, 2002, the additional repayment obligation totaled $10,451, which was subsequently paid. At March 31, 2003, there was no additional repayment obligation. The PrimeSource Surgical Credit Agreement contains covenants that require the maintenance of defined financial ratios and income levels and limit additional borrowings and capital expenditures. PrimeSource Surgical was in compliance with these covenants as of June 30, 2003. Other notes payable include a $100,000 note payable for tenant improvements to Luxtec's leased premises in West Boylston, Massachusetts, which bears interest at 9.5% and is due September 19, 2005. Payments are interest only for the first 12 months, with remaining payments calculated on a 7-year amortization table with a balloon payment on September 19, 2005. At June 30, 2003 and June 30, 2002, Luxtec had outstanding borrowing of $77,650 and $91,481, respectively, under the tenant note payable. In addition, other notes payable include a PrimeSource Surgical non-interest bearing demand note payable with an original amount of $559,977 (net of unamortized discount of $40,023 based on an imputed interest rate of 8%) to its special legal counsel in payment of existing outstanding accounts payable, which matures May 30, 2004. Monthly principal payments are $30,000 commencing on October 20, 2002. At June 30, 2003 and June 30, 2002, PrimeSource Surgical had outstanding borrowing of $357,173 (net of unamortized discount of $12,827) and $559,977, respectively, on this note payable to legal counsel. Finally, other notes payable include a PrimeSource Surgical $250,000 note payable to Citizens in payment of the bank refinancing amendment fee. Equal principal payments on the note of $62,500 each were or are due March 31, 2003, June 30, 2003, September 30, 2003 and December 31, 2003. At June 30, 2003 and June 30, 2002, PrimeSource Surgical had outstanding borrowings of $187,500 and $250,000, respectively, on this note payable to Citizens. This note has been recorded as deferred financing costs and is being amortized over the life of the PrimeSource Surgical Credit Agreement. On August 6, 2002, we raised $2,254,466, before costs, in additional capital through the issuance and sale of the Series G Stock and the warrants to purchase common stock. In addition, on September 15, 2002, November 15, 2002, January 15, 2003 and June 30, 2003, we raised an additional $1,615,536, before costs and in aggregate, in capital through the issuance and sale of additional shares of Series G Stock. The proceeds from the offerings were used to pay certain trade payables and to reduce outstanding borrowings under our credit facilities. As of June 30, 2003, we had $489,911 of cash and cash equivalents. In addition, the principal source of our short-term borrowing is the PrimeSource Surgical 30 Line of Credit. As of June 30, 2003, we had approximately $627,000 available under the PrimeSource Surgical Line of Credit. In addition, we may attempt to raise additional equity or debt capital in the future. RECENT ACCOUNTING PRONOUNCEMENTS In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The Standard is effective for disposal activities that are initiated after December 31, 2002. The Company does not expect this Standard to have a material effect on its financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION -- TRANSITION AND DISCLOSURE -- AN AMENDMENT OF FASB STATEMENT NO. 123. SFAS No. 148 amends SFAS No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect on the method used on reported results. The disclosure requirements apply to all companies for fiscal quarters beginning after December 15, 2002. In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS. FIN 45 addresses the disclosure requirements of a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. FIN 45 also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements of FIN 45 are effective for the Company in its quarter ended December 31, 2002. The liability recognition requirements will be applicable prospectively to all guarantees issued or modified after December 31, 2002. The Company had no guarantees requiring disclosure. In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), CONSOLIDATION OF VARIABLE INTEREST ENTITIES which will be effective for the Company as of June 30, 2004. The Company has no variable interest entities. Under FIN 46, companies are required to consolidate variable interest entities for which they are deemed to be the primary beneficiary, and disclose information about those in which they have a significant variable interest. In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in the fair value or the redemption amount, as applicable, in earnings. SFAS No. 150 is effective immediately for financial instruments (except for mandatorily redeemable financial instruments issued by nonpublic companies) 31 entered into or modified after May 31, 2003. It is effective for financial instruments (except for mandatorily redeemable financial instruments issued by nonpublic companies) issued on or before May 31, 2003 at the beginning of the first interim period beginning after June 15, 2003. Finally, it is effective for mandatorily redeemable financial instruments issued by nonpublic companies for fiscal years beginning after December 15, 2003. The effect of adopting SFAS No. 150 will be recognized as a cumulative effect of an accounting change as of the beginning of the period of adoption. The company anticipates adoption to have an effect on the classification of its liabilities, and does not anticipate a material effect on its results of operations. RISK FACTORS IF WE ARE UNABLE TO ACHIEVE OUR BUSINESS OBJECTIVES AND COMPLY WITH THE COVENANTS IN OUR CREDIT FACILITIES WE MAY HAVE TO SUSPEND OR CEASE OPERATIONS. We had income from continuing operations of $777,990 for our fiscal year ended June 30, 2003. If we are unable to generate sufficient positive cash flow and/or raise additional equity or debt capital, we may have insufficient funds to continue our operations. In addition, if we are unable to comply with the covenants of our credit facilities, our creditors may accelerate repayment of the borrowings under our facilities. THE INDUSTRY IN WHICH WE PARTICIPATE IS INCREASINGLY COMPETITIVE WHICH COULD MAKE IT MORE DIFFICULT FOR US TO IMPROVE OUR FINANCIAL PERFORMANCE. The changing health-care environment in recent years has led to increasingly intense competition among health-care suppliers. Competition is focused on price, service and product performance. Pressure in these areas is expected to continue. Increased competition may lead to price and other forms of competition that could have a material adverse effect on our market share, business and results of operations. Also, we may face increased competition for acquisition opportunities, which may inhibit our ability to consummate suitable acquisitions on favorable terms. OUR COMMON STOCK IS NOT LISTED ON AN EXCHANGE WHICH MAKES IT DIFFICULT FOR OUR STOCKHOLDERS TO SELL THEIR STOCK. Although we are a public reporting company, our shares of capital stock are not listed on any stock exchange or quoted on any quotation system. We cannot assure that holders of our capital stock will be able to dispose of their shares. PROVISIONS IN OUR ARTICLES OF ORGANIZATION AND BY-LAWS COULD MAKE IT HARDER FOR A THIRD PARTY TO ACQUIRE CONTROL OF US AND COULD DETER AN ACQUISITION. Provisions of our Articles of Organization, as amended, and the Amended and Restated By-Laws of the Massachusetts Business Corporation Law could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. Our Board of Directors has the authority to issue shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by our stockholders, subject to certain limitations. The rights of the holders of our common stock may be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that we may issue in the future. The issuance of preferred stock by us may have the effect of delaying, deferring or preventing a change of our control without further action by our stockholders and may adversely affect the voting and other rights of the holders of our common stock. In addition, our Articles of Organization do not permit cumulative 32 voting. Further, the majority of the members of our Board of Directors serve a staggered three-year term, which may also make it more difficult for a third-party to gain control of our Board of Directors. PRIMESOURCE SURGICAL HAS A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO PREDICT ITS FUTURE PERFORMANCE. PrimeSource Surgical, which is our material subsidiary, commenced operations in 1996, and grew rapidly through the acquisition of a number of specialty medical products sales and marketing organizations. Accordingly, PrimeSource Surgical has only a limited operating history from which to evaluate and forecast its business. As a result of PrimeSource Surgical's limited operating history, we may be unable to accurately forecast financial results going forward. Moreover, failure to meet our revenue, targets and financial projections may have an immediate and negative impact on our total results of operations. OUR BUSINESS WILL SUFFER IF WE FAIL TO ATTRACT AND RETAIN EXPERIENCED SALES REPRESENTATIVES. The success and growth of our business depends on our ability to attract and retain qualified and experienced sales representatives. There is significant competition for experienced specialty medical products sales representatives. It is uncertain whether we can continue to attract and retain qualified personnel. If we cannot attract, retain and motivate qualified sales personnel, we will not be able to expand our business and our ability to perform under our existing contracts will be impaired, which would negatively affect our results of operations. OUR BUSINESS WOULD SUFFER IF WE LOST KEY SUPPLIERS. Our success is partly dependent on our ability to successfully predict and adjust production capacity to meet demand, which is partly dependent upon the ability of external suppliers to deliver components at reasonable prices and in a timely manner. Capacity or supply constraints, as well as purchase commitments, could adversely affect our future operating results. We cannot assure that we will be able to maintain our existing supplier relationships or secure additional suppliers as needed. IF SUPPLIERS TERMINATE THEIR AGREEMENTS WITH US, OUR PRODUCT OFFERINGS MAY SUFFER. Following an initial one-year term, many of our standard supplier agreements may be terminated by either party on 90 days' notice. After expiration of the initial term, such suppliers may terminate or seek to renegotiate their agreements. If a significant number of suppliers terminate their agreements with us, the range of products we will be able to offer would be adversely affected. The ability of suppliers to terminate their agreements may result in new agreement terms that are less favorable to us, which could have a material adverse effect on our earnings. SALES TO LARGER CUSTOMERS MAY INCREASE THE LENGTH OF OUR SALES CYCLE AND DECREASE OUR PROFIT MARGINS. Increasing sales to larger buyers may be an important element of a future business strategy. As we sell to larger organizations, it is expected that the time from initial contact to final approval will increase. During this sales cycle, we may expend substantial funds and management resources without any corresponding revenue. If approval of contracts is delayed or does not occur, our financial condition and operating results for a particular period may be adversely affected. Approval of contracts may be subject to delays for reasons over which we will have little or no control, including: o potential customers' internal approval processes; o customers' concerns about implementing a new method of doing business; and o seasonal and other timing effects. 33 Increased sales to larger accounts may result in lower profit margins as larger customers typically have greater leverage in negotiating the price and other terms of business relationships. If we do not generate sufficient transaction volume to offset any lower margins, our operating results may be materially and adversely affected. GOVERNMENTAL OR PRIVATE INITIATIVES TO REDUCE HEALTHCARE COSTS COULD HAVE A MATERIAL ADVERSE EFFECT ON THE SPECIALTY MEDICAL PRODUCTS INDUSTRY. The primary trend in the United States healthcare industry is toward cost containment. Comprehensive government healthcare reform intended to reduce healthcare costs, the growth of total healthcare expenditures and expanded healthcare coverage for the uninsured have been proposed in the past and may be considered again in the near future. Implementation of government healthcare reform may adversely affect specialty medical products companies, which could decrease the business opportunities available to us. In addition, the increasing use of managed care, centralized purchasing decisions and consolidations among, and integration of, healthcare providers are continuing to affect purchasing and usage patterns in the healthcare system. Decisions regarding the use of specialty medical products are increasingly being consolidated into group purchasing organizations, regional integrated delivery systems and similar organizations and are becoming more economically focused, with decision makers taking into account the cost of the product and whether a product reduces the cost of treatment. Significant cost containment initiatives adopted by government or private entities could have a material adverse effect on the business of the Company. IF WE ISSUE ADDITIONAL CAPITAL STOCK OUR CURRENT STOCKHOLDERS RIGHTS MAY BE ADVERSELY AFFECTED. We may issue additional securities which would dilute the ownership interests of our current stockholders. The terms and preferences of any securities we may issue could be superior to those of our currently outstanding capital stock. Current stockholders' rights to dividends and upon liquidation may be adversely affected. We may undertake business combination transactions wherein we would issue equity as consideration. Such transactions would have a dilutive effect on our stockholders. OUR MAJOR STOCKHOLDER HAS SUBSTANTIAL CONTROL OF US AND COULD DELAY OR PREVENT A CHANGE IN CONTROL THAT STOCKHOLDERS MAY BELIEVE WOULD IMPROVE MANAGEMENT AND/OR OUR BUSINESS. As a result of its ownership of Series G Preferred Stock and common stock, GE Capital Equity Investments, Inc., is able to exercise substantial control over the election of our directors and determine the outcome of most corporate actions requiring stockholder approval, including a merger with or into another company, the sale of all or substantially all of our assets and amendment to our Articles of Organization. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Our market risk exposure relates to outstanding debt. The balance of our outstanding bank debt at June 30, 2003 was $6,113,521, all of which is subject 34 to interest rate fluctuations. A hypothetical 10% change in interest rates applied to the fair value of debt would not have a material impact on our earnings or cash flows. 35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PRIMESOURCE HEALTHCARE, INC. and Subsidiaries Consolidated Financial Statements as of June 30, 2003 and 2002, and for the Years Ended June 30, 2003, 2002 and 2001 and Independent Auditors' Report Page Independent Auditors' Report F-1 Consolidated Balance Sheets as of June 30, 2003 and 2002 F-2 - F-3 Consolidated Statements of Operations for the Years Ended June 30, 2003, 2002 and 2001 F-4 - F-5 Consolidated Statements of Stockholders' Equity (Capital Deficiency) for the Years Ended June 30, 2003, 2002 and 2001 F-6 Consolidated Statements of Cash Flows for the Years Ended June 30, 2003, 2002 and 2001 F-7 - F-8 Notes to Consolidated Financial Statements F-9 - F-34
36 INDEPENDENT AUDITORS' REPORT Board of Directors PrimeSource Healthcare, Inc. Tucson, Arizona We have audited the accompanying consolidated balance sheets of PrimeSource Healthcare, Inc. and subsidiaries (the "Company") as of June 30, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity (capital deficiency), and cash flows for each of the three years in the period ended June 30, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PrimeSource Healthcare, Inc. and subsidiaries as of June 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2003 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 6 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets with indefinite lives as required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was effective July 1, 2002. Deloitte & Touche LLP Phoenix, Arizona October 14, 2003
PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 2003 AND 2002 ------------------------------------------------------------------------------------------------------------------- ASSETS 2003 2002 CURRENT ASSETS: Cash and cash equivalents $ 489,911 $ 285,735 Accounts receivable - net of allowance for doubtful accounts of approximately $214,000 (2003) and $400,000 (2002) 6,111,062 6,348,534 Inventories - net 7,517,965 7,496,108 Income taxes receivable 67,800 110,000 Prepaid expenses and other current assets 172,397 207,765 ------------ ----------- Total current assets 14,359,135 14,448,142 PROPERTY AND EQUIPMENT - Net 996,358 1,139,935 INTANGIBLE ASSETS - Net of accumulated amortization of approximately $236,000 (2003) and $267,000 (2002) 118,290 143,272 GOODWILL - Net 15,956,883 21,499,956 OTHER ASSETS - Net of accumulated amortization of approximately $782,000 (2003) and $345,000 (2002) 233,874 355,463 ------------ ----------- TOTAL $ 31,664,540 $37,586,768 ============ =========== (Continued)
F-2
PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 2003 AND 2002 ------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) 2003 2002 CURRENT LIABILITIES: Accounts payable $ 5,636,333 $ 5,587,886 Accrued expenses 2,240,770 3,307,581 Accrued restructuring costs 690,968 1,111,133 Customer deposits 72,895 220,901 Lines of credit 5,926,021 7,530,875 Current portion of long-term debt 559,877 1,855,481 Current portion of capital lease obligations 25,425 36,923 ------------ ------------ Total current liabilities 15,152,289 19,650,780 ------------ ------------ CAPITAL LEASE OBLIGATIONS - Net of current portion 21,433 47,789 ------------ ------------ LONG-TERM DEBT - Net of current portion 105,696 1,244,307 ------------ ------------ COMMITMENTS AND CONTINGENCIES (Notes 7, 8, 9, 10 and 12) SERIES C REDEEMABLE, CONVERTIBLE PREFERRED STOCK $1.00 par value - authorized, 344,864 shares; issued and outstanding, 344,864 shares; aggregate liquidation preference of $18,983,193 16,313,946 ------------ SERIES E REDEEMABLE, CONVERTIBLE PREFERRED STOCK no par value - authorized, 1,000,000 shares; issued and outstanding, 325,000 shares; aggregate liquidation preference of $10,009,288 2,029,864 ------------ SERIES F REDEEMABLE, CONVERTIBLE PREFERRED STOCK no par value - authorized, 5,221,248 shares; issued and outstanding, 5,221,248 shares; aggregate liquidation preference of $5,402,061 3,649,145 ------------ SERIES G REDEEMABLE, CONVERTIBLE PREFERRED STOCK no par value - authorized, 230,000 shares; issued and outstanding, 222,500 shares; aggregate liquidation preference of $14,687,737 5,699,121 ------------ STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY): Common stock, $0.01 par value - authorized, 75,000,000 shares; issued and outstanding, 22,375,094 (2003) and 7,978,309 (2002) shares 223,750 79,783 Additional paid-in capital 21,347,451 12,490,202 Accumulated deficit (10,885,200) (17,919,048) ------------ ------------ Total stockholders' equity (capital deficiency) 10,686,001 (5,349,063) ------------ ------------ TOTAL $ 31,664,540 $ 37,586,768 ============ ============ See notes to consolidated financial statements. (Concluded)
F-3
PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED JUNE 30, 2003, 2002, AND 2001 ------------------------------------------------------------------------------------------------------------------- 2003 2002 2001 NET SALES $ 46,360,019 $ 53,695,717 $ 48,402,469 COST OF SALES 29,297,572 35,329,128 33,475,261 ------------ ------------ ------------ GROSS PROFIT 17,062,447 18,366,589 14,927,208 ------------ ------------ ------------ OPERATING EXPENSES: Selling expenses 7,450,394 8,890,380 8,188,831 General and administrative expenses 7,015,217 8,625,555 8,341,048 Depreciation and amortization expenses 843,500 2,455,081 1,637,648 Restructuring expenses 345,507 3,954,498 ------------ ------------ ------------ Total operating expenses 15,654,618 23,925,514 18,167,527 ------------ ------------ ------------ OPERATING INCOME (LOSS) 1,407,829 (5,558,925) (3,240,319) INTEREST EXPENSE (839,243) (679,244) (917,785) OTHER INCOME (EXPENSE) 189,704 (115,357) (16,306) ------------ ------------ ------------ INCOME (LOSS) FROM CONTINUING OPERATIONS 758,290 (6,353,526) BEFORE INCOME TAX BENEFIT (PROVISION) (4,174,410) INCOME TAX BENEFIT (PROVISION) 19,700 61,700 (207,200) ------------ ------------ ------------ INCOME (LOSS) BEFORE DISCONTINUED OPERATIONS AND BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 777,990 (6,291,826) (4,381,610) ------------ ------------ ------------ DISCONTINUED OPERATIONS: INCOME (LOSS) FROM DISCONTINUED OPERATION - NET OF INCOME TAX 121,697 101,263 (554) LOSS ON DISPOSAL OF DISCONTINUED OPERATION - NET OF INCOME TAX (73,830) ------------ ------------ ------------ TOTAL 47,867 101,263 (554) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE - GOODWILL IMPAIRMENT (4,454,656) ------------ ------------ ------------ NET LOSS (3,628,799) (6,190,563) (4,382,164) DIVIDENDS AND ACCRETION ON PREFERRED STOCK (1,147,094) (2,652,571) (1,419,114) EFFECT OF EQUITY RECAPITALIZATION 11,809,741 ------------ ------------ ------------ NET INCOME (LOSS) AVAILABLE FOR COMMON STOCKHOLDERS $ 7,033,848 $(8,843,134) $(5,801,278) ============ ============ ============
F-4
PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED JUNE 30, 2003, 2002, AND 2001 ------------------------------------------------------------------------------------------------------------------- 2003 2002 2001 INCOME (LOSS) PER SHARE BEFORE DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE - GOODWILL IMPAIRMENT: Basic $ 0.54 $(1.13) $(1.37) ======= ======= ======= Diluted $ 0.24 $(1.13) $(1.37) ======= ======= ======= LOSS PER SHARE FROM DISCONTINUED OPERATIONS - NET OF INCOME TAX DISPOSAL OF OPERATION: Basic $0.02 ======= Diluted $0.02 ======= LOSS PER SHARE FROM CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE - GOODWILL IMPAIRMENT: Basic $(0.21) ======= Diluted $(0.09) ======= INCOME (LOSS) PER SHARE: Basic $ 0.33 $(1.11) $(1.37) ======= ======= ======= Diluted $ 0.15 $(1.11) $(1.37) ======= ======= ======= See notes to consolidated financial statements. (Concluded)
F-5
PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY) YEARS ENDED JUNE 30, 2003, 2002, AND 2001 ------------------------------------------------------------------------------------------------------------------------------------ Series B Convertible Additional Total Preferred Stock Common Stock Paid-in Accumulated Stockholders' ------------------------------------------ Shares Amount Shares Amount Capital Deficit Equity (Deficiency) BALANCE, JULY 1, 2000 46,889 $1,195,543 2,874,166 $28,742 $1,523,186 $(3,274,636) $ (527,165) Issuance of common stock in and effect of reverse merger 3,335,000 33,350 4,649,905 4,683,255 Issuance of common stock 578,324 5,783 1,077,785 1,083,568 Conversion of preferred stock to common (46,889)(1,195,543) 1,172,214 11,722 1,183,821 Preferred stock dividends and accretion (1,419,114) (1,419,114) Net loss - - - - - (4,382,164) (4,382,164) --------- ------------ ---------- --------- ----------- ------------- ----------- BALANCE, JUNE 30, 2001 - - 7,959,704 79,597 8,434,697 (9,075,914) (561,620) Issuance of common stock 18,605 186 24,814 25,000 Warrants and beneficial conversion features of preferred stock 3,912,000 3,912,000 Preferred stock dividends and accretion (2,652,571) (2,652,571) Restricted common stock vesting 118,709 118,709 Refund fractional shares (18) (18) Net loss - - - - - (6,190,563) (6,190,563) --------- ------------ ---------- --------- ----------- ------------- ----------- BALANCE, JUNE 30, 2002 - - 7,978,309 79,783 12,490,202 (17,919,048) (5,349,063) Equity recapitalization 14,735,066 147,351 6,785,864 11,809,741 18,742,956 Warrants issued with issuance of Series G preferred stock 2,062,000 2,062,000 Preferred stock dividends and accretion (1,147,094) (1,147,094) Cancellation of shares in legal settlement (132,963) (1,330) (41,218) (42,548) Cancellation of shares in sale of PEC assets (201,067) (2,011) (62,330) (64,341) Cancellation of shares in sale of Ruby Merger (4,251) (43) (1,317) (1,360) Issuance of compensatory stock options 110,000 110,000 Restricted common stock vesting 4,250 4,250 Net loss - - - - - (3,628,799) (3,628,799) --------- ------------ ---------- --------- ----------- ------------- ----------- BALANCE, JUNE 30, 2003 - $ - 22,375,094 $223,750 $21,347,451 $(10,885,200) $10,686,001 ========= ============ ========== ========= =========== ============= =========== See notes to consolidated financial statements.
F-6
PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2003, 2002, AND 2001 ----------------------------------------------------------------------------------------------------------- 2003 2002 2001 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(3,628,799) $(6,190,563) $(4,382,164) Adjustments to reconcile net loss to net cash provided by (used in ) operating activities: Depreciation and amortization expenses 849,657 2,462,411 1,659,771 Amortization of debt discount 28,600 67,311 Loss on sale of division 73,830 1,038,823 Change in fair value of warrant put obligation (95,000) (172,000) Loss on disposal of property and equipment 22,147 124,132 8,179 Goodwill impairment 4,454,656 Write-off of intangible assets 12,406 25,132 Issuance of common stock for services 4,250 25,000 100,000 Gain on legal settlement (42,548) Stock compensation expense 110,000 118,709 Changes in operating assets and liabilities - net of effect of business acquisitions and dispositions: Accounts receivable (313,913) 2,208,904 873,575 Inventories (397,713) 1,978,659 (822,554) Income taxes receivable and payable 42,200 (119,500) 859,666 Prepaid expenses and other current assets (31,021) 4,644 131,166 Other assets (80,723) (181,504) (381,710) Accounts payable 578,565 (5,235,025) 779,767 Accrued expenses (604,266) 568,636 316,944 Accrued restructuring costs (420,165) 1,111,133 Customer deposits (148,006) (347,215) 379,456 --------- ----------- ----------- Net cash provided by (used in) operating activities 468,151 (2,486,750) (557,461) --------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (255,320) (86,828) (475,280) Purchase of intangible assets (64,166) Acquisition of other assets (31,904) Proceeds from sale of property and equipment 157 6,462 7,200 Cash paid for business acquisitions - net (391,000) Payment of business acquisition costs (785,159) Proceeds from business disposition 1,000,000 --------- ----------- ----------- Net cash provided by (used in) investing activities 744,837 (176,436) (1,644,239) --------- ----------- ----------- (Continued)
F-7
PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2003, 2002, AND 2001 ------------------------------------------------------------------------------------------------------------------- 2003 2002 2001 CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings under lines of credit 16,785,191 19,506,353 28,043,512 Repayments under lines of credit (18,390,045) (20,027,304) (28,674,599) Borrowings under long-term debt 600,000 11,854 Repayment of long-term debt (2,731,323) (872,711) (2,361,116) Repayment on capital leases (36,666) (47,192) (31,340) Proceeds from issuance of common stock 3,261 Proceeds from issuance of preferred stock - net of costs 3,364,031 3,167,170 5,706,061 Stock repurchases (18) ------------ ------------ ------------ Net cash (used in) provided by financing activities (1,008,812) 2,326,298 2,697,633 ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 204,176 (336,888) 495,933 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 285,735 622,623 126,690 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 489,911 $ 285,735 $ 622,623 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION - Cash paid during the year for: Interest $ 698,685 $ 741,905 $ 945,393 ============ ============ ============ Income taxes $ 30,000 $256,100 $ 109,638 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS - Issuance of note payable for debt refinancing cost $ 250,000 ============ Discount on issuance of note payable for legal services $ (12,827) ============ Fair value of common stock cancelled in sale of asset $ 64,341 ============ Fair value of common stock cancelled in legal settlement $ 42,548 ============ Equipment acquired under capital lease $ 54,745 $ 39,906 ============ ============ Common stock issued for services $ 4,250 $ 25,000 $ 100,000 ============ ============ ============ During the year ended June 30, 2001, the Company acquired entities in transactions summarized as follows: Fair value of assets acquired, including transaction costs $17,076,173 Issuance of common stock (4,254,000) Issuance of series D preferred stock (1,456,180) Cash paid in business acquisition - net of refund (391,000) ------------ Liabilities assumed $10,974,993 ============ See notes to consolidated financial statements. (Concluded)
F-8 PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 2003, 2002, AND 2001 -------------------------------------------------------------------------------- 1. NATURE OF BUSINESS PrimeSource Healthcare, Inc. ("PrimeSource" or the "Company"), a Massachusetts corporation formerly known as Luxtec Corporation, is a specialty medical products sales, marketing, manufacturing, and service company. The Company sells a broad portfolio of specialty medical products, some of which it manufactures, to hospitals and surgery centers nationwide through a dedicated organization of sales and marketing professionals. On March 2, 2001, Luxtec Corporation ("Luxtec"), a Massachusetts publicly held corporation, completed a merger (the "Merger") with PrimeSource Surgical, Inc., a Delaware corporation ("PrimeSource Surgical"), resulting in PrimeSource Surgical becoming a wholly-owned subsidiary of Luxtec. Pursuant to the agreement and Plan of Merger, dated November 27, 2000, as amended, the former stockholders of PrimeSource Surgical received Luxtec capital stock in exchange for their PrimeSource Surgical capital stock. On June 22, 2001, the stockholders of Luxtec approved a name change to PrimeSource Healthcare, Inc. Luxtec's year-end was previously October 31 but changed to June 30, PrimeSource Surgical's year-end. Luxtec was a delisted public company at the time of the acquisition. For accounting purposes, the acquisition has been treated as the acquisition of Luxtec by PrimeSource Surgical with PrimeSource Surgical as the acquirer (reverse acquisition). The acquisition has been accounted for using the purchase method of accounting, and the results of operations have been included from March 2, 2001, the date of acquisition. The historical financial statements prior to March 2, 2001 are those of PrimeSource Surgical. All shares and per share data prior to the acquisition have been restated to reflect the par value and capital structure of Luxtec. The Merger between PrimeSource Surgical and Luxtec was effected by Luxtec acquiring 100 percent of the issued and outstanding common stock of PrimeSource Surgical in exchange for 3,301,239 shares of common stock, par value $.01 per share (the "Common Stock"), 46,889 shares of Series B Convertible Preferred Stock, par value $1.00 per share (the "Series B Stock"), 344,864 shares of Series C Redeemable, Convertible Preferred Stock, par value $1.00 per share (the "Series C Stock"), and 9,674 shares of Series D Exchangeable, Convertible Preferred Stock, par value $1.00 per share (the "Series D Stock") of Luxtec. In addition, the Company assumed PrimeSource Surgical options to purchase 2,519,542 shares of common stock and PrimeSource Surgical warrants to purchase 578,088 shares of common stock. On March 3, 2001, the Company issued 4,334 shares of Series D Stock and 450,000 shares of common stock in exchange for 10,000 shares of the Company's previously outstanding Series A Redeemable Preferred Stock and warrants to purchase 450,000 shares of common stock at $3.00 per share (Note 3). On December 29, 2000, PrimeSource Surgical acquired all the outstanding common stock of Ruby Merger Sub ("Ruby"), which included New England Medical Specialties, Inc. ("NEMS") and Professional Equipment Co., Inc. ("PEC"), two specialty distribution organizations in the northeastern United States. The transaction was accounted for using the purchase method of accounting. F-9 PrimeSource Surgical acquired the companies for aggregate consideration of $1,310,000, of which $391,000 was paid in cash and $919,000 was paid by issuing 390,804 shares of common stock. An additional 21,262 shares of common stock with a fair value of $50,000 were issued to certain employees of the acquired companies. These shares are restricted, and vest 33 percent on the first, second, and third anniversaries of the acquisition (Note 3). The following unaudited pro forma combined condensed financial information for the fiscal year ended June 30, 2001 includes the results of operations for the Company, presented as if PrimeSource Surgical had been combined with Luxtec, NEMS, and PEC for all of 2001, along with adjustments that give effect to events that are directly attributable to the transaction and expected to have a continuing impact. Net sales $58,991,021 ============ Net loss $(7,834,540) ============ Loss per share, basic and diluted $(1.22) ============ Effective June 30, 2002, Ruby, the Company's indirect wholly-owned subsidiary, sold all of the assets of the former PEC line of business in exchange for the cancellation of previously issued stock to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business. Goodwill and other impaired assets were written off in 2002, resulting in a loss of $1,038,823, which is recorded in restructuring expense in the statement of operations. On June 30, 2003, PrimeSource Surgical, Inc., a subsidiary of the Company, sold all of the issued and outstanding capital stock of Ruby for cash proceeds of $1,000,000 to New England Medical Specialties, Inc., a newly formed entity ("NMSI"). The Company recognized a loss of $73,830 on the sale. The cash proceeds were used to payoff the PrimeSource Term Note with Citizens Bank of Massachusetts ("Citizens"). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION - The accompanying consolidated financial statements have been prepared on the accrual basis of accounting. The Company has incurred net losses of $3,628,799 in 2003, $6,190,563 in 2002, and $4,382,164 in 2001. The Company's business plan continues to focus on improving operations through internal growth of its specialty medical products lines and through additional manufacturing acquisitions of strategic businesses. The Company is focusing its marketing efforts on forming partnerships with other medical products companies to widen the customer base for its products. The Company's primary debt financing is provided under loans from two different banks. As of June 30, 2003, the Company had $4,654,436 of outstanding borrowings under the PrimeSource Surgical credit agreement (the "PrimeSource Surgical Credit Agreement"), and $1,271,585 outstanding under the Luxtec credit agreement F-10 (the "Luxtec Credit Agreement"), as further discussed in Note 7. The two credit agreements discussed above include certain financial covenants, with which the Company was in compliance at June 30, 2003. The PrimeSource Surgical Credit Agreement matures on March 31, 2004 and the Luxtec Credit Agreement matures on December 31, 2003. The Company is evaluating refinancing its credit agreements or raising additional funding through equity placements to consolidate its credit agreements into a single agreement. Based upon discussions to date, Company management believes it will obtain adequate bank facilities and funding to continue to fund operations. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: PrimeSource Surgical; Ruby (dba NEMS and PEC); and Bimeco, Inc. All intercompany balances and transactions have been eliminated. CASH AND CASH EQUIVALENTS - The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. CONCENTRATIONS OF CREDIT RISK - The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and accounts receivable. The Company primarily sells to hospitals and other healthcare providers, and ongoing customer credit evaluations are performed with respect to the Company's customers. Collateral is generally not required. In addition, the Company routinely maintains cash in excess of $100,000 in certain banks to pay general accounts payable, payroll, etc. The Company, by policy, places the investments with financial institutions evaluated as highly creditworthy. At June 30, 2003, the Company had uninsured cash balances totaling $269,979. INVENTORIES consist of raw materials, work-in-process, and finished goods, stated at the lower of cost or market. Cost is recorded using the first-in first-out method for Luxtec and average costing for the remaining companies. PROPERTY AND EQUIPMENT are recorded at cost. Depreciation has been provided using the straight-line method over estimated useful lives, generally three to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. LONG-LIVED ASSETS - The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. In accordance with SFAS No. 144, long-lived assets should be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. The Company periodically reviews the carrying value of long-lived assets to determine whether impairment to such value has occurred. GOODWILL AND OTHER INTANGIBLE ASSETS - Effective January 1, 2002, goodwill is no longer amortized but instead is subject to periodic impairment testing in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. See Note 6. Intangible assets with finite lives are stated at cost, net of accumulated amortization and are tested for impairment in accordance with SFAS No. 144. These assets are amortized on the straight-line method over the estimated useful lives or periods of expected benefit, but not in excess of 20 years. Intangible assets with indefinite lives are no longer amortized but instead are subject to periodic impairment testing in accordance with SFAS No. 142. OTHER ASSETS consist principally of deposits and deferred financing costs. Deferred financing costs are amortized over the life of the related debt using the effective interest method. F-11 REVENUE RECOGNITION - The Company recognizes revenue at the time of shipment and passage of title. The Company also receives revenues under certain agency arrangements and recognizes revenue, on a net basis, when the agency sale is complete. Provision is made currently for estimated sales returns and allowances, which have historically been insignificant. The Company expenses warranty costs as incurred as amounts have historically been insignificant and Luxtec offers minimal warranty of products. There were no warranty costs for the years ended June 30, 2003 and 2002 and for the year ended June 30, 2001, total costs were approximately $11,000 and are included in cost of goods sold in the accompanying consolidated statements of operations. SHIPPING AND HANDLING COSTS are included in costs of sales. RESEARCH AND DEVELOPMENT COSTS are incurred by the Company's Luxtec division and are charged to operations as incurred. Total research and development costs for the years ended June 30, 2003 and 2002 were approximately $253,000 and $87,000 respectively. INCOME TAXES - The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, income taxes are recognized for: (a) the amount of taxes payable or refundable for the current year, and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax asset will not be realized. STOCK-BASED COMPENSATION - The Company accounts for stock-based awards to employees using the intrinsic-value method in accordance with Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Common stock of the Company has been delisted since November 17, 2000 and does not trade on any exchange and is not quoted on any quotation system. Fair value of the Company's common stock is determined by the Company's Board of Directors based upon the most recent significant capital stock transaction adjusted by current major events affecting the Company's financial condition. Had compensation expense for these employee stock option grants been determined based on the fair value at the grant dates, `consistent with SFAS No. 123, the Company's net income (loss) for fiscal year 2003, 2002 and 2001 would have been the pro forma amounts indicated below:
2003 2002 2001 Net income (loss) available to common $7,033,848 $(8,843,134) $(5,801,278) stockholders, as reported Stock-based employee compensation (521,258) (401,185) (611,336) expense determined under fair-value ---------- ------------ ------------ method Pro forma net income (loss) $6,512,590 $(9,244,319) $(6,412,614) ========== ============ ============ Earnings Per Share: Basic- as reported $ 0.33 $ (1.11) $ (1.37) Basic- pro forma $ 0.31 $ (1.16) $ (1.51) Diluted- as reported $ 0.15 $ (1.11) $ (1.37) Diluted- pro forma $ 0.14 $ (1.16) $ (1.51) Black-Scholes Assumptions Risk-free interest rate 3.10% 5.21% 5.28% Expected volatility 50% 50% 50% Expected lives- in years 6 7 7 Expected dividend yield 0% 0% 0%
F-12 FINANCIAL INSTRUMENTS - Pursuant to SFAS No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, the Company is required to disclose the fair value of all financial instruments at June 30, 2003 and 2002. The Company generally considers the carrying value of such amounts in the financial statements to approximate their fair value due to the relatively short period of time between origination of the instruments and their expected realization or the variable interest rate nature of such instruments. At June 30, 2003 and 2002, the estimated fair value of the company's long-term debt was approximately $666,000 and $3,100,000, respectively. The Company estimates the fair value of its long-term debt generally using discounted cash flow analysis based on current interest rates for instruments with similar maturities. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. LOSS PER COMMON SHARE - SFAS No. 128, EARNINGS PER SHARE, requires the dual presentation of basic and diluted earnings (loss) per share on the face of the statement of operations and the disclosure of the reconciliation between the numerators and denominators of basic and diluted earnings (loss) per share calculations. The following represents a reconciliation from basic earnings per share to diluted earnings per share. Options and warrants to purchase common stock totaling 1,640,185, 5,713,342 and 4,409,289 were outstanding at June 30, 2003, 2002 and 2001, respectively, but were not included in the computation of diluted earnings per share because the effect would be antidilutive. Put warrants totaling 282,022 for the years ended June 30, 2002 and 2001 were not included in the computation of diluted earnings per share because the effect would also be antidilutive.
2003 2002 2001 Weighted-average shares outstanding - basic 21,059,853 7,975,208 4,249,494 Incremental shares due to assumed exercise of 14,479,944 outstanding options and warrants Incremental shares due to assumed conversion of 17,484,715 Series G preferred stock ---------- ---------- ---------- Weighted average shares outstanding - diluted 53,024,512 7,975,208 4,249,494 ========== ========== ==========
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In accordance with SFAS No. 142, the Company completed the test for impairment as of July 1, 2002, and concluded that consolidated goodwill was impaired. The Company recorded a non-cash charge of $4,454,656 to reduce the carrying value of its goodwill. This charge is non-operational in nature and is reflected as a cumulative effect of a change in accounting principle, effective July 1, 2002, in the accompanying Consolidated Statements of Operations. No income tax effect was recognized as the Company is in a loss position and any expense recorded would be offset by a reduction in the corresponding valuation allowance. The total impairment amount of $4,454,656 is attributable to the Company's manufacturing reporting segment and represents a portion of the previously unamortized goodwill resulting from the Company's reverse merger with PrimeSource Surgical on March 2, 2001. In calculating the impairment charge, the F-13 consolidated goodwill was allocated to each reporting segment based upon the estimated fair value of each reporting unit. The fair value of the each reporting unit was estimated using a weighted average of the income methodology approach, the market methodology approach and the asset based approach. In October 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144 requires that long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. The standard was effective for the Company's fiscal year beginning July 1, 2002. The Company reported discontinued operations relating to the sale of Ruby stock and related disposal of NEMS in the year ended June 30, 2003. In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The standard is effective for disposal activities that are initiated after December 31, 2002. The Company does not expect this standard to have a material effect on its financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION -- TRANSITION AND DISCLOSURE -- AN AMENDMENT OF FASB STATEMENT NO. 123. SFAS No. 148 amends SFAS No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect on the method used on reported results. The disclosure requirements apply to all companies for fiscal quarters beginning after December 15, 2002. The Company has elected not to voluntarily change to the fair value based method of accounting for stock-based compensation at this time. The Company has included the additional disclosure requirements in Notes 2 and 9. In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS. FIN No. 45 addresses the disclosure requirements of a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. FIN No. 45 also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements of FIN No. 45 were effective for the Company in its quarter ended December 31, 2002. The liability recognition requirements will be applicable prospectively to all guarantees issued or modified after December 31, 2002. The Company had no guarantees requiring disclosure. In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), CONSOLIDATION OF VARIABLE INTEREST ENTITIES which will be effective for the Company as of June 30, 2004. Under FIN 46, companies are required to consolidate variable interest entities for which they are deemed to be the primary beneficiary, and disclose information about those in which they have a significant variable interest. The Company has no variable interest entities. In May 2003, the FASB issued Statement 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in the fair value or the redemption amount, as applicable, in earnings. SFAS No. 150 is effective immediately for financial instruments (except for mandatorily redeemable financial instruments issued by nonpublic companies) F-14 entered into or modified after May 31, 2003. It is effective for financial instruments (except for mandatorily redeemable financial instruments issued by nonpublic companies) issued on or before May 31, 2003 at the beginning of the first interim period beginning after June 15, 2003. Finally, it is effective for mandatorily redeemable financial instruments issued by nonpublic companies for fiscal years beginning after December 15, 2003. The effect of adopting Statement 150 will be recognized as a cumulative effect of an accounting change as of the beginning of the period of adoption. The Company anticipates adoption to have an effect on the classification of its liabilities, and does not anticipate a material effect on its results of operations. RECLASSIFICATIONS - Certain reclassifications have been made to the 2001 and 2002 consolidated financial statements to conform to the 2003 presentation. As a result of PrimeSource Surgical Inc.'s disposal of Ruby in 2003, the Company's previously reported consolidated financial statements for 2002 and 2001 have been restated to present the discontinued Ruby operations separate from continuing operations. 3. ACQUISITIONS AND DISPOSALS LUXTEC ACQUISITION - As discussed in Note 1, on March 2, 2001, Luxtec completed a merger with PrimeSource Surgical for aggregate consideration of $4,791,180, which was paid in stock and by assumption of liabilities. Liabilities assumed, net of assets acquired, and costs, totaled $3,931,462. Total goodwill arising from this transaction was $8,722,642, which was originally being amortized over 10 years prior to adoption of SFAS 142. The acquisition was accounted for using the purchase method of accounting, and the operating results have been included in the Company's consolidated financial statements from the date of acquisition. In connection with the Merger, for each share of PrimeSource Surgical common stock, par value $0.001 per share, the PrimeSource Surgical stockholders received 0.744183 of a share of Luxtec common stock, par value $0.01 per share. For each share of PrimeSource Surgical Series A preferred stock, par value $0.001 per share, Series B-1 preferred stock, par value $0.001 per share, and Series B-2 preferred stock, par value $0.001 per share, the PrimeSource Surgical stockholders received 0.02976732 of a share of Luxtec Series B Stock, par value $1.00 per share. Each share of Series B Stock was subsequently converted to 25 shares of PrimeSource common stock, as further discussed at Note 8. For each share of PrimeSource Surgical Series B-3 preferred stock, par value $0.001 per share, Series C convertible preferred stock, par value $0.001 per share, Series C-2 convertible preferred stock, par value $0.001 per share, the PrimeSource Surgical stockholders received 0.02976732 of a share of Luxtec Series C Stock, par value $1.00 per share. For each share of PrimeSource Surgical Series C-3 exchangeable preferred stock, par value $0.001 per share, the PrimeSource Surgical stockholders received 0.02976732 of a share of Luxtec Series D Stock, par value $1.00 per share. NEMS AND PEC ACQUISITIONS - As discussed in Note 1, effective December 29, 2000, the Company acquired NEMS and PEC for aggregate consideration of $1,310,000, of which $391,000 was paid in cash and by issuing 390,804 shares of the Company's F-15 common stock with an estimated fair value of $919,000. Total goodwill arising from this transaction was $1,384,792. The acquisition was accounted for using the purchase method of accounting, and the operating results have been included in the Company's consolidated financial statements from the date of acquisition. PEC DISPOSAL - As discussed in Note 1, effective September 20, 2002, Ruby, the Company's indirect wholly owned subsidiary, sold all of the assets of the former PEC line of business in exchange for the cancellation of previously issued stock to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business. Goodwill and other impaired assets were written off in June 2002, resulting in a loss of $1,038,823, which is recorded in restructuring expense in the statement of operations. DISCONTINUED OPERATION - On June 30, 2003, PrimeSource Surgical, Inc., a subsidiary of the Company, sold all of the issued and outstanding capital stock of Ruby for cash proceeds of $1,000,000 to NMSI. The Company recognized a loss on disposal of $73,830. Ruby was reported in the critical care business segment. Revenues and income (loss) from the discontinued operation, net of income tax effect were as follows:
2003 2002 2001 Revenues $ 5,740,135 $ 5,249,566 $ 2,629,141 ========= ========= ========= Income (loss) from discontinued operation $ 121,697 $ 101,263 $ (554) net of income tax effect ========= ========= =========
Assets and liabilities of the discontinued operation included in our consolidated financial statements as of June 30 were as follows: 2002 Assets $ 1,689,073 Liabilities 722,736 ------------ Net assets (liabilities) of discontinued operation $ 966,344 ============ 4. INVENTORIES Inventories consist of the following at June 30: 2003 2002 Raw materials $ 775,583 $ 1,162,080 Work-in-process 885 29,168 Finished goods 7,847,729 7,903,032 Reserve for obsolescence (1,106,232) (1,598,172) ----------- ----------- Inventories - net $ 7,517,965 $ 7,496,108 =========== =========== F-16 5. PROPERTY AND EQUIPMENT Property and equipment consist of the following at June 30:
2003 2002 Office equipment $ 466,598 $ 708,211 Furniture and fixtures 346,031 305,627 Machinery and equipment 731,916 568,061 Leasehold improvements 477,809 395,604 ----------- --------- Total 2,022,354 1,977,503 Less accumulated depreciation and amortization (1,025,996) (837,568) ----------- --------- Property and equipment - net $ 996,358 $1,139,935 =========== ==========
Depreciation expense totaled $381,145, $536,707 and $355,313 in fiscal year 2003, 2002 and 2001, respectively. Property and equipment held under capital leases amounted to $46,291 and $81,194, less accumulated amortization of $30,456 and $26,705, at June 30, 2003 and 2002, respectively. 6. GOODWILL AND OTHER INTANGIBLE ASSETS In 2001, the FASB issued SFAS No. 141, ACCOUNTING FOR BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 142 modified accounting for business combinations after June 30, 2001 and affected the Company's treatment of goodwill and other intangible assets with indefinite lives effective July 1, 2002. SFAS No. 142 requires that goodwill and intangible assets with indefinite lives existing at the date of adoption be reviewed for possible impairment and that impairment tests be performed at least annually. Additionally, intangible assets with finite lives must be assessed and classified consistent with the statement's criteria. Intangible assets with finite lives will continue to be amortized over those periods. Amortization of goodwill and intangible assets with indefinite lives will cease. The following table sets forth, for all periods presented, a reconciliation of net income to conform to the requirements of SFAS No. 142. F-17
2003 2002 2001 Reported net loss $(3,628,799) $(6,190,563) $(4,382,164) Add back - Goodwill amortization 1,722,256 1,137,000 ------------ ------------ ------------ Adjusted net loss $(3,628,799) $(4,468,307) $(3,245,164) ============ ============ ============ Basic earnings per share: Reported net income (loss) $ 0.33 $ (1.11) $ (1.37) Goodwill adjustments 0.21 0.27 ------------ ------------ ------------ Adjusted net income (loss) $ 0.33 $ (0.90) $ (1.10) ============ ============ ============ Diluted earnings per share: Reported net income (loss) $ 0.15 $ (1.11) $ (1.37) Goodwill adjustments 0.21 0.27 ------------ ------------ ------------ Adjusted net income (loss) $ 0.15 $ (0.90) $ (1.10) ============ ============ ============
The changes in the carrying amount of goodwill for the year ended June 30, 2003, are as follows:
DISTRIBUTION SURGICAL MANUFACTURING TOTAL CRITCAL CARE LUXTEC Balance at July 1, 2002 $12,660,950 $1,279,512 $ 7,559,494 $21,499,956 Less: Disposal of NEMS (671,531) (671,531) Goodwill adjustment from reversal of (416,886) (416,886) purchase accounting reserve Transitional impairment charge (4,454,656) (4,454,656) ----------- ---------- ----------- ----------- Balance at June 30, 2003 $12,660,950 $ 607,981 $ 2,687,952 $15,956,883 =========== ========== =========== ===========
7. LINES OF CREDIT AND LONG-TERM DEBT Long-term debt consisted of the following as of June 30:
2003 2002 Term loan payable to bank--PrimeSource Surgical $2,258,307 Term note payable to bank--Luxtec 150,000 Other notes payable $665,573 691,481 ---------- ---------- Total debt 665,573 3,099,788 Less current portion (559,877) (1,855,481) ---------- ---------- Total long-term debt $105,696 $1,244,307 ========== ==========
F-18 Lines of credit consisted of the following as of June 30:
2003 2002 Lines of credit - PrimeSource Surgical $4,654,436 $6,255,573 Line of credit - Luxtec 1,271,585 1,275,302 --------- --------- Total long-term debt $5,926,021 $7,530,875 ========== ==========
On March 2, 2001, the Company entered into an Amended and Restated Security and Loan Agreement (the "Luxtec Credit Agreement") for a $2,500,000 line of credit (the "Luxtec Line of Credit") with ARK CLO 2000-1 LIMITED ("ARK"). On August 6, 2002, the Company amended the Luxtec Credit Agreement. Pursuant to the amendment to the Luxtec Credit Agreement, ARK waived and amended certain provisions under the Luxtec Credit Agreement. Under the amendment, as of June 30, 2003, the maximum amount available to borrow under the Luxtec Line of Credit was limited to the lesser of $1,275,000 or a certain percentage of accounts receivable and inventory, as defined ($1,271,585 at June 30, 2003). As of June 30, 2003, borrowings bore interest at ARK's prime rate plus 3.0% (7.00% at June 30, 2003). Unused portions of the Luxtec Line of Credit accrue a fee at an annual rate of 1.00%. Borrowings are secured by substantially all of PrimeSource Healthcare's assets, excluding the capital stock of, and assets held by, PrimeSource Surgical. At June 30, 2003, there was no availability for additional borrowings under the Luxtec Line of Credit. Borrowings under the Luxtec Line of Credit are payable upon maturity on December 31, 2003. On March 2, 2001, as part of the Luxtec Credit Agreement, the Company executed an Amended and Restated Term Note (the "Luxtec Term Note") in the amount of $300,000 with ARK. The Luxtec Term Note bore interest at prime plus 0.5% and was secured by substantially all of PrimeSource Healthcare's assets, excluding the capital stock of, and assets held by, PrimeSource Surgical. The Luxtec Term Note required monthly principal payments of $10,000 commencing on March 31, 2001. The Luxtec Term Note was scheduled to mature on March 31, 2002 with a balloon payment of $150,000 on that date. ARK granted an extension on the payment of the Luxtec Term Note until May 31, 2002. On August 6, 2002, the Company repaid the entire outstanding balance of the Luxtec Term Note in connection with the Luxtec Credit Agreement amendment. The Luxtec Credit Agreement contains covenants that require the maintenance of defined financial ratios and income levels and limit additional borrowings and capital expenditures. The Company was in compliance with these financial covenants as of June 30, 2003. On June 14, 1999, the Company's wholly owned subsidiary, PrimeSource Surgical, entered into an Amended and Restated Credit Agreement (the "PrimeSource Surgical Credit Agreement") with Citizens for a line of credit (the "PrimeSource Surgical Line of Credit"). On August 6, 2002, PrimeSource Surgical amended the PrimeSource Surgical Credit Agreement, pursuant to which the maturity date of the revolving line of credit under the PrimeSource Surgical Credit Agreement was extended to March 31, 2004, the maturity date of the term loan was extended to December 31, 2003, and certain other changes were made including modifications to interest rates and covenant requirements. Under the amendment, as of June 30, 2003, the maximum amount available to borrow under the PrimeSource Surgical Line of Credit is limited to the lesser of $8,000,000 or a certain percentage of accounts receivable and inventory, as defined by the PrimeSource Surgical Credit Agreement ($4,654,436 at June 30, 2003). As of June 30, 2003, borrowings bore a variable step interest rate at Citizens' prime rate plus 4.50% (8.50% at June F-19 30, 2003). Unused portions of the PrimeSource Surgical Line of Credit accrue a fee at an annual rate of 0.375%. Borrowings are secured by substantially all of the assets directly held by PrimeSource Surgical. At June 30, 2003, there was $627,369 of availability under the PrimeSource Surgical Line of Credit. Borrowings under the PrimeSource Surgical Line of Credit are payable upon maturity in March 31, 2004. On June 14, 1999, as part of the PrimeSource Surgical Credit Agreement, PrimeSource Surgical executed an Amended and Restated Term Note (the "PrimeSource Surgical Term Loan") in the original amount of $5,000,000 with Citizens. On June 30, 2003, we paid off the entire outstanding balance of the PrimeSource Surgical Term Loan in connection with the sale of Ruby and the funding of the most recent Preferred Series G round. The PrimeSource Surgical Term Loan was collateralized by substantially all the assets directly held by PrimeSource Surgical. In connection with the August 6, 2002 amendment to the PrimeSource Surgical Credit Agreement, previously deferred payments of $675,000 were paid, the interest rate was modified to a variable step interest rate and the required PrimeSource Surgical Term Loan monthly principal payments were changed to $50,000 between August 2002 and January 2003, $75,000 between February 2003 and July 2003 and $100,000 between August 2003 and November 2003, with the remainder ($316,658) due on December 31, 2003. Prior to its repayment in full, and as of June 30, 2003, the PrimeSource Surgical Term Loan bore interest at Citizens' prime rate plus 4.50% (8.50% at June 30, 2003). The PrimeSource Surgical Term Loan was subject to a term loan facility fee. PrimeSource Surgical accrued a $75,000 fee on August 6, 2002, in connection with the amendment to the PrimeSource Surgical Credit Agreement. PrimeSource Surgical was obligated to pay an additional $75,000 fee under the PrimeSource Surgical Term Loan on the last day of each calendar quarter, beginning on September 30, 2002 and for every quarter thereafter until the earlier of payment in full of the PrimeSource Surgical Term Loan or December 31, 2003. The accrued term loan facility fees were reduced by 40% because on June 30, 2003, we paid off the entire outstanding balance of the PrimeSource Surgical Term Loan in connection with the sale of Ruby and the funding of the most recent Preferred Series G round. In connection with the PrimeSource Surgical Term Loan payoff on June 30, 2003, the amount outstanding under this term loan facility fee is $180,000, which is included in accrued expenses and is due on or before December 31, 2003. The PrimeSource Surgical Term Loan was also subject to an additional repayment obligation. Commencing with the three-month period ended December 31, 2002, and for each three-month period thereafter, fifty percent (50%) of excess cash flow (as defined in the PrimeSource Credit Agreement) generated during the three-month period was applied to the principal amount of the PrimeSource Surgical Term Loan. At June 30, 2003, there was no additional repayment obligation. The PrimeSource Surgical Credit Agreement contains covenants that require the maintenance of defined financial ratios and income levels and limit additional borrowings and capital expenditures. PrimeSource Surgical was in compliance with these covenants as of June 30, 2003. Other notes payable include a $100,000 note payable for tenant improvements to Luxtec's leased premises in West Boylston, Massachusetts, which bears interest at 9.5% and is due September 19, 2005. Payments are interest only for the first 12 months, with remaining payments calculated on a 7-year amortization table with a balloon payment on September 19, 2005. At June 30, 2003 and 2002, Luxtec had outstanding borrowings of $77,650 and $91,481, respectively, under the tenant note payable. In addition, other notes payable include a PrimeSource Surgical non-interest bearing demand note payable with an original balance of $559,977 (net of unamortized discount of $40,023 based on an imputed interest rate of 8%) to its special legal counsel in payment of existing outstanding accounts payable, which matures May 30, 2004. Monthly principal payments are $30,000 commencing on October 20, 2002. At June 30, 2003 and 2002, PrimeSource F-20 Surgical had outstanding borrowings of $357,173 (net of unamortized discount of $12,827) and $559,977, respectively, on this note payable to legal counsel. Finally, other notes payable include a PrimeSource Surgical $250,000 note payable to Citizens in payment of the bank refinancing amendment fee. Equal principal payments on the note of $62,500 were or are due March 31, 2003, June 30, 2003, September 30, 2003 and December 31, 2003. At June 30, 2003 and June 30, 2002, PrimeSource Surgical had outstanding borrowings of $187,500 and $250,000, respectively, on this note payable to Citizens. This note has been recorded as deferred financing costs and is being amortized over the life of the PrimeSource Surgical Credit Agreement. 8. PREFERRED STOCK SERIES B CONVERTIBLE PREFERRED STOCK - Series B Stock was issued in the Merger and was convertible into 25 shares of common stock automatically upon amendment of the Company's articles of organization to increase the authorized number of shares of common stock. In June 2001, the Company's stockholders approved the amendment to increase the Company's authorized number of common shares. As a result, the 46,889 shares of Series B Stock automatically converted into 1,172,214 shares of common stock. SERIES C REDEEMABLE, CONVERTIBLE PREFERRED STOCK - Series C Stock issued in the Merger was convertible into approximately 28 shares of common stock at the option of the holder at any time, based upon the conversion ratio at June 30, 2002, as defined. Each share of Series C Stock has one vote for each share of common stock into which it would be convertible. In addition, Series C Stock ranked senior to Series B Stock and common stock and ranks junior to the Series D Stock, Series E Stock and Series F Stock. Series C Stock accrued dividends at 8 percent per annum of the original issue price of $42.76 per share. Series C Stock had a liquidation preference equal to the greater of (i) $50.50 per share plus an amount in cash equal to all accrued but unpaid dividends or (ii) the amount the holders would have received had the holders converted their shares of Series C Stock into common stock immediately prior to a liquidation event. The Series C Stock had a mandatory redemption date of June 3, 2005, and was redeemable at the original issue price of $42.76 per share plus accrued but unpaid dividends. Due to the redemption feature, the Series C Stock had been excluded from stockholders' equity. The Series C Stock also had special consent rights to certain of the Company's activities, including, but not limited to, amendment of the Company's articles or bylaws and merger or consolidation of the Company. Cumulative accrued dividends as of June 30, 2002 and 2001 totaled $1,567,561 and $387,850, respectively. On August 6, 2002 and prior to the issuance and sale of the Series G Stock, the Company recapitalized its equity structure. Each outstanding share of Series C Convertible Preferred Stock, par value $1.00 per share (the "Series C Stock"), was converted into 27.5871 shares of the Company's common stock. In connection with the conversion of the Series C Stock, the Company issued the former holders of the Series C Stock warrants to purchase an aggregate of 7,390,613 shares of our common stock with an exercise price of $0.01 per share and a 10-year life. These warrants became exercisable on December 31, 2002 and expire on August 6, 2012. Additionally, exercise prices on warrants to purchase an aggregate of 140,330 shares of the Company's common stock previously issued to certain former holders of the Series C Stock were repriced from $1.68 per share to $0.01 per F-21 share. The value of the warrants issued and the warrants which were repriced was recorded as additional paid-in capital. The value of these warrants totaled $2,359,000 and was calculated using the Black-Scholes method with the following assumptions: an expected life of 7 years, volatility of 50% and a zero coupon rate of 4.09%. SERIES D EXCHANGEABLE, CONVERTIBLE PREFERRED STOCK - Series D Stock issued in the Merger was exchangeable for equity securities of the Company to be issued in the future and was convertible into 200 shares of common stock at the option of the holder. Each share of Series D Stock had one vote for each share of common stock into which it would be convertible. In addition, Series D Stock ranked senior to Series C Stock and common stock and junior to the Series E Stock and Series F Stock. Series D Stock accrued dividends at the rate of 10 percent per year of the stated liquidation value of $342.08 per share and had a liquidation preference equal to $342.08 per share plus an amount in cash equal to all accrued but unpaid dividends. Accrued dividends as of June 30, 2001 totaled $157,540. On January 23, 2002, all the outstanding shares of Series D Exchangeable, Convertible Preferred Stock were automatically exchanged for shares of Series F Redeemable Convertible Preferred Stock, no par value (the "Series F Preferred Stock"). The Company issued an aggregate of 5,221,248 shares of Series F Preferred Stock upon exchange of the Series D Preferred Stock. No cash proceeds were received in connection with the issuance of the Series F Preferred Stock. Pursuant to the provisions of the Certificate of Vote establishing the Series D Preferred Stock, as of January 23, 2002, the Series D Preferred Stock is no longer outstanding. The holders of the formerly outstanding Series D Stock held warrants to purchase common stock and the number of shares and price under such warrants were determined based on the Company consummating a qualified equity financing, as defined. On January 23, 2002, the exercise price per share was set at $1.00 and the aggregate number of shares of the Company's common stock subject to purchase pursuant to such warrants was set at 1,751,130. See further discussion of the accounting treatment for the warrants at the Series F Stock below. SERIES E REDEEMABLE, CONVERTIBLE PREFERRED STOCK - On June 29, 2001, the Company created a new stock class, Series E preferred stock (the "Series E Stock"), with 1,000,000 authorized shares and no par value per share. In July 2001, the Company issued 325,000 shares for gross proceeds of $3,250,000. Warrants to purchase five shares of common stock at $1.00 per share were issued with each share of Series E Stock. These warrants vested immediately and expire June 28, 2011. Series E Stock was convertible into 10 shares of common stock at the option of the holder at any time. Each share of Series E Stock had one vote for each share of common into which it would be convertible. In addition, Series E Stock ranked senior to common stock, Series C stock and Series D stock. Series E Stock accrued dividends at the rate of 8 percent per year of the original issuance price of $10.00 per share and had a liquidation preference equal to $30.00 per share plus an amount equal to all accrued but unpaid dividends. The Series E Stock had a mandatory redemption date of June 3, 2005, and was redeemable at the original issue price of $10.00 per share plus accrued but unpaid dividends. The Series E Stock also had special consent rights to certain of the Company's activities, including, but not limited to, amendment of the Company's articles or bylaws and merger or consolidation of the Company. As noted above, in connection with the Series E Stock issuance, warrants to purchase an aggregate of 1,625,000 shares of common stock were issued with an exercise price of $1.00 per share. The value of these warrants was calculated using the Black-Scholes method with the following assumptions: an expected life of 7 years, volatility of 50% and a zero-coupon bond rate of 5.1%. The resulting value of $950,000 was recorded directly to additional paid in capital. The resultant beneficial conversion feature of $950,000 was also recorded directly to additional paid in capital. F-22 On August 6, 2002 and subsequent to the conversion of the Series C Stock and Series F Stock, each outstanding share of Series E Convertible Preferred Stock, no par value (the "Series E Stock"), was exchanged for 0.3125 shares of Series G Stock. In connection with the exchange of the Series E Stock, the Company issued the former holders of the Series E Stock warrants to purchase an aggregate of 817,000 shares of Company common stock with an exercise price of $.01 per share. These warrants became exercisable on December 31, 2002 and expire on August 6, 2012. Additionally, in accordance with their terms, exercise prices on 1,625,000 warrants to purchase common stock previously issued to certain Series E Stockholders were repriced from $1.00 per share to $.01 per share. The value of the warrants issued and the warrants which were repriced were recorded as additional paid-in capital. The value of these warrants totaled $763,000 and was calculated using the Black-Scholes method with the following assumptions: expected life of seven years, volatility of 50% and a zero coupon rate of 4.09%. SERIES F REDEEMABLE, CONVERTIBLE PREFERRED STOCK - On January 23, 2002, the Company created a new stock class, Series F preferred stock (the "Series F Stock"), with 5,221,248 authorized shares and no par value per share. Series F Stock was convertible into 5,221,248 shares of common stock at the option of the holder at any time. Each share of Series F Stock had one vote for each share of common into which it would be convertible. In addition, Series F Stock ranked senior to all other stock of the Company outstanding at June 30, 2002. Series F Stock accrued dividends at the rate of 8 percent per year of the original issuance price and has a liquidation preference equal to $1.00 per share plus an amount equal to all accrued but unpaid dividends. The Series F Stock has a mandatory redemption date of June 3, 2005, and was redeemable at the original issue price plus accrued but unpaid dividends. The Series F Stock also had special consent rights to certain of the Company's activities, including, but not limited to, amendment of the Company's articles or bylaws and merger or consolidation of the Company. In connection with the Series F Stock issuance, the terms of certain warrants were determined at a price per share at $1.00 for an aggregate of 1,751,130 shares of our common stock. The value of these warrants was calculated using the Black-Scholes method with the following assumptions: an expected life of 7 years, volatility of 50% and a zero-coupon bond rate of 4.790%. The resulting value of $1,006,000 was recorded directly to additional paid in capital. The resultant beneficial conversion feature of $1,006,000 was also recorded directly to additional paid in capital. On August 6, 2002, simultaneously with the conversion of the Series C Stock, each outstanding share of Series F Convertible Redeemable Preferred Stock, no par value (the "Series F Stock"), was converted into one share of common stock. In connection with the conversion of the Series F Stock, the Company issued the former holders of the Series F Stock warrants to purchase an aggregate of 1,614,560 shares of Company common stock with an exercise price of $.01 per share and a 10-year life. The warrants became exercisable on December 31, 2002 and expire on August 6, 2012. Additionally, the exercise price on previously issued warrants to purchase an aggregate of 1,751,130 shares of common stock was adjusted from $1.00 per share to $.01 per share. The value of the warrants issued and the warrants which were repriced was recorded as additional paid-in capital. The value of these warrants totaled $1,052,000 and was calculated using the Black-Scholes method with the following assumptions: an expected life of 7 years, volatility of 50% and a zero coupon rate of 4.09%. SERIES G REDEEMABLE, CONVERTIBLE PREFERRED STOCK - On August 6, 2002, the Company created a new series of preferred stock, Series G Convertible Redeemable Preferred Stock, no par value (the "Series G Stock"), and the Company issued and F-23 sold 70,452 shares of Series G Stock on that date for proceeds of $1,866,037, net of costs of $388,429. The Series G Stock has 230,000 authorized shares. In connection with the issuance of the Series G Stock, the Company issued warrants to purchase an aggregate of 3,300,000 shares of common stock at $.01 per share. These warrants became exercisable on December 31, 2002 and expire on August 6, 2012. In addition, on September 15, 2002, November 15, 2002, January 15, 2003 and June 30, 2003, the Company issued and sold an additional aggregate 50,485.5 shares of Series G Stock for proceeds of $1,497,994, net of costs of $117,542. Each share of Series G Stock is convertible into 100 shares of common stock, subject to adjustment, at the option of the holder. Each share of Series G Stock has one vote for each share of common into which it would be convertible. In addition, Series G Stock ranks senior to all other outstanding stock of the Company. Series G Stock accrues dividends at the rate of 8% per year of the original issuance price of $32.00 per share and has a liquidation preference equal to $64.00 per share plus an amount equal to all accrued but unpaid dividends. Accrued dividends as of June 30, 2003, totaled $447,736. The Series G Stock has a mandatory redemption date of June 3, 2005, and is redeemable at the original issue price of $32.00 per share plus accrued but unpaid dividends. The Series G Stock also has special consent rights to certain of the Company's activities, including, but not limited to, amendment of the Company's articles or bylaws and merger or consolidation of the Company. As noted above, in connection with the Series G Stock issuance, the Company issued warrants to purchase an aggregate of 3,300,000 shares of common stock with an exercise price of $.01 per share and a 10-year life. The value of these warrants was calculated using the Black-Scholes method with the following assumptions: an expected life of 7 years, volatility of 50% and a zero-coupon bond rate of 4.09%. The resulting value of $1,031,000 was recorded as additional paid-in capital on August 6, 2002 in connection with the sale of the Series G Stock. The resultant beneficial conversion feature of $1,031,000 was recorded directly to additional paid-in capital in December 2002 when the Series G Stock became convertible. As of June 30, 2003, the aggregate redemption amount of the Series G Stock, including accrued dividends, totaled $7,567,736. The difference between carrying amount of $5,699,121 and the aggregate redemption amount relates to the value of the warrants issued in connection with the issuance of Series G Stock, the resultant beneficial conversion feature, and stock issuance costs. These amounts are being accreted into the Series G Stock amount out of retained earnings through June 3, 2005, the date of redemption. In connection with the equity recapitalization, former holders of Series C Stock, Series F Stock and Series E Stock received consideration totaling approximately $10,183,000, including common stock, Series G Stock, new warrants and the repricing of certain existing warrants, in exchange for the retirement of Series C Stock, Series F Stock and Series E Stock with a carrying value of approximately $21,993,000. The difference of $11,809,741 has been credited to retained earnings. REVERSE STOCK SPLIT - In connection with the Merger described in Note 1, the Company had a reverse stock split, resulting in the exchange of 0.744183 of a share of Luxtec common stock for each share of PrimeSource Surgical common stock. In addition, certain PrimeSource Surgical stock classes were exchanged for Luxtec stock classes, as discussed in Note 3. The effect of the reverse stock split and exchange of stock classes has been reflected retroactively for all periods presented. 9. STOCK OPTIONS AND WARRANTS STOCK OPTIONS - In January 1997, PrimeSource Surgical adopted a stock option plan (the "1997 Plan") for the grant of stock options and other awards to certain officers, key employees, or other persons affiliated with the Company. The maximum number of shares of common stock that may be issued pursuant to the 1997 Plan is 10,000,000. The 1997 Plan also provides for various vesting F-24 schedules, as determined by the compensation committee of the Board of Directors, and have terms not to exceed 10 years. The vested options may be exercised at any time and generally expire 10 years from the date of grant. The Company issued equity-based options to certain employees during fiscal year 2003. The exercise price was at the deemed fair market value of the stock at the date of grant. During fiscal year 2003, the Company also issued equity-based options to a certain employee as required under the executed employment agreement with the Company. The exercise price was below the deemed fair market value of the stock at the date of grant. In accordance with the requirements of APB Opinion No. 25, the Company has recorded deferred equity-based compensation for the difference between the exercise price of the stock and the deemed fair market value of the Company's stock at the date of grant. The deferred equity-based compensation is amortized to expense on a straight-line basis, over the one-year period during which the options become vested. As of June 30, 2003, the Company had recorded cumulative deferred equity-based compensation related to these options in the amount of $110,000. In addition to the 1997 Plan, the Company has adopted several stock option plans sponsored by Luxtec. The 1992 stock plan (the "1992 Plan") provides for the grant of incentive stock options, nonqualified stock options, stock awards, and direct sales of stock. Under the 1992 Plan, incentive stock options may be granted at an exercise price not less than the fair market value of the Company's common stock on the date of grant. The Board of Directors at its discretion may grant nonqualified options. The 1992 Plan also provides for various vesting schedules, as determined by the compensation committee of the Board of Directors, and have terms not to exceed 10 years. Under the 1992 Plan, 500,000 total shares are authorized for issuance. The 1992 Plan, previously sponsored by Luxtec, is available to issue up to an aggregate of 25,000 shares of common stock in semiannual offerings. Stock is sold at 5 percent of fair market value, as defined. No shares were subscribed to or issued under the 1992 Plan in the period from March 2, 2001 through June 30, 2003. The 1995 directors' plan (the "1995 Director Plan") was adopted for non-employee directors and provides that an aggregate of up to 200,000 nonqualified options may be granted to non-employee directors, as determined by the compensation committee of the Board of Directors. Under the terms of the 1995 Director Plan, options are granted at not less than the fair market value of the Company's common stock on the date of grant. The 1995 Director Plan also provides that the options are exercisable at varying dates, as determined by the compensation committee of the Board of Directors, and that they have terms not to exceed 10 years. At June 30, 2003 and June 30, 2002, there were 64,000, and 68,000 shares, respectively, available for future grants under the 1995 Director Plan. WARRANTS - In connection with the issuance of a new series of its preferred stock, Series G Stock in August 2002, the Company granted warrants to purchase 3,300,000 shares of common stock at $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012. Prior to the issuance and sale of Series G Stock in August 2002, the Company converted outstanding shares of Series C Stock into shares of Company common stock. In connection with the conversion of the Series C Stock, the Company granted former holders of Series C Stock warrants to purchase 7,390,613 shares F-25 of common stock with an exercise price of $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012. Additionally, exercise prices on warrants to purchase 140,330 shares of common stock previously issued to certain preferred stockholders were repriced from $1.68 per share to $.01 per share. Simultaneously with the conversion of Series C Stock in August 2002, each outstanding share of Series F Stock was converted into shares of common stock. In connection with the conversion, the Company granted the former holders of Series F Stock warrants to purchase 1,614,560 shares of common stock with an exercise price of $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012. Additionally, the exercise price on previously issued warrants to purchase 1,751,130 shares of common stock was adjusted form $1.00 per share to $.01 per share. The warrants vested immediately and expire in December 2010. Subsequent to the conversion of the Series C Stock and Series F Stock, each outstanding share of the Company's Series E Stock was exchanged for shares of Series G Stock. In connection with the exchange of the Series E Stock, the Company granted former holders of Series E Stock warrants to purchase 817,000 shares of the Company's common stock with an exercise price of $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012. Additionally, the exercise price on 1,625,000 warrants to purchase common stock previously issued to certain Series E Stock stockholders was repriced from $1.00 per share to $.01 per share. The warrants vested immediately and expire in July 2011. An additional 118,605 warrants were issued to certain other stockholders related to prior year grants with expiration dates of June 2011, and exercise prices of $1.00 and $2.35. Prior to the merger with PrimeSource Surgical, Luxtec issued warrants to certain lenders and other purchasers of Luxtec's stock. Total warrants issued entitled the holders to purchase 438,171 shares of the Company's common stock, at exercise prices of $3.00 to $6.00 per share. The warrants expired December 31, 2001. Related to a private placement of its preferred stock in September 2000, the Company granted warrants to purchase 157,860 shares of the Company's common stock at $1.68 per share. These warrants vested immediately and expire in September 2011. F-26 Changes in shares under options and warrants, in common stock equivalents, for the years ended June 30, 2001, 2002 and 2003 are as follows:
OPTIONS WARRANTS --------------------------------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE SHARES EXERCISE SHARES EXERCISE OUTSTANDING PRICE OUTSTANDING PRICE Balance, July 1, 2000 1,531,322 $1.63 420,227 $1.03 Grants 1,903,210 1.58 157,861 1.68 Outstanding Luxtec options at acquisition 454,500 3.03 438,171 5.70 Canceled (496,002) 1.48 ----------- ----------- Balance, June 30, 2001 3,393,030 1.81 1,016,259 3.15 Grants 112,000 1.00 3,494,780 1.01 Canceled (1,864,554) 1.72 (438,173) 5.70 ----------- ----------- Balance, June 30, 2002 1,640,476 1.85 4,072,866 1.04 Grants 7,487,000 0.32 13,122,173 0.01 Canceled (525,212) 1.42 (356,485) 1.01 ----------- ----------- Balance, June 30, 2003 8,602,264 0.53 16,838,554 0.02 =========== =========== Vested and exercisable, June 30, 2003 1,474,960 16,838,554 =========== =========== Vested and exercisable, June 30, 2002 996,076 4,072,866 =========== =========== Vested and exercisable, June 30, 2001 1,182,204 1,016,259 =========== ===========
The weighted-average fair value of option grants in fiscal 2003, 2002 and 2001 was approximately $0.1602, $0.5803 and $0.8021, respectively. F-27 Outstanding stock options and warrants at June 30, 2003 consist of the following:
Options Warrants ------------------------------------- ------------------------------------- Weighted Weighted Average Weighted Average Weighted Remaining Average Remaining Average Range of Contractual Exercise Contractual Exercise Exercise Prices Shares Life (Years) Price Shares Life (Years) Price $0.00 - $0.60 7,162,000 8.2 $0.32 16,638,633 8.8 $0.01 $0.61 - $1.20 662,268 5.6 $1.03 163,786 4.9 $1.07 $1.21 - $1.80 418,999 3.7 $1.68 17,530 7.2 $1.68 $1.81 - $2.40 235,497 6.6 $2.34 18,605 7.6 $2.35 $2.41 - $3.00 106,500 3.8 $2.65 $3.01 - $3.60 1,000 2.5 $3.56 $3.61 - $4.80 16,000 1.4 $4.63 ------ 8,602,264 7.7 $0.53 16,838,554 8.8 $0.02 ========= ==========
Compensation expense in the amount of $110,000 for fiscal 2003 has been recognized for certain employee stock options granted below market value. No compensation expense has been recognized for the remaining employee stock option grants. Had compensation expense for these employee stock option grants been determined based on the fair value at the grant dates, consistent with SFAS No. 123, the Company's net income (loss) for fiscal years 2003, 2002 and 2001 would have been the pro forma amounts indicated below:
2003 2002 2001 Net income (loss) available to common stockholders, as reported $7,033,848 $(8,843,134) $(5,801,278) Stock-based employee compensation expense determined under fair-value method (521,258) (401,185) (611,336) ---------- ------------ ------------ Pro forma net income (loss) $6,512,590 $(9,244,319) $(6,412,614) ========== ============ ============ Earnings Per Share: Basic- as reported $ 0.33 $ (1.11) $ (1.37) Basic- pro forma $ 0.31 $ (1.16) $ (1.51) Diluted- as reported $ 0.15 $ (1.11) $ (1.37) Diluted- pro forma $ 0.14 $ (1.16) $ (1.51) Black-Scholes Assumptions: Risk-free interest rate 3.10% 5.21% 5.28% Expected volatility 50% 50% 50% Expected lives- in years 6 7 7 Expected dividend yield 0% 0% 0%
F-28 10. 401(k) RETIREMENT PLAN The Company and PrimeSource Surgical separately maintain qualified 401(k) retirement plans. The plans cover substantially all employees who have over six months of service and have attained ages 18 and 21 for the Company and PrimeSource Surgical plans, respectively. The 401(k) plans provide for a contribution by the Company each year, at the Company's discretion. The Company match totaled $110,706, $169,347, and $148,949, for the years ended June 30, 2003, 2002 and 2001, respectively. 11. INCOME TAXES The benefit (provision) for income taxes for the years ended June 30 is based on the following components:
2003 2002 2001 Current income taxes Federal $ 1,600 State 18,100 $ 61,700 $(207,200) --------- ----------- ----------- Total current 19,700 61,700 (207,200) --------- ----------- ----------- Deferred income taxes: Federal (172,700) 1,458,900 1,269,400 State (18,800) 209,200 217,900 --------- ----------- ----------- Total deferred (191,500) 1,668,100 1,487,300 --------- ----------- ----------- Change in valuation allowance 191,500 (1,668,100) (1,487,300) --------- ----------- ----------- Total $ 19,700 $ 61,700 $(207,200) ========= =========== ==========
A reconciliation of the provision for income taxes to the amount of income tax (benefit) expense that would result from applying the federal statutory rate (35%) to loss before income tax benefit (provision) is as follows:
2003 2002 2001 Income tax benefit at statutory rate $1,270,080 $ 2,223,700 $ 1,461,400 Nondeductible warrant put expense (income) 66,500 (33,250) 60,200 State tax (expense) benefit, net of federal benefit 112,700 202,350 3,100 Meals and entertainment (20,100) (14,300) (22,800) Nondeductible goodwill (1,448,700) (613,100) (225,500) Change in valuation allowance 191,500 (1,668,100) (1,487,300) General business credit (13,200) (45,000) Loss on sale of subsidiary (18,100) Expiring net operating losses (118,000) Other (2,980) 9,400 3,700 ---------- ----------- ----------- Total $ 19,700 $ 61,700 $ (207,200) ========== =========== ===========
F-29 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows at June 30:
2003 2002 Current: Restructuring reserve $ 229,400 $ 387,400 Accrued vacation 62,400 57,500 Inventory valuation adjustment 453,600 805,000 Bad debt reserve 87,700 152,200 Accrued distributor costs 205,000 394,400 Other 46,400 120,600 ----------- ----------- Total current 1,084,500 1,917,100 ----------- ----------- Long-term: Depreciation and amortization 114,600 155,700 Credit carryforwards 243,600 256,900 Capital loss carryforwards 300,100 300,100 Charitable loss carryforwards 6,800 Net operating loss carryforwards 6,763,700 6,075,000 ----------- ----------- Total long-term 7,428,800 6,787,700 ----------- ----------- Total 8,513,300 8,704,800 Valuation allowance (8,513,300) (8,704,800) ----------- ----------- Total $ - $ - =========== ===========
At June 30, 2003, the Company had federal net operating loss carryforwards of approximately $16,930,300 and state net operating loss carry forwards of approxiamately $13,967,700. The Company's federal and state net operating losses expire in the tax years ending June 30, 2003 through 2022. At June 30, 2003, the Company had federal and State credit carry forwards of approximately $131,500 and $112,100, respectively. The Company's federal and state credits will generally expire in the tax years ended June 30, 2003 through 2023. The Company also has a federal capital loss carryforward of approximately $732,000. The Company's federal capital loss carryforward will begin to expire in the tax year ending June 30, 2005. Certain changes in stock ownership may result in a limitation on the amount of net operating loss carryforwards that can be utilized each year. A full valuation allowance has been provided against the Company's deferred tax assets as of June 30, 2003 and 2002, as it is more likely than not that sufficient taxable income will not be generated to realize these temporary differences. Any future reduction of the valuation allowance established at the dates of the acquisitions (Note 3) will reduce the goodwill related to such acquisition. 12. COMMITMENTS AND CONTINGENCIES LEASES - The Company leases office space and certain computer equipment and software under capital and noncancelable operating leases. Rent expense for the F-30 years ended June 30, 2003, 2002, and 2001 was $654,116, $726,455 and $584,944, respectively. Minimum annual lease payments under capital and noncancelable operating leases are as follows:
CAPITAL OPERATING LEASES LEASES 2004 $29,061 $775,640 2005 13,967 615,300 2006 9,066 204,318 2007 4,266 2008 1,645 --------- ---------- Total minimum lease payments 52,094 $1,601,169 ========== Amount representing interest (5,236) --------- Present value of future minimum lease payments 46,858 Less current portion of capital lease obligations (25,425) --------- Capital lease obligations - net of current portion $21,433 =========
EXECUTIVE COMPENSATION - In May 2001, the Company entered into an employment agreement with its former President and Chief Executive Officer. The employment agreement committed the Company to minimum compensation, severance amounts, and future equity-based incentives. Two other executive officers had employment agreements that provide for compensation and severance amounts. In connection with the restructuring discussed in Note 14, all three agreements were severed. At June 30, 2003, the President/Chief Executive Officer and other executive officers of the Company's subsidiaries had employment agreements that provide for compensation and certain severance benefits. As a result of an agreement of understanding prior to June 30, 2003, the Company President/Chief Executive Officer resigned, and certain benefits were accrued at June 30, 2003 in the amount of $195,507. LITIGATION - The Company is involved in litigation incidental to its business. Management does not believe the ultimate disposition of this litigation will have a material adverse effect on the Company's consolidated financial statements. On September 5, 2002, two former executive officers and directors of the Company filed a complaint against the Company in Arizona Superior Court, County of Pima. The complaint alleges a breach by the Company of the severance agreements with each of them and seeks an aggregate of at least $1.2 million in compensatory damages. The Company believes that it has meritorious defenses and it intends to defend its position with respect to this complaint. During the quarter ended September 30, 2002, the Company resolved an outstanding matter relating to alleged non-compete violations with a former employee. Pursuant to the terms of the settlement, the former employee paid the Company a cash settlement in the amount of $168,099, net of costs of $71,901, and returned for cancellation 132,963 shares of Company common stock valued at $42,548. F-31 13. BUSINESS SEGMENTS The Company is organized into three operating segments based on operating criteria. These segments are Specialty Medical Products Manufacturing, Specialty Distribution Services - Surgical, and Specialty Distribution Services - Critical Care. A description of each segment and principal products and operations are as follows: SPECIALTY MEDICAL PRODUCTS MANUFACTURING - This segment includes the Luxtec division acquired in March 2001, which designs and manufactures fiber optic headlight and video camera systems, light sources, cables, retractors, and custom-made and other surgical equipment for the medical and dental industries. SPECIALTY MEDICAL DISTRIBUTION - PrimeSource Surgical - The surgical segment is a regional sales and marketing organization that markets and sells surgical products primarily to hospitals and surgery centers. The primary specialty areas include gynecology, cardiovascular, endoscopy, and general surgery. These products and services are primarily used in hospital operating rooms and in outpatient surgery centers. This segment does business as PrimeSource Surgical. SPECIALTY MEDICAL DISTRIBUTION - PrimeSource Critical Care - The critical care segment is a regional sales and marketing organization that sells products primarily to hospitals and surgery centers in the southeastern and northeastern United States and includes the Bimeco, Inc., NEMS, and PEC operations. Within this segment, the primary specialties include maternal and childcare and neonatal intensive care. The results of the PEC operation is only included in fiscal years 2002 and 2001. Operations that are not included in any of the segments are included in the category "Other" and consist primarily of corporate staff operations, including selling, general, and administrative expenses of $3,527,516, $4,194,680 and $2,655,817 for 2003, 2002, and 2001, respectively. Operating income for each segment consists of net sales less cost of sales, selling expenses, depreciation and amortization expenses, and the segment's general and administrative expenses. The sales between segments are made at market prices and are eliminated in consolidation. Cost of products sold reflects current costs adjusted, where appropriate, for lower of cost or market inventory adjustments. The total assets of each segment consist primarily of net property and equipment, inventories, accounts receivable, and other assets directly associated with the segment's operations. Included in the total assets of the corporate staff operations are property and equipment and other assets. Following the Merger, certain products of the Specialty Medical Products Manufacturing segment were sold to the Specialty Medical Distribution - PrimeSource Surgical segment. Total sales between these segments totaled approximately $5,055,400, $5,178,351 and $1,480,000 for the years ended June 30, 2003, 2002 and 2001. F--32 In June 2003, the Company sold the capital stock of Ruby which was included in the Critical Care segment. The segment information has been restated to reflect historical segment information as adjusted for the reclassification of the NEMS portion of Ruby's operations as discontinued operations Disclosures regarding the Company's reportable segments including a corporate management fee allocation with reconciliation to consolidated totals are presented below.
DISTRIBUTION - DISTRIBUTION - PRIMESOURCE PRIMESOURCE CORPORATE/ SURGICAL CRITICAL CARE MANUFACTURING OTHER TOTAL Net sales 2003 $26,181,812 $11,939,529 $ 8,238,678 $ 46,360,019 2002 29,412,136 16,743,545 7,540,036 53,695,717 2001 33,698,000 11,824,793 2,879,676 48,402,469 Net income (loss) 2003 $ 137,765 $ 260,978 $(3,090,253) $ (937,289) $(3,628,799) 2002 448,525 (242,670) 913,610 (7,310,028) (6,190,563) 2001 (2,703,417) (386,039) 1,363,109 (2,655,817) (4,382,164) Total assets 2003 $25,041,081 $ 3,361,430 $ 2,935,095 $ 326,934 $ 31,664,540 2002 14,827,268 6,895,708 15,406,712 457,080 37,586,768 2001 32,846,222 8,017,389 4,113,415 472,928 45,449,954 Restructuring expenses 2003 $ 345,507 $ 345,507 2002 $ 1,038,823 2,915,675 3,954,498 Depreciation and amortization 2003 $ 195,959 $ 24,048 $ 155,984 $ 467,509 $ 843,500 2002 243,350 170,495 1,344,814 696,422 2,455,081 2001 910,002 57,838 324,743 345,065 1,637,648 Interest expense 2003 $ 282,899 $ 129,604 $ 111,959 $ 314,781 $ 839,243 2002 273,612 207,856 159,218 38,558 679,244 2001 527,003 322,348 68,434 917,785
PrimeSource Surgical and its subsidiaries have no significant sales to foreign companies; however, Luxtec has several foreign customers. The Company's external sales, based upon the customer's country of origin by geographic area for the years ended June 30, 2003, 2002 and 2001, totaled $44,015,000, $51,688,000 and $47,771,000 respectively for sales in the United States and $2,345,000, $2,008,000 and $631,000 for sales to foreign companies. 14. RESTRUCTURING In fiscal year 2000, PrimeSource Surgical approved plans for a major restructuring of its operations, with the goal of centralizing distribution facilities, eliminating unprofitable divisions, and reducing costs. The restructuring was substantially completed in the first quarter of fiscal 2001. In fiscal year 2002, the Company approved plans for further restructuring of operations involving narrowing the focus of the Company's operations, the consolidation of certain under performing sales regions, the reduction of corporate overhead through workforce reductions, the restructuring of the Company's balance sheet through the refinancing of the Company's and PrimeSource F-33 Surgical's senior bank debt and the reduction of debt levels through improved earnings. During the year ended June 30, 2002, approximately twenty-nine administrative employees were released along with several former members of the Company's senior management team, including the Company's former Chief Executive Officer, its former Chief Financial Officer and its former chairman and Executive Vice President. In fiscal year 2003, the Company recorded additional severance amounts for the resignation of its 2003 President and Chief Executive Officer, costs of probable legal settlement for two former executive officers and directors of the Company and the sale of NEMS. Activity consists of the following:
LOSS ON EMPLOYEE DISPOSAL OF OTHER RELATED DIVISION CONTRACTS TOTAL Estimated costs for 2000 restructuring $ 258,000 $ 732,000 $ 41,000 $ 1,031,000 Cash payments (217,000) (17,000) (234,000) Other adjustments - (732,000) - (732,000) --------- ---------- --------- ----------- Balance, June 30, 2000 41,000 - 24,000 65,000 Other adjustments (41,000) - (24,000) (65,000) --------- ---------- --------- ----------- Balance 30, 2001 - - - - Estimated costs for 2002 restructuring 1,379,000 1,038,823 1,536,675 3,954,498 Cash payments (585,000) - (901,000) (1,486,000) Other adjustments (141,000) (1,038,823) (177,542) (1,357,365) --------- ---------- --------- ----------- Balance, June 30, 2002 653,000 - 458,133 1,111,133 Estimated costs for 2003 restructuring 195,507 150,000 345,507 Cash payments (584,739) (166,320) (751,059) Other adjustments - - (14,613) (14,613) --------- ---------- --------- ----------- Balance, June 30, 2003 $ 263,768 $ - $ 427,200 $ 690,968 ========= ========== ========= ===========
****** F-34 ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES. (a) Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of June 30, 2003. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2003, the Company's disclosure controls and procedures are effective. (b) Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates (the registrant's fourth fiscal quarter in the case of our annual report) that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) The following individuals were directors of PrimeSource as of September 1, 2003.
BOARD OF DIRECTORS Name Age Director Since Position Term Ends ---- --- -------------- -------- --------- William H. Lomicka 64 2001 Director and Chairman of the Board 2004 Larry H. Coleman, Ph.D 58 2001 Director 2004 Shaun D. McMeans 41 2003 Director, Chief Operating Officer & Chief 2003 Financial Officer Joseph H. Potenza 56 2003 Director, President 2005
CLASS I DIRECTORS SERVING A TERM EXPIRING AT THE 2004 ANNUAL MEETING WILLIAM H. LOMICKA, DIRECTOR-- Mr. Lomicka was appointed to our Board of Directors on March 2, 2001, pursuant to our merger with PrimeSource Surgical. Mr. Lomicka is the Chairman of Coulter Ridge Capital, a private investment firm. From 1989 to 1998, Mr. Lomicka was President of Mayfair Capital, a private investment firm. Mr. Lomicka, formerly the Senior V.P. Finance of Humana, Inc., presently serves on the boards of numerous companies, both public and private. Representative companies include: Pomeroy Computer Resources, Spectracare, Medventure Technologies, Broadband Laboratories and Franklin Health. Mr. Lomicka graduated from the College of Wooster in Wooster, Ohio, and earned his M.B.A. from the Wharton Graduate School of the University of Pennsylvania. 64 CLASS II DIRECTORS SERVING A TERM EXPIRING AT THE 2005 ANNUAL MEETING LARRY H. COLEMAN, PH.D., DIRECTOR - Dr. Coleman was appointed to our Board of Directors on March 2, 2001, pursuant to our merger with PrimeSource Surgical. Dr. Coleman is the founder and Managing General Partner of Coleman Swenson Booth Inc., a private venture capital fund established in 1986. Dr. Coleman began his venture capital career in 1983 as President of HCA Capital, a wholly owned subsidiary of Columbia/HCA Healthcare Corporation. Dr. Coleman has served as a director on the boards of over 20 companies and is currently a board member of MediSphere Health Partners, Inc., LifeMetrix, Inc., ClearTrack Information Network, Inc., and Active Services Corporation. Dr. Coleman graduated from the University of North Carolina with an A.B. and earned his Ph.D. from the University of South Dakota. JOSEPH H. POTENZA, DIRECTOR AND PRESIDENT - Mr. Potenza was appointed to our Board of Directors on September 1, 2003. Prior to joining PrimeSource, Mr. Potenza held senior management positions with McKesson HBOC as Vice President of the Corporate Program and with Medibuy where he was responsible for the National Accounts and Corporate Program. From 1977 to 1997, Mr. Potenza developed his career with American Hospital Supply Corporation/Baxter Healthcare Corporation, culminating as Eastern Region President, running a $750 million distribution business with 650 employees and seven distribution facilities. He received a Bachelor of Arts degree in English from Norwich University and a Master of Arts degree in Management from Central Michigan University. CLASS III DIRECTORS SERVING A TERM EXPIRING AT THE 2003 ANNUAL MEETING SHAUN D. MCMEANS, DIRECTOR AND CHIEF OPERATING OFFICER & CHIEF FINANCIAL OFFICER - Mr. McMeans was appointed to our Board of Directors on September 1, 2003. Mr. McMeans has 20 years of experience in manufacturing and distribution businesses, specializing in operations, accounting and financial management. Prior to becoming the Company's Chief Financial Officer, he served as Vice President of Operations and Corporate Controller. Prior to joining the Company, Mr. McMeans held operational and financial management positions with Burnham Corporation, a leading domestic manufacturer and distributor of residential and commercial boilers. Mr. McMeans earned a Bachelor of Science degree in accounting from The Pennsylvania State University and is a certified public accountant. He began his career in public accounting with the former Peat, Marwick, Mitchell and Company. (b) Executive Officers of the Company Reference is made to "Executive Officers and Key Management Personnel in Part I. 65 SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Under Section 16(a) of the Securities Exchange Act of 1934, as amended, our directors, some of our officers and persons holding more than ten percent of our common stock are required to report their ownership of our common stock and any changes in such ownership to the Securities and Exchange Commission and us. To our knowledge, based solely on a review of copies of those reports furnished to us, all Section 16(a) filing requirements applicable to these persons were complied with during our fiscal year ended June 30, 2003. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth the compensation of our Chief Executive Officer, and the two highest-compensated executive officers of the Company as of June 30, 2003, or, collectively, the "Named Executive Officers": SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ANNUAL COMPENSATION AWARDS ------------------- ------------ FISCAL SECURITIES YEAR UNDERLYING NAME AND PRINCIPAL POSITION ENDED SALARY($) BONUS($) OPTIONS (#) --------------------------- ----- --------- -------- ----------- Bradford C. Walker June 30, 2003 229,198(2) 0 1,957,500 Current President, Chief June 30, 2002 0(2) 0 0 Executive Officer and June 30, 2001 0 0 0 Director (1) Shaun D. McMeans June 30, 2003 145,000 7,500 975,000 Chief Operating and Chief June 30, 2002 138,591 9,990 0 Financial Officer June 30, 2001 115,267 0 50,000 Joseph H. Potenza June 30, 2003 178,333 12,500 1,300,000 Senior Vice President, Sales & June 30, 2002 166,637 0 0 Marketing June 30, 2001 55,267 0 148,837
--------- (1) We appointed Mr. Walker as President and Chief Restructuring Officer in October 2001. In August 2002, we appointed Mr. Walker as President and Chief Executive Officer. Effective September 1, 2003, Mr. Walker resigned from his position as our President and Chief Executive Officer and as a member of our Board of Directors. (2) For our fiscal year ended June 30, 2002, Mr. Walker was not an employee of PrimeSource. Beginning in October 2001 and through June 30, 2002, Corporate Revitalization Partners provided consulting services to PrimeSource in connection with PrimeSource's restructuring. During that period, Mr. Walker was a Managing Director of Corporate Revitalization Partners. In the fiscal years ended June 30, 2002 and June 30, 2003, PrimeSource paid Corporate Revitalization Partners $430,500 and $62,838, respectively, for consulting fees. 66 The following table sets forth information with respect to stock option grants to our Named Executive Officers during the fiscal year ended June 30, 2003:
OPTION GRANTS IN LAST FISCAL YEAR (a) (b) (c) (d) (e) (f) (g) NUMBER OF % OF TOTAL SECURITIES OPTIONS EXERCISE EXPIRATION REALIZED VALUE AT ASSUMED NAME UNDERLYING GRANTED TO PRICE DATE ANNUAL RATES OF STOCK PRICE OPTIONS EMPLOYEES IN APPRECIATION FOR OPTION TERM GRANTED(1) FISCAL YEAR -------------------------------------------------------------------------------------------------------------------------- 0% 5% 10% -- -- --- Bradford C. Walker (2) 1,950,000 26.02% $ 0.32 August 6, 2012 $392,430 $994,495 Bradford C. Walker (3) 7,500 0.10% $16.00 August 6, 2012 $120,000 $ 75,467 $191,249 Shaun D. McMeans 975,000 13.01% $ 0.32 March 1, 2013 $196,215 $497,248 Joseph H. Potenza 1,300,000 17.35% $ 0.32 March 1, 2013 $261,620 $662,997
--------- (1) Except with respect to Mr. Walker's option grant described in note (3), the option exercise price is the fair value of our common stock on the respective grant dates as determined by the Board of Directors. 325,000 options issued to Mr. Potenza and Mr. McMeans vest over a three-year term, one third are scheduled to vest on March 1, 2004, and the balance will vest in twenty-four equal monthly installments on the first day of each month thereafter. 975,000 options issued to Mr. Potenza and 650,000 options issued to Mr. McMeans vest over a four year term, twenty-five percent vest on the anniversary of the grant date each year. (2) This option vested on the first anniversary of the grant date and will remain exercisable through the date that is the earlier of (a) one year from the effective date of the filing of a qualifying registration statement or (b) five years following the date Mr. Walker ceases to provide any services to PrimeSource. (3) This is an option to purchase Series G Convertible Redeemable Preferred Stock. This option vested on the first anniversary of the grant date and will remain exercisable through the date that is the earlier of (a) one year from the effective date of the filing of a qualifying registration statement or (b) five years following the date Mr. Walker ceases to provide any services to PrimeSource. Each share of Series G Convertible Redeemable Preferred Stock is convertible into 100 shares of common stock. The following table sets forth information with respect to options to purchase our stock granted to the Named Executive Officers as of our fiscal year ended June 30, 2003:
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES NUMBER OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED SHARES OPTIONS AT FISCAL IN-THE-MONEY OPTIONS ACQUIRED ON YEAR-END(#) AT FISCAL YEAR-END($)(1) NAME EXERCISE(#) VALUE REALIZED($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE ---------------------------------------------------------------------------------------------------------------------- Bradford C. Walker (1) 0 0 0/1,950,000 0/0 Bradford C. Walker (2) 0 0 0/7,500 0/$120,000 Shaun D. McMeans 0 0 55,498/1,006,711 0/0 Joseph H. Potenza 0 0 86,821/1,362,016 0/0
--------- (1) With respect to options to purchase our common stock, value is based on an estimated fair market value of $ 0.32 per share on June 30, 2003, minus the exercise price of such options, multiplied by the number of shares 67 underlying such options. With respect to options to purchase our Series G Convertible Redeemable Preferred Stock, value is based on an estimated fair market value on June 30, 2003 of $32.00 per share, minus the exercise price of such options, multiplied by the number of shares underlying such options. (2) This is an option to purchase Series G Convertible Redeemable Preferred Stock. Each share of Series G Convertible Redeemable Preferred Stock is convertible into 100 shares of common stock. COMPENSATION OF NON-EMPLOYEE DIRECTORS As of June 30, 2003, we do not pay our non-employee directors for attendance at meetings of the Board of Directors or meetings of a committee thereof. We do, however, pay expenses for attendance at meetings of the Board of Directors and committees thereof. In addition, non-employee directors are compensated with options to purchase shares of our common stock, in accordance with the 1995 Stock Option Plan for Non-Employee Directors, or the "Directors Plan." Under the terms of the Directors Plan, we grant our non-employee directors non-qualified stock options to purchase a total of 12,000 shares of common stock upon their election or appointment to the Board of Directors, with 4,000 options vesting on the date of grant, and 4,000 shares vesting annually thereafter provided the individual continues to serve on the Board of Directors. The options granted pursuant to the 1995 Director Plan have an exercise price equal to the fair market value per share of our common stock, as determined by the board of directors on the date the option is granted. 68 EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN- CONTROL ARRANGEMENTS WALKER EMPLOYMENT AGREEMENT On August 6, 2002, we entered into an employment agreement (the "Walker Agreement") with Bradford C. Walker to become our President and Chief Executive Officer and a member of our Board of Directors. The Walker Agreement was to expire on August 6, 2004 and offered no renewal option. Mr. Walker was entitled to a base salary of $250,000 per year for the first year of his employment after which year, said salary was to be reviewed by the Board of Directors. Upon review and at the Board of Directors' discretion, the salary may have been increased but not decreased. Mr. Walker was also entitled to receive an annual bonus of not less than $50,000 based upon an incentive bonus program established by the Chairman of the Compensation Committee and approved by the Board of Directors. In connection with the execution of the Walker Agreement, we granted Mr. Walker an incentive stock option to purchase 1,950,000 shares of our common stock at an exercise price per share equal to the fair market value of a share of our common stock on the date of grant, as determined by the Board of Directors. Additionally, we granted Mr. Walker an option to purchase 7,500 shares of our Series G Convertible Redeemable Preferred Stock at an exercise price of $16 per share. Additionally, on August 6, 2003, Mr. Walker would be granted an additional incentive stock option to purchase 1,300,000 shares of our common stock at an exercise price per share equal to the fair market value of a share of common stock on the date of grant, as determined by the Board of Directors. The described stock options will become fully vested and exercisable on the first anniversary of the date of grant of each such option. Following termination of employment, these options may be exercised by Mr. Walker during the period that is the lesser of one (1) year following the effective date of a registration statement covering the option shares or five (5) years. If we were to terminate Mr. Walker other than for death, disability or cause, or should he be deemed to be terminated by us, all unvested stock options will immediately become vested. Additionally, upon a change in control, as defined in the Walker Agreement, all unvested stock options will become vested. If we were to terminate Mr. Walker other than for death, disability or cause, upon execution by Mr. Walker of a waiver and release of claims against us, we will be obligated to pay Mr. Walker a lump sum amount equal to the lesser of six (6) months base salary or the base salary from the effective date of termination through the expiration date of the Walker Agreement. If we were to terminate Mr. Walker without Cause at any time within twelve (12) months after a of change in control, we will be obligated to pay Mr. Walker a lump sum amount equal to his base salary from the effective date of such termination through the expiration date of the Walker Agreement. If Mr. Walker's employment with us terminates for any reason, he may not compete with us or solicit our employees for a period of one year from his date of termination. 69 WALKER SEVERANCE AGREEMENT On September 5, 2003, we entered into a severance agreement with Mr. Walker pursuant to which Mr. Walker resigned as our President, Chief Executive Officer and a member of our Board of Directors effective September 1, 2003. Mr. Walker is entitled to receive severance payments equal to $20,833.33 monthly, for six (6) consecutive months from and after September 1, 2003 (the "Severance Period"). Mr. Walker is entitled to receive additional severance payments of $25,000 payable on September 5, 2003, and $25,000 payable on or within five (5) business days after the last day of the Severance Period. During the Severance Period, Mr. Walker and his dependents are entitled to continued coverage under our standard insurance plans, policies or programs, providing health, dental, vision, accidental death and dismemberment, long-term disability and life insurance coverage. The severance agreement provides that Mr. Walker's option to purchase 1,300,000 shares of our common stock, granted on or about August 6, 2003, his option to purchase 1,950,000 shares of our common stock, granted on August 6, 2002, and his option to purchase 7,500 shares of our Series G Convertible Redeemable Preferred Stock, granted on August 6, 2002, each are fully vested and exercisable at any time prior to the earlier of (i) the date that is one (1) year following the registration of the applicable option's underlying shares under the Securities Act of 1933, as amended or (ii) March 1, 2009. In consideration for the severance benefits, Mr. Walker agreed to release any claims he may have against us and our affiliates. We agreed to release Mr. Walker from any claims we may have against him. Furthermore, Mr. Walker agreed to cooperate with our reasonable requests for consultation and services during the Severance Period. Finally, Mr. Walker agreed that, during the Severance Period, he will not compete with us. The Company's obligation to pay severance benefits and payments under the severance agreement will cease if Mr. Walker competes with us during the Severance Period. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS BENEFICIAL OWNERSHIP OF COMPANY SECURITIES The following tables furnish certain information as of September 1, 2003 (except as otherwise noted), as to our equity securities beneficially owned by each of our directors, by each of the individuals named in the Summary Compensation Table and by all of our directors and executive officers as a group, and, to our knowledge, by any beneficial owner of more than 5% of any class or series of our outstanding equity securities. 70
--------------------------- ----------------------- ----------------------- -------------------------- -------------------- NAME OF BENEFICIAL OWNER NUMBER OF SHARES OF NUMBER OF SHARES OF AGGREGATE NUMBER OF PERCENT OF CLASS COMMON STOCK SERIES G CONVERTIBLE SHARES OF COMMON STOCK VOTING POWER BENEFICIALLY OWNED REDEEMABLE PREFERRED BENEFICIALLY OWNED OR PRESENTLY HELD(3) STOCK BENEFICIALLY UNDERLYING PREFERRED OWNED(1) STOCK BENEFICIALLY OWNED(2) --------------------------- ------------------------- ------------------------ -------------------------- -------------------- GE Capital Equity Investments, Inc.(4) 17,369,734(5) 125,000 29,869,734 44.58% --------------------------- ------------------------- ------------------------ -------------------------- -------------------- Coleman Swenson Hoffman Booth IV L.P.(6) 7,968,545(7) 77,187.5 15,687,295 23.41% --------------------------- ------------------------- ------------------------ -------------------------- -------------------- Webbmont Holdings L.P.(8) 3,428,271(9) 14,843.75 4,912,645 7.33% --------------------------- ------------------------- ------------------------ -------------------------- -------------------- Larry H. Coleman, Ph.D.(10) 7,968,545(7) 77,187.5 15,687,295 23.41% --------------------------- ------------------------- ------------------------ -------------------------- -------------------- William H. Lomicka 838,006(11) 5,468.75 1,384,881 2.07% --------------------------- ------------------------- ------------------------ -------------------------- -------------------- Shaun D. McMeans 63,807(12) 0 63,807 * --------------------------- ------------------------- ------------------------ -------------------------- -------------------- Joseph H. Potenza 99,224(13) 0 99,224 * --------------------------- ------------------------- ------------------------ -------------------------- -------------------- Bradford Walker 3,250,000(14) 7,500(15) 4,000,000 5.97% --------------------------- ------------------------- ------------------------ -------------------------- -------------------- All directors and executive officers as a 8,969,582 82,656.25 17,235,207 25.72% group (4 persons) --------------------------- ------------------------- ------------------------ -------------------------- --------------------
----------------------------------------------- Unless otherwise indicated, the address of each person is care of PrimeSource Healthcare, Inc. 3700 E. Columbia Street, Tucson, Arizona 85714. Shares of common stock subject to options or warrants exercisable within sixty days of September 1, 2003, are deemed outstanding for purposes of computing the percentage ownership of the person holding such options or warrants but are not outstanding for purposes of computing the percentage of any other person. * Less than 1%. 1 Each share of Series G Convertible Redeemable Preferred Stock entitles its holder to one hundred votes, subject to adjustment, in any vote of the holders of our common stock and may be converted into 100 shares of our common stock, subject to adjustment. 2 Includes common stock and the common stock underlying the Series G Convertible Redeemable Preferred Stock owned as of September 1, 2003 and common stock underlying options and warrants that are exercisable within sixty days of September 1, 2003. 3 Based upon the aggregate number of shares of our common stock outstanding and underlying outstanding shares of the Series G Convertible Redeemable Preferred Stock owned as of September 1, 2003 and options and warrants exercisable within sixty days of September 1, 2003 to acquire our common stock. 4 The address of GE Capital Equity Investments is 120 Long Ridge Road, Stamford, Connecticut 06927. 71 5 Includes 3,721 shares of our common stock underlying options that are exercisable within sixty days of September 1, 2003. Also includes 9,398,639 shares of our common stock subject to purchase pursuant to warrants that are exercisable within sixty days of September 1, 2003. 6 The address of Coleman Swenson Hoffman Booth IV L.P. is 237 Second Avenue South, Franklin, Tennessee 37064-2649. 7 Includes 15,100 shares of our common stock underlying options that are exercisable within sixty days of September 1, 2003. Also includes 4,380,356 shares of our common stock subject to purchase pursuant to warrants that are exercisable within sixty days of September 1, 2003. 8 The address of Webbmont Holdings L.P. is 1680 Hiram-Douglasville Highway, Suite 108, Hiram, Georgia 30141. 9 Includes 1,456,876 shares of our common stock subject to purchase pursuant to warrants that are exercisable within sixty days of September 1, 2003. Includes 15,930 shares of our common stock held of record by Robert Neale Fisher, 8,434 shares of our common stock held of record by Virginia A. Fisher, 353,057 shares of our common stock held of record by Investors Equity, Inc. and 1,586,531 shares of our common stock held of record by Webbmont Holdings, L.P., all of which are considered beneficially held by Robert W. Fisher. Mr. Fisher is the President of Woodcrest Associates, Ltd., the general partner of Webbmont Holdings, L.P. Also includes 7,442 shares of our common stock underlying options held by Mr. Fisher that are exercisable within sixty days of September 1, 2003. 10 Dr. Coleman is the Managing General Partner of CSHB Ventures IV L.P., the General Partner of Coleman Swenson Booth IV, L.P. 11 Includes 29,984 shares of our common stock underlying options that are exercisable within sixty days of September 1, 2003. Also includes 186,694 shares of our common stock subject to purchase pursuant to warrants that are exercisable within sixty days of September 1, 2003. 12 Includes 63,807 shares of our common stock underlying options that are exercisable within sixty days of September 1, 2003. 13 Includes 99,224 shares of our common stock underlying options that are exercisable within sixty days of September 1, 2003. 14 Includes 3,250,000 shares of our common stock underlying options that are exercisable within sixty days of September 1, 2003. 15 Includes 7,500 shares of the Series G Convertible Redeemable Preferred Stock subject to purchase pursuant to warrants that are exercisable within sixty days of September 1, 2003. 72 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Beginning in October 2000 and through August 6, 2002, we engaged Corporate Revitalization Partners, or CRP, as consultants to assist us in our restructuring. Bradford C. Walker, who was appointed as our President and Chief Restructuring Officer in October 2002, a member of our Board of Directors in May 2002 and our President and Chief Executive Officer on August 6, 2002, was a Managing Director of CRP throughout the period of October 2000 through August 6, 2002. We expensed aggregate consulting fees and expenses in the amount of $430,500 and $62,838, respectively, to CRP for Mr. Walker's services from October 2001 through June 30, 2002. On August 6, 2002, we entered into an employment agreement with Mr. Walker in connection with his appointment as our President and Chief Executive Officer. See "Employment Agreements--Walker Employment Agreement." On August 6, 2002, we entered into a Purchase Agreement, or the Purchase Agreement, with GE Capital Equity Investments, Inc., or GE Capital, Coleman Swenson Hoffman Booth IV L.P., or Coleman Swenson, Webbmont Holdings, L.P., or Webbmont, Investors Equity, Inc., or Investors Equity, and William H. Lomicka. Pursuant to the Purchase Agreement, we have issued and sold an aggregate of 81,343 shares of Series G Stock and warrants to purchase an aggregate of 3,300,000 shares of our common stock for an aggregate consideration of $2,602,976. In addition, subject to the terms and conditions of the Purchase Agreement, we may sell up to an additional 21,782 shares of Series G Stock to these purchasers for an additional aggregate consideration of up to $697,024. GE Capital is known to us to be a record holder of more than five percent of a class of our voting securities. Larry H. Coleman, who is a member of our Board of Directors, is the Managing General Partner of CSHB Ventures IV L.P., the General Partners of Coleman Swenson, and Coleman Swenson is known to us to be a record holder of more than five percent of a class of our voting securities. Webbmont and Investors are considered affiliated parties and are known to us to collectively be a record holder of more than five percent of a class of our voting securities. Finally, Mr. Lomicka is a member of our Board of Directors and is known to us to be a record holder of more than five percent of a class of our voting securities. Also on August 6, 2002, we entered into a Conversion and Exchange Agreement with GE Capital, Coleman Swenson, Webbmont, Investors Equity and Mr. Lomicka. Pursuant to the Conversion and Exchange Agreement, the holders of the Series C Stock converted all outstanding shares of Series C Stock into an aggregate of 9,513,797 shares of common stock and received warrants to purchase an aggregate of 7,390,614 shares of our common stock at a price of $.01 per share, the holders of the Series F Stock converted all outstanding shares of Series F Stock into an aggregate of 5,221,248 shares of common stock and received warrants to purchase an aggregate of 1,614,560 shares of our common stock at a price of $.01 per share, and the holders of the Series E Stock exchanged all of the outstanding shares of Series E Stock for an aggregate of 101,562.5 shares of Series G Stock and received warrants to purchase an aggregate of 817,000 shares of our common stock at a price of $.01 per share. 73 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (i) Consolidated Financial Statements --------------------------------- Independent Auditors' Report Consolidated Balance Sheets as of June 30, 2003 and June 30, 2002. Consolidated Statements of Operations for the years ended June 30, 2003, June 30, 2002 and June 30, 2001. Consolidated Statements of Stockholders' Equity (Capital Deficiency) for the years ended June 30, 2003, June 30, 2002 and June 30, 2001. Consolidated Statements of Cash Flows for the years ended June 30, 2003, June 30, 2002 and June 30, 2001 Notes to Consolidated Financial Statements (ii) Independent Auditors' Report on Schedules (iii) Financial Statement Schedules - Schedule II 74 INDEPENDENT AUDITORS' REPORT ON SCHEDULES To the Board of Directors and Stockholders of PrimeSource Healthcare, Inc. Tucson, Arizona We have audited the consolidated financial statements of PrimeSource Healthcare, Inc. and subsidiaries (the "Company") as of June 30, 2003 and 2002 for each of the three years in the period ended June 30, 2003, and have issued our report thereon dated October 14, 2003; such financial statements and report are included elsewhere in this annual report on Form 10-K of PrimeSource Healthcare, Inc. and subsidiaries. Our audits also included the consolidated financial statement schedules of the Company for 2003 and 2002, Schedule II - Valuation and Qualifying Accounts. The financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such 2003 and 2002 consolidated financial statement schedules, when considered in relation to the basic 2003 and 2002 consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. DELOITTE & TOUCHE LLP Phoenix, Arizona October 14, 2003 75 VALUATION AND QUALIFYING ACCOUNTS
Additions Balance at the Charged to costs Charged to other Balance at the beginning of year and expenses amounts Deductions end the year FOR THE YEAR ENDED JUNE 30, 2002: Accounts receivable allowances for doubtful accounts $ 622,387 $ 539,207 $ (33,697) $ (727,524) $ 400,373 Inventory reserves - for obsolescence 1,659,410 705,693 (76,977) (689,954) 1,598,172 Deferred income tax valuation allowance 7,042,400 1,662,400 8,704,800 ----------- ---------- ---------- ------------ ----------- Total allowances deducted from assets $ 9,324,197 $1,244,900 $1,551,726 $(1,417,478) $10,703,345 =========== ========== ========== ============ =========== FOR THE YEAR ENDED JUNE 30, 2003: Accounts receivable allowances for doubtful accounts $ 400,373 $ 173,345 $ (92,964) $ (266,859) $ 213,895 Inventory reserves - for obsolescence 1,598,172 416,716 (80,869) (827,787) 1,106,232 Deferred income tax valuation allowance 8,704,800 (191,500) 8,513,300 ----------- ---------- ---------- ------------ ----------- Total allowances deducted from assets $10,703,345 $ 590,061 $(173,833) $(1,286,146) $ 9,833,427 =========== ========== ========== ============ ===========
76 3. Exhibits -------- Each exhibit set forth below in the Index to Exhibits is filed as a part of this report. All exhibits not filed herewith are incorporated herein by reference to a prior filing as indicated. 2.1 Agreement and Plan of Merger, dated November 27, 2000, by and between Luxtec Corporation, Laser Merger Sub, Inc. and PrimeSource Surgical, Inc. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on November 30, 2000). 2.2 Amendment No. 1 to the Agreement and Plan of Merger, dated February 8, 2001, by and between Luxtec Corporation, Laser Merger Sub, Inc. and PrimeSource Surgical, Inc. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.1 Articles of Organization. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 3.2 Amendment, dated March 30, 1982, to Articles of Organization. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 3.3 Amendment, dated August 9, 1984, to Articles of Organization. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 3.4 Amendment, dated April 10, 1992, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1993). 3.5 Amendment, dated October 20, 1995, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1995). 3.6 Amendment, dated October 20, 1995, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1995). 3.7 Amendment, dated September 16, 1996, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 3.8 Certificate of Vote of Directors Establishing a Series of a Class of Stock dated September 16, 1996. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 3.9 Certificate of Correction dated October 4, 1996. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 3.10 Certificate of Correction dated October 4, 1996. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 77 3.11 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated February 27, 2001 (Series B Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.12 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated February 27, 2001 (Series C Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.13 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated February 27, 2001 (Series D Exchangeable Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.14 Certificate of Correction dated March 2, 2001 (Series C Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.15 Certificate of Correction dated March 2, 2001. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.16 Articles of Amendment to Articles of Organization, dated as of June 27, 2001. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on July 11, 2001). 3.17 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated June 28, 2001 (Series E Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on July 11, 2001). 3.18 Certificate of Correction dated July 13, 2001. (Incorporated by reference to Form 10-K, File No. 0-14961, filed October 15, 2001). 3.19 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated January 23, 2002 (Series F Convertible Redeemable Preferred Stock). (Incorporated by reference to Form 10-Q, File No. 0-14961, filed on February 14, 2002). 3.20 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated August 6, 2002 (Series G Convertible Redeemable Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on August 8, 2002). 3.21 Articles of Amendment to Articles of Organization, dated as of December 17, 2002. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed February 14, 2003). 3.22 Amended and Restated By-Laws (Incorporated by reference to Form 8-K, File No. 0 -14961, filed August 8, 2002). 4.1 Specimen of Common Stock Certificate. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 78 4.2 Registration Rights Agreement made as of June 3, 1996, between the Company and the Purchasers identified therein. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed September 13, 1996). 4.3 Second Amended and Restated Registration Rights, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. and the persons listed as Stockholders therein. (Incorporated by reference to Form 8-K, File No. 0-14961, filed August 8, 2002). 4.4 Amended and Restated Co-Sale Agreement, dated June 28, 2001, by and among PrimeSource Healthcare, Inc. and the persons listed as Stockholders therein. (Incorporated by reference to Form 10-K, File No. 0-14961, filed October 15, 2001). 4.5 Co-Sale Agreement, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. and the persons listed as Stockholders on the signature pages thereto. (Incorporated by reference to Form 8-K, File No. 0-14961, filed August 8, 2002). 10.1 Employment Agreement, entered into between PrimeSource Healthcare, Inc. and Bradford C. Walker, effective upon the Initial Closing (as defined in the Purchase Agreement dated as of August 6, 2002). (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.2 Employment Agreement entered into between James L. Hersma and Luxtec Corporation, a Massachusetts corporation, dated as of May 4, 2001. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed May 21, 2001). 10.3 Amended and Restated Credit Agreement, dated as of June 14, 1999, by and among PrimeSource Surgical, Inc, a Delaware corporation, Bimeco, Inc., a Florida corporation ("Bimeco"), Medical Companies Alliance, Inc., a Utah corporation, Douglas Medical, Inc., a Florida corporation and Citizens Bank of Massachusetts. (Incorporated by reference to Form == 10-K, File No. 0-14961, filed September 30, 2002). 10.4 First Amendment to Amended and Restated Credit Agreement, dated as of August 22, 2000, by and among PrimeSource Surgical, Inc, a Delaware corporation, Bimeco, Inc., a Florida corporation, and Citizens Bank of Massachusetts. (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.5 Second Amendment to Amended and Restated Credit Agreement, dated as of December 15, 2000, by and among PrimeSource Surgical, Inc., Bimeco, Inc. Ruby Merger Sub, Inc. and Citizens Bank of Massachusetts. (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.6 Third Amendment to Amended and Restated Credit Agreement, dated as of March 2, 2001, by and among PrimeSource Surgical, Inc, a Delaware corporation, Bimeco, Inc., a Florida corporation, Ruby Merger Sub, Inc., a Delaware corporation, Luxtec Corporation, a Massachusetts corporation and Citizens Bank of Massachusetts. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed May 21, 2001). 79 10.7 Fourth Amendment to Amended and Restated Credit Agreement, dated as of August 6, 2002, among PrimeSource Surgical, Inc., Bimeco, Inc., Ruby Merger Sub, Inc., PrimeSource Healthcare, Inc. and Citizens Bank of Massachusetts. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 10.8 Amended and Restated Loan and Security Agreement, dated March 2, 2001, by and among Luxtec Corporation, Fiber Imaging Technologies, Inc., Cathtec Incorporated, CardioDyne, Inc. and ARK CLO 2000-1, Limited. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed May 21, 2001). 10.9 First Amendment to Amended and Restated Loan and Security Agreement, dated as of August 31, 2001, by and among PrimeSource Healthcare, Inc. (f/k/a Luxtec Corporation), Fiber Imaging Technologies, Inc., Cathtec Incorporated, and Cardiodyne, Inc., and Ark CLO 2000-1, Limited. (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.10 Second Amendment and Waiver to the Amended and Restated Loan and Security Agreement, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. (f/k/a Luxtec Corporation), Fiber Imaging Technologies, Inc., Cathtec Incorporated, and Cardiodyne, Inc., and Ark CLO 2000-1, Limited. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 10.11 Luxtec Corporation 1992 Stock Plan, as amended. (Incorporated by reference to Form 10-K, File No. 0-14961, filed January 28, 1994). 10.12 Luxtec Corporation 1995 Stock Option Plan for Non-Employee Directors. (Incorporated by reference to Form 10-K, File No. 0-14961, filed January 27, 1996). 10.13 Tucson Medical Corporation 1997 Stock Option / Stock Issuance Plan, as amended. (Incorporated by reference to Schedule 14A, File No. 0-14961, filed June 1, 2001). 10.14 Unit Purchase Agreement among PrimeSource Healthcare, Inc. and the Purchasers named in Schedule I thereto, dated as of June 28, 2001. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 11, 2001). 10.15 Form of Warrant. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 11, 2001). 10.16 Conversion and Exchange Agreement, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. and the persons listed in the signature pages thereto. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 10.17 Purchase Agreement, dated as of August 6, 2002, among PrimeSource Healthcare, Inc. and the Initial Purchasers named in Schedule I thereto. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 80 10.18 Lease Agreement, dated as of March 1, 2000, by and between Holualoa Butterfield Industrial, L.L.C. and PrimeSource Surgical, Inc. (Incorporated by reference to Form 10-K, File No. 0-14961, filed on October 15, 2001). 10.19 Stock Purchase Agreement, dated June 30, 2003, by and among PrimeSource Surgical, Inc., Peter Miller, Peter Eule and New England Medical Specialties, Inc. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 2, 2003). 10.20 Waiver Agreement, dated June 30, 2003, by and among PrimeSource Healthcare, Inc. and the Purchasers named therein. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 2, 2003). 10.21 Severance Agreement, dated September 5, 2003, by and between PrimeSource Healthcare, Inc. and Bradford C. Walker. (Incorporated by reference to Form 8-K, File No. 0-14961, filed September 8, 2003). 21.1 Subsidiaries of the Registrant. 31.1 Certification of the President Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the President and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K: None. 81 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PRIMESOURCE HEALTHCARE, INC. by /s/Joseph H. Potenza --------------------------------- Joseph H. Potenza, President October 14, 2003 82 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ William H. Lomicka Director October 14, 2003 ---------------------- William H. Lomicka /s/ Larry H. Coleman Director October 14, 2003 ---------------------- Larry H. Coleman /s/ Joseph H. Potenza President and Director October 14, 2003 ---------------------- Joseph H. Potenza /s/ Shaun D. McMeans Chief Operating Officer, October 14, 2003 ---------------------- Chief Financial Officer Shaun D. McMeans and Treasurer, Director 83 EXHIBIT INDEX ------------- 2.1 Agreement and Plan of Merger, dated November 27, 2000, by and between Luxtec Corporation, Laser Merger Sub, Inc. and PrimeSource Surgical, Inc. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on November 30, 2000). 2.2 Amendment No. 1 to the Agreement and Plan of Merger, dated February 8, 2001, by and between Luxtec Corporation, Laser Merger Sub, Inc. and PrimeSource Surgical, Inc. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.1 Articles of Organization. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 3.2 Amendment, dated March 30, 1982, to Articles of Organization. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 3.3 Amendment, dated August 9, 1984, to Articles of Organization. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 3.4 Amendment, dated April 10, 1992, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1993). 3.5 Amendment, dated October 20, 1995, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1995). 3.6 Amendment, dated October 20, 1995, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1995). 3.7 Amendment, dated September 16, 1996, to Articles of Organization. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 3.8 Certificate of Vote of Directors Establishing a Series of a Class of Stock dated September 16, 1996. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 3.9 Certificate of Correction dated October 4, 1996. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 3.10 Certificate of Correction dated October 4, 1996. (Incorporated by reference to Form 10-K, File No. 0-14961, filed for the fiscal year ended October 31, 1996). 88 3.11 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated February 27, 2001 (Series B Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.12 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated February 27, 2001 (Series C Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.13 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated February 27, 2001 (Series D Exchangeable Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.14 Certificate of Correction dated March 2, 2001 (Series C Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.15 Certificate of Correction dated March 2, 2001. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on March 16, 2001). 3.16 Articles of Amendment to Articles of Organization, dated as of June 27, 2001. (Incorporated by reference to Form 8-K, File No. 0-14961, filed on July 11, 2001). 3.17 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated June 28, 2001 (Series E Convertible Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on July 11, 2001). 3.18 Certificate of Correction dated July 13, 2001. (Incorporated by reference to Form 10-K, File No. 0-14961, filed October 15, 2001). 3.19 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated January 23, 2002 (Series F Convertible Redeemable Preferred Stock). (Incorporated by reference to Form 10-Q, File No. 0-14961, filed on February 14, 2002). 3.20 Certificate of Vote of Directors Establishing a Series or a Class of Stock, dated August 6, 2002 (Series G Convertible Redeemable Preferred Stock). (Incorporated by reference to Form 8-K, File No. 0-14961, filed on August 8, 2002). 3.21 Articles of Amendment to Articles of Organization, dated as of December 17, 2002. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed February 14, 2003). 3.22 Amended and Restated By-Laws (Incorporated by reference to Form 8 K, File No. 0 -14961, filed August 8, 2002). 4.1 Specimen of Common Stock Certificate. (Incorporated by reference to Form S-18, File No. 33-5514B, declared effective on July 7, 1986). 4.2 Registration Rights Agreement made as of June 3, 1996, between the Company and the Purchasers identified therein. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed September 13, 1996). 89 4.3 Second Amended and Restated Registration Rights, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. and the persons listed as Stockholders therein. (Incorporated by reference to Form 8-K, File No. 0-14961, filed August 8, 2002). 4.4 Amended and Restated Co-Sale Agreement, dated June 28, 2001, by and among PrimeSource Healthcare, Inc. and the persons listed as Stockholders therein. (Incorporated by reference to Form 10-K, File No. 0-14961, filed October 15, 2001). 4.5 Co-Sale Agreement, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. and the persons listed as Stockholders on the signature pages thereto. (Incorporated by reference to Form 8-K, File No. 0-14961, filed August 8, 2002). 10.1 Employment Agreement, entered into between PrimeSource Healthcare, Inc. and Bradford C. Walker, effective upon the Initial Closing as defined in the Purchase Agreement dated as of August 6, 2002). (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.2 Employment Agreement entered into between James L. Hersma and Luxtec Corporation, a Massachusetts corporation, dated as of May 4, 2001. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed May 21, 2001). 10.3 Amended and Restated Credit Agreement, dated as of June 14, 1999, by and among PrimeSource Surgical, Inc, a Delaware corporation, Bimeco, Inc., a Florida corporation ("Bimeco"), Medical Companies Alliance, Inc., a Utah corporation, Douglas Medical, Inc., a Florida corporation and Citizens Bank of Massachusetts. (Incorporated by reference to Form == 10-K, File No. 0-14961, filed September 30, 2002). 10.4 First Amendment to Amended and Restated Credit Agreement, dated as of August 22, 2000, by and among PrimeSource Surgical, Inc, a Delaware corporation, Bimeco, Inc., a Florida corporation, and Citizens Bank of Massachusetts. (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.5 Second Amendment to Amended and Restated Credit Agreement, dated as of December 15, 2000, by and among PrimeSource Surgical, Inc., Bimeco, Inc. Ruby Merger Sub, Inc. and Citizens Bank of Massachusetts. (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.6 Third Amendment to Amended and Restated Credit Agreement, dated as of March 2, 2001, by and among PrimeSource Surgical, Inc, a Delaware corporation, Bimeco, Inc., a Florida corporation, Ruby Merger Sub, Inc., a Delaware corporation, Luxtec Corporation, a Massachusetts corporation and Citizens Bank of Massachusetts. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed May 21, 2001). 10.7 Fourth Amendment to Amended and Restated Credit Agreement, dated as of August 6, 2002, among PrimeSource Surgical, Inc., Bimeco, Inc., Ruby Merger Sub, Inc., PrimeSource Healthcare, Inc. and Citizens 90 Bank of Massachusetts. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 10.8 Amended and Restated Loan and Security Agreement, dated March 2, 2001, by and among Luxtec Corporation, Fiber Imaging Technologies, Inc., Cathtec Incorporated, CardioDyne, Inc. and ARK CLO 2000-1, Limited. (Incorporated by reference to Form 10-Q, File No. 0-14961, filed May 21, 2001). 10.9 First Amendment to Amended and Restated Loan and Security Agreement, dated as of August 31, 2001, by and among PrimeSource Healthcare, Inc. (f/k/a Luxtec Corporation), Fiber Imaging Technologies, Inc., Cathtec Incorporated, and Cardiodyne, Inc., and Ark CLO 2000-1, Limited. (Incorporated by reference to Form 10-K, File No. 0-14961, filed September 30, 2002). 10.10 Second Amendment and Waiver to the Amended and Restated Loan and Security Agreement, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. (f/k/a Luxtec Corporation), Fiber Imaging Technologies, Inc., Cathtec Incorporated, and Cardiodyne, Inc., and Ark CLO 2000-1, Limited. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 10.11 Luxtec Corporation 1992 Stock Plan, as amended. (Incorporated by reference to Form 10-K, File No. 0-14961, filed January 28, 1994). 10.12 Luxtec Corporation 1995 Stock Option Plan for Non-Employee Directors. (Incorporated by reference to Form 10-K, File No. 0-14961, filed January 27, 1996). 10.13 Tucson Medical Corporation 1997 Stock Option / Stock Issuance Plan, as amended. (Incorporated by reference to Schedule 14A, File No. 0-14961, filed June 1, 2001). 10.14 Unit Purchase Agreement among PrimeSource Healthcare, Inc. and the Purchasers named in Schedule I thereto, dated as of June 28, 2001. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 11, 2001). 10.15 Form of Warrant. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 11, 2001). 10.16 Conversion and Exchange Agreement, dated as of August 6, 2002, by and among PrimeSource Healthcare, Inc. and the persons listed in the signature pages thereto. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 10.17 Purchase Agreement, dated as of August 6, 2002, among PrimeSource Healthcare, Inc. and the Initial Purchasers named in Schedule I thereto. (Incorporated by reference to Form 8-K, File No 0-14961, filed August 8, 2002). 10.18 Lease Agreement, dated as of March 1, 2000, by and between Holualoa Butterfield Industrial, L.L.C. and PrimeSource Surgical, Inc. (Incorporated by reference to Form 10-K, File No. 0-14961, filed on October 15, 2001). 91 10.19 Stock Purchase Agreement, dated June 30, 2003, by and among PrimeSource Surgical, Inc., Peter Miller, Peter Eule and New England Medical Specialties, Inc. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 2, 2003). 10.20 Waiver Agreement, dated June 30, 2003, by and among PrimeSource Healthcare, Inc. and the Purchasers named therein. (Incorporated by reference to Form 8-K, File No. 0-14961, filed July 2, 2003). 10.21 Severance Agreement, dated September 5, 2003, by and between PrimeSource Healthcare, Inc. and Bradford C. Walker. (Incorporated by reference to Form 8-K, File No. 0-14961, filed September 8, 2003). 21.1 Subsidiaries of the Registrant. 31.1 Certification of the President Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the President and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K: None. 92