**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

----

 

**FORM 10-Q**

 

| **(MARK ONE)**                                                                                                                                                                                                                                                |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                          |   |
| **ý**                                                                                                                                                                                                                                                    | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934.** |
|                                                                                                                                                                                                                                                          |   |
| **For the quarterly period ended September  28, 2003**                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                          |   |
| **OR**                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                          |   |
| **o**                                                                                                                                                                                                                                                         | **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: 001-15883** |

 

| **MANUFACTURERS’  SERVICES LIMITED**                                                                                   |
|-----------------------------------------------------------------------------------------------------------------------------|
| (EXACT NAME OF REGISTRANT AS  SPECIFIED IN ITS CHARTER)                                                                     |
|                                                                                                                        |   |   |
| **DELAWARE**                                                                                                                |   | **04-3258036** |
| (STATE OR OTHER JURISDICTION OF  INCORPORATION OR ORGANIZATION)                                                             |   | (I.R.S. EMPLOYER  IDENTIFICATION NO.) |
|                                                                                                                        |   |   |
| **300 BAKER AVENUE, SUITE 106, CONCORD,  MASSACHUSETTS 01742  (978) 287-5630**                                              |
| (ADDRESS, INCLUDING ZIP CODE AND TELEPHONE  NUMBER,  INCLUDING AREA CODE, OF REGISTRANT’S PRINCIPAL EXECUTIVE OFFICES) |
|                                                                                                                        |   |   |
| **NOT APPLICABLE.**                                                                                                         |
| (Former Name, Former Address and Former  Fiscal Year, if Changed Since Last Report)                                         |

 

----

 

Indicate by check mark whether the Registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý      No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act). Yes   ý       No  o

 

At October 24, 2003, there were 34,150,823 shares of Common Stock,$0.001 par value, outstanding.

 

 

----

 

MANUFACTURERS’ SERVICES LIMITED

INDEX

 
| PART I. FINANCIAL INFORMATION |
|-------------------------------|
|                          |   |
| Item 1.                       | Consolidated Financial Statements |
|                          | Consolidated Balance Sheets (Unaudited) —  September 28, 2003 and December 31, 2002 |
|                          | Consolidated Statements of Operations  (Unaudited) — Three and Nine Months Ended September 28, 2003 and September  29, 2002 |
|                          | Consolidated Statements of Cash Flows  (Unaudited) — Nine Months Ended September 28, 2003 and September 29, 2002 |
|                          | Notes to Consolidated Financial Statements |
| Item 2.                       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
| Item 3.                       | Quantitative and Qualitative Disclosure  about Market Risk |
| Item 4.                       | Controls and Procedures |
|                          |   |
| PART II - OTHER INFORMATION   |
|                          |   |
| Item 1.                       | Legal Proceedings |
| Item 6.                       | Exhibits and Reports on Form 8K |
|                          |   |
|                          | Signatures |
|                          |   |
|                          | Certifications |

 

2

----

 

PART I.FINANCIAL INFORMATION

Item 1.    Financial Statements

MANUFACTURERS’SERVICES LIMITED

CONSOLIDATEDBALANCE SHEETS - UNAUDITED

(IN THOUSANDS,EXCEPT SHARE DATA)
|                                                                                                                                                                                                                             |   | **September  28,  2003** |    | **December  31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-------------------------|--------|
| ASSETS                                                                                                                                                                                                                           |   |                     |    |                    |   |
| Current assets:                                                                                                                                                                                                                  |   |                     |    |                    |   |
| Cash and cash equivalents                                                                                                                                                                                                        |   | $                        | 54,836  |                    | $      | 48,955 |   |
| Accounts receivable, less allowance for  doubtful accounts of $559 and $2,753 at September 28, 2003 and December 31,  2002, respectively                                                                                         |   | 115,234                  |    | 109,083                 |   |
| Inventories                                                                                                                                                                                                                      |   | 112,175                  |    | 98,827                  |   |
| Prepaid expenses and other current assets                                                                                                                                                                                        |   | 15,844                   |    | 21,945                  |   |
| Total current assets                                                                                                                                                                                                             |   | 298,089                  |    | 278,810                 |   |
|                                                                                                                                                                                                                             |   |                     |    |                    |   |
| Property and equipment, net                                                                                                                                                                                                      |   | 42,662                   |    | 34,659                  |   |
| Goodwill and intangible                                                                                                                                                                                                          |   | 7,166                    |    | 8,441                   |   |
| Other assets                                                                                                                                                                                                                     |   | 10,363                   |    | 9,497                   |   |
| Total assets                                                                                                                                                                                                                     |   | $                        | 358,280 |                    | $      | 331,407 |   |
|                                                                                                                                                                                                                             |   |                     |    |                    |   |
| LIABILITIES, CONVERTIBLE PREFERRED STOCK  AND STOCKHOLDERS’ EQUITY                                                                                                                                                          |   |                     |    |                    |   |
| Current liabilities:                                                                                                                                                                                                             |   |                     |    |                    |   |
| Current portion of long-term debt and  capital lease obligations                                                                                                                                                                 |   | $                        | 4,306   |                    | $      | 5,654 |   |
| Accounts payable                                                                                                                                                                                                                 |   | 129,939                  |    | 127,085                 |   |
| Accrued expenses and other current  liabilities                                                                                                                                                                                  |   | 36,632                   |    | 39,157                  |   |
| Total current liabilities                                                                                                                                                                                                        |   | 170,877                  |    | 171,896                 |   |
|                                                                                                                                                                                                                             |   |                     |    |                    |   |
| Long-term debt and capital lease  obligations                                                                                                                                                                                    |   | 19,900                   |    | 18,003                  |   |
| Other liabilities                                                                                                                                                                                                                |   | 6,754                    |    | 5,260                   |   |
| Total liabilities                                                                                                                                                                                                                |   | 197,531                  |    | 195,159                 |   |
|                                                                                                                                                                                                                             |   |                     |    |                    |   |
| Commitments and contingencies (Note 13)                                                                                                                                                                                          |   |                     |    |                    |   |
|                                                                                                                                                                                                                             |   |                     |    |                    |   |
| Series A convertible preferred stock,  $0.001 par value, 830,000 shares authorized; 830,000 shares issued and  outstanding at June 29, 2003 and December 31, 2002, respectively (Liquidation  value of $50 per share)            |   | 37,035                   |    | 35,551                  |   |
|                                                                                                                                                                                                                             |   |                     |    |                    |   |
| Series B convertible preferred stock,  $0.001 par value, 500,000 shares authorized; 500,000 and 0 shares issued and  outstanding at September 28, 2003 and December 31, 2002, respectively  (Liquidation value of $50 per share) |   | 21,449                   |    | —                  |   |
|                                                                                                                                                                                                                             |   |                     |    |                    |   |
| Stockholders’ equity:                                                                                                                                                                                                       |   |                     |    |                    |   |
| Preferred stock, $0.001 par value,  3,670,000 shares authorized; no shares issued and outstanding                                                                                                                                |   | —                   |    | —                  |   |
| Common stock, $0.001 par value; 150,000,000  shares authorized**;**35,800,640  shares issued and 33,998,693 outstanding at September 28, 2003 and  34,725,397 shares issued and 33,174,177 outstanding at December 31, 2002      |   | 36                       |    | 35                      |   |
| Additional paid in capital                                                                                                                                                                                                       |   | 266,548                  |    | 264,809                 |   |
| Accumulated deficit                                                                                                                                                                                                              |   | (155,349                 | )       | (150,264                | )      |
| Accumulated other comprehensive loss                                                                                                                                                                                             |   | (2,223                   | )       | (7,136                  | )      |
| Treasury stock, at cost; 1,551,220 shares  at September 28, 2003 and December 31, 2002                                                                                                                                           |   | (6,747                   | )       | (6,747                  | )      |
| Total stockholders’ equity                                                                                                                                                                                                  |   | 102,265                  |    | 100,697                 |   |
| Total liabilities, convertible preferred  stock and stockholders’ equity                                                                                                                                                    |   | $                        | 358,280 |                    | $      | 331,407 |   |

 

See accompanying notes to the interim consolidated financialstatements.

 

3

----

 

MANUFACTURERS’ SERVICES LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED

(IN THOUSANDS, EXCEPT PER SHARE DATA)

 
|                                       |   | **Three  months ended** |    | **Nine  months ended**  |    |
|--------------------------------------------|--------|-------------------------|---------|-------------------------|---------|
|                                       |   | **September  28, 2003** |    | **September  29, 2002** |    | **September  28, 2003** |   | **September  29, 2002** |   |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Net sales                                  |   | $                       | 188,955 |                    | $       | 201,593 |   | $ | 532,531 |   | $ | 644,790 |   |
| Cost of goods sold                         |   | 174,124                 |    | 184,452                 |    | 489,446 |   | 586,558 |   |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Gross profit                               |   | 14,831                  |    | 17,141                  |    | 43,085 |   | 58,232 |   |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Operating expenses:                        |   |                    |    |                    |    |   |   |   |   |
| Selling, general and administrative        |   | 13,902                  |    | 15,510                  |    | 39,452 |   | 46,535 |   |
| Amortization of intangibles                |   | 45                      |    | —                  |    | 45 |   | 3,706 |   |
| Restructuring and asset writedowns         |   | 4,888                   |    | 9,763                   |    | 5,593 |   | 14,651 |   |
| Other operating income                     |   | —                  |    | —                  |    | — |   | (800 | ) |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Operating loss                             |   | (4,004                  | )  | (8,132                  | )  | (2,005 | )  | (5,860 | )  |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Interest expense, net                      |   | (1,000                  | )       | (1,059                  | )       | (3,102 | ) | (6,196 | ) |
| Change in fair value of derivatives        |   | (20                     | )       | 1,260                   |    | 300 |   | 2,170 |   |
| Foreign exchange gain (loss)               |   | 22                      |    | (21                     | )       | 428 |   | 35 |   |
| Loss from extinguishment of debt           |   | —                  |    | —                  |    | — |   | (4,031 | ) |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Loss before provision for income taxes     |   | (5,002                  | )       | (7,952                  | )  | (4,379 | )  | (13,882 | ) |
| Provision for income taxes                 |   | 199                     |    | 480                     |    | 706 |   | 1,498 |   |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Net loss                                   |   | $                       | (5,201  | )                       | $       | (8,432 |  ) | $ | (5,085 | )  | $ | (15,380 | ) |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Net loss applicable to common stockholders |   | $                       | (6,468  | )                       | $       | (9,150 | ) | $ | (8,103 | ) | $ | (17,107 | ) |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Basic income (loss) per share:             |   |                    |    |                    |    |   |   |   |   |
| Net loss applicable to common stockholders |   | $                       | (0.19   | )                       | $       | (0.28 | ) | $ | (0.24 | ) | $ | (0.53 | ) |
| Weighted average shares outstanding        |   | 33,919                  |    | 32,584                  |    | 33,607 |   | 32,474 |   |
|                                       |   |                    |    |                    |    |   |   |   |   |
| Diluted income (loss) per share:           |   |                    |    |                    |    |   |   |   |   |
| Net loss applicable to common stockholders |   | $                       | (0.19   | )                       | $       | (0.28 | ) | $ | (0.24 | ) | $ | (0.53 | ) |
| Weighted average shares outstanding        |   | 33,919                  |    | 32,584                  |    | 33,607 |   | 32,474 |   |

 

See accompanying notes to the interimconsolidated financial statements.

 

4

----

 

MANUFACTURERS’ SERVICES LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED

(IN THOUSANDS)

 
|                                                                                      |   | **Nine  months ended**   |       |
|-------------------------------------------------------------------------------------------|--------|--------------------------|------------|
|                                                                                      |   | **September  28,  2003** |       | **September  29,  2002** |   |
|                                                                                      |   |                     | ** ** |   | ** ** |
| CASH FLOWS RELATING TO OPERATING  ACTIVITIES:                                             |   |                     |       |   |   |
| Net (loss)                                                                                |   | $                        | (5,085     | )  | $ | (15,380 | ) |
| Adjustments to reconcile net (loss) to net  cash provided by operating activities:        |   |                     |       |   |   |
| Depreciation and amortization                                                             |   | 11,538                   |       | 17,763 |   |
| Amortization of capitalized finance fees                                                  |   | 1,138                    |       | 2,135 |   |
| Write-off of capitalized bank fees                                                        |   | —                   |       | 4,031 |   |
| Change in fair value of derivative                                                        |   | (300                     | )          | (2,170 | ) |
| Changes in allowance for doubtful accounts                                                |   | (91                      | )          | 402 |   |
| Non cash charge for stock compensation                                                    |   | 540                      |       | 476 |   |
| Foreign exchange gain (loss)                                                              |   | (191                     | )          | (53 | ) |
| Goodwill impairment                                                                       |   | 2,258                    |       |   |   |
| Deferred taxes                                                                            |   | 169                      |       | 453 |   |
| Write down and (gain) loss on disposal of  fixed assets                                   |   | (101                     | )          | 6,710 |   |
| Changes in operating assets and  liabilities:                                             |   |                     |       |   |   |
| Accounts receivable                                                                       |   | (3,631                   | )     | 66,898 |   |
| Inventories                                                                               |   | (6,157                   | )     | 34,588 |   |
| Prepaid expenses and other assets                                                         |   | 6,023                    |       | 122 |   |
| Accounts payable                                                                          |   | (8,547                   | )          | (27,754 | ) |
| Accrued expenses and other liabilities                                                    |   | (4,615                   | )          | (8,685 | ) |
| Net cash (used in) provided by operating  activities                                      |   | (7,052                   | )     | 79,536 |   |
|                                                                                      |   |                     |       |   |   |
| CASH FLOWS RELATING TO INVESTING  ACTIVITIES:                                             |   |                     |       |   |   |
| Acquisition of business, net of cash  acquired                                            |   |                     |       | (5,250 | ) |
| Acquisition of assets                                                                     |   | (1,136                   | )          |   |   |
| Proceeds from sale of fixed assets                                                        |   | 5,160                    |       | 4,025 |   |
| Purchases of property and equipment                                                       |   | (10,249                  | )          | (2,648 | ) |
| Cost of internal use software                                                             |   | (596                     | )          | (353 | ) |
| Net cash (used in) provided by investing  activities                                      |   | (6,821                   | )          | (4,226 | ) |
|                                                                                      |   |                     |       |   |   |
| CASH FLOWS RELATING TO FINANCING  ACTIVITIES:                                             |   |                     |       |   |   |
| Proceeds from issuance of convertible  preferred stock and warrants net of issuance costs |   | 22,969                   |       | 37,720 |   |
| Proceeds from long-term debt                                                              |   | —                   |       | 9,189 |   |
| Net payments on previous revolving  line-of-credit                                        |   | —                   |       | (111,811 | ) |
| Net proceeds from new credit facilities                                                   |   | 228                      |       | 9,421 |   |
| Payments on term loan                                                                     |   | (999                     | )          | — |   |
| Repayments of long-term debt and capital  lease obligations                               |   | (5,380                   | )          | (5,620 | ) |
| Debt issuance and amendment costs                                                         |   | (300                     | )          | (4,605 | ) |
| Proceeds from exercise of stock options                                                   |   | 1,629                    |       | 795 |   |
| Proceeds from employee stock purchase plan                                                |   | 921                      |       | 586 |   |
| Net cash provided (used) in financing activities                                          |   | 19,068                   |       | (64,325 | ) |
| Effect of foreign exchange rates on cash                                                  |   | 686                      |       | 1,505 |   |
| Net increase in cash                                                                      |   | 5,881                    |       | 12,490 |   |
| Cash and cash equivalents at beginning of  period                                         |   | $                        | 48,955     |   | $ | 30,906 |   |
| Cash and cash equivalents at end of period                                                |   | $                        | 54,836     |   | $ | 43,396 |   |

 

See accompanying notes to the interimconsolidated financial statements.

 

5

----

 

MANUFACTURERS’ SERVICES LIMITED

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

(IN THOUSANDS, EXCEPT SHARE DATA)

 

1.  BASIS OF PRESENTATION

 

The accompanying consolidated financial statements of Manufacturers’Services Limited (the “Company”) are unaudited, and certain information andfootnote disclosure related thereto, normally included in financial statementsprepared in accordance with generally accepted accounting principles, has beenomitted in accordance with Rule 10-01 of Regulation S-X. Accordingly, thesestatements should be read in conjunction with the audited financial statementsand notes thereto for the year ended December 31, 2002 included in theCompany’s Annual Report on Form 10-K. In the opinion of management, theaccompanying unaudited consolidated financial statements were preparedfollowing the same policies and procedures used in the preparation of theaudited financial statements and reflect all adjustments (consisting of normalrecurring adjustments) considered necessary to present fairly the financialposition and results of operations of the Company. The results of operationsfor the interim periods are not necessarily indicative of the results for theentire fiscal year.  Certain amounts inprior year financial statements have been reclassified to conform to thecurrent year presentation.

 

Borrowings under the Company’s credit agreement, which was entered intoin June 2002 (the “2002 Credit Agreement”) are dependent upon a borrowing basecalculation derived from accounts receivable and inventory. Availability ofborrowings fluctuates according to the quantity and quality of the Company’sreceivables and inventory and the legal jurisdiction of the Company’sreceivables and inventory.   Borrowingsunder our 2002 Credit Agreement could be limited by a number of factors,including the following:

 

•                  revenuereductions from decreased customer demand or lost customers causing lowerborrowing assets, particularly accounts receivable,

 

•                  a lower amountof our business being conducted in the US and Mexico,

 

•                  deterioration inthe value of the assets comprising the borrowing base, or

 

•                  failure tocomply with Credit Agreement covenants.

 

The Company is currently in compliance with all covenants under the2002 Credit Agreement.  In the event itdoes not have adequate funding from its existing credit facilities, the Companywould work with its lending institutions to modify the 2002 Credit Agreement oridentify other potential sources of capital to obtain necessary debt or equityfinancing.  In such a circumstance,there is no assurance the Company would be able to modify the 2002 CreditAgreement with existing lenders or obtain alternative debt or equity financingto satisfy its funding needs.

 

2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

InMay 2003, the Financial Accounting Standards Board (“FASB”) issued SFASNo. 150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity,” which establishes standardsfor how an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. Financial instruments that are withinthe scope of the statement, which previously were often classified as equity,must now be classified as liabilities. This statement is effective forfinancial instruments entered into or modified after May 31, 2003, andotherwise shall be effective at the beginning of the first interim periodbeginning after June 15, 2003. The Company has determined that theadoption of SFAS No. 150 did not have an impact on its consolidatedfinancial statements.

 

InApril 2003, the FASB issued SFAS No. 149, “Amendments of Statement 133 onDerivative Instruments and Hedging Activities,” which amends and clarifiesfinancial accounting and reporting for derivative instruments, includingcertain derivative instruments embedded in other contracts and for hedgingactivities under SFAS No. 133. This statement is effective for contractsentered into or modified after June 30, 2003, with certain exceptions, andfor hedging relationships designated after June 30, 2003. The adoption ofSFAS No. 149 did not have a material impact on its condensed consolidatedfinancial statements.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation- Transition and Disclosure” (“SFAS 148”).  This statement amends SFAS No. 123,“Accounting for Stock-Based Compensation,” (“SFAS 123”) to providealternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation.  Under the provisions of SFAS 148, companiesthat choose to adopt the accounting provisions of SFAS 123 will be permitted toselect from three transition methods: the prospective method, the modifiedprospective method and the retroactive restatement method. The prospectivemethod, however, may no longer be applied for adoptions of the accountingprovisions of SFAS

 

6

----

 

123 for periods beginning after December 15, 2003. SFAS 148requires certain new disclosures that are incremental to those required by SFAS123, which must also be made in interim financial statements. The transitionand annual disclosure provisions of SFAS 148 are effective for fiscal yearsending after December 31, 2002. The Company has adopted the new interimdisclosure provisions.  The Company hasdecided not to voluntarily adopt the accounting provisions of SFAS 123 aspermitted under the provisions of SFAS 148.

 

In June 2002, the FASB issued SFAS No. 146, “Accounting forExit or Disposal Activities”.  SFASNo. 146 addresses significant issues regarding the recognition, measurementand reporting of costs that are associated with exit and disposal activities,including restructuring activities that were accounted for under EITFNo. 94-3.  The Company adopted theprovisions of SFAS No. 146 effective for exit or disposal activitiesinitiated after December 31, 2002. The effect-on-adoption of SFAS No. 146 changed the timing of whenrestructuring charges are recorded from a commitment date approach to when theliability is incurred.

 

In April 2002, the FASB issued SFAS No. 145 “Rescission of FASBStatements No.4, 44 and 64, Amendment of FASB Statement No.13, and TechnicalCorrections as of April 2002”.  FASB No.145 eliminates FASB No. 4 “Reporting Gains and Losses from Extinguishment of Debt”,which required companies to classify gains or losses from the extinguishment ofdebt as an extraordinary item, net of tax. As a result of this new FASB, gainsand losses from extinguishment of debt should be classified as extraordinaryitems only if they meet the criteria in APB Opinion No. 30 “Reporting theResults of Operations-Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions”.  The Company does notbelieve that the extinguishment of debt will qualify as an extraordinary itemas defined in APB 30, and therefore the Company will be required to classifythese charges as non-operating expenses. The Company has adopted SFAS No. 145 on January 1, 2003, and has reclassifiedthe extraordinary loss to a non-operating loss in all applicable comparativeperiods.

 

In June 2001, the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations” to be effective for all fiscal years beginning afterJune 15, 2002, with early adoption permitted.  SFAS No. 143 establishes accounting standards for therecognition and measurement of an asset retirement obligation and itsassociated asset retirement cost. It also provides accounting guidance forlegal obligations associated with the retirement of tangible long-lived assets.The Company adopted SFAS No. 143 in the first quarter of 2003 and theadoption did not impact its financial position, results of operations or cashflows.

 

3.  INVENTORY

 

Inventories are comprised of the following:

 
|                                   |   | **September  28,  2003** |    | **December  31,  2002** |   |
|----------------------------------------|--------|--------------------------|---------|-------------------------|--------|
| Raw  materials and purchased inventory |   | $                        | 94,876  |                    | $      | 82,532 |   |
| Work-in-process                        |   | 12,946                   |    | 10,559                  |   |
| Finished goods                         |   | 4,353                    |    | 5,736                   |   |
|                                   |   | $                        | 112,175 |                    | $      | 98,827 |   |

 

4.  BUSINESS SEGMENT INFORMATION

 

The Company’s operations comprise a single line of business, providingelectronics design and manufacturing services. Information about the Company’soperations in different geographic regions is presented in the table below:

 
|                    |   | **Three  Months Ended** |    | **Nine  Months Ended**  |   |
|-------------------------|--------|-------------------------|---------|-------------------------|--------|
|                    |   | **September  28, 2003** |    | **September  29, 2002** |   | **September  28, 2003** |   | **September  29, 2002** |   |
| Geographic net sales    |   |                    |    |                    |   |   |   |   |   |
| United States           |   | $                       | 99,746  |                    | $      | 123,986 |   | $ | 282,169 |   | $ | 431,063 |   |
| Spain                   |   | 50,904                  |    | 41,891                  |   | 130,584 |   | 126,208 |   |
| Other foreign countries |   | 38,305                  |    | 35,716                  |   | 119,778 |   | 87,519 |   |
|                    |   | $                       | 188,955 |                    | $      | 201,593 |   | $ | 532,531 |   | $ | 644,790 |   |

 
|                    |   | **September  28,  2003** |   | **December  31,  2002** | ** ** |
|-------------------------|--------|--------------------------|--------|-------------------------|------------|
| Long-lived assets       |   |                     |   |                    |       |
| United States           |   | $                        | 16,482 |                    | $          | 20,042 |   |
| Spain                   |   | 23,828                   |   | 13,009                  |       |
| Other foreign countries |   | 12,716                   |   | 11,105                  |       |
|                    |   | $                        | 53,026 |                    | $          | 44,156 |   |

 

7

----

 

5. STOCK-BASED COMPENSATION

 

The Company’s employee stock compensation plans are accounted for inaccordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” (“APB 25”) and related interpretations. Underthis method, no compensation expense is recognized as long as the exerciseprice equals or exceeds the market price of the underlying stock on the date ofgrant. The Company elected the disclosure-only alternative permitted under SFASNo. 123 for fixed stock-based awards to employees. All non-employeestock-based awards are accounted for in accordance with SFAS 123.

 

The Company uses the Black-Scholes option pricing model to estimate thefair value of options granted.  TheBlack-Scholes model was developed for use in estimating the value of tradedoptions that have no vesting restrictions and are fully transferable.  The Company’s employee stock options havecharacteristics significantly different from those of traded options;therefore, the Black-Scholes option pricing model may not provide a reliablemeasure of the fair value of the Company’s options.

 

The following table illustrates the effect on net loss and loss pershare if the Company had applied the fair value recognition provisions of SFASNo. 123.

 
|                                                                                       |   | **Three Months Ended**  |       | **Nine Months Ended**   |       |
|--------------------------------------------------------------------------------------------|--------|-------------------------|------------|-------------------------|------------|
|                                                                                       |   | **September  28, 2003** |       | **September  29, 2002** |       | **September  28, 2003** |   | **September  29, 2002** |   |
|                                                                                       |   |                    | ** ** |                    | ** ** |   | ** ** |   | ** ** |
| Net loss available to common stockholders,  as reported                                    |   | $                       | (6,468     | )                       | $          | (9,150 | ) | $ | (8,103 | ) | $ | (17,107 | ) |
| Add : Total stock-based employee  compensation expense included in reported net loss       |   | 92                      |       | 142                     |       | 542 |   | 475 |   |
| Deduct : Stock-based employee compensation  expense determined under the fair value method |   | (2,080                  | )          | $                       | (1,923     | ) | (4,840 | ) | (5,260 | ) |
| Pro forma net loss available to common  stockholders                                       |   | $                       | (8,456     | )                       | $          | (10,931 | ) | $ | (12,401 | ) | $ | (21,892 | ) |
|                                                                                       |   |                    |       |                    |       |   |   |   |   |
| Basic and Diluted net loss per share:                                                      |   |                    |       |                    |       |   |   |   |   |
| As reported                                                                                |   | $                       | (0.19      | )                       | $          | (0.28 | ) | $ | (0.24 | ) | $ | (0.53 | ) |
| Pro forma                                                                                  |   | $                       | (0.25      | )                       | $          | (0.34 | ) | $ | (0.37 | ) | $ | (0.67 | ) |

 

6.  EARNINGS PER SHARE

 

The following table illustrates the reconciliation of the numerator anddenominator of basic and diluted loss per share as required by SFAS 128:

 
|                                                     |   | **Three  Months Ended**  |   | **Nine  Months Ended**   |   |
|----------------------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
|                                                     |   | **September  28,  2003** |   | **September  29,  2002** |   | **September  28,  2003** |   | **September  29,  2002** |   |
| Numerator - basic and diluted earnings per  share:       |   |                     |   |                     |   |   |   |   |   |
| Loss                                                     |   | $                        | (5,201 | )                        | $      | (8,432 | )  | $ | (5,085 | )  | $ | (15,380 | ) |
| Dividends on convertible preferred stock                 |   | (737                     | )      | (396                     | )      | (1,829 | ) | (1,032 | ) |
| Accretion of convertible preferred stock                 |   | (530                     | )      | (322                     | )      | (1,189 | ) | (695 | ) |
| Loss available to common stockholders                    |   | $                        | (6,468 | )                        | $      | (9,150 | ) | $ | (8,103 | ) | $ | (17,107 | ) |
|                                                     |   |                     |   |                     |   |   |   |   |   |
| Denominator:                                             |   |                     |   |                     |   |   |   |   |   |
| Basic and diluted - weighted average shares  outstanding |   | 33,919                   |   | 32,584                   |   | 33,607 |   | 32,474 |   |
|                                                     |   |                     |   |                     |   |   |   |   |   |
| Basic and diluted loss per share                         |   | $                        | (0.19  | )                        | $      | (0.28 | ) | $ | (0.24 | ) | $ | (0.53 | ) |

 

For the three and nine months ended September 28, 2003, 8,238anti-dilutive option and warrant shares, and for the three and nine monthsended September 29, 2002**,**8,681 anti-dilutive option and warrantshares have been excluded from the calculation of diluted earnings per share,as the Company had a net loss available to common stockholders for theseperiods.

 

In addition, for three months ended September 28, 2003 and September29, 2002 and the nine months ended September 28, 2003 and September 29, 2002, atotal of 10,760**,**6,831, 10,760 and6,831 shares, respectively, of convertible preferred stock and preferredstock dividends have been excluded from the calculation of diluted earning pershare on an “if converted” basis as they are anti-dilutive in nature until theCompany exceeds a certain net income threshold.

 

8

----

 

7.  COMPREHENSIVE INCOME (LOSS)

 

The following table illustrates the components of comprehensive income(loss) as required by SFAS 130:

 
|                                     |   | **Three  Months Ended**  |   | **Nine  Months Ended**   |   |
|------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
|                                     |   | **September  28,  2003** |   | **September  29,  2002** |   | **September  28,  2003** |   | **September  29,  2002** |   |
| Net Income (loss)                        |   | $                        | (5,201 | )                        | $      | (8,432 | )  | $ | (5,085 | )  | $ | (15,380 | ) |
| Other comprehensive income (loss)        |   |                     |   |                     |   |   |   |   |   |
| Foreign currency translation adjustments |   | 477                      |   | 30                       |   | 4,913 |   | 4,084 |   |
|                                     |   |                     |   |                     |   |   |   |   |   |
| Comprehensive loss                       |   | $                        | (4,724 | )                   | $      | (8,402 | )  | $ | (172 | )  | $ | (11,296 | ) |

 

8. RESTUCTURING

 

During the third quarter of fiscal 2003, the Company recordedrestructuring charges of $2,630.  Thesecharges primarily related to severance costs of $2,192, additional contingentliability of $400 and $63 of other costs in connection with the shutdown of theAthlone, Ireland plant.  These amountswere partially offset by a reversal of $25 related to a prior yearrestructuring expense.  Therestructuring of the Athlone plant includes the reduction of approximately 225manufacturing and managerial employees.

 

In the second quarter of 2003, the Company recorded a net restructuringcharge of $954.  This included a chargeof $1,600 related to certain costs in connection with the planned closing ofthe Company’s Athlone, Ireland plant, which was formally announced in July2003.  This charge relates to anestimated contingent liability for which the expected settlement had beendetermined to be probable as of June 29, 2003. This amount was offset by a reversal of $432 of restructuring reservesrelated to the final sale of the Company’s China operation, which had been shutdown in the third quarter of 2002 and a recorded gain of $214 on assets thathad previously been written down at its China facility in accordance with SFAS144.

 

In the first quarter of 2003, the Company reversed $249 ofrestructuring reserves related mainly to severance expenses which are no longerexpected to be incurred.

 

In the third quarter of 2002, the Company recorded restructuring andasset writedown charges of $9,763, primarily related to closing its facility inMt. Prospect, Illinois and restructuring of certain manufacturing space inSingapore.  The total cost was comprisedof severance of $3,696 related to the termination of approximately 313manufacturing and managerial employees, asset write downs of $2,107 and leasetermination and facility costs of $3,960. This plan was substantially complete by the end of the second quarter of2003, except for lease payments in Singapore, which may continue until thelease expires in 2010.

 

In the second quarter of 2002, the Company recorded a gain of $569 fromthe sale of its Salt Lake City building. This was recorded as a reversal of a restructuring charge, which hadbeen taken in the third quarter of 2001 when the Company wrote down thebuilding to its estimated fair market value.

 

In the first quarter of 2002, the Companyimplemented a plan to restructure certain operations, primarily related toclosing its facility in China and a workforce reduction at its corporateheadquarters.  The China facility, whichceased operations during the third quarter of 2002, was closed, as the site didnot meet the Company’s long-term strategic goals.  The total charge recorded for this plan was $5,457, which wascomprised of asset write-downs of $3,069, lease termination costs of $548 andseverance of $1,840 related to the reduction of 371 manufacturing and 24managerial employees.  This plan wascompleted by the end of the second quarter of 2003.

 

During the full year 2002, the Company implemented variousrestructuring plans throughout its organizations to align its cost structurewith the reduced revenue stream as a result of the economic downturn in the EMSindustry.  In total for all 2002, theCompany incurred restructuring charges of $13,488 consisting of assetwrite-downs of $4,315, employee severance of $5,343 and lease termination costsof $3,830.

 

The following table sets forth the activity in the restructuringreserves from December 31, 2002 to September 28, 2003:

 
|                           |   | **Employee  Severance and  Related Expenses** |    | **Lease Payments  on Facilities and  Equipment** |   | **Other Plant  Closing Costs** |   | **Total** |   |
|--------------------------------|--------|-----------------------------------------------|---------|--------------------------------------------------|--------|--------------------------------|--------|-----------|--------|
| Balances at  December 31, 2002 |   | $                                             | 1,973   |                                             | $      | 3,572                          |   | $         | — |   | $ | 5,545 |   |
| Charges  utilized              |   | (1,416                                        | )       | (865                                             | )      | —                         |   | (2,281    | )      |
| Provision  adjustments         |   | (249                                          | )       | —                                           |   | —                         |   | (249      | )      |
| Balance at  March 30, 2003     |   | 308                                           |    | 2,707                                            |   | —                         |   | 3,015     |   |
| Restructuring  provision       |   | —                                        |    | —                                           |   | 1,600                          |   | 1,600     |   |
| Charges  utilized              |   | (201                                          | )       | (146                                             | )      | —                         |   | (347      | )      |
| Provision  adjustments         |   | —                                        |    | (432                                             | )      | —                         |   | (432      | )      |
| Balance at  June 29, 2003      |   | 107                                           |    | 2,129                                            |   | 1,600                          |   | 3,836     |   |
| Restructuring  provision       |   | 2,192                                         |    | —                                           |   | 463                            |   | 2,655     |   |
| Charges  utilized              |   |                                          |    | (84                                              | )      | —                         |   | (84       | )      |
| Provision  adjustments         |   | (25                                           | )  |                                             |   | —                         |   | (25       | )      |
| Balance at  September 28, 2003 |   | $                                             | 2,274   |                                             | $      | 2,045                          |   | $         | 2,063  |   | $ | 6,382 |   |

 

9

----

 

Reserves remaining at September 28, 2003mainly represent lease termination payments in Singapore, which may continueuntil the lease expires in 2010, and liabilities related to the Athlone plantclosing which should be settled by the fourth quarter of 2003.

 

9. GOODWILL AND INTANGIBLE ASSET

 

In accordance with SFAS No. 142, the Company is required to perform anannual goodwill impairment test.  TheCompany has chosen the beginning of its third fiscal quarter, which began onJune 30, 2003 as its annual test date. This involves determining the estimated fair value of each reportingunit and comparing it to the reporting unit’s carrying amount.  If a reporting unit’s carrying amountexceeds its fair value, an indication exists that the reporting unit’s goodwillis impaired and the Company would be required to perform the second step of theimpairment test.  The Company completedits annual impairment test during the fiscal third quarter.

 

The results of step one of the annual impairment test for each of theCompany’s three reporting units with goodwill indicated that a potentialimpairment existed only within its Westford reporting unit, which had recordedgoodwill of $2,258 as of June 29, 2003. The Company performed the second step of the impairment test forWestford, and compared the units implied fair value (determined by allocatingthe unit’s fair value based on expected future discounted cash flows, to allassets, recognized and unrecognized, and liabilities) to the unit’s carryinggoodwill amount of $2,258.  This secondstep indicated that all of Westford’s goodwill was impaired and the entirecarrying amount of the goodwill was recorded as an impairment loss in the thirdquarter of 2003. 

 

In connection with the acquisition of certain manufacturing assets, andassumed liabilities and the execution of a four-year manufacturing servicesagreement at the Barcelona, Spain operation of Telesincro, S.A., a subsidiaryof Groupe Ingenico, the Company has recorded an intangible asset of $904related to this customer contractual relationship.  This customer relationship intangible is being amortized over thelife of the manufacturing services agreement. Intangible amortization expense of $45 was recorded in the third quarterof 2003.

 

Changes in the net carrying amount of goodwill for the nine-monthperiod ended September 28, 2003 were as follows:

 
| Balance at  December 31, 2002            |   | $      | 8,441  |   |
|------------------------------------------|--------|--------|--------|--------|
| Goodwill  impairment                     |   | (2,258 | )      |
| Foreign  currency translation adjustment |   | 124    |   |
| Balance at  September 28, 2003           |   | $      | 6,307  |   |

 

 

10.  CONVERTIBLE PREFERRED STOCK

 

On July 2, 2003, the Company issued $25,000 of Series B ConvertiblePreferred Stock (“Series B Preferred”) and warrants to purchase 1,165,254shares of common stock in a private placement to qualified accreditedinvestors.  Proceeds of the Series BPreferred and warrants, net of costs, were approximately $22,969.  The Series B Preferred have been recorded astemporary equity, and the warrants will be recorded as liabilities.

 

The Series B Preferred accrues dividends quarterly at the rate of 4.50%per annum, payable quarterly in common stock or cash, at the Company’s option.The Series B Preferred is convertible to common stock at any time by holdersbased on a conversion price of $5.90 per share. The Series B Preferred has a scheduledmaturity of July 3, 2008, unless converted earlier.  The Company may redeem the Series B Preferred on or after July 3,2006, in whole or in part, at its option, at par value payable in the Company’scommon stock or cash, at the Company’s option, plus accrued and unpaiddividends, if any, payable in cash.  Ifthe Company chooses to pay dividends in common stock or to redeem theconvertible preferred stock with common stock, the number of shares of commonstock issued will be computed using 95% of the market value of the common stockat that time. The warrants are exercisable at any time through July 3, 2008 atthe exercise price of $6.275 per share. The Company has the right to requirethe exercise of the warrants at any time if the common stock trades for 175% ofthe exercise price of the warrants for a specified period of time.

 

A portion of the total consideration received was allocated to thewarrants based on their initial fair value of $1,950 and the residual proceedswere allocated to the Series B Preferred. The resulting initial Series B Preferred balance will be accreted to theliquidation value of $50 per share, subject to certain adjustments over thelife of the Series B Preferred.  Thediscount on the Series B Preferred resulting from allocation of proceeds to thewarrants will be accreted, using the effective interest method, through thescheduled maturity date and will be recorded as a charge against additionalpaid in capital.  In the event the Companyelects to call the Series B Preferred in advance of the maturity date,accretion of the remaining discount will occur.  All such amounts for accretion will be deducted from the netincome available to common stockholders, for purposes of earnings per sharecalculations.

 

In March 2002, the Company issued $41,500 of Series A ConvertiblePreferred Stock (“Series A Preferred”) and warrants to purchase 1,612,281shares of common stock in a private placement to qualified accreditedinvestors.  Proceeds of the Series APreferred,

 

10

----

 

net of costs of the offering, were $37,720. The Series A Preferred isrecorded as temporary equity, and the warrants are recorded as liabilities.

 

The Series A Preferred accrues dividends quarterly at the rate of 5.25%per annum, payable quarterly in common stock or cash, at the Company’s option.The Series A Preferred is convertible to common stock at any time by holdersbased on a conversion price of $6.44 per share. The Company may require holdersto convert to common stock provided the price of its common stock has traded at150% of the conversion price, or $9.65 per share, for a specified period.  The Series A preferred has a scheduledmaturity of March 14, 2007, unless converted earlier, and is redeemablefor the Company’s common stock or cash, at the Company’s option.  If the Company chooses to pay dividends incommon stock or to redeem the Series A Preferred with common stock, the numberof shares of common stock issued will be computed using 95% of the market valueof the common stock at that time. The warrants are exercisable at any timethrough March 14, 2007 at the exercise price of $7.02 per share. TheCompany has the right to require the exercise of the warrants afterMarch 14, 2003 if the common stock trades for 175% of the exercise priceof the warrants for a specified period.

 

A portion of the total consideration received was allocated to thewarrants based on their fair value of $3,189 and the residual proceeds wereallocated to the Series A Preferred. The resulting initial Series A Preferred balance will be accreted to theliquidation value of $50 per convertible preferred share, subject to certainadjustments over the life of the Series A Preferred.  The discount resulting from allocation of proceeds to thewarrants will be accreted, using the effective interest method, through thescheduled maturity date and will be recorded as a charge against additionalpaid in capital.  In the event theCompany elects to call the Series A Preferred in advance of the maturity date,accretion of the remaining discount will occur.  All such amounts for accretion are deducted from the net incomeavailable to common stockholders, for purposes of basic earnings per sharecalculations.

 

11.  ACQUISITIONS

 

On July 22, 2003, the Company acquired certain manufacturing assets andassumed certain liabilities of the Barcelona, Spain operation of Telesincro,S.A., a subsidiary of Groupe Ingenico for approximately $1,136 in cash.  Included in the transfer were approximately280 manufacturing employees.  The sitehad been Ingenico’s only internal manufacturing facility for electronic paymentterminals.  The purchased assets includeproduction assets, service inventory and intellectual property necessary tomanufacture, repair and otherwise service the terminals.  As part of the transaction the Companyagreed to lease 5,500 square meters in the Barcelona facility for three yearsand entered into a four year manufacturing services agreement to manufacture,repair and service terminals for Ingenico. The agreement includes a minimum guaranteed cost protection for theCompany for the first three years.

 

In addition, the Company transferred 250,000 shares of its common stockto Ingenico as an incentive for Ingenico to award additional revenue amountsover the next three years.  These sharesare not registered or transferable for the three-year period and the Companyretains the right to repurchase the shares at $0 in the event that Ingenico hasnot awarded the Company the required revenue amounts.  At such time as the contingency becomes reasonably probable andestimatable, the Company’s financial statements, for the period or periods willreflect that impact.

 

On July 1, 2002, the Company acquired all of the capital stock andcertain assets of Lexmark Electronics S.A. de C.V., a subsidiary of LexmarkInternational, Inc. located in Reynosa, Mexico, that provides printed circuitboard assemblies for laser printers, for approximately $6,002 in cash andassumed liabilities. Included in the purchase price is $3,200 of inventory thatthe Company had agreed to purchase within 60 days after the closing.  The acquired assets consist of cash of $752,manufacturing assets and working capital related to the operations, while theliabilities consist of accounts payable and accrued liabilities. Thetransaction was accounted for as a purchase of a business, and the purchaseprice was allocated to the assets and liabilities based upon their relativefair values at the date of acquisition. The excess of the fair value of assets acquired over the purchase pricewas allocated to the acquired fixed assets, which reduced their recorded fairvalues.  As part of the transaction, theCompany retained approximately 230 facility employees, entered into a lease fora 156,000 square foot manufacturing facility in Reynosa and entered into aneighteen-month supply agreement to provide printed circuit board assemblies toLexmark.

 

 

12. GUARANTEES AND INDEMNIFICATION OBLIGATIONS

 

As permitted under Delaware law, we have agreements whereby weindemnify our officers and directors for certain events or occurrences whilethe officer or director is, or was, serving at our request in such capacity.The term of the indemnification period is for the officer’s or director’slifetime. The maximum potential amount of future payments we could be requiredto make under these indemnification agreements is unlimited; however, we haveDirectors and Officers Liability insurance policies that limit our exposure forevents covered under the policies and enable us to recover a portion of anyfuture amounts paid. As a result of the coverage under our insurance policies,we believe the estimated fair value of these indemnification agreements isminimal. Most of these indemnification agreements were grandfathered under theprovisions of FIN No. 45 as they were in effect prior to December 31,2002. Accordingly, we have no liabilities recorded for these agreements as ofSeptember 28, 2003.

 

In conjunction with our initial public offering in June 2000, we enteredinto an Underwriting Agreement with several underwriters in which we agreed toindemnify the underwriters for losses, claims or damages caused by an untruestatement or alleged

 

11

----

 

untrue statement or omission or alleged omission of a material factcontained in or omitted from our Registration Statement. The term and maximumpotential amounts of this indemnification is not limited. However, we have aDirectors and Officers Liability Insurance policy that limits our expense forevents covered by such policies. Accordingly, we believe the estimated fairvalue of this indemnification obligation is minimal. Accordingly, we have noliabilities recorded from the agreement as of September 28, 2003.

 

In June 2002, we entered into a Credit Agreement in which we agreed toindemnify each lender party thereto, from any taxes or incurred lending costspaid by such lenders in connection with the Credit Agreement, including as aresult of any change in the tax laws or other regulations. This indemnificationobligation is unlimited as to time and amount. We have never been required tomake any payments pursuant to this indemnification. As a result, we believe theestimated fair value of this indemnification agreement is minimal. Accordingly,we have no liabilities recorded for those agreements as of September 28, 2003.

 

The Company provides for the estimated cost of product warranties,primarily from historical information, at the time product revenue isrecognized. While the Company engages in extensive product quality programs andprocesses, the Company’s warranty obligation is affected by product failurerates, utilization levels, material usage, service delivery costs incurred incorrecting a product failure, and supplier warranties on parts delivered to theCompany.  Should actual product failurerates, utilization levels, material usage, service delivery costs or supplierwarranties on parts differ from the Company’s estimates, revisions to theestimated warranty liability would be required. 

 

 
| Balance at  December 31, 2002                                            |   | $      | 1,359  |   |
|--------------------------------------------------------------------------|--------|--------|--------|--------|
| Accruals for  warranties during the nine months ended September 28, 2003 |   | 88     |   |
| Settlements  made during the nine months ended September 28, 2003        |   | (231   | )      |
|                                                                     |   |   |   |
| Balance at  September 28, 2003                                           |   | $      | 1,216  |   |

 

 

13.  COMMITMENTS ANDCONTINGENCIES

 

A class action complaint filed on December 6, 2000, allegingviolations of federal securities laws has been pending in the United StatesDistrict Court, Southern District of New York against the Company, certain ofits former officers and the underwriters that participated in the Company’sinitial public offering (“IPO”). The Company understands that various otherplaintiffs have filed substantially similar class action cases againstapproximately 300 other publicly traded companies and their IPO underwriters,which cases have been consolidated to a single federal district court forcoordinated case management. The complaint, which seeks unspecified damagesamong other things, alleges that the prospectus filed by the Company relatingto stock sold in its initial public offering contained false and misleadingstatements with respect to the commission arrangements between the underwritersand their customers. The Company believes that this claim against the Companylacks merit.

 

On July 15, 2002, the Company together with the other issuersnamed as defendants in these coordinated proceedings filed a collective motionto dismiss the consolidated complaints against them on various legal grounds.  On October 9, 2002, the court approveda stipulation between the plaintiffs and the individual defendants providingfor the dismissal of the individual defendants without prejudice.  In February 2003, that motion wasdenied with respect to most issuers, including the Company.

 

The Company has agreed to enter into aMemorandum of Understanding proposed by the plaintiffs containing the terms ofan agreement resolving the claims of the plaintiffs against the Company and itsnamed officers.  While theCompany can make no assurances regarding the outcome of this action, theCompany believes that the final result will have no material effect on itsconsolidated financial condition or result of operations.

 

In addition, the Company is from time to time subject to legalproceedings and claims, which arise in the normal course of its business. Inthe opinion of management, the amount of ultimate liability with respect tothese actions will not have a material adverse effect on the Company’sfinancial position or its results of operations.

 

The Company uses forward currency exchange contracts primarily to hedgecertain operational ("cash flow" hedges) and balance sheet("fair value" hedges) exposures resulting from fluctuations incurrency exchange rates.  Such exposuresprimarily result from portions of the Company's operations and assets that aredenominated in currencies other than the functional currencies of thebusinesses conducting the operations or holding the assets. The Company entersinto currency exchange contracts in the normal course of business, andaccordingly, the hedges are not speculative in nature. The Company does nothold or transact in financial instruments for purposes other than riskmanagement.

 

12

----

 

14.  SUBSEQUENT EVENTS

 

On October 15, 2003, the Company announced that it had entered into anagreement and plan of merger with Celestica, Inc. that provides for theacquisition by Celestica of all of the outstanding shares of the Company.  Under the transaction, each outstandingshare of common stock of the Company will be exchanged for 0.375 subordinatevoting shares of Celestica subject to certain adjustments.  In addition, the holders of Series A andSeries B convertible preferred shares of the Company will be entitled toreceive, at the shareholder's election, US$52.50 per share plus accrueddividends in cash or a number of subordinate voting shares of Celestica subjectto certain adjustments equal to 0.375 times the number of shares of commonstock of the Company into which the Series A and Series B shares may beconverted (plus, in the case of the Series B preferred shares, a"make-whole" payment of US$2.25 per share payable in either cash orshares at the option of the Company). The share exchange ratio will be adjusted,if necessary, to ensure that the value of the consideration received for eachshare of common stock of the Company (based on the 20 trading day volume weighted average NYSE closing priceof the subordinate voting shares of Celestica determined on the third businessday prior to the completion of the transaction) will be not less than US$6.00and not more than US$7.25. 

 

The merger agreement, which has been approved unanimously by the boardsof directors of the Company and Celestica, is subject to the Company'sshareholder approval, certain governmental consents and other closingconditions.   Certain institutionalshareholders of the Company and officers of the Company, holding sharesrepresenting approximately 41.5% of the votes to be cast on the merger, haveentered into unconditional agreements to vote in favor of the merger, and theinstitutional shareholders have also granted Celestica the option to acquirefrom them, under certain circumstances, Company shares representing 30% of thevotes that can be cast in connection with the merger. All parties have agreedto proceed expeditiously to close the transaction.

 

The merger agreement requires the Company to conduct its business untilthe transaction with Celestica is completed in accordance with specifiedoperating covenants which preclude certain activities which are not in theordinary course of business and consistent with past practices.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS

 

FORWARD LOOKING STATEMENTS

 

References in this report to “the Company”, “MSL”, “we”, “our”, or “us”mean Manufacturers’ Services Limited together with its subsidiaries, exceptwhere the context otherwise requires. This Quarterly Report on Form 10-Qcontains certain statements that are, or may be deemed to be, forward-lookingstatements within the meaning of section 27A of the Securities Act of 1933 andsection 21E of the Securities Exchange Act of 1934, and are made in relianceupon the protections provided by such acts for forward-looking statements.These forward-looking statements (such as when we describe what we “believe,”“expect” or “anticipate” will occur, and other similar statements) include, butare not limited to, statements regarding future sales and operating results,future prospects, anticipated benefits of proposed (or future) acquisitions andnew facilities, growth, the capabilities and capacities of business operations,any financial or other guidance and all statements that are not based onhistorical fact, but rather reflect our current expectations concerning futureresults and events. The ultimate correctness of these forward-lookingstatements is dependent upon a number of known and unknown risks and events,and is subject to various uncertainties and other factors that may cause ouractual results, performance or achievements to be different from any futureresults, performance or achievements expressed or implied by these statements.The factors described under “Risk Factors” below are among the factors thatcould affect future results and events, causing those results and events todiffer materially from those expressed or implied in our forward-lookingstatements.

 

All forward-looking statements included in this Report onForm 10-Q are made only as of the date of this Report on Form 10-Q.We anticipate that subsequent events and developments will cause our views tochange.  However, while we may elect toupdate forward-looking statements at some point in the future, we specificallydisclaim any obligation to do so.  Theforward-looking information contained in this report should not be relied uponas representing our views as of any date subsequent to the date of this report.

 

OVERVIEW

 

We are a global electronic manufacturing and supply chain servicescompany providing a portfolio of integrated capabilities that allows ourcustomers to get their products to market faster, reduce their total costs andimprove their operating performance. Our customers include leading OEMs who have chosen outsourcing as acore manufacturing strategy. We have developed relationships with OEMs ina diverse range of industries, including industrial equipment, commercialavionics, retail infrastructure, medical

 

13

----

 

products, voice and data communications, network storage, officeequipment, computers, computer peripherals and consumer electronics.  By efficiently and aggressively managing ourbusiness, costs and asset base, we are able to offer our customers anoutsourcing solution that represents a lower total cost of ownership than thattypically provided by their internal operations. We seek to differentiateourselves by providing a superior customer experience through open and activecommunication, personalized service, a deep understanding of our customers’needs, attention to each customers unique operating requirements, customizedand flexible supply chain solutions and rapid response.

 

We provide integrated supply chain solutions that address all stages ofour customer’s product life cycle, including engineering and design, newproduct introduction, global supply chain management, printed circuit boardassembly, high speed automated manufacturing, final product assembly includingconfigure-to-order and build-to-order, integration and testing of complexsystems, fulfillment and distribution and after-market services.  We believe this comprehensive range ofservices provides opportunities for growth by attracting new customers and capturingadditional outsourcing opportunities with our existing customers.

 

We have a global network consisting of 15****manufacturing, design andfulfillment facilities in the world’s major electronics markets—North America,Europe and Asia—to serve the increasing outsourcing needs of both multinationaland regional OEMs.  Our manufacturing facilities are strategically locatednear our customers and their end-markets, which benefits our customers byreducing the time required to get their products to market and by increasingtheir flexibility to respond quickly to changing market conditions. We believethat the combination of our services and our global manufacturing network hasenabled us to become an integral part of our customers’ product development andmanufacturing strategies.

 

Since our founding in 1994 through 2000, our growth had been drivenprimarily by acquisitions of existing OEM manufacturing facilities and by theincreasing number of OEMs who had outsourced their manufacturingrequirements. During the past three years, we have closed certain facilitiesand reduced our workforce to reflect our reduced revenue stream resulting fromadverse economic conditions affecting demand for our customers’ end-marketproducts.  Despite this recentdownsizing, we intend to continue to actively pursue strategic acquisitions andto continue to benefit from expected increases in the number of OEMs thatoutsource their manufacturing requirements, as demonstrated by our recentacquisition of certain assets and assumed liabilities of Telesincro in July 2003.

 

During the past 2 years we have been repositioning ourselves in the EMSmarket by developing our offerings, adding new customers and refocusing therelationships we have and the business we do with existing customers toemphasize those services where we provide the most value.  We focus principally on those customers andprograms where we are the lead EMS provider.

 

We work closely with our customers to anticipate and forecast theirfuture volume of orders and delivery dates. We derive most of our net sales underpurchase orders from our customers. We recognize sales, net of expected productreturn and warranty costs, typically at the time of product shipment or asservices are rendered, provided no post-delivery obligations remain andcollection is reasonably assured. Our cost of goods sold usually includes thecost of components and materials, labor costs and manufacturing overhead.  Under some contracts, our customers will ownthe components and consign the inventory to us.  In these situations, we may recognize revenue (and related costof sales) only on the labor and overhead used to assemble the product.  The procurement of raw materials andcomponents requires us to commit significant working capital to our operationsand to manage the purchasing, receiving, inspection and stocking of theseitems. Our typical customer contract contains provisions which specify that wemay recover from the customer inventory costs and material acquisition costsfor raw material, which becomes excess or obsolete due to customer reschedules,cancellations or product changes.

 

Our operating results are affected by the level of capacity utilizationin our manufacturing facilities, indirect labor costs and selling, general andadministrative expenses. Gross margins and operating income generally improveduring periods of high-volume and high-capacity utilization in ourmanufacturing facilities and decline during periods of low-volume andlow-capacity utilization. However, certain of our customer contracts containedguaranteed minimum cost protection, requiring the customer to either purchasecertain contractual minimum quantities or pay for amounts less than the minimumpurchase commitment.  Such contractshelped offset the negative impact of low-capacity utilization on gross marginsand operating income.  

 

Our business strategy includes the continued expansion of our globalmanufacturing network. Currently, approximately 70% of our net sales worldwideare denominated in US dollars, while our labor and utility costs in facilities outsideof the United States are denominated in local currencies. Foreign currencygains and losses are the result of transacting business in a currency that isdifferent from the functional currency of our operating entity and themovements in those currencies between the time a transaction is recorded forfinancial reporting purposes and the time payment is made or received. Wecurrently use forward foreign exchange contracts on a limited basis to minimizeour foreign currency risk but not for trading purposes. We expect to continueto utilize forward foreign exchange contracts only to the extent that thesecontracts minimize exposure and reduce risk from exchange rate fluctuations onspecific underlying transactions that create foreign currency exchange raterisk for us. Any increase or decrease in our use of derivative financialinstruments will likely be as a result of these contracts.

 

14

----

 

RECENT ACQUISTIONS

 

On July 22, 2003, we acquired certain manufacturing assets and assumedcertain liabilities of the Barcelona, Spain operation of Telesincro, S.A., asubsidiary of Groupe Ingenico for approximately $1.1 million in cash.  Included in the transfer were approximately280 manufacturing employees.  The site hadbeen Ingenico’s only internal manufacturing facility for electronic paymentterminals.  The purchased assets includeproduction assets, service inventory and intellectual property necessary tomanufacture, repair and otherwise service the terminals.  As part of the transaction, we agreed tolease 5,500 square meters in the Barcelona facility for three years and enteredinto a four year manufacturing services agreement to manufacture, repair andservice terminals for Ingenico.  Theagreement includes a minimum guaranteed cost protection from Ingenico for thefirst three years.

 

In addition, we transferred 250,000 shares of our common stock toIngenico as an incentive for Ingenico to award us additional revenue amountsover the next three years.  These sharesare not registered or transferable for the three-year period and we retain theright to repurchase the shares at $0 in the event that Ingenico has not awardedus the required revenue amounts.  Atsuch time as the contingency becomes reasonably probable and estimatable, theCompany’s financial statements, for the period or periods will reflect thatimpact.

 

In connection with the acquisition of the Ingenico assets, assumedliabilities and manufacturing agreement, the Company has recorded an intangibleasset of $0.9, related to payments in excess of the fair market value of theacquired net assets and transaction related costs.  This customer relationship intangible asset is being amortizedover the life of the manufacturing services agreement.  

 

On July 1, 2002, we acquired for approximately $6.0 millionin cash and assumed liabilities, all of the capital stock and certain assets ofLexmark Electronics S.A. de C.V., a subsidiary of LexmarkInternational, Inc. located in Reynosa, Mexico, that provides printedcircuit board assemblies for laser printers. Included in the purchase price was$3.2 million of inventory that we had agreed to purchase within60 days after the closing. The acquired assets consist of cash of$0.8 million, manufacturing assets and other working capital related tothe operations, while the liabilities consist of accounts payable and accruedliabilities. The transaction was accounted for as a purchase of a business, andthe purchase price was allocated to the assets and liabilities based upon theirrelative fair values at the date of acquisition. The excess of the fair valueof assets acquired over the purchase price was allocated to the acquired fixedassets, which reduced their recorded fair values. As part of the transaction,we retained approximately 230 employees, assumed an existing lease that expiresin February 2010, for a 156,000 square foot manufacturing facility inReynosa and entered into an eighteen-month supply agreement to provide printedcircuit board assemblies to Lexmark. The supply agreement included certainminimum guaranteed purchase commitments for the first 12 months.

 

RESTUCTURINGS AND ASSET WRITEDOWNS

 

During the third quarter of 2003, the Company was informed by one ofits customers that certain fulfillment services provided at the customer’sRichmond site will not be required after April 2004.  With the transition to another customer site of this program theCompany will cease activities at the customer-controlled site.  The program represented approximately 7.5% ofthe Company's revenue for the first nine months of fiscal 2003.  The Company believes that other businesswith new and existing customers, will offset this decline in 2004.  The Company does not expect chargesassociated with the cessation of this customer program to exceed approximately$250.

 

In connection with the third quarter 2003 plan to streamlineoperations, reduce manufacturing capacity and reduce general and administrativeexpenses, we announced the closing of our Athlone, Ireland plant, which is tobe substantially completed by the end of 2003. We recorded a restructuring charge of $2.6 million in the third quarterof 2003.  These charges primarilyrelated to severance costs of $2.1 million, additional contingent liability of$0.4 million and $0.1 million of other costs in connection with the shutdown ofthe Athlone, Ireland plant.  Theseamounts were partially offset by a reversal of restructuring expense initiallyrecorded in a prior year.  We estimatethat we will record an additional $4.2 million of restructuring relatedexpenses in the fourth quarter of 2003 related to this site closure.  Substantially all of the customers at theAthlone facility, which had revenues for the nine months ended September 29,2003 of $22.4 million, will be transferred to other MSL sites.  This plan includes the reduction ofapproximately 225 manufacturing and managerial employees.

 

In the second quarter of 2003, we recorded a net restructuring andasset writedown charge of $1.0 million. This included a charge of $1.6 million related to certain costs inconnection with the planned closing of our Athlone, Ireland plant, which wasformally announced in July 2003.  Thischarge relates to a contingent liability for which the expected settlement hadbeen determined to be probable as of June 29, 2003.  This amount was offset by a reversal of $0.4 million ofrestructuring reserves related to the final sale of our China operation, whichhad been shut down in the third quarter of 2002 and a recorded gain of $0.2million on assets that had previously been written down at our China facilityin accordance with SFAS 144.

 

In the first quarter of 2003, we reversed $0.2 million of restructuringreserves related mainly to severance expenses, which were no longer expected tobe incurred.

 

In the third quarter of 2002, we recordedrestructuring and asset write-down charges of $9.8 million, primarilyrelated to closing our facility in Mt. Prospect, Illinois and restructuring ofcertain manufacturing space in Singapore. Prior to its closing, the Mt Prospect facility generated net sales in2002 of $95.4 million (principally from three customers) and net income of$10.7million. However, the net income amount included approximately$21.5 million in additional revenue from a guaranteed minimum contractwith 3Com that expired on June 30, 2002. We have disengaged fromactivities with 3Com as of September 29, 2002, and all other customershave been transferred to our other facilities. The total restructuring chargeis comprised of severance of $3.7 million related to the termination ofapproximately 313 manufacturing and managerial employees, asset write downs of$2.1 million and lease termination and facility costs of$4.0 million. This plan was substantially complete by the end of thesecond quarter of 2003, except for lease payments in Singapore, which maycontinue until the lease expires in 2010. 

 

15

----

 

In the second quarter of 2002, we recorded a gain of $0.6 million fromthe sale of our Salt Lake City building. This was recorded as a reversal of a restructuring charge, which hadbeen taken in the third quarter of 2001 when we wrote down the building to itsestimated fair market value.

 

In the first quarter of 2002, we implementeda plan to restructure certain operations, primarily related to closing ourfacility in China and a workforce reduction at our corporate headquarters.  The China facility, which ceased operationsduring the third quarter of 2002, was closed, as the site did not meet ourlong-term strategic goals.  The totalcharge recorded for this plan was $5.5 million, which was comprised of assetwrite-downs of $3.1 million, lease termination costs of $0.6 million andseverance of $1.8 million related to the reduction of 371 manufacturing and 24managerial employees.  This plan wascompleted by the end of the second quarter of 2003.

 

During the full year 2002, we implemented various restructuring plansthroughout our organization to align our cost structure with the reducedrevenue stream as a result of the economic downturn in the EMS industry. Intotal for all 2002, we incurred restructuring charges of $13.4 millionconsisting of asset write-downs of $4.3 million, employee severance of $5.3million and lease termination costs of $3.8 million.

 

The following table sets forth the activity in the restructuringreserves from December 31, 2002 to September 28, 2003:

 
|                           |   | **Employee  Severance and  Related Expenses** |   | **Lease Payments  on Facilities and  Equipment** |   | **Other Plant  Closing Costs** |   | **Total** |   |
|--------------------------------|--------|-----------------------------------------------|--------|--------------------------------------------------|--------|--------------------------------|--------|-----------|--------|
| Balances at  December 31, 2002 |   | $                                             | 1.9    |                                             | $      | 3.6                            |   | $         | — |   | $ | 5.5 |   |
| Charges  utilized              |   | (1.4                                          | )      | (0.9                                             | )      | —                         |   | (2.3      | )      |
| Provision  adjustments         |   | (0.2                                          | )      | —                                           |   | —                         |   | (0.2      | )      |
| Balance at  March 30, 2003     |   | 0.3                                           |   | 2.7                                              |   | —                         |   | 3.0       |   |
| Restructuring  provision       |   | —                                        |   | —                                           |   | 1.6                            |   | 1.6       |   |
| Charges utilized               |   | (0.2                                          | )      | (0.2                                             | )      | —                         |   | (0.4      | )      |
| Provision  adjustments         |   | —                                        |   | (0.4                                             | )      | —                         |   | (0.4      | )      |
| Balance at  June 29, 2003      |   |                                          | 0.1    |                                             |   | 2.1                            |   |      | 1.6    |   |   | 3.8 |   |
| Restructuring  provision       |   | 2.2                                           |   | —                                           |   | 0.5                            |   | 2.7       |   |
| Charges  utilized              |   | —                                        |   | (0.1                                             | )      | —                         |   | (0.1      | )      |
| Provision  adjustments         |   | —                                        |   | —                                           |   | —                         |   | —    |   |
| Balance at  September 28, 2003 |   | $                                             | 2.3    |                                             | $      | 2.0                            |   | $         | 2.1    |   | $ | 6.4 |   |

 

Reserves remaining at September 28, 2003mainly represent lease termination payments in Singapore, which may continueuntil the lease expires in 2010, and liabilities related to the Athlone plantclosing which should be settled by the first quarter of 2004.

 

GOODWILL IMPAIRMENT

 

 

In accordance with SFAS No. 142, we were required to perform an annualgoodwill impairment test as of the beginning of its third fiscal quarter, whichbegins on June 30, 2003.  This involvesdetermining the estimated fair value of each reporting unit and comparing it tothe reporting unit’s carrying amount. If a reporting unit’s carrying amount exceeds its fair value, anindication exists that the reporting unit’s goodwill is impaired and we wouldbe required to perform the second step of the impairment test.  We completed the annual impairment testduring the fiscal third quarter.

 

The results of step one of the annual impairment test for each of ourthree reporting units with goodwill indicated that a potential impairmentexisted only within our Westford reporting unit, which had recorded goodwill of$2.3 million as of June 29, 2003.  Weperformed the second step of the impairment test for Westford, and compared theunits implied fair value (determined by allocating the unit’s fair value basedon expected future discounted cash flows, to all assets, recognized andunrecognized, and liabilities) to the unit’s carrying goodwill amount of $2.3million.  This second step indicatedthat all of Westford’s goodwill was impaired and the entire carrying amount ofthe goodwill was recorded as an impairment loss in the third quarter of 2003.

 

16

----

 

RESULTS OF OPERATIONS

 

The following table sets forth specified operating data, in dollars andas a percentage of net sales, for the periods indicated:

 
|                                                 |   | **Three  Months Ending**   |    | **Nine  Months Ending** |    |
|------------------------------------------------------|--------|----------------------------|---------|-------------------------|---------|
|                                                 |   | **September  28, 2003**    |    | **September  29, 2002** |    | **September  28, 2003** |   | **September  29, 2002** |   |
|                                                 |   | **(Dollars in thousands)** |    |
| Net sales                                            |   | $                          | 188,955 |                    | 100.0   | % | $ | 201,593 |   | 100.0 | % | $ | 532,531 |   | 100.0 | % | $ | 644,790 |   | 100.0 | % |
| Cost of goods sold                                   |   | 174,124                    |    | 92.2                    |    | 184,452 |   | 91.5 |   | 489,446 |   | 91.9 |   | 586,558 |   | 91.0 |   |
| Gross profit                                         |   | 14,831                     |    | 7.8                     |    | 17,141 |   | 8.5 |   | 43,085 |   | 8.1 |   | 58,232 |   | 9.0 |   |
|                                                 |   |                       |    |                    |    |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                  |   | 13,902                     |    | 7.4                     |    | 15,510 |   | 7.7 |   | 39,452 |   | 7.4 |   | 46,535 |   | 7.2 |   |
| Amortization expense                                 |   | 45                         |    | 0.0                     |    | — |   | — |   | 45 |   | 0.0 |   | 3,706 |   | 0.6 |   |
| Restructuring and asset writedowns                   |   | 4,888                      |    | 2.6                     |    | 9,763 |   | 4.8 |   | 5,593 |   | 1.1 |   | 14,651 |   | 2.3 |   |
| Other operating income                               |   | —                     |    | —                  |    | — |   | — |   | — |   | — |   | (800 | ) | (0.1 | ) |
|                                                 |   |                       |    |                    |    |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating income (loss)                              |   | (4,004                     | )  | (2.1                    | )  | (8,132 | )  | (4.0 | )  | (2,005 | )  | (0.4 | )  | (5,860 | )  | (0.9 | )  |
|                                                 |   |                       |    |                    |    |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense, net                                |   | (1,000                     | )       | (0.5                    | )       | (1,059 | ) | (0.5 | ) | (3,102 | ) | (0.6 | ) | (6,196 | ) | (1.0 | ) |
| Gain (loss) on Change in derivatives                 |   | (20                        | )       | (0.0                    | )       | 1,260 |   | 0.6 |   | 300 |   | 0.1 |   | 2,170 |   | 0.3 |   |
| Foreign exchange gain (loss)                         |   | 22                         |    | 0.0                     |    | (21 | )  | (0.0 | )  | 428 |   | 0.1 |   | 35 |   | 0.0 |   |
| Loss on extinguishment of debt                       |   | —                     |    | —                  |    | — |   | — |   | — |   | — |   | (4,031 | ) | (0.6 | ) |
|                                                 |   |                       |    |                    |    |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) before provision for income taxes      |   | (5,002                     | )       | (2.6                    | )       | (7,952 | )  | (3.9 | )  | (4,379 | )  | (0.8 | )  | (13,882 | ) | (2.2 | ) |
| Provision for income taxes                           |   | 199                        |    | 0.1                     |    | 480 |   | 0.2 |   | 706 |   | 0.1 |   | 1,498 |   | 0.2 |   |
|                                                 |   |                       |    |                    |    |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                    |   | $                          | (5,201  | )                       | (2.8    | )% | $ | (8,432 | )  | (4.2 | )% | $ | (5,085 | )  | (1.0 | )% | $ | (15,380 | ) | (2.4 | )% |
|                                                 |   |                       |    |                    |    |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss) applicable to common  stockholders |   | $                          | (6,468  | )                       | (3.4    | )% | $ | (9,150 | ) | (4.5 | )% | $ | (8,103 | ) | (1.5 | )% | $ | (17,107 | ) | (2.7 | )% |

 

FISCAL QUARTER ENDED SEPTEMBER 28, 2003 COMPARED TO FISCAL QUARTERENDED SEPTEMBER 29, 2002

 

NET SALES

 

Net sales for the quarter ended September 28, 2003 decreased by $12.6million, or 6.2%, to $189.0 million from $201.6 million for the quarter endedSeptember 29, 2002.  A portion of thisdecrease relates to the closing of our Mt. Prospect, IL facility in the thirdquarter of 2002, which had revenues in the third quarter of 2002 of $19.0million.  Of the Mt Prospect revenues,$4.5 million related to business with 3Com, which ended in the third quarter of2002, with the remaining revenue from this facility being transferred to ourother manufacturing sites**.  **Thebalance of the decrease of approximately $8.1 million consists of $8.0 millionfrom two customers with whom we no longer conduct business in 2003 and $10.8million due to a decline in end market demand for certain customers’ products,which was partially offset by $10.7 million in revenue subsequent to theacquisition of our Barcelona, Spain operations.

 

GROSS PROFIT

 

Gross profit decreased from 8.5% of net sales for the quarter endedSeptember 29, 2002 to 7.8% of net sales for the quarter ended September 28,2003. Our gross margin in the third quarter of 2003 was impacted by theexpiration, prior to the quarter ended September 28, 2003, of contracts havingfixed minimum cost protection with two customers that had contributed $1.6million to our gross profit in the third quarter of 2002.  This decrease was partially offset by thepositive impact of improved inventory management in the third quarter of 2003compared to 2002 and a favorable change in customer mix.  We anticipate that continued pricingpressure may cause gross margins to decline in future periods.

 

SELLING, GENERAL AND ADMINISTRATIVE

 

Selling, general and administrative expense for the quarter endedSeptember 28, 2003 decreased to $13.9 million, or 7.4% of net sales, from $15.5million, or 7.7% of net sales, for the quarter ended September 29, 2002. Thisnet decrease of $1.6 million related primarily to reduced expenses resultingfrom restructuring activities including the closure of our Mt Prospect andChina facilities of $0.2 million and $0.7 million, respectively, executed bythe Company during 2002.  These wereoffset by increased expenses from our acquired operations in Barcelona, Spainof $0.5 million and the ramping of our business in Reynosa, Mexico of $0.7million, as well as approximately $0.2 million of M&A related expenses**.**

** **

The remaining decrease of $2.1 million consists mainly of loweremployee recruiting and relocation expenses of $1.0 million, which had beenincurred mostly in Concord in the second quarter of 2002, decreased consultingcosts of $0.2 million and $0.9 million from the various restructuringactivities and other cost reductions to offset our reduced revenue amounts.

 

17

----

 

AMORTIZATION EXPENSE

 

Amortization expense for the three-month period ended September 28,2003 was $0.05 million and zero for the same period last year.  The third quarter 2003 amortization expenserelates to a customer intangible recorded in connection with the newly acquiredIngenico relationship.  This customerintangible is being amortized over the four-year life of a supply agreement weentered with this customer on July 22, 2003. See the previous discussion in the section titled “Recent Acquisitions”.

 

RESTRUCTURING AND ASSET WRITEDOWNS

 

See the previous discussion in the section titled “Restructuring andAsset Writedowns”.

 

GOODWILL IMPAIRMENT

 

See the previous discussion in the section titled “GoodwillImpairment”.

 

INTEREST EXPENSE, NET

 

Net interest expense decreased to $1.0 million for the quarter endedSeptember 28, 2003 from $1.1 million for the quarter ended September 29, 2002,reflecting lower average borrowings in addition to the impact of decreasinginterest rates.

 

 

CHANGE IN FAIR VALUE OF DERIVATIVES

 

During the third quarter of 2003, we recorded a loss as a result of anincrease in the fair value of warrant derivatives issued with our Series A andB convertible preferred stock of $0.02 million compared to a gain of $1.3million for third quarter of 2002.  Thewarrant derivatives were issued with our Series A and B convertible preferredstock offerings in the first quarter of 2002 and third quarter of 2003,respectively.  

 

The Series A and B warrant derivatives were originally fair valued at$3.2 million and $2.0 million, respectively. The Series A warrants’ fair value increased from $2.35 million at June29, 2003 to $2.42 million at September 28, 2003, resulting in a loss of $0.07million.  The series B warrants’ fairvalue decreased from $1.95 million at July 3, 2003, the issue date, to $1.90million at September 28, 2003, resulting in a gain of $0.05 million.  The increase in the value of this liabilitywas recorded as a non-operating loss in the third quarter of 2003 and anon-operating gain in the third quarter of 2002.

 

FOREIGN EXCHANGE GAINS/LOSSES

 

There were no significant foreign exchange gains or losses for eitherof the three-month periods ended September 28, 2003 or September 29, 2002.

 

PROVISION FOR INCOME TAXES

 

Provision for income taxes was $0.2 million for the quarter endedSeptember 28, 2003 and $0.5 million for the quarter ended September 29, 2002.Our tax provisions in both quarters resulted from the mix of profits and lossesexperienced across the jurisdictions within which we operate.

 

NINE MONTHS ENDED SEPTEMBER 28, 2003 COMPARED TO NINE MONTHS ENDEDSEPTEMBER 29, 2002

 

NET SALES

 

Net sales for the nine months ended September 28, 2003 decreased by$112.3 million, or 17.4%, to $532.5 million from $644.8 million for the ninemonths ended September 29, 2002. A portion of the decrease relates to theclosing of our Mt. Prospect facility in the third quarter of 2002, which hadrevenues for the nine months ended September 29, 2002 of $95.4 million.   Of the Mt Prospect revenues, $41.2 millionrelated to business with 3Com, which ended in the third quarter of 2002, withthe remaining revenue from this facility being transferred to our othermanufacturing sites**.** ** **The balance of the decrease ofapproximately $71.1 million consists of $66.8 million from three customers whomwe no longer do business with in 2003 and $37.5 million due to a decline in endmarket demand for certain customers’ products, which was partially offset by$10.7 million in revenue from the acquisition of our Barcelona, Spainoperations and $22.5 million in revenue from the acquisition of our Reynosa,Mexico operations, which was included in our operation for three of the ninemonths ended September 29, 2002 versus the entire nine months ended September28, 2003.

 

GROSS PROFIT

 

Gross profit decreased to 8.1% of net sales for the nine months endedSeptember 28, 2003 from 9.0% of net sales for the nine months ended September29, 2002. This decrease resulted primarily from the loss of our take or paycontracts with two customers,

 

18

----

 

each of which expired during 2002 but had positively contributed to ourgross profit in the nine months ended September 29, 2002.  This decrease was partially offset by thepositive impact of lower inventory write-downs in 2003 compared to 2002 and afavorable change in customer mix, with a higher percentage of our revenuescoming from products with higher gross margins.

 

SELLING, GENERAL AND ADMINISTRATIVE

 

Selling, general and administrative expense for the nine months endedSeptember 28, 2003 decreased to $39.5 million, or 7.4% of net sales, from $46.5million, or 7.2% of net sales, for the nine months ended September 29,2002.  This net decrease of $7.0 millionrelated primarily to the various restructuring activities the Company executedin 2002 offset by an increase in expenses from our new Reynosa, Mexicofacilities of $2.7 million and our new Barcelona, Spain facility of $0.5million.  The closure of the MtProspect, IL and China facilities contributed $2.8 million to this overalldecrease for the nine month period ended September 28, 2003.

 

The remaining decrease of $7.4 million consists mainly of loweremployee recruiting and relocation expenses of $1.6 million, which had beenincurred mostly in Concord in the second quarter of 2002, decreased consultingcosts of $0.9 million, mainly in the Corporate headquarters for internal auditand tax planning services, decreased bad debt charges of $0.6 million, whichhad been incurred primarily in Asia in the first quarter of 2002, lower travelrelated costs of $0.4 and lower employee labor costs of $2.5 million from thevarious restructuring activities and other cost reductions to offset ourreduced revenue amounts.

 

 

AMORTIZATION EXPENSE

 

Amortization expense was $0.05 million in the nine month period endedSeptember 28, 2003 compared to $3.7 million for the nine month period endedSeptember 29, 2002.  The amortizationexpense in the nine month period ended September 28, 2003 is the firstquarterly amortization expense associated with our Ingenico customerrelationship intangible.  See previousdiscussion in the section titled “ Recent Acquisitions”.  The amortization expense in 2002 related toour asset acquisition from 3Com in September 2000, which consisted mainly ofcustomer relationships.  

 

RESTRUCTURING AND ASSET WRITEDOWNS

 

See the previous discussion in the section titled "Restructuringand Asset Writedowns".

 

GOODWILL IMPAIRMENT

 

See the previous discussion in the section titled “GoodwillImpairment”.

 

OTHER OPERATING INCOME

 

During the nine month period ended September 28, 2002, the Companyreceived a $1.1 million fee related to costs incurred in pursuing anunsuccessful acquisition opportunity in the fourth quarter of 2001.  This amount was netted against $0.3 million ofexpenses incurred during the period related to this acquisition opportunity.

 

INTEREST EXPENSE, NET

 

Net interest expense decreased to $3.1 million for the nine monthsended September 28, 2003, from $6.2 million for the nine months ended September29, 2002, reflecting lower average borrowings and decreased interest rates.

 

CHANGE IN FAIR VALUE OF DERIVATIVE

 

During the nine months ended September 28, 2003, we recorded a gain of$0.3 million related to a reduction in the fair value of our series A and Bpreferred share warrant derivatives compared to a gain of $2.2 million relatedto a reduction of the series A warrant derivative for the nine months endedSeptember 29, 2002.  The warrantderivatives were issued with our Series A and B convertible preferred stockofferings in the first quarter of 2002 and third quarter of 2003,respectively.  

 

The Series A and B warrant derivatives were originally fair valued at$3.2 million and $2.0 million, respectively. The series A warrants’ fair value decreased from $2.67 million atDecember 31, 2002 to $2.42 million at September 28, 2003, resulting in a gainof $0.25 million.  The series Bwarrants’ fair value decreased from $1.95 million at July 3, 2003, the issuedate, to $1.90 million at September 28, 2003, resulting in a gain of $0.05million.  The decrease in the value ofthis liability was recorded as a non-operating loss for the nine month periodsending September 28, 2003 and September 29, 2003.

 

FOREIGN EXCHANGE TRANSACTION GAINS/LOSSES

 

Foreign exchange gains for the nine months ended September 28, 2003were $0.4 million compared to effectively no foreign

 

19

----

 

exchange gains or losses for nine months ended September 29, 2002.  The gain in 2003 related primarily to theweakening of the US Dollar against the Euro for activities in our Valencia,Spain subsidiary.

 

LOSS ON EXTINGUISHMENT OF DEBT

 

In connection with the replacement of a previous credit facility, anextraordinary loss of $4.0 million was recorded in the second quarter of2002.  This loss related to thewrite-off of deferred financing costs under the old credit facility.

 

PROVISION FOR INCOME TAXES

 

Provision for income taxes was $0.7 million for the nine months endedSeptember 28, 2003 compared to $1.5 million for the nine months ended September29, 2002.  Our tax provisions in bothperiods resulted from the mix of profits and losses experienced by us acrossthe jurisdictions within which we operate. For the nine months ended September28, 2003, pretax income in the United States and Asia was primarily offset bynet operating loss carryforwards, while tax provisions were recorded in Franceand Spain.  For the nine months endedSeptember 29, 2002, pretax income in the United States was offset by net operatingloss carryforwards while losses in Asia provided us with no income tax benefitbecause we do not believe it is more likely than not that we will be able toutilize these taxable losses in the future. Profits in Spain and France required us to record tax provisions duringthe nine month period ended September 29, 2002.

 

LIQUIDITY AND CAPITAL RESOURCES

 

At September 28, 2003, we had cash and cash equivalents of $54.8million, total bank and other debt of $24.2 million and $46.0 million of unusedborrowing capacity under the credit agreement we entered into in 2002 (“2002Credit Agreement”).  In addition, we had$3.0 million of unused borrowing capacity under a revolving credit facility inSpain.  During the nine months endedSeptember 28, 2003, our operations were funded primarily with cash flow fromoperating activities, available cash and net proceeds of $23.0 million from ourSeries B convertible preferred stock offering on July 3, 2003. 

 

Net cash used by operating activities of $7.1 million for the ninemonths ended September 28, 2003 resulted primarily from an increase inoperating assets of $3.8 million and a decrease in our operating liabilities of$13.2 million, offset in part by net cash provided by operations prior tochanges in operating assets and liabilities of $9.9 million.  The increase in operating assets included a$6.2 million increase in inventory associated with higher revenue levelsexpected in the fourth quarter of 2003 as compared to the first quarter of2003, due in part to the ramp of business at our Barcelona operations.   The decrease in operating liabilitiesincluded a decrease in accounts payable of $8.5 million as a result of reducedvolume through our manufacturing sites and a reduction of $4.6 million inaccrued expenses mainly as a result of lower accrued salaries and benefits andaccrued taxes.  Net cash provided byoperations prior to changes in operating assets and liabilities resulted from anet loss of $5.1 million that includes $15.0 million of non-cash adjustments tonet income.  The largest components ofthe non-cash adjustments to net income were $11.5 million of depreciation andamortization expense and a $2.3 million goodwill impairment charge, which wasrecorded in the third quarter of 2003.

 

Net cash provided by operating activities of $79.5 million for the ninemonths ended September 29, 2002 resulted primarily from a decrease in operatingassets of $101.6 million and net cash generated by operations prior to changesin operating assets and liabilities of $14.3 million, the result of a net lossof $15.4 million that included $29.7 million of non-cash adjustment to netincome. The decrease in operating assets included a $66.9 million reduction inaccounts receivable, most of which was a direct result of the reduction inrevenue, and $34.6 million in inventory reductions, caused by the reducedvolume through the manufacturing sites and improved inventory management.  The significant components of the non-cashadjustments to net income were $17.8 million of depreciation and amortizationexpense, write-downs and losses on disposal of fixed assets of $6.7 million,$4.0 million for the write-off of capitalized bank fees in connection with theCompany’s refinancing of its credit facility during the second quarter of2002.  These sources of cash fromoperations were offset by a decrease in operating liabilities of $36.4 million,due primarily to reductions in accounts payable related to lower inventoryrequirements.

 

Net cash used in investing activities for the nine months endedSeptember 28, 2003 was $6.8 million, consisting of $10.8 million of capitalexpenditures, mainly for the purchase of a previously leased surface mounttechnology (“SMT”) line of $4.8 million in the first quarter of 2003, offset by$5.1 million in proceeds from the sale of fixed assets, $4.8 million of whichrelated to the same SMT line, which was subsequently leased back in the firstquarter in a sales/leaseback transaction that has been treated as a capitallease. This sales/leaseback transaction required us to restrict $2.1 million incash over the three year term of the lease. This cash has been reclassified to other assets at September 28,2003.  Net cash used in investingactivities for the nine month period ended September 28, 2003 includes $1.1million related to the acquisition of certain assets and assumed liabilities ofthe Barcelona, Spain operation of Telesincro, S.A., a subsidiary of GroupeIngenico.

 

Net cash provided by investing activities for the nine months endedSeptember 29, 2002 was $4.2 million, consisting of $4.0 million of proceedsfrom the sale of the Company’s Salt Lake City building during the secondquarter, offset by capital expenditures of $3.0 million and $5.3 million of netcash used for the acquisition of Lexmark’s Reynosa, Mexico facility in thethird quarter of 2002.

 

20

----

 

Net cash provided in financing activities for the nine months endedSeptember 28, 2003 was $19.1 million, consisting mainly of the issuance of theSeries B convertible preferred stock, which provided a net $23.0 million, and$2.6 million of proceeds from the exercise of stock options and our stockpurchase plan, partially offset by payments on long term debt and leaseobligations of $5.4 million and $1.0 million of payments on our term loan.  

 

Net cash used in financing activities for the nine months endedSeptember 29, 2002 was $64.3 million consisting primarily of $117.4 million ofnet payments on the Company’s previous credit facility, which was replaced bythe 2002 Credit Agreement during the second quarter of 2002, and $4.6 millionin debt issuance costs.  This was offsetin part by $9.4 million in borrowings under the 2002 Credit Agreement, $9.2million from a mortgage loan on the Company’s Spain facility, proceeds from theexercise of stock options and our stock purchase plan of $1.4 million and $37.7million in net proceeds from the issuance of our Series A convertible preferredstock and warrants.

 

In March 2002, we issued$41.5 million of Series A Convertible Preferred Stock (“Series A Preferred)and warrants to purchase 1,612,281 shares of common stock in a privateplacement to qualified accredited investors (the “Offering”). Proceeds of theOffering, net of costs of the Offering, were $37.7 million.  The Series A Preferred accrues dividendsquarterly at the rate of 5.25% per annum, payable quarterly in common stock orcash, at our option.  Ifwe choose to pay dividends in common stock or to redeem the Series A Preferredwith common stock, the shares of common stock issued will be computed using 95%of the market value of the common stock over a prescribed measurement period.

 

The Series A Preferred is convertible to common stock based on aconversion price of $6.44 per share. We may require holders to convert tocommon stock provided the price of our common stock has traded at 150% of theconversion price for a specified period. The Series A Preferred has a scheduled maturity of March 14, 2007,unless converted earlier, and is redeemable for our common stock or cash, atour option. The warrants are exercisable at any time through March 14,2007. We have the right to require the exercise of the warrants afterMarch 14, 2003 if our common stock trades for 175% of the warrant exerciseprice for a specified period.

 

On July 2, 2003, we issued $25.0 million of Series B ConvertiblePreferred Stock (“Series B Preferred”) and warrants to purchase 1,165,254shares of common stock in a private placement to qualified accreditedinvestors.  Proceeds of the Series BPreferred, net of costs, were approximately $23.0 million.  The Series B Preferred will be recorded astemporary equity, and the warrants will be recorded as liabilities.

 

The Series B Preferred accrues dividends quarterly at the rate of 4.50%per annum, payable quarterly in common stock or cash, at our option. The SeriesB Preferred is convertible to common stock at any time by holders based on aconversion price of $5.90 per share and has a scheduled maturity of July 3,2008, unless converted earlier.  We mayredeem the Series B Preferred on or after July 3, 2006, in whole or in part, atour option, at par value payable in our common stock or cash, at our optionplus accrued and unpaid dividends, if any, payable in cash.  If we choose to pay dividends in commonstock or to redeem the Series B Preferred with common stock, the number ofshares of common stock issued will be computed using 95% of the market value ofthe common stock at that time. The warrants are exercisable at any time throughJuly 3, 2008 at the exercise price of $6.275 per share. We have the right torequire the exercise of the warrants at any time if our common stock trades for175% of the exercise price of the warrants for a specified period of time.

 

A portion of the total consideration received was allocated to thewarrants based on their fair value of $1.9 million and the residual proceedswere allocated to the Series B Preferred. The resulting initial Series B Preferred balance will be accreted to theliquidation value of $50 per share, subject to certain adjustments over thelife of the Series B Preferred.  Thediscount on the Series B Preferred resulting from allocation of proceeds to thewarrants will be accreted, using the effective interest method, through thescheduled maturity date and will be recorded as a charge against additionalpaid in capital.  In the event we electto call the Series B Preferred in advance of the maturity date, accretion ofthe remaining discount will occur.  Allsuch amounts for accretion will be deducted from the net income available tocommon stockholders, for purposes of earnings per share calculations.

 

We have a $130.5 million credit facility consisting of a $120 millionsenior secured revolving credit facility and a $10.5 million three-year termloan (the “2002 Credit Agreement”).  The2002 Credit Agreement is secured by substantially all domestic assets and apledge of 65% of the shares of certain foreign subsidiaries.  Restrictive covenants for the 2002 CreditAgreement include restrictions on leverage ratios as well as covenants requiringminimum net worth, domestic adjusted EBITDA and fixed charge coverageratios.  The three-year term loan has aregular quarterly payment of $0.3 million payable on the first business day ofeach quarter, with the remaining outstanding balance due at maturity.

 

Also in June 2002, we entered into a ten-year mortgage loan for 10million Euros ($9.2 million) and a 3 million Euro ($2.7 million) revolvingcredit facility in Valencia, Spain. This revolving credit facility, which was due to expire on June 26, 2003,was extended for six months through December 31, 2003.  There were no borrowings under the revolvingcredit facility at September 28, 2003.

 

21

----

 

Borrowings under the revolving facility of the 2002 Credit Agreementare limited to the sum of 85% of all eligible accounts receivable of the U.S.domestic subsidiaries of the Company and 85% of the orderly liquidation valueof the eligible inventory of the U.S. domestic subsidiaries of the Company.  Borrowings are limited further by anyoutstanding letters of credit, which were $3.0 million at September 28,2003.  A weekly borrowing base isdetermined by domestic receivables and domestic inventory.  The revolving facility provides for anannual commitment fee of 0.50% on the unused portion of the revolving facility,payable in arrears quarterly.  The costof borrowing under the revolving facility is either the base rate (the bank’sprime rate) or LIBOR, plus the applicable spread costs.  We have the option of choosing either thebase rate or LIBOR.  In the first yearthe spread cost is fixed for base rate and LIBOR loans.  The spread on the base rate loans is 1.75%over the base rate and on the LIBOR loans is the chosen LIBOR period rate plus3.0% for the three months ended September 28, 2003.  In the second and third years the spreads will reset quarterlybased on the average net availability of borrowings for the precedingquarter.  The spread on the base rateloans will be between 1.25% and 2.25% and on the LIBOR loans will be between2.5% and 3.5%. The interest rate under the term loan is equal to the sum of theCash Interest Rate (which is the greater of (i) the base rate in effect plus6.0% or (ii) 11.0%) plus the Deferred Interest Rate (which is equal to 3.0%).  The interest rate on the term loan atSeptember 28, 2003 was 14.0%.

 

The 2002 Credit Facility requires us to obtain within 180 days of theclosing (and maintain at all times), interest rate hedging agreements coveringa notional amount of not less than $10 million of the revolving loans,provided, that upon the request of the administrative agent, we must increasethe amount covered by the hedge agreements up to an aggregate amount equal to25% of the aggregate outstanding balance of the revolving loans at suchtime.  However, in no event shall theaggregate amount covered by such hedge agreements at any time exceed $20million**. **Since we did not have anyborrowings against the revolving credit facility at September 28, 2003, wereceived a temporary waiver of the interest rate hedge requirement throughJanuary 31, 2004 and have not entered into any interest rate hedge agreement atSeptember 28, 2003.

 

Our principal sources of funding our operating expenses, capitalexpenditures and debt obligations are expected to be our current cash and cashequivalents, including cash from our recent Series B Preferred Stock offering,cash generated from operations and available borrowings under our 2002 CreditAgreement. The amount of cash generated from operations will be dependent uponsuch factors as the successful execution of our business plan and worldwideeconomic conditions. Borrowings under 2002 Credit Agreement are dependent upona borrowing base calculation derived from our domestic accounts receivable andinventory.  Availability fluctuatesaccording to the quantity and quality of our receivables and US inventory.  Borrowings under our 2002 Credit Agreementcould be limited by a number of factors, including the following:

 

•  revenue reductions fromdecreased customer demand or lost customers causing lower borrowing assets,particularly accounts receivable,

 

•  a lower amount of our business beingconducted in the US and Mexico,

 

•  deterioration in the value of the assetscomprising the borrowing base, or

 

•  failure to comply with Credit Agreementcovenants.

 

We are currently in compliance with all covenants under our 2002 CreditAgreement.  In the event we do not haveadequate funding from our 2002 Credit Agreement, we would work with our lendinginstitutions to modify the 2002 Credit Agreement or identify other sources ofcapital to obtain necessary debt or equity financing. There is no assurance wewould be able to modify the 2002 Credit Agreement with existing lenders orobtain alternative debt or equity financing to satisfy our funding needs.

 

The closing of the merger transaction with Celestica will triggerprepayment fees of approximately $1.35 million related to the revolvingfacility and the 3 year term loan of the 2002 Credit Agreement.  If the merger agreement is terminated undercertain circumstances we may be required to reimburse Celestica’s expenses upto $2 million or pay a termination fee of $10 million.

 

Although we believe that our current cash balances, funds generatedfrom operations and borrowings under the 2002 Credit Agreement will be adequateto meet our anticipated future operating expenses, capital expenditures anddebt obligations for at least the next twelve months, there can be no assurancewe will have sufficient funds to meet our cash requirements over the nexttwelve months and as such we continue to consider financing opportunities thatwould provide additional liquidity.

 

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

InMay 2003, the Financial Accounting Standards Board (“FASB”) issued SFASNo. 150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity,” which establishes standardsfor how an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. Financial instruments that arewithin the scope of the statement, which previously were often classified asequity, must now be classified as liabilities. This statement is effective forfinancial instruments entered into or modified after May 31, 2003, andotherwise shall be effective at the beginning of the first interim

 

22

----

 

periodbeginning after June 15, 2003.  Wehave determined that the adoption of SFAS No. 150 will not have a materialimpact on our consolidated financial statements.

 

InApril 2003, the FASB issued SFAS No. 149, “Amendments of Statement 133 onDerivative Instruments and Hedging Activities,” which amends and clarifiesfinancial accounting and reporting for derivative instruments, includingcertain derivative instruments embedded in other contracts and for hedgingactivities under SFAS No. 133. This statement is effective for contractsentered into or modified after June 30, 2003, with certain exceptions, andfor hedging relationships designated after June 30, 2003.  This adoption of SFAS No. 149 did nothave a material impact on our consolidated financial statements.

 

In December 2002, the FASB issued SFAS No. 148, Accounting forStock-Based Compensation- Transition and Disclosure” (“SFAS 148”).  This statement amends SFAS 123 to providealternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation.  Under the provisions of SFAS 148, companiesthat choose to adopt the accounting provisions of SFAS 123 will be permitted toselect from three transition methods: the prospective method, the modifiedprospective method and the retroactive restatement method. The prospectivemethod, however, may no longer be applied for adoptions of the accountingprovisions of SFAS 123 for periods beginning after December 15, 2003. SFAS148 requires certain new disclosures that are incremental to those required bySFAS 123, which must also be made in interim financial statements. Thetransition and annual disclosure provisions of SFAS 148 are effective forfiscal years ending after December 31, 2002. We have adopted the newinterim disclosure provisions effective for the interim periods beginning afterDecember 15, 2002.  We have decidednot to voluntarily adopt the accounting provisions of SFAS 123 as permittedunder the provisions of SFAS 148.

 

In June 2002, the FASB issued SFAS No. 146, “Accounting forExit or Disposal Activities”.  SFASNo. 146 addresses significant issues regarding the recognition,measurement and reporting of costs that are associated with exit and disposalactivities, including restructuring activities that are currently accounted forunder EITF No. 94-3.  We adoptedthe provisions of SFAS No. 146 effective for exit or disposal activitiesinitiated after December 31, 2002. The effect-on-adoption of SFAS No. 146 changed the timing of whenrestructuring charges are recorded from a commitment date approach to when theliability is incurred.

 

In April 2002, the FASB issued SFAS No. 145 “Rescission of FASBStatements No.4, 44 and 64, Amendment of FASB Statement No.13, and TechnicalCorrections as of April 2002”.  FASB No.145 eliminates FASB No. 4 “Reporting Gains and Losses from Extinguishment ofDebt”, which required companies to classify gains or losses from theextinguishment of debt as an extraordinary item, net of tax. As a result ofthis new FASB, gains and losses from extinguishment of debt should beclassified as extraordinary items only if they meet the criteria in APB OpinionNo.30 “Reporting the Results of Operations-Reporting the Effects of Disposal ofa Segment of a Business, and Extraordinary, Unusual and Infrequently OccurringEvents and Transactions”.  We do notbelieve that the extinguishment of debt will qualify as an extraordinary itemas defined in APB 30, and therefore we will be required to classify thesecharges as non-operating expenses.  Wehave adopted SFAS No. 145 on January 1, 2003, and have reclassified theextraordinary loss to a non-operating loss in all applicable periods forcomparative purposes.

 

In June 2001, the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations” to be effective for all fiscal years beginning afterJune 15, 2002, with early adoption permitted.  SFAS No. 143 establishes accounting standards for therecognition and measurement of an asset retirement obligation and itsassociated asset retirement cost. It also provides accounting guidance forlegal obligations associated with the retirement of tangible long-livedassets.  We have adopted SFASNo. 143 in the first quarter of 2003 and determined that it did not impactour financial position, results of operations or cash flows.

 

RELATED PARTY TRANSACTIONS

 

At September 28, 2003, affiliates of Credit Suisse First BostonCorporation (“CFSB”) owned approximately 47% of our outstanding common stock,not including warrants to purchase 749,797 shares of the our common stock, andhad one seat on our Board of Directors. Details of the warrants are included below.  CSFB and certain of its affiliates have entered intounconditional agreements to vote in favor of the merger agreement withCelestica and have granted Celestica the option to acquire from them, undercertain circumstances, shares of our common stock, representing approximately75% of their votes than can be cast in connection with the merger.  Further, CSFB is a member of the bank groupunder our 2002 Credit Agreement and has committed to lend up to $10 million ofthe overall 2002 Credit Agreement.  Inconnection with structuring this Credit Agreement in the second quarter of2002, certain affiliates of CFSB were paid $0.6 million.

 

Affiliates of CFSB participated in our Series A convertible preferredstock offering in March 2002.  Theseaffiliates purchased 300,000 shares of the convertible preferred stock, whichis convertible into 2,331,003 shares of common stock, and warrants to purchase582,751 shares of common stock.   Inconnection with this investment, we paid an affiliate of CSFB an advisory feeof 1.446% on the total amount invested in the offering (an aggregate of $0.6million) in return for (i) CSFB’s services in helping to structure andarrange the transaction, (ii) the agreement by the CSFB affiliates not tosell or otherwise transfer any of the our securities for six months (other thanas part of an underwritten offering we initiate), and (iii) the agreementby the CSFB affiliates to accept piggyback registration rights instead ofhaving the common stock issuable upon the conversion or exercise of itssecurities included in the shelf registration statement which was filed withthe SEC to register the resale of the common stock underlying the preferredstock and warrants sold to other investors in the offering.  The registration statement, covering5,937,461 shares, became effective on April 23, 2002.  CFSB and its affiliates did not participate in our July 2003Series B convertible preferred stock offering.

 

23

----

 

Affiliates of CFSB also participated in the issuance of our redeemablepreferred stock in November 1999, which included warrants to purchased1,160,542 shares of common stock. The redeemable preferred stock was redeemedand warrants to purchase 937,812 shares were cancelled at the time of ourinitial public offering in June 2000. At September 28, 2003, 167,046 of these warrants were still outstanding.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We do not have any financial partnerships with unconsolidated entities,such as entities often referred to as structured finance, special purposeentities or variable interest entities which are often established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes. Accordingly, we are not exposed to any financing,liquidity, market or credit risk that could arise if we had such relationships.

 

### **RISK FACTORS**

 

YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKINGAN INVESTMENT DECISION. ADDITIONAL RISKS NOT PRESENTLY KNOWN TO US OR THAT WECURRENTLY DEEM IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS. ANY OF THESE RISKSCOULD HAVE A MATERIAL AND NEGATIVE EFFECT ON OUR BUSINESS, FINANCIAL CONDITIONOR RESULTS OF OPERATIONS.

 

WE HAVE ENTERED INTO A MERGER AGREEMENT TO BE ACQUIRED, BUT IT IS POSSIBLETHAT THE MERGER MAY BE DELAYED OR NOT BE CONSUMATED

 

On October 15, 2003, we entered into a merger agreement with Celestica,Inc. that provides for the acquisition by Celestica of all of our outstandingshares.  Under the transaction, eachoutstanding share of our common stock will be exchanged for 0.375 subordinatevoting shares of Celestica.  Inaddition, the holders of our Series A and Series B convertible preferred shareswill be entitled to receive, at the shareholder's election, US$52.50 per shareplus accrued dividends in cash or a number of subordinate voting shares ofCelestica equal to 0.375 times the number of shares of our common stock intowhich the Series A and Series B shares may be converted (plus, in the case ofthe Series B preferred shares, a "make-whole" payment of US$2.25 pershare payable in either cash or shares at our option). The share exchange ratiowill be adjusted, if necessary, to ensure that the value of the considerationreceived for each share of our common stock (based on the 20 trading day volumeweighted average NYSE closing price of the subordinate voting shares ofCelestica determined on the third business day prior to the completion of thetransaction) will be not less than US$6.00 and not more than US$7.25. 

 

The merger agreement, which has been approved unanimously by the boardsof directors our Company and Celestica, is subject to approval of ourshareholders, certain governmental consents and other closing conditions.  Certain of our institutional shareholdersand officers of our Company, holding shares representing approximately 41.5% ofthe votes to be cast on the merger, have entered into unconditional agreementsto vote in favor of the merger, and the institutional shareholders have alsogranted Celestica the option to acquire from them, under certain circumstances,shares of our common stock representing 30% of the votes that can be cast inconnection with the merger. All parties have agreed to proceed expeditiously toclose the transaction.

 

We expect this transaction to close sometime around December 31,2003.  However the timing of the closingis subject to governmental regulatory reviews and approvals, and other closingconditions.  The governmental regulatorybodies may delay or oppose the acquisition, which may have an adverse impact onour operational performance in the future. Certain members of our management team will be required to focus on theclosing of the transaction, which may have an adverse impact on our futureoperational performance.

 

In addition, if the acquisition does not close due to the failure tosatisfy closing conditions or for other reasons, it is likely that the marketvalue of our common stock will decrease. 

 

BECAUSE A SIGNIFICANT PORTION OF OUR SALES CURRENTLY COMES FROM A SMALLNUMBER OF CUSTOMERS, ANY DECREASE IN SALES FROM THESE CUSTOMERS COULD HARM OUROPERATING RESULTS.

 

We depend on a small number of customers for a large portion of ourbusiness. Our ten largest customers accounted for approximately 86% of netsales in the nine months ended September 28, 2003 and approximately 80% of netsales for fiscal 2002.  Changes in ourcustomers’ orders have, in the past, had a significant impact on our operatingresults. If a major customer significantly reduces the amount of business itdoes with us, there would be an adverse impact on our operating results.

 

We expect to continue to depend on sales to our major customers.Because it is not always possible to replace lost business on a timely basis,it is likely that our operating results would be adversely affected if one ormore of our major customers were to cancel, delay or reduce a large amount ofbusiness with us. Our customer agreements typically permit the customer toterminate the agreement on three to six month’s notice. Were a customer toterminate its agreement with us, it is likely that our operating results,through lower revenue and lower fixed cost absorption, would be adverselyaffected.  Moreover, our operating results inthe past have

 

24

----

 

been positively affected by several customercontracts containing guaranteed minimum commitments.  While those contracts generally have fixed terms and may not beterminated (absent a breach) prior to their stated expiration, the favorableeffects of the contracts are unlikely to be replicated after these contractsexpire or otherwise terminate.

 

In addition, we generate significant accounts receivable in connectionwith providing services to our major customers. If one or more of our customerswere to become insolvent or otherwise be unable to pay for our services or wereto become unwilling to make payments in a timely fashion, our operating resultsand financial condition could be adversely affected.

 

THE INCURRENCE OF INDEBTEDNESS COULD HARM OUR OPERATING RESULTS ANDFINANCIAL CONDITION. WE DEPEND ON OUR CREDIT FACILITIES TO FINANCE OUROPERATIONS AND THE MODIFICATION OR TERMINATION

OF THESE FACILITIES COULD HARM OUR OPERATING RESULTS AND FINANCIALCONDITION.

 

Our growth and acquisition strategy could require us to incursubstantial amounts of indebtedness. As of September 28, 2003, our total debtwas $24.2 million and our interest expense for the quarter then ended was $1.0million. In addition, we may incur additional indebtedness in the future.  Our future level of indebtedness could haveadverse consequences for our business, including:

 

•  vulnerability to the effects of pooreconomic and industry conditions affecting our business;

 

•  dedication of a substantial portion of ourcash flow from operations to repayment of debt and interest expense, limitingthe availability of cash for working capital, capital expenditures oracquisitions which may be attractive to us;

 

•  reduced flexibility in planning for, orreacting to, changes in our business and industry, due to the debt repaymentobligations and restrictive covenants contained in our debt instruments; and

 

•  failure to comply with the financialcovenants under the agreements governing our indebtedness relating to matterssuch as fixed charge coverage ratio, minimum adjusted tangible net worth, andminimum domestic EBITDA, resulting in an event of default, which if not curedor waived, could cause substantially all of our indebtedness to becomeimmediately due and payable.

 

We have financial instruments that are subject to interest rate risk,principally debt obligations under our 2002 Credit Agreement. An increase inthe base rates upon which our interest rates are determined could have anadverse effect on our operating results and financial condition.

 

WE HAVE MADE SEVERAL STRATEGIC ACQUISITIONS OF MANUFACTURING FACILITIESAND BUSINESSES AND MAY MAKE MORE ACQUISITIONS IN THE FUTURE, AND THE FAILURE TOSUCCESSFULLY INTEGRATE ACQUIRED FACILITIES AND BUSINESSES MAY ADVERSELY AFFECT OURFINANCIAL PERFORMANCE.

 

We have made several significant acquisitions in the past, andselectively pursuing strategic acquisitions remains an important part of ouroverall business strategy. However, any acquisitions we make could result in:

 

•  difficulty integrating our operations,technologies, financial controls and information systems, products and serviceswith those of the acquired facility;

 

•  difficulty in managing and operatinggeographically dispersed businesses, including some located in foreigncountries;

 

•  diversion of our capital and ourmanagement’s attention away from other business issues;

 

•  an increase in our expenses and our workingcapital requirements;

 

•  potential loss of key employees andcustomers of facilities or businesses we acquire; and

 

•  financial risks, such as:

 

•  potential liabilities of the facilities andbusinesses we acquire, including employees;

 

•  our need to incur additional indebtedness;and

 

•  dilution if we issue additional equitysecurities.

 

25

----

 

We may not successfully integrate any operations, technologies,systems, products or services that we acquire, and we cannot assure you thatany of our recent or future acquisitions will be successful. If any of ourrecent or future acquisitions are not successful, it is likely that ourfinancial performance will be adversely affected.

 

OUR GROWTH MAY BE LIMITED AND OUR COMPETITIVE POSITION MAY BE HARMED IFWE ARE UNABLE TO IDENTIFY, FINANCE AND COMPLETE FUTURE ACQUISITIONS.

 

We expect to selectively pursue strategic acquisitions as part of ouroverall business strategy. Competition for acquiring attractive facilities andbusinesses in our industry is substantial. In executing this part of ourbusiness strategy, we may experience difficulty in identifying suitableacquisition candidates or in completing selected transactions. In addition, our2002 Credit Agreement limits our ability to acquire the assets or businesses ofother companies. If we are able to identify acquisition candidates, suchacquisitions may be financed with substantial debt or with potentially dilutiveissuances of equity securities. Our ability to successfully completeacquisitions in the future will depend upon several factors, including the continuedavailability of financing. We cannot assure you that financing for acquisitionswill be available on terms acceptable to us, if at all.

 

IF WE ARE LEFT WITH EXCESS INVENTORY, OUR OPERATING RESULTS WILL BEADVERSELY AFFECTED.

 

We typically purchase components and manufacture products inanticipation of customer orders based on customer forecasts. For a variety ofreasons, such as decreased end-user demand for the products we aremanufacturing, our customers may not purchase all of the products we have manufacturedor for which we have purchased components. In such event, we would attempt torecoup our materials and manufacturing costs by means such as returningcomponents to our vendors, disposing of excess inventory through other channelsor requiring our OEM customers to purchase or otherwise compensate us for suchexcess inventory. Some of our significant customer agreements do not give usthe ability to require our OEM customers to do so. To the extent we areunsuccessful in recouping our material and manufacturing costs, not only wouldour net sales be adversely affected, but our operating results would bedisproportionately adversely affected. Moreover, carrying excess inventorywould reduce the working capital we have available to continue to operate andgrow our business.

 

As of September 28, 2003, $54.6 million of our gross inventory was heldunder a supply agreement with one major customer. Of this amount, approximately45.8% is inventory that exceeds demand to fulfill forecast requirements at September28, 2003. Our supply agreement places responsibility on our customer forinventory purchased consistent with its forecasts, but requires us to hold suchinventory, subject in some instances to a monthly carrying charge, prior to thetime the customer declares the product end of life.  At such time as the product is declared end of life, the customeris required to repurchase any remaining unmitigated inventory. We believe thatwe have properly valued the inventory that we are responsible for as of September28, 2003 and believe the customer is credit worthy.

 

LONG-TERM PURCHASE ORDERS AND COMMITMENTS ARE NOT TYPICAL IN OURINDUSTRY, AND REDUCTIONS, CANCELLATIONS OR DELAYS IN CUSTOMER ORDERS WOULDADVERSELY AFFECT OUR OPERATING RESULTS.

 

As is typical in the EMS industry, we do not usually obtain long-termpurchase orders or commitments from our customers. Instead, we work closelywith our customers to develop non-binding forecasts of the future volume oforders.  Customers may cancel theirorders, change production quantities from forecasted volumes or delayproduction for a number of reasons beyond our control.  Significant or numerous cancellations,reductions or delays in orders by our customers would reduce our net sales. Inaddition, because many of our costs are fixed, a reduction in net sales couldhave a disproportionate adverse effect on our operating results. From time totime we make capital investments in anticipation of future businessopportunities. There can be no assurance that we will receive the anticipatedbusiness. If we are unable to obtain the anticipated business, our operatingresults and financial condition may be harmed.

 

COMPETITION FROM EXISTING OR NEW COMPANIES IN THE EMS INDUSTRY COULDCAUSE US TO EXPERIENCE DOWNWARD PRESSURE ON PRICES, FEWER CUSTOMER ORDERS,REDUCED MARGINS, THE INABILITY TO TAKE ADVANTAGE OF NEW BUSINESS OPPORTUNITIESAND THE LOSS OF MARKET SHARE.

 

We operate in a highly competitive industry. We compete against manydomestic and foreign companies, some of which have substantially greatermanufacturing, financial, research and development and marketing resources thanwe do. Some of our competitors have broader geographic breadth and range ofservices than we do. In addition, some of our competitors may have moredeveloped relationships with our existing customers than we do. We also facecompetition from the manufacturing operations of our current and potentialcustomers, who continually evaluate the benefits of internal manufacturingversus outsourcing. As more OEMs dispose of their manufacturing assets andincrease the outsourcing of their products, we will face increasing competitivepressures to grow our business in order to maintain our competitive position.

 

WE DEPEND ON OUR SUPPLIERS, SOME OF WHICH ARE THE SOLE SOURCE FOR OURCOMPONENTS, AND OUR PRODUCTION WOULD BE SUBSTANTIALLY CURTAILED IF THESESUPPLIERS ARE NOT ABLE TO MEET OUR DEMANDS AND ALTERNATIVE SOURCES ARE NOTAVAILABLE.

 

26

----

 

We order raw materials and components to complete our customers’orders, and some of these raw materials and components are ordered fromsole-source suppliers. Although we work with our customers and suppliers tominimize the impact of shortages in raw materials and components, we sometimesexperience short-term adverse effects due to price fluctuations, extended leadtimes and delayed shipments. In the past, there have been industry-wideshortages of electronic components, particularly memory and logic devices. If asignificant shortage of raw materials or components were to occur, we may haveto delay shipments to customers and our operating results would be adverselyaffected. In some cases, supply shortages of particular components willsubstantially curtail production of products using these components. While mostof our significant customer contracts permit quarterly or other periodicreviews of pricing based on decreases and increases in the prices of rawmaterials and components, we are not always able to pass on price increases toour customers. Accordingly, some raw material and component price increasescould adversely affect our operating results. We also depend on a small numberof suppliers for many of the other raw materials and components that we use inour business. If we were unable to continue to purchase these raw materials andcomponents from our suppliers, our operating results would be adverselyaffected. Because many of our costs are fixed, our margins depend on our volumeof output at our facilities and a reduction in volume will adversely affect ourmargins.

 

UNCERTAINTIES AND ADVERSE TRENDS AFFECTING THE ELECTRONICS INDUSTRY ORANY OF OUR MAJOR CUSTOMERS MAY ADVERSELY AFFECT OUR OPERATING RESULTS.

 

Our business depends on the electronics industry, which is subject torapid technological change, short product life cycles and pricing and marginpressure.  In addition, the electronicsindustry has historically been cyclical and subject to significant downturnscharacterized by diminished product demand, rapid declines in average sellingprices and production over-capacity. When these factors adversely affect ourcustomers, we may suffer similar effects. Our customers’ markets are alsosubject to economic cycles and are likely to experience recessionary periods inthe future. The economic conditions affecting the electronics industry, ingeneral, or any of our major customers, in particular including the economicslowdown, may adversely affect our operating results.

 

BECAUSE WE HAVE SIGNIFICANT OPERATIONS OVERSEAS, OUR OPERATING RESULTSCOULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER FACTORS EXISTINGIN FOREIGN COUNTRIES IN WHICH WE OPERATE.

 

We have substantial manufacturing operations in Europe, Asia andMexico. Our international operations are subject to inherent risks, which mayadversely affect us, including:

 

•    political and economicinstability in countries or geographies where we have manufacturing facilities,particularly in Asia and Mexico where we conduct a portion of our business;

 

•    fluctuations in the value offoreign currencies;

 

•    high levels of inflation,historically the case in a number of countries in Asia and Mexico where we dobusiness;

 

•    changes in labor conditionsand difficulties in staffing and managing our foreign operations;

 

•    greater difficulty incollecting our accounts receivable and longer payment cycles;

 

•    burdens and costs of ourcompliance with a variety of foreign laws;

 

•    increases in the duties andtaxes we pay;

 

•    imposition of restrictions oncurrency conversion or the transfer of funds; and

 

•    expropriation of privateenterprises.

 

OUR BUSINESS MAY BE IMPACTED BY GEOPOLITICAL EVENTS

 

As a global business, we operate and have customers located in manycountries.  Geopolitical events such asterrorist acts may effect the overall economic environment and negativelyimpact the demand for our customers’ products. As a result, customer orders may be lower and our financial results maybe adversely affected.

 

OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS ANDSEASONALITY AND IF WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS ORINVESTORS THE PRICE OF OUR SECURITIES MAY DECREASE.

 

27

----

 

Our annual and quarterly results may vary significantly depending onvarious factors, many of which are beyond our control, and may not meet theexpectations of securities analysts or investors. If this occurs, the price ofour common stock would likely decline. These factors include:

 

•    variations in the timing andvolume of customer orders relative to our manufacturing capacity;

 

•    introduction and marketacceptance of our customers’ new products;

 

•    changes in demand for ourcustomers’ existing products;

 

•    the timing of our expendituresin anticipation of future orders;

 

•    effectiveness in managing ourmanufacturing processes;

 

•    changes in competitive andeconomic conditions generally or in our customers’ markets;

 

•    the timing of, and the pricewe pay for, acquisitions and related integration costs;

 

•    changes in the cost oravailability of components or skilled labor; and

 

•    foreign currency exposure.

 

As is the case with many technology companies, we typically ship asignificant portion of our products in the last few weeks of a quarter. As aresult, any delay in anticipated sales is likely to result in the deferral ofthe associated revenue beyond the end of a particular quarter, which would havea significant effect on our operating results for that quarter. In addition,most of our operating expenses do not vary directly with net sales and aredifficult to adjust in the short term. As a result, if net sales for aparticular quarter were below our expectations, we could not proportionatelyreduce operating expenses for that quarter, and, therefore, that revenue shortfallwould have a disproportionate adverse effect on our operating results for thatquarter.

 

LOSS OF ANY OF OUR KEY PERSONNEL COULD HURT OUR BUSINESS BECAUSE OFTHEIR EXPERIENCE IN THE EMS INDUSTRY AND THEIR TECHNOLOGICAL EXPERTISE.

 

We operate in the highly competitive EMS industry and depend on theservices of our key senior executives and our technological experts. The lossof the services of one or several of our key employees or an inability toattract, train and retain qualified and skilled employees, specificallyengineering, operations and sales personnel, could result in the loss ofcustomers or otherwise inhibit our ability to operate and grow our businesssuccessfully. In addition, our ability to successfully integrate acquiredfacilities or businesses depends, in part, on our ability to retain andmotivate key management and employees hired by us in connection with theacquisition.

 

IF WE ARE UNABLE TO MAINTAIN OUR TECHNOLOGICAL EXPERTISE IN DESIGN ANDMANUFACTURING PROCESSES WE WILL NOT BE ABLE TO SUCCESSFULLY COMPETE.

 

We believe that our future success will depend upon our ability todevelop and provide design and manufacturing services that meet the changingneeds of our customers. This requires that we successfully anticipate andrespond to technological changes in design and manufacturing processes in acost-effective and timely manner.  As aresult, we continually evaluate the advantages and feasibility of new productdesign and manufacturing processes. We cannot, however, assure you that ourprocess development efforts will be successful.

 

WE ARE SUBJECT TO A VARIETY OF ENVIRONMENTAL LAWS THAT EXPOSE US TOPOTENTIAL FINANCIAL LIABILITY.

 

Our operations are regulated under a number of federal, state andforeign environmental and safety laws and regulations that govern, among otherthings, the discharge of hazardous materials into the air and water as well asthe handling, storage and disposal of these materials. These laws andregulations include the Clean Air Act, the Clean Water Act, the Resource,Conservation and Recovery Act, and the Comprehensive Environmental Response,Compensation and Liability Act, as well as analogous state and foreign laws.Compliance with these environmental laws is a major consideration for usbecause we use hazardous materials in our manufacturing process. In addition,because we are a generator of hazardous wastes, we, along with any other personwho arranges for the disposal of our wastes, may be subject to financialexposure for costs associated with an investigation and any remediation ofsites at which we have arranged for the disposal of hazardous wastes if thesesites become contaminated, even if we fully comply with applicable

 

28

----

 

environmental laws. In the event of a violation of environmental laws,we could be held liable for damages and for the costs of remedial actions andcould also be subject to revocation of our effluent discharge permits. Anyrevocation could require us to cease or limit production at one or more of ourfacilities, thereby negatively impacting our revenues and results ofoperations. Environmental laws could also become more stringent over time,imposing greater compliance costs and increasing risks and penalties associatedwith any violation, which also could negatively impact our operating results.

 

OUR CONTROLLING STOCKHOLDERS AND SOME OF OUR DIRECTORS MAY HAVEINTERESTS THAT DIFFER FROM YOURS.

 

Credit Suisse First Boston, through certain of its affiliates, ownsapproximately 47% of our outstanding common stock and, as a result, hassignificant control over our business, policies and affairs, including,effectively, the power to appoint new management, prevent or cause a change ofcontrol and approve any action requiring the approval of the holders of ourcommon stock, such as adopting amendments to our certificate of incorporationand approving mergers or sales of all or substantially all of our assets.Circumstances may occur in which the interests of these stockholders could bein conflict with your interests.

 

PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY, DETEROR PREVENT SOMEONE FROM ACQUIRING US, WHICH COULD DECREASE THE VALUE OF OURCOMMON STOCK.

 

Provisions in our charter and bylaws may have the effect of delaying,deterring or preventing a change of control or changes in our management thatinvestors might consider favorable unless approved by our stockholders anddirectors affiliated with Credit Suisse First Boston. Those provisions serve tolimit the circumstances in which a premium may be paid for our common stock inproposed transactions or where a proxy contest for control of our board may beinitiated. If a change of control or change in management is delayed, deterredor prevented, the market price of our common stock could suffer.

 

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

 

Other than the forward currency exchange contracts discussed belowthere have been no material changes in our market risk during the quarter endedSeptember 28, 2003.  Market riskinformation is contained under the caption “Quantitative and QualitativeDisclosure Relating to Market Risks” in our Annual Report on Form 10-K for thefiscal year ended December 31, 2002.

 

The Company uses forward currency exchange contracts primarily to hedgecertain operational ("cash flow" hedges) and balance sheet("fair value" hedges) exposures resulting from fluctuations incurrency exchange rates.  Such exposuresprimarily result from portions of the Company's operations and assets that aredenominated in currencies other than the functional currencies of thebusinesses conducting the operations or holding the assets. The Company entersinto currency exchange contracts in the normal course of business, andaccordingly, the hedges are not speculative in nature. The Company does nothold or transact in financial instruments for purposes other than riskmanagement.

 

At September 28, 2003, we had entered intoforward currency exchange contracts to sell Euros and purchase a net amount of approximately$20.2 million.  We also had entered intoa forward currency exchange contract to sell approximately $1.4 million andpurchase Mexican Pesos.  A hypothetical10% fluctuation in the exchange rates of the underlying currencies may resultin a change in unrealized gain/loss of approximately $2.0 million.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

The Company’s management, with the participation of the Company’s chiefexecutive officer and chief financial officer, evaluated the effectiveness ofthe Company’s disclosure controls and procedures (as defined in Rules 13a-15(e)and 15d-15(e) under the Exchange Act) as of September 28, 2003.  In designing and evaluating the Company’sdisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving their objectives and management necessarilyapplied its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.  Based on thisevaluation, the Company’s chief executive officer and chief financial officerconcluded that, as of September 28, 2003, the Company’s disclosure controls andprocedures were (1) designed to ensure that material information relating tothe Company, including its consolidated subsidiaries, is made known to theCompany’s chief executive officer and chief financial officer by others withinthose entities, particularly during the period in which this report was beingprepared and (2) effective, in that they provide reasonable assurance thatinformation required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms.

 

No change in the Company’s internal control over financial reporting(as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurredduring the fiscal quarter ended September 28, 2003 that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

29

----

 

PART II. OTHERINFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

A class action complaint filed on December 6,2000, alleging violations of federal securities laws has been pending in theUnited States District Court, Southern District of New York against us, certainof our former officers and the underwriters that participated in our initialpublic offering (“IPO”).  We understandthat various other plaintiffs have filed substantially similar class actioncases against approximately 300 other publicly traded companies and their IPOunderwriters, which cases have been consolidated to a single federal districtcourt for coordinated case management. The complaint, which seeks unspecified damages among other things,alleges that the prospectus filed by us relating to stock sold in our initialpublic offering contained false and misleading statements with respect to thecommission arrangements between the underwriters and their customers.  We believe that this claim against us lacksmerit.

 

On July 15, 2002, we together with the otherissuers named as defendants in these coordinated proceedings filed a collectivemotion to dismiss the consolidated complaints on various legal grounds.  On October 9, 2002, the court approved astipulation between the plaintiffs and the individual defendants providing forthe dismissal of the individual defendants without prejudice.  In February 2003, that motion was deniedwith respect to most issuers.

 

We have agreed to enter into a Memorandum ofUnderstanding proposed by the plaintiffs containing the terms of an agreementresolving the claims of the plaintiffs against us and our named officers.  While we can make noassurances regarding the outcome of this action, we believe that the finalresult will have no material effect on its consolidated financial condition orresult of operations.

 

We are party to other lawsuits in the ordinary course of business. Wedo not believe that these other proceedings individually or in the aggregatewill have a material adverse effect on our financial position, results ofoperations or cash flows.

 

30

----

 

ITEM 6.EXHIBITS AND REPORTS ON FORM 8-K

 

(a)           Exhibits

 

 
|     | **EXHIBIT NUMBER** |                                   | **DESCRIPTION**                                                                                                                                                                   |   |
|----------|--------------------|----------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|     |               |                                   |                                                                                                                                                                              |   |
|     | 2.1(1)             |                                   | Securities Purchase Agreement dated as of  January 20, 1995 by and among MSL and the parties listed therein.                                                                      |   |
|     | 2.2(1)             |                                   | Warrant Agreement dated as of August 31,  1995 by and among MSL, Bank of America National Trust and Savings Association  and the parties listed therein.                          |   |
|     | 2.3(1)             |                                   | Preferred Stock and Warrant Subscription  Agreement dated as of November 26, 1999 by and among MSL and the parties  listed therein.                                               |   |
|     | 2.4(1)             |                                   | Escrow Agreement dated as of November 26,  1999 by and among MSL and the parties listed therein.                                                                                  |   |
|     | 2.5(1)             |                                   | Asset Purchase Agreement dated as of  November 19, 1999 among 3Com Corporation, MSL and Manufacturers’ Services  Salt Lake City Operations, Inc.                             |   |
|     | 2.6(2)             |                                   | Asset Purchase Agreement dated as of  September 26, 2000 among 3Com Corporation, MSL and Manufacturers’ Services  Salt Lake City Operations, Inc.                            |   |
|     | 3.1(1)             |                                   | Restated Certificate of Incorporation of  MSL.                                                                                                                                    |   |
|     | 3.2(1)             |                                   | Amended and Restated By-Laws of MSL.                                                                                                                                              |   |
|     | 3.4(5)             |                                   | Amended and Restated Articles of  Incorporation of MSL.                                                                                                                           |   |
|     | 3.3(1)             |                                   | Form of certificate representing shares of  common stock, $.001 par value per share.                                                                                              |   |
|     | 4.1(1)             |                                   | Stockholders Agreement dated as of January  20, 1995 by and among MSL and the stockholders named therein.                                                                         |   |
|     | 4.2(1)             |                                   | Stockholders Agreement Amendment dated  November 26, 1999 by and among MSL and the stockholders named therein.                                                                    |   |
|     | 4.3(1)             |                                   | Credit Agreement dated August 21, 1998  among MSL, MSL Overseas Finance B.V. and the lenders named therein.                                                                       |   |
|     | 4.4(1)             |                                   | First Amendment to Credit Agreement and  Limited Waiver dated as of February 26, 1999 by and among MSL, MSL Overseas  Finance B.V. and the lenders named in the Credit Agreement. |   |
|     | 4.5(1)             |                                   | Second Amendment to Credit Agreement and  Consent dated as of November 23, 1999 by and among MSL, MSL Overseas Finance  B.V. and the lenders named in the Credit Agreement.       |   |
|     | 4.6(4)             |                                   | First Amended and Restated Credit Agreement  dated as of September 29, 2000 by and between MSL and the lenders named in  the Credit Agreement.                                    |   |
|     | 4.7(4)             |                                   | First Amendment Agreement and Consent dated  as of September 29, 2000 by and between MSL and the lenders named therein.                                                           |   |
|     | 4.8(3)             |                                   | First Amendment to First Amended and  Restated Credit Agreement dated as of October 25, 2000 by and between MSL and  the lenders named therein.                                   |   |
|     | 4.9(5)             |                                   | Second Amendment to First Amended and  Restated Credit Agreement dated as of March 2, 2001 by and between MSL and  the lenders named therein.                                     |   |
|     | 4.10(7)            |                                   | Third Amendment to First Amended and  Restated Credit Agreement dated as of October 18, 2001 by and between MSL and  the lenders named therein.                                   |   |
|     | 4.11(9)            |                                   | Certificate of Designations of 5.25% Series  A Convertible Preferred Stock of MSL dated March 14, 2002.                                                                           |   |
|     | 4.12(11)           |                                   | Credit Agreement dated as of June 20, 2002  by and between MSL and the lenders named therein.                                                                                     |   |
|     | 10.1(1)            |                                   | Employment Agreement dated as of January  20, 1995 by and between MSL and Kevin C. Melia.                                                                                    |   |
|     | 10.2(1)            |                                   | Employment Letter dated as of June 20, 1997  by and between MSL and Robert E. Donahue.                                                                                            |   |
|     | 10.3(1)            |                                   | Employment Letter dated as of September 27,  1995 by and between MSL and Rodolfo Archbold.                                                                                        |   |
|     | 10.4(1)            |                                   | Employment Letter dated as of January 4,  1996 by and between MSL and Dale R. Johnson.                                                                                            |   |
|     | 10.5(1)            |                                   | Severance Letter dated June 25, 1996 by and  between MSL and Dale R. Johnson.                                                                                                     |   |
|     | 10.6(1)            |                                   | Employment Letter dated as of January 23,  1998 by and between MSL and James N. Poor.                                                                                             |   |
|     | 10.7(1)            |                                   | Second Amended and Restated Non-Qualified  Option Plan.                                                                                                                           |   |
|     | 10.8(1)            |                                   | Form of 2000 Equity Incentive Plan.                                                                                                                                               |   |
|     | 10.9(1)            |                                   | Form of 2000 Employee Stock Purchase Plan.                                                                                                                                        |   |
|     | 10.10(1)           |                                   | Form of Indemnification Agreement.                                                                                                                                                |   |
|     | 10.11(1)           |                                   | Office/Warehouse Lease dated as of April  14, 1997 by and between Amberjack, Ltd. and Manufacturers’ Services  Limited-Roseville, Inc.                                       |   |
|     | 10.12(1)           |                                   | Lease dated as of May 5, 1998 by and  between International Business Machines Corporation and Manufacturers’  Services Western U.S. Operations, Inc.                         |   |
|     | 10.14(1)+          |                                   | Outsourcing Agreement dated as of June 1,  1998 by and between International Business Machines Corporation and  Manufacturers’ Services Western US Operations, Inc.          |   |
|     |               |                                   |                                                                                                                                                                              |   |
| 10.19(1) |               | 2000 Cash Incentive Compensation Plan. |
|          |                    |                                        |                                                                                                                                                                                   |        |

 

31

----

 
| 10.22(4)   |   | 2000 Non-employee Director Stock Option  Plan, as amended.                                                                                                                                                              |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.23(4)   |   | 2000 Non-qualified Stock Option Plan.                                                                                                                                                                                   |
| 10.24(4)   |   | Second Amended and Restated Non-qualified Stock  Option Plan, as amended.                                                                                                                                               |
| 10.25(4)   |   | 2000 Equity Incentive Plan, as amended.                                                                                                                                                                                 |
| 10.26(5)   |   | Form of Change in Control Agreement for  Kevin Melia, Robert Donahue, Albert Notini, Rodolfo Archbold, James Poor,  Alan Cormier, Richard Gaynor, Francis Binder, Richard Buckingham and Sam  Landol.                   |
| 10.28(5)   |   | Amendment to Employment Letter dated as of  September 27, 1995 between MSL and Rodolfo Archbold.                                                                                                                        |
| 10.30(6)   |   | 2000 Equity Incentive Plan, as amended.                                                                                                                                                                                 |
| 10.31(6)   |   | 2000 Employee Stock Purchase Plan, as  amended.                                                                                                                                                                         |
| 10.32(6)   |   | 2000 Non-Qualified Stock Option Plan, as  amended.                                                                                                                                                                      |
| 10.33(7)   |   | Amendment to Supply Agreement between  Manufacturers Services Salt Lake City Operations, Inc. and 3Com Corporation  effective as of September 14, 2001.                                                                 |
| 10.34(8)+  |   | Amendment to the Outsourcing Agreement  dated as of June 1, 1998 by and between International Business Machines  Corporation and Manufacturers’ Services Western US Operations, Inc.                               |
| 10.35(8)   |   | Severance Agreement effective March 29,  2002 by and between MSL and Robert E. Donahue.                                                                                                                                 |
| 10.36(8)   |   | Employment Agreement dated as of January 2,  2002 by and between MSL and Kevin C. Melia.                                                                                                                                |
| 10.37(8)   |   | Employment Agreement dated as of January  31, 2002 by and between MSL and Albert A. Notini.                                                                                                                        |
| 10.38(8)   |   | Employment Agreement dated as of December  19, 2002 by and between MSL and Robert C. Bradshaw.                                                                                                                          |
| 10.39(8)   |   | Employment Agreement dated as of January  30, 2002 by and between MSL and Santosh Rao.                                                                                                                                  |
| 10.40(8)   |   | Form of Change in Control Agreement for  Santosh Rao, Bruce Leasure, Dewayne Rideout.                                                                                                                                   |
| 10.41(10)  |   | Severance Agreement effective March 29,  2002 by and between MSL and Rodolfo Archbold.                                                                                                                                  |
| 10.42(11)  |   | Severance Agreement effective March 29,  2002 by and between MSL and James N. Poor.                                                                                                                                     |
| 10.43(11)  |   | 2000 Equity Incentive Plan, as amended on  May 15, 2002.                                                                                                                                                                |
| 10.44(11)  |   | 2000 Employee Stock Purchase Plan, as  amended on May 15, 2002.                                                                                                                                                         |
| 10.45(11)  |   | 2000 Non-Employee Director Stock Option  Plan, as amended on May 15, 2002                                                                                                                                          |
| 10.46(12)  |   | Credit Agreement Dated June 20, 2002 among  the Company, Bank of America N.A. and certain other financial institutions  named therein.                                                                                  |
| 10.47(13)  |   | Accession Agreement dated August 22, 2002  among Congress Financial Corporation, Bank of America, MSL, et al.                                                                                                           |
| 10.48(13)  |   | Notice of Assignment and Acceptance dated  August 21, 2002 among HSBC Business Credit (USA) Inc., Bank of America,  N.A. and MSL.                                                                                  |
| 10.49(13)  |   | Notice of Assignment and Acceptance dated  August 20, 2002 among Orix Financial Services, Bank of America, N.A. and  MSL.                                                                                          |
| 10.50 (14) |   | Severance Agreement effective  January 2, 2003 by and between MSL and Kevin C. Melia                                                                                                                               |
| 10.51 (14) |   | Amendment No. 1 dated August 16, 2002 to  the Credit Agreement dated June 20, 2002 by and among the Company, Bank  of America, N.A. and certain other financial institutions named therein.                        |
| 10.52 (14) |   | Amendment and Waiver No. 2 dated as of  December 2002 to the Credit Agreement dated June 20, 2002 by and among  the Company, Bank of America, N.A. and certain other financial institutions  named therein.        |
| 10.53 (14) |   | Waiver and Undertaking Agreement No. 3  dated as of February 2003 to the Credit Agreement dated June 20, 2002 by and  among the Company, Bank of America, N.A. and certain other financial  institutions named therein. |
| 10.54 (14) |   | Waiver Agreement No. 4 dated March 21,  2003 to the Credit Agreement dated June 20, 2002 by and among the Company,  Bank of America, N.A. and certain other financial institutions named therein.             |
| 10.55 (15) |   | Employment Agreement dated April 29, 2003  between MSL and Albert A. Notini.                                                                                                                                            |
| 10.56      |   | Amendment and Waiver Agreement No. 5 dated  July 3, 2003 to the Credit Agreement dated June 20, 2002 by and among  the Company, Bank of America, N.A. and certain other financial institutions  named therein      |
| 31.1       |   | Section 302 Certification                                                                                                                                                                                               |
| 31.2       |   | Section 302 Certification                                                                                                                                                                                               |
| 32         |   | Section 906 Certification                                                                                                                                                                                               |

 

----

+                                         Confidentialtreatment requested as to certain portions which portions have been filedseparately with the Securities and Exchange Commission.

 

 (1)                               Filed as an Exhibit tothe Registrant’s Registration Statement on Form S-1, as amended (FileNo. 333-96227), filed on February 4, 2000.

 

(2)                                  Filedas an Exhibit to the Registrant’s Current Report on Form 8-K filed onOctober 11, 2000.

 

(3)                                  Filedas an Exhibit to the Registrant’s Current Report on Form 8-K filed onDecember 5, 2000.

 

(4)                                  Filedas an Exhibit to the Registrant’s Quarterly Report on Form 10-Q filed onNovember 14, 2000.

 

(5)                                  Filedas an Exhibit to the Registrant’s Annual Report on Form 10-K filed onApril 2, 2001.

 

(6)                                  Filedas an Exhibit to the Registrant’s Quarterly Report on Form 10-Q filed onAugust 14, 2001.

 

32

----

 

(7)                                  Filedas an Exhibit to the Registrant’s Quarterly Report on Form 10-Q filed onNovember 14, 2001.

 

(8)                                  Filedas an Exhibit to the Registrant’s Annual Report on Form 10-K filed onMarch 29, 2002.

 

(9)                                  Filedas an Exhibit to the Registrant’s Current Report on Form 8-K filed onMarch 18, 2002.

 

(10)                            Filedas an Exhibit to the Registrant’s Quarterly Report on Form 10-Q filed onMay 15, 2002.

 

(11)                            Filedas an Exhibit to the Registrant’s Quarterly Report on Form 10-Q filed onAugust 14, 2002.

 

(12)                            Filedas an Exhibit to the Registrant’s Current Report on Form 8-K filed onJune 28, 2002.

 

(13)                            Filedas an Exhibit to the Registrant’s Quarterly Report on Form 10-Q filed onNovember 13, 2002.

 

(14)                            Filedas an Exhibit to the Registrant’s Annual Report on Form 10-K filed on March 31,2003.

 

(15)                            Filedas an Exhibit to the Registrant’s Quarterly Report on Form 10-Q filed on August6, 2003

 

 

(b)     Reports on Form 8-K providing during thequarterly period ended September 28, 2003:

 

(1) On July 9, 2003 the Company filed areport on Form 8-K pursuant to Item 5, Other Events, related to the Company’s4.5% Series B Convertible Preferred stock and warrants.

 

(2) On July 25, 2003 the Company furnished areport on Form 8-K pursuant to Item 9, Regulation FD Disclosure and Item 12,Results of Operations and Financial Condition, relating to the Company’s pressrelease announcing second quarter financial results.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized:

 
|   |   | MANUFACTURERS’ SERVICES LIMITED |
|--------|--------|--------------------------------------|
|   |   | (Registrant)                         |
|   |   |                                 |   |
|   |   | Date: October 31, 2003               |
|   |   |                                 |   |
|   |   | By:                                  | /s/ Albert A. Notini |   |
|   |   |                                 | Albert A. Notini |   |
|   |   |                                 | Executive Vice President and  Chief Financial Officer  (Principal Financial Officer) |   |
|   |   |                                 |   |   |
|   |   | By:                                  | /s/ Richard J. Gaynor |   |
|   |   |                                 | Richard J. Gaynor |   |
|   |   |                                 | Vice President and |   |
|   |   |                                 | Corporate Controller  (Principal Accounting Officer) |   |

 

33

----