**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**Form 10-Q**

 

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| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended September 30, 2005**

 

**Commission File Number: 333-118675**

 

**Accellent Corp.**

(Exact name of registrant as specified in itscharter)

 
| **Colorado**                                                |                                                                                                                                                                        | **91-2054669**         |
|-------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------|
| (State or other jurisdiction of                             |                                                                                                                                                                        | (I.R.S. Employer       |
| incorporation or organization)                              | ** **                                                                                                                                                                  | Identification Number) |
|                                                        |                                                                                                                                                                        |                   |
| **200 West 7th Avenue**                                     |                                                                                                                                                                        |                   |
| **Collegeville, Pennsylvania**                              | ** **                                                                                                                                                                  | **19426-0992**         |
| (Address of registrant’s principal  executive offices) |                                                                                                                                                                        | (Zip code)             |
|                                                        |                                                                                                                                                                        |                   |
|                                                        | Registrant’s Telephone Number, Including  Area Code:                **(610) 489-0300** |                   |
|                                                             |                                                                                                                                                                             |                        |  |  |

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past90 days.     Yes  ý      No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act).

Yes  o      No  ý

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

Yes  o      No  ý

 

Asof November 1, 2005, 100 shares of the Registrant’s common stock wereoutstanding.  The registrant is a whollyowned subsidiary of Accellent Inc.

 

 

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**Table of Contents**

 
| **PART I**  | **FINANCIAL INFORMATION** | ** **                                                                                  |
|------------------|---------------------------|---------------------------------------------------------------------------------------------|
|             |                      |                                                                                        |   |
|             | ITEM  1.                  | Financial  Statements                                                                       |   |
|             |                      | Unaudited Condensed Consolidated Balance  Sheets                                            |   |
|             |                      | Unaudited Condensed Consolidated Statements  of Operations                                  |   |
|             |                      | Unaudited Condensed Consolidated Statements  of Cash Flows                                  |   |
|             |                      | Notes to Unaudited Condensed Consolidated  Financial Statements                             |   |
|             |                      |                                                                                        |   |
|             | ITEM  2.                  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|             |                      |                                                                                        |   |
|             | ITEM  3.                  | Quantitative  and Qualitative Disclosures About Market Risk                                 |   |
|             |                      |                                                                                        |   |
|             | ITEM  4.                  | Controls  and Procedures                                                                    |   |
|             |                      |                                                                                        |   |
| **PART II** | **OTHER INFORMATION**     | ** **                                                                                  |
|             |                      |                                                                                        |   |
|             | ITEM  6.                  | Exhibits                                                                                    |   |
|             |                      |                                                                                        |   |
| Signatures       |                      |                                                                                        |   |

 

2

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**PART I.   FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**ACCELLENT CORP.**

**Unaudited Condensed Consolidated BalanceSheets**

**As of September 30, 2005 and December 31,2004**

**(in thousands)**

 
| ** **                                                                                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                             |       |                         |       |                        |       |
| Current assets:                                                                                        |       |                         |       |                        |       |
| Cash and cash equivalents                                                                              |       | $                            | 7,388      |                        | $          | 16,004 |   |
| Accounts receivable, net of allowances of  $2,067 and $2,909, respectively                             |       | 56,561                       |       | 48,354                      |       |
| Inventories                                                                                            |       | 61,393                       |       | 58,014                      |       |
| Prepaid expenses and other                                                                             |       | 2,706                        |       | 3,471                       |       |
| Total current assets                                                                                   |       | 128,048                      |       | 125,843                     |       |
| Property and equipment, net                                                                            |       | 96,102                       |       | 85,945                      |       |
| Goodwill                                                                                               |       | 284,879                      |       | 289,461                     |       |
| Intangibles, net                                                                                       |       | 83,654                       |       | 81,874                      |       |
| Deferred financing costs and other assets                                                              |       | 15,985                       |       | 17,106                      |       |
| Total assets                                                                                           |       | $                            | 608,668    |                        | $          | 600,229 |   |
| **Liabilities and stockholder’s equity**                                                          |       |                         |       |                        |       |
| Current liabilities:                                                                                   |       |                         |       |                        |       |
| Current portion of long-term debt                                                                      |       | $                            | 1,961      |                        | $          | 1,961 |   |
| Accounts payable                                                                                       |       | 20,218                       |       | 20,447                      |       |
| Accrued payroll and benefits                                                                           |       | 12,143                       |       | 13,011                      |       |
| Accrued interest                                                                                       |       | 3,741                        |       | 10,575                      |       |
| Accrued expenses, other                                                                                |       | 19,677                       |       | 26,986                      |       |
| Total current liabilities                                                                              |       | 57,740                       |       | 72,980                      |       |
| Notes payable and long-term debt                                                                       |       | 372,663                      |       | 366,091                     |       |
| Other long-term liabilities                                                                            |       | 25,255                       |       | 23,667                      |       |
| Total liabilities                                                                                      |       | 455,658                      |       | 462,738                     |       |
| Redeemable and convertible preferred stock of parent company                                           |       | —                       |       | 30                          |       |
| Stockholder’s equity:                                                                             |       |                         |       |                        |       |
| Common stock, par value $.01 per share,  1,000 shares authorized and 100 shares issued and outstanding |       | —                       |       | —                      |       |
| Additional paid-in capital                                                                             |       | 205,750                      |       | 201,348                     |       |
| Accumulated other comprehensive income                                                                 |       | 928                          |       | 1,716                       |       |
| Accumulated deficit                                                                                    |       | (53,668                      | )          | (65,603                     | )          |
| Total stockholder’s equity                                                                        |       | 153,010                      |       | 137,461                     |       |
| Total liabilities and stockholder’s equity                                                        |       | $                            | 608,668    |                        | $          | 600,229 |   |

 

The accompanying notes are an integral partof these financial statements.

 

3

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**ACCELLENT CORP.**

**Unaudited Condensed Consolidated Statementsof Operations**

**For the three and nine months ended September 30,2005 and 2004**

**(in thousands)**

 
| ** **                                                                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                                                                                                                 |       | $                                          | 116,655    |                                      | $          | 100,338 |   | $ | 340,253 |   | $ | 212,485 |   |
| Cost of sales                                                                                                             |       | 79,758                                     |       | 77,497                                    |       | 234,122 |   | 155,155 |   |
| Gross profit                                                                                                              |       | 36,897                                     |       | 22,841                                    |       | 106,131 |   | 57,330 |   |
| Selling, general and administrative  expenses                                                                             |       | 18,547                                     |       | 14,106                                    |       | 49,539 |   | 30,681 |   |
| Research and development expenses                                                                                         |       | 866                                        |       | 847                                       |       | 2,294 |   | 2,023 |   |
| Restructuring and other charges                                                                                           |       | 1,185                                      |       | 2,107                                     |       | 3,824 |   | 2,107 |   |
| Amortization of intangibles                                                                                               |       | 1,572                                      |       | 1,487                                     |       | 4,660 |   | 3,937 |   |
| Income from operations                                                                                                    |       | 14,727                                     |       | 4,294                                     |       | 45,814 |   | 18,582 |   |
| Interest expense, net                                                                                                     |       | 7,970                                      |       | 7,382                                     |       | 23,731 |   | 19,397 |   |
| Other (income) expense, including debt  prepayment penalties of $3,295 for the nine months ended September 30,  2004 |       | (42                                        | )          | 19                                        |       | 105 |   | 3,284 |   |
| Income (loss) before income taxes                                                                                         |       | 6,799                                      |       | (3,107                                    | )          | 21,978 |   | (4,099 | ) |
| Income tax expense                                                                                                        |       | 3,930                                      |       | 1,284                                     |       | 10,045 |   | 2,341 |   |
| Net income (loss)                                                                                                         |       | 2,869                                      |       | (4,391                                    | )          | 11,933 |   | (6,440 | ) |
| Dividends on redeemable and convertible  preferred stock of parent company                                                |       | —                                     |       | —                                    |       | — |   | (8,201 | ) |
| Net income (loss) available to common  stockholder                                                                        |       | $                                          | 2,869      |                                      | $          | (4,391 | ) | $ | 11,933 |   | $ | (14,641 | ) |

 

The accompanying notes are an integral partof these financial statements.

 

4

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**ACCELLENT CORP.**

**Unaudited Condensed Consolidated Statementsof Cash Flows**

**For the nine months ended September 30,2005 and 2004**

**(in thousands)**

 
| ** **                                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| **OPERATING  ACTIVITIES:**                                                            |       |                                      |       |   |   |
| Net income (loss)                                                                     |       | $                                         | 11,933     |   | $ | (6,440 | ) |
| Cash provided by operating activities:                                                |       |                                      |       |   |   |
| Depreciation and amortization                                                         |       | 16,062                                    |       | 11,289 |   |
| Amortization of debt discounts and non-cash  interest accrued                         |       | 2,002                                     |       | 6,942 |   |
| Deferred income taxes                                                                 |       | 6,532                                     |       | 993 |   |
| Non-cash compensation charge                                                          |       | 3,556                                     |       | 161 |   |
| Loss (gain) on disposal of assets                                                     |       | 310                                       |       | (114 | ) |
| Changes in operating assets and  liabilities, net of business acquired:               |       |                                      |       |   |   |
| Increase in accounts receivable                                                       |       | (7,379                                    | )          | (5,816 | ) |
| Increase in inventories                                                               |       | (2,462                                    | )          | (6,435 | ) |
| Decrease in prepaid expenses and other                                                |       | 790                                       |       | 898 |   |
| (Decrease) increase in accounts payable and  accrued expenses                         |       | (9,874                                    | )          | 4,701 |   |
| Net cash provided by operating activities                                             |       | 21,470                                    |       | 6,179 |   |
| **INVESTING  ACTIVITIES:**                                                            |       |                                      |       |   |   |
| Purchase of property, plant &  equipment                                     |       | (15,586                                   | )          | (8,718 | ) |
| Proceeds from sale of assets                                                          |       | 61                                        |       | 1,402 |   |
| Acquisition of business                                                               |       | (20,098                                   | )          | (214,001 | ) |
| Net cash used in investing activities                                                 |       | (35,623                                   | )          | (221,317 | ) |
| **FINANCING  ACTIVITIES:**                                                            |       |                                      |       |   |   |
| Proceeds from long-term debt                                                          |       | 8,000                                     |       | 372,000 |   |
| Principal payments on long-term debt                                                  |       | (1,473                                    | )          | (184,547 | ) |
| Capital contributions from parent                                                     |       | 30                                        |       | 67,862 |   |
| Redemption and repurchase of redeemable and  convertible preferred stock of parent    |       | (30                                       | )          | (12,563 | ) |
| Dividends paid on redeemable and  convertible preferred stock of parent company       |       | —                                    |       | (8,201 | ) |
| Deferred financing fees                                                               |       | (826                                      | )          | (15,968 | ) |
| Net cash provided by financing activities                                             |       | 5,701                                     |       | 218,583 |   |
| **EFFECT  OF EXCHANGE RATE CHANGES IN CASH:**                                         |       | (164                                      | )          | (16 | ) |
| (Decrease) increase in cash and cash  equivalents                                     |       | (8,616                                    | )          | 3,429 |   |
| Cash and cash equivalents at beginning of  period                                     |       | 16,004                                    |       | 3,974 |   |
| Cash and cash equivalents at end of period                                            |       | $                                         | 7,388      |   | $ | 7,403 |   |
| **Supplemental  disclosure of non-cash investing activities:**                        |       |                                      |       |   |   |
| Cash paid for businesses acquired                                                     |       |                                      |       |   |   |
| Working capital net of cash acquired of  $14,304 in 2004                              |       | $                                         | 1,888      |   | $ | 3,489 |   |
| Property, plant and equipment                                                         |       | 5,241                                     |       | 44,822 |   |
| Goodwill and intangible assets                                                        |       | 11,102                                    |       | 198,047 |   |
| Long-term liabilities                                                                 |       | (43                                       | )          | (41,506 | ) |
| Change in accrued expenses for acquisitions  related to earn-out and expense payments |       | 1,910                                     |       | 9,149 |   |
|                                                                                  |       | $                                         | 20,098     |   | $ | 214,001 |   |
|                                                                                  |       |                                      |       |   |   |
| Property, plant and equipment acquired  through long-term lease                       |       | $                                         | 392        |   | $ | — |   |

 

The accompanying notes are an integral partof these financial statements.

 

5

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**ACCELLENT CORP.**

**Notes to Unaudited Condensed ConsolidatedFinancial Statements**

**September 30, 2005**

 

**1.  Summaryof Significant Accounting Policies:**

 

*Basis of Presentation*

 

Theaccompanying unaudited condensed consolidated financial statements of AccellentCorp. (“the Company”) have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialstatements and the instructions to Form 10-Q and Regulation S-X.Accordingly, they do not include all information and footnotes required byaccounting principles generally accepted in the United States for completefinancial statements. In the opinion of management, all adjustments (consistingonly of normal recurring adjustments) considered necessary for a fairpresentation have been included. Operating results for interim periods are notnecessarily indicative of the results that may be expected for the fiscal yearas a whole. For further information, refer to the consolidated financialstatements and footnotes thereto included in the Company’s Annual Report on Form 10-Kfiled on March 15, 2005 with the Securities and Exchange Commission (File No. 333-118675)for the year ended December 31, 2004.

 

TheCompany changed its name from Medical Device Manufacturing, Inc. toAccellent Corp. on May 4, 2005.  TheCompany is a wholly owned subsidiary of Accellent Inc. (“Parent”).  Parent is a holding company with nooperations and whose only asset is the stock of the Company.  Proceeds from the issuance of debt and sale ofstock of Parent are used by the Company for its acquisitions of its subsidiaries.Additionally, the proceeds of the Company’s issuance of $175.0 million of 10% SeniorSubordinated Notes due July 15, 2012 (the “Senior Subordinated Notes”)were used to retire all of the senior notes of Parent. Accordingly, incompliance with provisions of Staff Accounting Bulletin 54 (Topic 5-J,Question 3), the accompanying financial statements reflect the push downof Parent’s debt, related interest expense, debt issuance costs, the Class B-1and B-2 Redeemable and Convertible Preferred Stock, and the Class C 8%Redeemable Preferred Stock and related dividends. The Parent debt pushed downto the Company is included in its consolidated balance sheets as long-termdebt. The Parent Class B-1 and B-2 Redeemable and Convertible PreferredStock, and the Class C 8% Redeemable Preferred Stock pushed down to theCompany is included in its consolidated balance sheets as redeemable andconvertible preferred stock of parent company.  The Class B-1 Redeemable andConvertible Preferred Stock were redeemed in September 2004.  The Class B-2 Redeemable and ConvertiblePreferred Stock were redeemed in June 2005.  Parent has also raised capital from the saleof common stock, Class A-1 through A-8 5% Convertible Preferred Stock, Class AAConvertible Preferred Stock and warrants exercisable for Class ABConvertible Preferred Stock. The proceeds from the common stock, Class A-1through A-8 5% Convertible Preferred Stock, Class AA Convertible PreferredStock and warrants exercisable for Class AB Convertible Preferred Stockhave been advanced to the Company and reflected in its consolidated balancesheets as additional paid-in capital since the Company is under no obligationto repay these amounts. Any costs incurred by Parent for the benefit of theCompany have been fully allocated to the Company.   Parent does not incur any common expenses forthe benefit of both Parent and the Company, therefore, no common expenses areallocated from Parent to the Company.  Forthe nine months ended September 30, 2004, Parent pushed down to theCompany interest expense, including debt issuance costs, and debt prepaymentpenalties of $6.7 million.  Parent didnot incur any interest expense or debt prepayment penalties for the nine monthsended September 30, 2005.

 

TheCompany’s operating results have been included in Parent’s consolidated UnitedStates and state income tax returns and in tax returns of certain foreignsubsidiaries.  The provision for incometaxes in the Company’s financial statements has been determined on a separatereturn basis.  Deferred tax assets andliabilities are recognized for the expected tax consequences of temporarydifferences between the tax basis of assets and liabilities and their reportedamounts.  No formal tax sharing agreementexists between the Company and Parent.

 

***Stock-based compensation***

 

The Company accounts for stock options issued by Parent to employees ofthe Company using the intrinsic value method of Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees”, and relatedinterpretations. Had the Company elected to recognize compensation expense forthe granting of Parent options under Parent stock option plans based on thefair values at the grant dates consistent with the methodology prescribed byStatement of Financial Accounting Standards No. 148, “Accounting for Stock-BasedCompensation,” pro forma net income (loss) would have been reported as follows(in thousands):

 

6

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| ** **                                                                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss):                                                                       |       |                                       |       |                                      |       |   |   |   |   |
| As reported                                                                              |       | $                                          | 2,869      |                                      | $          | (4,391 | ) | $ | 11,933 |   | $ | (6,440 | ) |
| Add total stock compensation expense, net  of tax, included in income (loss) as reported |       | 2,653                                      |       | 42                                        |       | 3,477 |   | 127 |   |
| Less total stock compensation expense—fair  value method net of tax                 |       | (3,117                                     | )          | (425                                      | )          | (4,698 | ) | (1,127 | ) |
| Pro forma net income (loss)                                                              |       | $                                          | 2,405      |                                      | $          | (4,774 | ) | $ | 10,712 |   | $ | (7,440 | ) |

 

Stock compensation expense, net of tax, included in net income asreported for the three and nine month periods ended September 30, 2005includes a charge of $2,001,000 and $2,747,000, respectively, to increase theCompany’s liability for phantom stock plans due to the increase in value ofParent’s common stock.

 

**2. Acquisitions:**

 

On June 30, 2004, the Company acquired MedSource Technologies, Inc.(“MedSource”).  The MedSource acquisitionwas accounted for as a purchase and accordingly the results of operationsinclude MedSource’s results beginning June 30, 2004. MedSource is an engineeringand manufacturing services provider to the medical device industry. Thepurchase price was $219.7 million, consisting of $208.8 million incash for the purchase of common stock and the cash out of options and warrants,and $10.9 million of transaction fees. The purchase was financed by acombination of new debt and equity as discussed in notes 6 and 8. In addition,the then existing indebtedness of MedSource equal to $36.1 million plusrelated accrued interest was repaid in conjunction with the acquisition. TheCompany estimates that it will incur $17.4 million for integration andother liabilities.

 

The purchase price for the MedSource acquisition was allocated asfollows (in thousands):

 
| Inventories                                |   | $       | 27,707  |   |
|--------------------------------------------|--------|---------|---------|--------|
| Accounts receivable                        |   | 24,782  |    |
| Prepaid expenses and other current assets  |   | 702     |    |
| Property and equipment                     |   | 44,144  |    |
| Goodwill                                   |   | 160,297 |    |
| Intangible and other assets                |   | 19,938  |    |
| Current liabilities                        |   | (30,304 | )       |
| Debt assumed                               |   | (36,131 | )       |
| Other long-term liabilities                |   | (5,736  | )       |
| Cash paid, net of cash acquired of $14,304 |   | $       | 205,399 |   |

 

The decrease in goodwill for the nine months ended September 30,2005 is primarily related to the reduction in accrued integration andrestructuring costs for MedSource as discussed in Note 3, and the expectedutilization of tax benefits acquired from MedSource as discussed in Note 7.

 

On September 12, 2005, theCompany acquired substantially all of the assets of Campbell Engineering, Inc.(“Campbell”) and certain real property owned by the shareholders of Campbelland used by Campbell in the conduct of its business.   TheCampbell acquisition was accounted for as a purchase and accordingly theresults of operations include Campbell’s results beginning September 12,2005.   Campbell is an engineering andmanufacturing firm providing design, analysis, precision fabrication, assemblyand testing of primarily orthopaedic implants and instruments.  The purchase price at closing was $18.2million, all of which was paid in cash.   An additional $12.0 million of consideration will be paid, if at all,pursuant to an earn out arrangement contingent upon the 2005 and 2006 full yearfinancial performance of the acquired business.    Anyadditional amounts paid under earn out provisions will be recorded as inincrease to the purchase price allocated to goodwill at the time the payment isearned.

 

7

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TheCompany has preliminarily identified the tangible and intangible assets as wellas the liabilities assumed in the Campbell acquisition.  The final purchase price allocation couldvary from the preliminary allocation. The preliminary purchase price allocation for the Campbell acquisitionwas as follows (in thousands):

 
| Inventories                               |   | $     | 1,401  |   |
|-------------------------------------------|--------|-------|--------|--------|
| Accounts receivable                       |   | 1,111 |   |
| Prepaid expenses and other current assets |   | 21    |   |
| Property and equipment                    |   | 5,241 |   |
| Goodwill                                  |   | 4,662 |   |
| Intangible and other assets               |   | 6,440 |   |
| Current liabilities                       |   | (645  | )      |
| Debt assumed                              |   | (43   | )      |
| Total purchase price                      |   | $     | 18,188 |   |

 

The Company determines the value and potential purchase price of targetacquisition companies based on multiples of future cash flow. These cash flowprojections may include an estimate of improved cash flow performance ascompared to historical performance of the target acquisition company based onprojected synergies. The value of the acquired company based on our cash flowanalysis may differ significantly from the carrying value of the acquired netassets, resulting in an allocation of a significant portion of the purchaseprice to goodwill.

 

The following unaudited pro forma consolidated financial informationreflects the purchase of MedSource and Campbell assuming the acquisitions hadoccurred as of the beginning of each period. This unaudited pro formainformation has been provided for informational purposes only and is notnecessarily indicative of the results of operations or financial condition thatactually would have been achieved if the acquisitions had been on the datesindicated, or that may be reported in the future (in thousands):

 
| ** **        | ** ** | **Nine months ended  September 30, 2005** | ** ** | **Nine months ended  September 30, 2004** | ** ** |
|-------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| Net sales         |       | $                                              | 348,542    |                                           | $          | 314,080 |   |
| Net income (loss) |       | 12,530                                         |       | 115                                            |       |
|                   |            |                                                |            |                                                |            |  |  |

 

The pro forma net income for the nine months ended September 30,2004 includes $2.3 million of restructuring charges recognized by MedSource.

 

**3. Restructuring and Other Charges:**

 

In connection with the MedSource acquisition, the Company identified$17.2 million of costs associated with eliminating duplicate positions andplant consolidations, which is comprised of $9.7 million in severancepayments and $7.5 million in lease termination and other contracttermination costs.   Severance paymentsrelate to approximately 520 employees in manufacturing, selling andadministration and are expected to be paid by the end of fiscal year 2007. Allother costs are expected to be paid by 2018. The costs of these plant consolidations were reflected in the purchaseprice of MedSource in accordance with the FASB Emerging Issues Task Force (“EITF”)  No. 95-3, *Recognitionof Liabilities in Connection with a Purchase Business Combination.*  These costs include estimates to closefacilities and consolidate manufacturing capacity, and are subject to changebased on the actual costs incurred to close these facilities.  Changes to these estimates could increase ordecrease the amount of the purchase price allocated to goodwill in the nearterm.  During the first nine months offiscal year 2005, the Company decreased the estimated liability for theMedSource facilities consolidation by $4.3 million, resulting in a decrease tothe purchase price allocation to goodwill in the same amount.

 

The Company recognized an additional $3.8 million of restructuringcharges and acquisition integration costs during the first nine months offiscal year 2005, including $1.2 million of severance costs and $2.1 million ofother exit costs including costs to move production processes from fivefacilities that are closing to other production facilities of the Company.  In addition to the

 

8

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$3.3 million in restructuring charges incurred during first nine monthsof fiscal year 2005, the Company incurred $0.5 million of costs for theintegration of MedSource.

 

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

 
| ** **                                                                                                                                      | ** ** | **Employee costs** | ** ** | **Other costs** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|-----------|------------|
| Balance as of December 31, 2004                                                                                                            |       | $                  | 7,764      |            | $          | 9,913     |       | $ | 17,677 |   |
| Adjustment to planned plant closure and  severance costs for the MedSource integration (reduction to the purchase  price allocated to goodwill) |       | (1,932             | )          | (2,387          | )          | (4,319    | )          |
| Restructuring and integration charges  incurred                                                                                                 |       | 1,191              |       | 2,633           |       | 3,824     |       |
| Paid year-to-date                                                                                                                               |       | (3,886             | )          | (3,080          | )          | (6,966    | )          |
| Balance September 30, 2005                                                                                                                 |       | $                  | 3,137      |            | $          | 7,079     |       | $ | 10,216 |   |

 

**4. Comprehensive Income:**

 

Comprehensive income (loss) represents net income plus the results ofany stockholder’s equity changes related to currency translation.  For the three and nine months ended September 30,2005 and 2004, the Company reported comprehensive income of (in thousands):

 
| ** **                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)                  |       | $                                          | 2,869      |                                      | $          | (4,391 | ) | $ | 11,933 |   | $ | (6,440 | ) |
| Cumulative translation adjustments |       | (85                                        | )          | 112                                       |       | (788 | ) | (91 | ) |
| Comprehensive income (loss)        |       | $                                          | 2,784      |                                      | $          | (4,279 | ) | $ | 11,145 |   | $ | (6,531 | ) |

 

**5. Inventories:**

 

Inventories at September 30, 2005 and December 31, 2004 consistedof the following (in thousands):

 
| ** **      | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                            | 22,174     |                        | $          | 20,939 |   |
| Work-in-process |       | 23,979                       |       | 24,068                      |       |
| Finished goods  |       | 15,240                       |       | 13,007                      |       |
| Total           |       | $                            | 61,393     |                        | $          | 58,014 |   |

 

**6. Short-term and long-term debt:**

 

Long-term debt at September 30, 2005 and December 31, 2004consisted of the following (in thousands):

 
| ** **                                                                                                                    | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Senior secured credit facility term loans,  interest at 6.09% at September 30, 2005 and 5.28% at December 31,  2004 |       | $                            | 191,575    |                        | $          | 193,030 |   |
| Senior secured credit facility revolving  credit facility loans, interest at 6.84% at September 30, 2005                 |       | 8,000                        |       | —                      |       |
| Senior Subordinated Notes maturing July 15,  2012, interest at 10%                                                       |       | 175,000                      |       | 175,000                     |       |
| Capital lease obligations                                                                                                     |       | 49                           |       | 22                          |       |
| Total debt                                                                                                                    |       | 374,624                      |       | 368,052                     |       |
| Less current portion                                                                                                          |       | (1,961                       | )          | (1,961                      | )          |
| Long-term debt, excluding current portion                                                                                     |       | $                            | 372,663    |                        | $          | 366,091 |   |

 

9

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The Company’s Senior Secured Credit Facility dated June 30, 2004and as amended on March 25, 2005 (the “Credit Agreement”) includes $194.0million of term loans and up to $40.0 million available under the revolvingcredit facility.  Additionally, theCompany may borrow up to $50.0 million in additional term loans, with theapproval of participating lenders.  Theinterest rate applicable to the term loans is as follows:  on base rate loans from base rate (generallythe applicable prime lending rate of Credit Suisse First Boston, as announcedfrom time to time) plus 2.00% to base rate plus 1.25%, on euro dollar rate loansfrom LIBOR plus 3.00% to LIBOR plus 2.25%.  Principal payments are due in the amounts of$1.9 million per year plus, beginning in 2006, 75% of Excess Cash Flow, asdefined by the Credit Agreement. The balance is due June 30, 2010.  As of September 30, 2005, $5.8 millionof the revolving credit facility was supporting the Company’s letters of creditand $8.0 million was borrowed, leaving $26.2 million available.

 

In connection with the acquisition of Campbell on September 12,2005, the Company used $8.0 million of its revolving credit facility (the “RevolvingLoan”) under the Credit Agreement to fund part of the acquisition. TheRevolving Loan is a euro dollar rate loan accruing interest at an annual rate equalto LIBOR plus 3.00%.  The Revolving Loan matures on June 30, 2010.

 

The Company incurred $0.8 million in fees in connection with theamendment of the Credit Agreement during the first nine months of fiscal year2005, which will be amortized to interest expense over the remaining term ofthe Credit Agreement. Also in connection with the amendment, the Company wroteoff deferred financing costs resulting in a charge to interest expense of $0.2million for the first six months of fiscal year 2005.

 

On June 30, 2004, the Company issued $175.0 million in aggregateprincipal amount of Senior Subordinated Notes. Interest on the Senior Subordinated Notes is payable on January 15thand July 15th of each year.

 

The Company’s debt agreements contain various covenants, includingminimum cash flow (as defined therein), debt service coverage ratios andmaximum capital spending limits. In addition, the debt agreements restrict theCompany from paying dividends and making certain investments.  The covenants and restrictions of theindenture governing the Senior Subordinated Notes apply only to the Company andnot Parent.  All covenants andrestrictions under the Credit Agreement apply to the Company, and the covenantsand restrictions other than financial covenants apply to Parent.

 

As of September 30, 2005, the Company and Parent were in compliancewith their respective covenants under the Credit Agreement and the Senior SubordinatedNotes.

 

**7. Income taxes:**

 

Income tax expense for the nine months ended September 30, 2005was $10.0 million on pre-tax income of $22.0 million, or 45.7% of pre-taxincome.  The effective rate is higherthan the statutory rate primarily due to $6.5 million in charges for non-cashdeferred income taxes, including $5.2 million for tax benefits acquired fromMedSource which have been credited to goodwill and not benefited in thestatement of operations and $1.3 million of charges for the different book andtax treatment for goodwill. The remaining $3.5 million of income tax expensefor the nine months ended September 30, 2005 includes $3.3 million forcertain state and foreign income taxes and $0.2 million for domestic federalincome taxes.  The Company expects tooffset most of its 2005 domestic federal income taxes with net operating losscarryforwards.   For the nine monthsended September 30, 2004, the Company recorded a tax provision of $2.3million on a pre-tax net loss of $4.1 million, primarily due to provisions forcertain state and foreign income taxes.

 

**8. Capital Stock and Redeemable Preferred Stock:**

 

The Company has 1,000 shares of common stock authorized and 100 sharesissued and outstanding, $.01 per value per share.  All shares are owned by Parent.

 

10

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The Company has received proceeds from the sale of permanent equity by Parent.The proceeds received by the Company from inception to September 30, 2005amounted to $205.8 million and are included in additional paid-in capital.The Company is under no obligation to repay these amounts to Parent. Fora further discussion of the equity instruments of Parent, see Notes 10 and11 of the consolidated financial statements included in Part II, Item 8 ofthe Company’s Annual Report on Form 10-K for the year ended December 31,2004.

 

Thefollowing table summarizes the amounts recorded as additional paid-in capitaland redeemable convertible preferred stock of Parent for the nine months ended September 30,2005 (in thousands):

 
| ** **                                                          | ** ** | **Additional  paid-in capital** | ** ** | **Redeemable  and  convertible  preferred  stock of  Parent** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------------------------------------|------------|
| Beginning balance, January 1, 2005                             |       | $                               | 201,348    |                                                          | $          | 30 |   |
| Amortization of stock-based compensation                            |       | 729                             |       | —                                                        |       |
| Compensation charge associated with phantom  stock plans of Parent  |       | 29                              |       | —                                                        |       |
| Capital contribution from Parent                                    |       | 3,644                           |       | —                                                        |       |
| Redemption of redeemable and convertible  preferred stock of Parent |       | —                          |       | (30                                                           | )          |
| Ending balance, September 30, 2005                             |       | $                               | 205,750    |                                                          | $          | — |   |

 

During the nine months ended September 30, 2005, the outstandingshares of Class B-2 Redeemable and Convertible Preferred Stock of Parent wereredeemed for the carrying value of $30,000. In addition, Parent issued 244,832 shares of its Class A-7 5%Convertible Preferred Stock to the former owners of Venusa in connection withVenusa achieving certain earn-out targets for fiscal year 2004. The Companyrecorded a contribution to capital of $3.6 million to reflect the issuance ofthese shares to the former owners of Venusa. There are no additional earn-out provisions relating to the Venusaacquisition.

 

In July 2005, the Board of Directors of Parent approved the grantof 609,237 shares of its restricted common stock to certain members of theCompany’s management.  The shares vest100% on the four year anniversary from the date of grant.  The Company is recording compensation expenseof $10.0 million over the vesting period of the restricted shares, or 48 months,resulting in a quarterly compensation charge to Selling, General andAdministrative expense, or SG&A, of $624,000 starting in July 2005.  Also in July 2005, the Board ofDirectors of Parent approved the grant of 281,152 stock options to certainmembers of the Company’s management at option prices that are below the fairmarket value of the underlying common stock. The Company is recording compensation expense of $2.3 million over thevesting period of the stock options, or 60 months, resulting in a quarterlycompensation charge to SG&A of $115,000 starting in July 2005.

 

**9.  Pension Plans:**

 

Effective January 1, 2004, the Company adopted SFAS No. 132(revised 2003), *Employers’ Disclosures about Pensions andOther Postretirement Benefits*. This standard requires the disclosureof the components of net periodic benefit cost recognized during interimperiods.  Components on net periodicpension cost for the three and nine months ended September 30, 2005 and2004 were as follows (in thousands):

 
| ** **                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost                   |       | $                                          | 23         |                                      | $          | 19 |   | $ | 70 |   | $ | 57 |   |
| Interest cost                  |       | 34                                         |       | 32                                        |       | 104 |   | 97 |   |
| Expected return of plan assets |       | (14                                        | )          | (14                                       | )          | (44 | ) | (42 | ) |
| Recognized net actuarial loss  |       | 11                                         |       | 6                                         |       | 35 |   | 17 |   |
|                           |       | $                                          | 54         |                                      | $          | 43 |   | $ | 165 |   | $ | 129 |   |

 

11

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Assuming that the actual return on plan assets is consistent with theexpected annualized rate of 7.0% for the remainder of fiscal year 2005, andthat interest rates remain constant, the Company would be required to maketotal contributions to its pension plans of $74,000 for fiscal year 2005.

 

**10. Subsequent Events:**

 

On October 6, 2005, the Companypurchased 100% of the outstanding membership interests in Machining TechnologyGroup, LLC (“MTG”), an Arlington, Tennessee based privately held manufacturingand engineering company specializing in rapid prototyping and manufacturing ofspecialized orthopaedic implants and instruments for the orthopaedicindustry.  The purchase price was $50.2 million which was paid in cash of$34.0 million and shares of Parent’s Class A-9 5% Convertible PreferredStock valued at $16.2 million.  Anadditional $6.0 million of consideration will be paid, if at all, pursuant toan earn out arrangement payable contingent upon the 2006 full year financialperformance of MTG.  If the earn out arrangement is earned, the paymentwould be expected to be made in the second quarter of 2007.  The closingcash payment was funded with a combination of approximately $21.5 million ofproceeds received from a draw on the Company’s existing revolving creditfacility pursuant to the Credit Agreement, and approximately $12.5 million ofproceeds received from the utilization of the term loan facility provided forunder the Credit Agreement.  Followingthe acquisition, the total amount available to be drawn on the revolving creditfacility was approximately $4.7 million, net of approximately $5.8 million ofletters of credit outstanding that reduced the amounts available under therevolving credit facility.

 

On October 7, 2005, Parent signed a definitive agreement and planof merger (the “Merger Agreement”) with an affiliate of Kohlberg Kravis Roberts &Co. L.P. (the “KKR Affiliate”).  In addition, the KKR Affiliate, Parentand certain stockholders of Parent executed a voting agreement in which thestockholders agreed to vote their shares in favor of the merger.  TheCompany anticipates that it will refinance existing debt, including its CreditFacility and its existing Senior Subordinated Notes, in connection with theclosing of the merger.

 

OnOctober 21, 2005, the Company commenced a cash tender offer and consentsolicitation for any and all of the outstanding Senior Subordinated Notes (the “Offer”).  The consents of the holders of theoutstanding Senior Subordinated Notes are being solicited to eliminatesubstantially all of the restrictive and reporting covenants, certain events ofdefault and certain other provisions in the indenture governing the Senior SubordinatedNotes.

 

The pending merger with the KKR Affiliate (the “Merger”),is subject to various customary conditions, including adoption of the mergeragreement by Parent’s stockholders, the expiration or early termination of anyapplicable waiting period under the Hart-Scott-Rodino Antitrust ImprovementsAct of 1976, as amended, the absence of certain legal impediments, the receiptof certain regulatory approvals and the receipt of debt and equity financings.If all of the other conditions to the Merger are satisfied, under the terms ofthe existing financing commitment letters, Parent can consummate the Mergereven if the Offer is not consummated and the requisite consents, as defined inthe Offer, are not obtained through a covenant defeasance of the SeniorSubordinated Notes in accordance with the terms of the Senior SubordinatedNotes.  If the Merger is not consummated,the Company will not purchase any of the Senior Subordinated Notes tenderedpursuant to the Offer or cause the proposed amendments in the Offer to becomeoperative.

 

12

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**11.  SupplementalGuarantor Condensed Consolidating Financial Statements:**

 

In connection with the Company’s issuance of its Senior SubordinatedNotes, all of its domestic subsidiaries (the “Subsidiary Guarantors”)guaranteed on a joint and several, full and unconditional basis, the repaymentby the Company of such notes. Certain foreign subsidiaries of the Company (the “Non-GuarantorSubsidiaries”) have not guaranteed such indebtedness.

 

The following tables present the unaudited consolidating statements ofoperations for the three and nine months ended September 30, 2005 and September 30,2004 of the Company (“Holdings”), the Subsidiary Guarantors and the Non-GuarantorSubsidiaries, the unaudited condensed consolidating balance sheets as of September 30,2005 and December 31, 2004, and cash flows for the nine months ended September 30,2005 and September 30, 2004.

 

**Consolidating Statements of Operations**

**Three months ended September 30, 2005(in thousands):**

 
| ** **                                    | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                     |       | $            | —     |                       | $          | 111,609                           |       | $                | 5,225      |             | $          | (179 | ) | $ | 116,655 |   |
| Cost of sales                                 |       | —       |       | 76,905                     |       | 3,032                             |       | (179             | )          | 79,758           |       |
| Selling, general and administrative  expenses |       | 2,917        |       | 15,001                     |       | 629                               |       | —           |       | 18,547           |       |
| Research and development expenses             |       | —       |       | 752                        |       | 114                               |       | —           |       | 866              |       |
| Restructuring and other charges               |       | —       |       | 1,145                      |       | 40                                |       | —           |       | 1,185            |       |
| Amortization of intangibles                   |       | —       |       | 1,572                      |       | —                            |       | —           |       | 1,572            |       |
| Income (loss) from operations                 |       | (2,917       | )          | 16,234                     |       | 1,410                             |       | —           |       | 14,727           |       |
| Interest expense                              |       | 7,943        |       | 27                         |       | —                            |       | —           |       | 7,970            |       |
| Other expense (income)                        |       | —       |       | 95                         |       | (137                              | )          | —           |       | (42              | )          |
| Equity in earnings of affiliates              |       | 11,450       |       | 1,286                      |       | —                            |       | (12,736          | )          | —           |       |
| Income tax expense (benefit)                  |       | (2,279       | )          | 5,948                      |       | 261                               |       | —           |       | 3,930            |       |
| Net income                                    |       | $            | 2,869      |                       | $          | 11,450                            |       | $                | 1,286      |             | $          | (12,736 | ) | $ | 2,869 |   |

 

**Consolidating Statements of Operations**

**Three months ended September 30, 2004(in thousands):**

 
| ** **                                    | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                     |       | $            | —     |                       | $          | 96,491                            |       | $                | 4,239      |             | $          | (392 | ) | $ | 100,338 |   |
| Cost of sales                                 |       | —       |       | 75,143                     |       | 2,746                             |       | (392             | )          | 77,497           |       |
| Selling, general and administrative  expenses |       | 63           |       | 13,378                     |       | 665                               |       | —           |       | 14,106           |       |
| Research and development expenses             |       | —       |       | 772                        |       | 75                                |       | —           |       | 847              |       |
| Restructuring and other charges               |       | —       |       | 2,107                      |       | —                            |       | —           |       | 2,107            |       |
| Amortization of intangibles                   |       | —       |       | 1,487                      |       | —                            |       | —           |       | 1,487            |       |
| Income (loss) from operations                 |       | (63          | )          | 3,604                      |       | 753                               |       | —           |       | 4,294            |       |
| Interest expense (income)                     |       | 7,393        |       | (84                        | )          | 73                                |       | —           |       | 7,382            |       |
| Other expense (income)                        |       | —       |       | 33                         |       | (14                               | )          | —           |       | 19               |       |
| Equity in earnings of affiliates              |       | 2,481        |       | 634                        |       | —                            |       | (3,115           | )          | —           |       |
| Income tax expense (benefit)                  |       | (584         | )          | 1,808                      |       | 60                                |       | —           |       | 1,284            |       |
| Net income (loss)                             |       | $            | (4,391     | )                          | $          | 2,481                             |       | $                | 634        |             | $          | (3,115 | ) | $ | (4,391 | ) |

 

13

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**Consolidating Statements of Operations**

**Nine months ended September 30, 2005 (inthousands):**

 
| ** **                                    | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                     |       | $            | —     |                       | $          | 326,707                           |       | $                | 14,006     |             | $          | (460 | ) | $ | 340,253 |   |
| Cost of sales                                 |       | —       |       | 226,176                    |       | 8,406                             |       | (460             | )          | 234,122          |       |
| Selling, general and administrative  expenses |       | 3,798        |       | 43,998                     |       | 1,743                             |       | —           |       | 49,539           |       |
| Research and development expenses             |       | —       |       | 2,023                      |       | 271                               |       | —           |       | 2,294            |       |
| Restructuring and other charges               |       | —       |       | 3,697                      |       | 127                               |       | —           |       | 3,824            |       |
| Amortization of intangibles                   |       | —       |       | 4,660                      |       | —                            |       | —           |       | 4,660            |       |
| Income (loss) from operations                 |       | (3,798       | )          | 46,153                     |       | 3,459                             |       | —           |       | 45,814           |       |
| Interest expense (income)                     |       | 23,648       |       | 76                         |       | 7                                 |       | —           |       | 23,731           |       |
| Other expense (income)                        |       | —       |       | 315                        |       | (210                              | )          | —           |       | 105              |       |
| Equity in earnings of affiliates              |       | 30,399       |       | 2,457                      |       | —                            |       | (32,856          | )          | —           |       |
| Income tax expense (benefit)                  |       | (8,980       | )          | 17,820                     |       | 1,205                             |       | —           |       | 10,045           |       |
| Net income (loss)                             |       | $            | 11,933     |                       | $          | 30,399                            |       | $                | 2,457      |             | $          | (32,856 | ) | $ | 11,933 |   |

 

**Consolidating Statements of Operations**

**Nine months ended September 30, 2004 (inthousands):**

 
| ** **                                    | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                     |       | $            | —     |                       | $          | 201,637                           |       | $                | 11,577     |             | $          | (729 | ) | $ | 212,485 |   |
| Cost of sales                                 |       | —       |       | 148,134                    |       | 7,750                             |       | (729             | )          | 155,155          |       |
| Selling, general and administrative  expenses |       | 174          |       | 28,565                     |       | 1,942                             |       | —           |       | 30,681           |       |
| Research and development expenses             |       | —       |       | 1,824                      |       | 199                               |       | —           |       | 2,023            |       |
| Restructuring and other charges               |       | —       |       | 2,107                      |       | —                            |       | —           |       | 2,107            |       |
| Amortization of intangibles                   |       | —       |       | 3,937                      |       | —                            |       | —           |       | 3,937            |       |
| Income (loss) from operations                 |       | (174         | )          | 17,070                     |       | 1,686                             |       | —           |       | 18,582           |       |
| Interest expense (income)                     |       | 19,359       |       | (169                       | )          | 207                               |       | —           |       | 19,397           |       |
| Other expense (income)                        |       | 3,295        |       | 67                         |       | (78                               | )          | —           |       | 3,284            |       |
| Equity in earnings of affiliates              |       | 11,490       |       | 1,420                      |       | —                            |       | (12,910          | )          | —           |       |
| Income tax expense (benefit)                  |       | (4,898       | )          | 7,102                      |       | 137                               |       | —           |       | 2,341            |       |
| Net income (loss)                             |       | $            | (6,440     | )                          | $          | 11,490                            |       | $                | 1,420      |             | $          | (12,910 | ) | $ | (6,440 | ) |

 

14

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**Condensed Consolidating Balance Sheets**

**September 30, 2005 (in thousands):**

 
| ** **                                | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Cash and cash equivalents                 |       | $            | 7,519      |                       | $          | (1,445                            | )          | $                | 1,314      |             | $          | — |   | $ | 7,388 |   |
| Receivables, net                          |       | —       |       | 54,195                     |       | 2,425                             |       | (59              | )          | 56,561           |       |
| Inventories                               |       | —       |       | 58,685                     |       | 2,708                             |       | —           |       | 61,393           |       |
| Prepaid expenses and other                |       | —       |       | 2,554                      |       | 152                               |       | —           |       | 2,706            |       |
| Total current assets                      |       | 7,519        |       | 113,989                    |       | 6,599                             |       | (59              | )          | 128,048          |       |
| Property, plant and equipment, net        |       | —       |       | 90,995                     |       | 5,107                             |       | —           |       | 96,102           |       |
| Intercompany receivable (payable)         |       | (56,311      | )          | 54,168                     |       | 2,143                             |       | —           |       | —           |       |
| Investment in subsidiaries                |       | 550,661      |       | 8,430                      |       | —                            |       | (559,091         | )          | —           |       |
| Goodwill                                  |       | 1,877        |       | 283,002                    |       | —                            |       | —           |       | 284,879          |       |
| Intangibles, net                          |       | —       |       | 83,654                     |       | —                            |       | —           |       | 83,654           |       |
| Deferred financing costs and other assets |       | 15,583       |       | 377                        |       | 25                                |       | —           |       | 15,985           |       |
| Total assets                              |       | $            | 519,329    |                       | $          | 634,615                           |       | $                | 13,874     |             | $          | (559,150 | ) | $ | 608,668 |   |
|                                      |       |         |       |                       |       |                              |       |             |       |             |       |
| Current portion of long-term debt         |       | $            | 1,940      |                       | $          | 21                                |       | $                | —     |             | $          | — |   | $ | 1,961 |   |
| Accounts payable                          |       | —       |       | 19,159                     |       | 1,118                             |       | (59              | )          | 20,218           |       |
| Accrued liabilities                       |       | (17,349      | )          | 50,101                     |       | 2,809                             |       | —           |       | 35,561           |       |
| Total current liabilities                 |       | (15,409      | )          | 69,281                     |       | 3,927                             |       | (59              | )          | 57,740           |       |
| Note payable and long-term debt           |       | 372,635      |       | 28                         |       | —                            |       | —           |       | 372,663          |       |
| Other long-term liabilities               |       | 9,093        |       | 14,645                     |       | 1,517                             |       | —           |       | 25,255           |       |
| Total liabilities                         |       | 366,319      |       | 83,954                     |       | 5,444                             |       | (59              | )          | 455,658          |       |
| Equity                                    |       | 153,010      |       | 550,661                    |       | 8,430                             |       | (559,091         | )          | 153,010          |       |
| Total liabilities and equity              |       | $            | 519,329    |                       | $          | 634,615                           |       | $                | 13,874     |             | $          | (559,150 | ) | $ | 608,668 |   |

 

15

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**Condensed Consolidating Balance Sheets**

**December 31, 2004 (in thousands):**

 
| ** **                                            | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Cash and cash equivalents                             |       | $            | 12,267     |                       | $          | 2,438                             |       | $                | 1,299      |             | $          | — |   | $ | 16,004 |   |
| Receivables, net                                      |       | —       |       | 46,805                     |       | 1,549                             |       | —           |       | 48,354           |       |
| Inventories                                           |       | —       |       | 55,686                     |       | 2,328                             |       | —           |       | 58,014           |       |
| Prepaid expenses and other                            |       | —       |       | 3,299                      |       | 172                               |       | —           |       | 3,471            |       |
| Total current assets                                  |       | 12,267       |       | 108,228                    |       | 5,348                             |       | —           |       | 125,843          |       |
| Property, plant and equipment, net                    |       | —       |       | 80,907                     |       | 5,038                             |       | —           |       | 85,945           |       |
| Intercompany receivable (payable)                     |       | (15,713      | )          | 15,189                     |       | —                            |       | 524              |       | —           |       |
| Investment in subsidiaries                            |       | 502,862      |       | 6,571                      |       | —                            |       | (509,433         | )          | —           |       |
| Goodwill                                              |       | 7,116        |       | 282,345                    |       | —                            |       | —           |       | 289,461          |       |
| Intangibles, net                                      |       | —       |       | 81,874                     |       | —                            |       | —           |       | 81,874           |       |
| Deferred financing costs and other assets             |       | 16,815       |       | 320                        |       | (29                               | )          | —           |       | 17,106           |       |
| Total assets                                          |       | $            | 523,347    |                       | $          | 575,434                           |       | $                | 10,357     |             | $          | (508,909 | ) | $ | 600,229 |   |
|                                                  |       |         |       |                       |       |                              |       |             |       |             |       |
| Current portion of long-term debt                     |       | $            | 1,940      |                       | $          | 21                                |       | $                | —     |             | $          | — |   | $ | 1,961 |   |
| Accounts payable                                      |       | 14           |       | 19,346                     |       | 1,087                             |       | —           |       | 20,447           |       |
| Accrued liabilities                                   |       | 12,865       |       | 36,115                     |       | 1,592                             |       | —           |       | 50,572           |       |
| Total current liabilities                             |       | 14,819       |       | 55,482                     |       | 2,679                             |       | —           |       | 72,980           |       |
| Note payable and long-term debt                       |       | 366,090      |       | 1                          |       | —                            |       | —           |       | 366,091          |       |
| Other long-term liabilities                           |       | 4,947        |       | 17,089                     |       | 1,107                             |       | 524              |       | 23,667           |       |
| Total liabilities                                     |       | 385,856      |       | 72,572                     |       | 3,786                             |       | 524              |       | 462,738          |       |
| Redeemable and convertible preferred stock  of parent |       | 30           |       | —                     |       | —                            |       | —           |       | 30               |       |
| Equity                                                |       | 137,461      |       | 502,862                    |       | 6,571                             |       | (509,433         | )          | 137,461          |       |
| Total liabilities and equity                          |       | $            | 523,347    |                       | $          | 575,434                           |       | $                | 10,357     |             | $          | (508,909 | ) | $ | 600,229 |   |

 

16

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**Consolidating Statements of Cash Flows**

**Nine months ended September 30, 2005 (inthousands):**

 
| *** ***                                                        | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Net cash (used in) provided by operating  activities                |       | $            | (32,477    | )                          | $          | 51,112                            |       | $                | 2,835      |             | $          | — |   | $ | 21,470 |   |
| Cash flows from investing activities:                               |       | —       |       |                       |       |                              |       |             |       |             |       |
| Capital expenditures                                                |       | —       |       | (14,692                    | )          | (894                              | )          | —           |       | (15,586          | )          |
| Transferred assets                                                  |       | —       |       | 201                        |       | (201                              | )          | —           |       | —           |       |
| Proceeds from sale of equipment                                     |       | —       |       | 61                         |       | —                            |       | —           |       | 61               |       |
| Acquisitions, net of cash acquired                                  |       | (20,098      | )          | —                     |       | —                            |       | —           |       | (20,098          | )          |
| Net cash used in investing activities                               |       | (20,098      | )          | (14,430                    | )          | (1,095                            | )          | —           |       | (35,623          | )          |
| Cash flows from financing activities:                               |       |         |       |                       |       |                              |       |             |       |             |       |
| Proceeds from debt                                                  |       | 8,000        |       | —                     |       | —                            |       | —           |       | 8,000            |       |
| Repayments                                                          |       | (1,455       | )          | (18                        | )          | —                            |       | —           |       | (1,473           | )          |
| Intercompany advances                                               |       | 42,108       |       | (40,489                    | )          | (1,619                            | )          | —           |       | —           |       |
| Redemption of redeemable and convertible  preferred stock of parent |       | (30          | )          | —                     |       | —                            |       | —           |       | (30              | )          |
| Capital contributions from parent                                   |       | 30           |       | —                     |       | —                            |       | —           |       | 30               |       |
| Deferred financing fees                                             |       | (826         | )          | —                     |       | —                            |       | —           |       | (826             | )          |
| Cash flows (used in) provided by financing  activities              |       | 47,827       |       | (40,507                    | )          | (1,619                            | )          | —           |       | 5,701            |       |
| Effect of exchange rate changes in cash                             |       | —       |       | (58                        | )          | (106                              | )          | —           |       | (164             | )          |
| Net decrease in cash and cash equivalents                           |       | (4,748       | )          | (3,883                     | )          | 15                                |       | —           |       | (8,616           | )          |
| Cash and cash equivalents, beginning of  period                     |       | 12,267       |       | 2,438                      |       | 1,299                             |       | —           |       | 16,004           |       |
| Cash and cash equivalents, end of period                            |       | $            | 7,519      |                       | $          | (1,445                            | )          | $                | 1,314      |             | $          | — |   | $ | 7,388 |   |

 

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**Consolidating Statements of Cash Flows**

**Nine months ended September 30, 2004 (inthousands):**

 
| ** **                                                              | ** ** | **Holdings** | ** ** | **Subsidiary  Guarantors** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------|------------|--------------|------------|----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided by (used in) operating  activities                    |       | $            | (15,059    | )                          | $          | 19,560                            |       | $                | 1,678      |             | $          | — |   | $ | 6,179 |   |
| Cash flows from investing activities:                                   |       | —       |       |                       |       |                              |       |             |       |             |       |
| Capital expenditures                                                    |       | —       |       | (7,778                     | )          | (940                              | )          | —           |       | (8,718           | )          |
| Transferred assets                                                      |       | —       |       | (8                         | )          | 8                                 |       | —           |       | —           |       |
| Proceeds from sale of equipment                                         |       | —       |       | 1,402                      |       | —                            |       | —           |       | 1,402            |       |
| Acquisitions, net of cash acquired                                      |       | (219,305     | )          | 5,304                      |       | —                            |       | —           |       | (214,001         | )          |
| Net cash used in investing activities                                   |       | (219,305     | )          | (1,080                     | )          | (932                              | )          | —           |       | (221,317         | )          |
| Cash flows from financing activities:                                   |       |         |       |                       |       |                              |       |             |       |             |       |
| Borrowing                                                               |       | 372,000      |       | —                     |       | —                            |       | —           |       | 372,000          |       |
| Repayments                                                              |       | (148,394     | )          | (36,153                    | )          | —                            |       | —           |       | (184,547         | )          |
| Intercompany advances                                                   |       | (14,567      | )          | 14,715                     |       | (148                              | )          | —           |       | —           |       |
| Capital contributions from parent                                       |       | 67,862       |       | —                     |       | —                            |       | —           |       | 67,862           |       |
| Redemption of redeemable and convertible  preferred stock of parent     |       | (12,563      | )          | —                     |       | —                            |       | —           |       | (12,563          | )          |
| Dividends paid on redeemable and  convertible preferred stock of parent |       | (8,201       | )          | —                     |       | —                            |       | —           |       | (8,201           | )          |
| Deferred financing fees                                                 |       | (15,968      | )          | —                     |       | —                            |       | —           |       | (15,968          | )          |
| Cash flows provided by (used in) financing  activities                  |       | 240,169      |       | (21,438                    | )          | (148                              | )          | —           |       | 218,583          |       |
| Effect of exchange rate changes in cash                                 |       | —       |       | 4                          |       | (20                               | )          | —           |       | (16              | )          |
| Net increase/(decrease) in cash and cash  equivalents                   |       | 5,805        |       | (2,954                     | )          | 578                               |       | —           |       | 3,429            |       |
| Cash and cash equivalents, beginning of  year                           |       | 14           |       | 3,394                      |       | 566                               |       | —           |       | 3,974            |       |
| Cash and cash equivalents, end of year                                  |       | $            | 5,819      |                       | $          | 440                               |       | $                | 1,144      |             | $          | — |   | $ | 7,403 |   |

 

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*This Quarterly Report on Form 10-Q includes “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. All statements other than statements of historical facts includedin this Form 10-Q, including, without limitation, certain statements under“Management’s Discussion and Analysis of Financial Condition and Results ofOperations”, may constitute forward-looking statements. In some cases you canidentify these “forward-looking statements” by words like “may,” “will,” “should,”“expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential”or “continue” or the negative of those words and other comparable words. Theseforward-looking statements involve risks and uncertainties. Our actual resultscould differ materially from those indicated in these statements as a result ofcertain factors as more fully discussed under the heading “Risk Factors”contained in our annual report on Form 10-K filed on March 15, 2005with the Securities and Exchange Commission (File No. 333-118675) for theCompany’s fiscal year ended December 31, 2004. The following discussionand analysis should be read in conjunction with the unaudited condensedconsolidated financial statements and notes thereto included herein.**We undertake no obligation toupdate publicly or publicly revise any forward-looking statement, whether as aresult of new information, future events or otherwise.*

 

Unless the context indicatesotherwise, all references in this quarterly report to “Accellent,” the “Company,”“we,” “our,” or “us” mean Accellent Corp. and its subsidiaries.  We are a wholly owned subsidiary of AccellentInc., a Maryland corporation, which we refer to herein as “Accellent Inc.” or “ourparent.”

 

**Overview**

 

We are the largest provider of outsourced precision manufacturing andengineering services in our target markets of the medical device industry.   We offer our customers design andengineering, precision component manufacturing, device assembly and supplychain management services. We have extensive resources focused on providing ourcustomers reliable, high quality, cost-efficient, integrated outsourcedsolutions. We often become the sole supplier of manufacturing and engineeringservices for the products we provide to our customers.

 

We primarily focus on the leading companies in three large and growingmarkets within the medical device industry: cardiology, endoscopy, and orthopaedics.Our customers include many of the leading medical device companies, including AbbottLaboratories, Boston Scientific, Guidant, Johnson & Johnson,Medtronic, Smith & Nephew, St. Jude Medical, Stryker, Tyco Internationaland Zimmer. During 2004, our top 10 customers accounted for approximately 55%of net sales with two customers each accounting for greater than 10% of netsales.  During the first nine months of2005, our top 10 customers accounted for approximately 61% of net sales withthree customers each accounting for greater than 10% of net sales.    Although we expect net sales from ourlargest customers to continue to constitute a significant portion of our netsales in the future, Boston Scientific has informed us that it intends totransfer a number of products currently assembled by us to its own assemblyoperation.  Based on preliminaryestimates and our experience to date with this customer, we expect net salesfrom Boston Scientific to decrease annually by approximately $40 million, withthe substantial majority of the net sales decrease taking place in 2006.  While we believe that the transferredbusiness can be replaced with new business from existing and potential newcustomers to offset the loss, there is no assurance that we will replace suchbusiness and the loss will not adversely affect our operating results in 2006and thereafter. While net sales are aggregated by us to the ultimate parent ofa customer, we typically generate diversified revenue streams within theselarge customers across separate divisions and multiple products.

 

OnSeptember 12, 2005, we, through our wholly owned subsidiary, CE HuntsvilleHoldings Corp., acquired substantially all of the assets of CampbellEngineering, Inc., or Campbell.  The Campbell acquisition was accounted for as a purchase and accordinglyour results of operations include Campbell’s results beginning September 12,2005.   Campbell is an engineering andmanufacturing firm providing design, analysis, precision fabrication, assemblyand testing of primarily orthopaedic implants and instruments.  Subject to the terms of the asset purchase agreement,we and our wholly-owned subsidiary CE Huntsville Holdings Corp. agreed to pay,in the aggregate, a cash purchase price for the assets (including theshareholder real property) of up to approximately $30.1 million, with approximately$18.1 million of which (before certain closing adjustments) was payable at theclosing.  The actual amount paid atclosing after closing adjustments was $17.7 million, plus estimated closingcosts of $0.5 million, for a total initial purchase price of $18.2million.   The remaining portion of the purchase pricewill be paid, if at all, pursuant to an earnout arrangement payable contingentupon the 2005 and 2006 full year financial performance of the acquiredbusiness.  If earned, the 2005 and 2006earnout payments would be expected to be made in

 

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thesecond quarters of 2006 and 2007, respectively. The closing cash payment was funded with a combination of cash on handand approximately $8.0 million of proceeds received from a draw on ourexisting revolving credit facility, or the Revolving Loan, included in theCredit Agreement.  The Revolving Loan isa euro dollar rate loan accruing interest at an annual rate equal to LIBOR plus3.00%.  The Revolving Loan matures on June 30,2010. In connection with the transaction, CE Huntsville Holdings Corp. became asubsidiary guarantor of the Senior Subordinated Notes and of our obligationsunder our Credit Agreement.

 

Subsequent to our third quarter of2005, on October 6, 2005, we purchased 100% of the outstanding membershipinterests in Machining Technology Group, LLC, or MTG, an Arlington, Tennesseebased privately held manufacturing and engineering company specializing inrapid prototyping and manufacturing of specialized orthopaedic implants andinstruments for the orthopaedic industry.  The acquisition was consummatedpursuant to an Interest Purchase Agreement, dated as of October 6, 2005,by and among Accellent Corp., Gary Stavrum and Timothy Hanson, the members ofMTG (the “Interest Purchase Agreement”). Subject to the terms of the Interest Purchase Agreement, we agreed topay, in the aggregate, approximately $50.2 million consisting of (i) approximately$33.0 million in cash (before certain closing adjustments)  which was paidat the closing, (ii) $16.2 million which was paid at the closing on ourbehalf by our parent company by the issuance of 407,407 shares of our parent’s Class A-95% Convertible Preferred Stock, and (iii) estimated closing costs of $1.0million.  An additional $6.0 million willbe paid, if at all, pursuant to an earnout arrangement payable contingent uponthe 2006 full year financial performance of MTG.  If the earnout arrangement is earned, theearnout payment would be expected to be made in the second quarter of2007.  The closing cash payment wasfunded with a combination of approximately $21.5 million of proceeds receivedfrom a draw on our existing revolving credit facility pursuant to our CreditAgreement, and approximately $12.5 million of proceeds received from theutilization of the term loan facility provided for under the Credit Agreement.

 

On October 7, 2005, our parent signed a definitive agreement andplan of merger (the “Merger Agreement”) with Accellent Acquisition Corp., anaffiliate of Kohlberg Kravis Roberts & Co. L.P. (the “KKR Affiliate”),whereby a wholly-owned subsidiary of the KKR Affiliate will merge (the “Merger”)with and into our parent, Accellent Inc., with Accellent Inc. being thesurviving entity.  In addition, the KKR Affiliate, our parent and certainstockholders of our parent executed a voting agreement in which thestockholders agreed to vote their shares in favor of the Merger.

 

OnOctober 21, 2005, we commenced a cash tender offer (the “Offer”) andconsent solicitation (the “Solicitation”) for any and all of the outstandingSenior Subordinated Notes.  The consentsof the holders of the outstanding Senior Subordinated Notes (each a “Holder”)are being solicited in the Solicitation to eliminate substantially all of therestrictive and reporting covenants, certain events of default and certainother provisions in the Indenture.  TheOffer is scheduled to expire at 5:00 p.m., New York City time, on November 21,2005, unless extended by us.  TheSolicitation is scheduled to expire at 5:00 p.m., New York City time, on November 3,2005, unless extended by us.  For afurther discussion of the Offer and the Solicitation, see the Company’s CurrentReport on Form 8-K filed with Securities and Exchange Commission, or SEC,on October 24, 2005.

 

TheMerger is subject to various customary conditions, including adoption of theMerger Agreement by our parent’s stockholders, the expiration or earlytermination of any applicable waiting period under the Hart-Scott-RodinoAntitrust Improvements Act of 1976, as amended, the absence of certain legalimpediments, the receipt of certain regulatory approvals and the receipt ofdebt and equity financings. If all of the other conditions to the Merger aresatisfied, under the terms of the existing financing commitment letters, ourparent can consummate the Merger even if the Offer is not consummated and therequisite consents, as defined in the Offer, are not obtained through acovenant defeasance of the Senior Subordinated Notes in accordance with the termsof the Senior Subordinated Notes.  If theMerger is not consummated, we will not purchase any of the Senior SubordinatedNotes tendered pursuant to the Offer or cause the proposed amendments to theindenture governing the Senior Subordinated Notes (the “Indenture”) in theOffer to become operative.  The proposedamendments, or the Amendments, include the elimination of substantially all ofthe restrictive and reporting convenants, certain events of default and certainother provisions of the Senior Subordinated Notes so that any non-tenderedSenior Subordinated Notes do not restrict our future financial or operatingflexibility.

 

We primarily recognize product net sales upon shipment, when titlepasses to the customer or, if products are shipped on consignment to aparticular customer, when the customer uses the product. For services, werecognize net sales during the period in which our services are rendered.  We primarily generate our net salesdomestically.  In 2004, approximately 85%of our net sales were sold to customers located in the U.S.  Since a substantial majority of the leadingmedical device companies are located in the U.S., we expect our net sales toU.S.-based companies to remain a high percentage of our net sales in thefuture.

 

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Our operations are based on purchase orders that typically provide for30 to 90 days delivery from the time the purchase order is received, butwhich can provide for delivery within 30 days or up to 180 days,depending on the product and the customer’s ability to forecast requirements.

 

Cost of goods sold includes raw materials, labor and othermanufacturing costs associated with the products we sell. Some productsincorporate precious metals, such as gold, silver and platinum. Changes inprices for those commodities are generally passed through to our customers.

 

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

 

Amortization of intangible assets is primarily related to ouracquisitions of G&D, Inc. d/b/a Star Guide, Noble-Met, Ltd., UTI Corporation,American Technical Molding, Inc., Venusa, Ltd. and Venusa de Mexico, S.A.de C.V. (together with Venusa, Ltd., “Venusa”), MedSource and Campbell Engineering, Inc. Interest expense is primarily related toindebtedness incurred to finance our acquisitions.

 

Concurrent with our acquisition of MedSourceon June 30, 2004, we aligned our management by the three medical devicemarket segments which we serve.  As aresult of this alignment, we have three operating segments: endoscopy,cardiology and orthopaedics.  We havedetermined that all of our operating segments meet the aggregation criteria ofparagraph 17 of SFAS No. 131, and are treated as one reportable segment.

 

In connection with the MedSource acquisition, we identified $17.2 millionof costs associated with eliminating duplicate positions and plant consolidations,which is comprised of $9.7 million in severance payments and $7.5 millionin lease termination and other contract termination costs.   Severance payments relate to approximately520 employees in manufacturing, selling and administration and are expected tobe paid by the end of fiscal year 2007. All other costs are expected to be paidby 2018.  The costs of these plantconsolidations were reflected in the purchase price of MedSource in accordancewith the FASB Emerging Issues Task Force (“EITF”)  No. 95-3, *Recognitionof Liabilities in Connection with a Purchase Business Combination.*  These costs include estimates to closefacilities and consolidate manufacturing capacity, and are subject to changebased on the actual costs incurred to close these facilities.  Changes to these estimates could increase ordecrease the amount of the purchase price allocated to goodwill in the nearterm.  During the first nine months offiscal year 2005, we decreased the estimated liability for the MedSource facilitiesconsolidation by $4.3 million, resulting in a decrease to the purchase priceallocation to goodwill in the same amount. The MedSource acquisition is described in greater detail under Part I,Item 1 “Financial Statements, Note 2 – Acquisitions.”

 

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

 
| ** **                                                                                                                                      | ** ** | **Employee costs** | ** ** | **Other costs** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|-----------|------------|
| Balance as of December 31, 2004                                                                                                            |       | $                  | 7,764      |            | $          | 9,913     |       | $ | 17,677 |   |
| Adjustment to planned plant closure and  severance costs for the MedSource integration (reduction to the purchase  price allocated to goodwill) |       | (1,932             | )          | (2,387          | )          | (4,319    | )          |
| Restructuring and integration charges  incurred                                                                                                 |       | 1,191              |       | 2,633           |       | 3,824     |       |
| Paid year-to-date                                                                                                                               |       | (3,886             | )          | (3,080          | )          | (6,966    | )          |
| Balance September 30, 2005                                                                                                                 |       | $                  | 3,137      |            | $          | 7,079     |       | $ | 10,216 |   |

 

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**Results of Operations**

 

The following table sets forth percentages derived from theconsolidated statements of operations for the three and nine months ended September 30,2005 and 2004, presented as a percentage of net sales.

 
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| STATEMENT OF OPERATIONS DATA:                 |       |                                       |       |                                      |       |   |   |   |   |
| Net Sales                                     |       | 100.0                                      | %          | 100.0                                     | %          | 100.0 | % | 100.0 | % |
| Cost of Sales                                 |       | 68.4                                       |       | 77.2                                      |       | 68.8 |   | 73.0 |   |
| Gross Profit                                  |       | 31.6                                       |       | 22.8                                      |       | 31.2 |   | 27.0 |   |
| Selling, General and Administrative  Expenses |       | 15.9                                       |       | 14.1                                      |       | 14.5 |   | 14.4 |   |
| Research and Development Expenses             |       | 0.7                                        |       | 0.8                                       |       | 0.7 |   | 1.0 |   |
| Restructuring and Other Charges               |       | 1.0                                        |       | 2.1                                       |       | 1.1 |   | 1.0 |   |
| Amortization of Intangibles                   |       | 1.4                                        |       | 1.5                                       |       | 1.4 |   | 1.9 |   |
| Income from Operations                        |       | 12.6                                       |       | 4.3                                       |       | 13.5 |   | 8.7 |   |

 

**Three Months Ended September 30, 2005 Comparedto Three Months Ended September 30, 2004**

 

*Net Sales*

 

Net sales for the third quarter of 2005 were $116.7 million, anincrease of $16.4 million or 16% compared to net sales of $100.3 millionfor the third quarter of 2004. Higher net sales was due to a $19.4 million increasefrom higher shipments as we were awarded new products and increases in unitshipments on existing products to customers that serve the endoscopic, cardiologyand orthopaedic markets, and the acquisition of Campbell, which increased netsales by $0.7 million.  These increaseswere partially offset by our facility rationalization program, which includedthe closing or sale of select facilities, resulting in a reduction in net salesattributable to former MedSource facilities of $3.7 million for the thirdquarter of 2005.  Three customers, Johnson &Johnson, Boston Scientific and Medtronic each accounted for greater than 10% ofnet sales for the third quarter of 2005. Two customers, Boston Scientific and Johnson & Johnson,accounted for greater than 10% of net sales for the third quarter of 2004.

 

*Gross Profit*

 

Gross profit for the third quarter of 2005 was $36.9 million ascompared to $22.8 million for the third quarter of 2004.   The $14.1 million increase in gross profitwas primarily due to the MedSource acquisition and unit volume increases.  Additionally, gross profit for the thirdquarter of 2004 included a $3.2 million write-off of the step-up of inventoryrelated to the acquisition of MedSource. Gross profit for the third quarter of 2005 includes a $0.1 millionwrite-off of the step-up of inventory related to the acquisition of Campbell.

 

Gross margin was 31.6% of net sales for the third quarter of 2005 ascompared to 22.8% of net sales for the third quarter of 2004.  The increase in gross margins is due toincreased sales, which lead to improved leverage of our fixed cost of sales,and cost reduction efforts including the closure of production facilities.  Also, gross margin for the third quarter of2004 included the write-off of the step-up of inventory related to theacquisition of MedSource, which reduced gross margin by 3.2% in that quarter.

 

*Selling, General and Administration Expenses*

 

Selling, general and administrative expenses, or SG&A, were $18.5 millionfor the third quarter of 2005 compared to $14.1 million for the third quarterof 2004. The increase in SG&A costs were primarily due to an increase in non-cashstock-based compensation of $2,625,000 for the third quarter of 2005 as aresult of our increased liability for phantom stock plans due to the increasein value of our parent’s stock, and to amortize compensation related torestricted stock and stock options granted during the third quarter of2005.  In addition, our SG&A expensesfor the third quarter of 2005 include $0.6 million of expenses related to the Merger.

 

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In July 2005, the Board of Directors of our parent approved the grantof 609,237 shares of restricted common stock of our parent to certain members ofits and our management.  Each sharesvests 100% on the four year anniversary from the date of grant.  We are recording compensation expense of $10.0million over the vesting period of the restricted stock, or 48 months,resulting in a quarterly compensation charge to SG&A expense of $624,000starting in July 2005.  Also in July 2005,the Board of Directors of our parent approved the grant of 281,152 stockoptions to certain members of its and our management at option prices that arebelow the fair market value of the underlying common stock.  We are recording compensation expense of $2.3million over the vesting period of the stock options, or 60 months, resultingin a quarterly compensation charge to SG&A of $115,000 starting in July 2005.  If the Merger is consummated, the restrictedstock and stock options granted in July 2005 will fully vest, resulting inan acceleration of all remaining unamortized non-cash stock based compensation.

 

SG&A expenses were 15.9% of net sales for the third quarter of 2005versus 14.1% of net sales for the third quarter of 2004.  The increased percentage was primarily due toincreased charges for stock-based compensation.

 

*Research and Development Expenses*

 

Research and development expenses, or R&D, for the third quarter of2005 were $0.9 million or 0.7% of net sales, which is relatively unchangedfrom R&D expenses of $0.8 million or 0.8% of net sales for the thirdquarter of 2004.

 

*Restructuring and Other Charges*

 

We recognized $1.2 million of restructuring charges and acquisition integrationcosts during the third quarter of 2005, including $0.3 million of severancecosts and $0.7 million of other exit costs including costs to move productionprocesses from five facilities that are in the process of being closed andproduction transferred to our other existing facilities.  In addition, we incurred $0.2 million ofcosts for the integration of MedSource during the third quarter of 2005.

 

*Amortization*

 

Amortization was $1.6 million for the third quarter of 2005, aslight increase from the $1.5 million for the third quarter of 2004. The higheramortization was primarily due to the acquisition of Campbell, which weacquired on September 12, 2005.  Basedon our initial estimate of the value of assets acquired from Campbell, weexpect to incur approximately $0.5 million of annual amortization expenserelating to intangible assets acquired from Campbell.

 

*Interest Expense, net*

 

Interest expense, net was $8.0 million for the third quarter of 2005compared to $7.4 million for the third quarter of 2004.  The increase is primarily due to higherinterest rates charged on borrowings outstanding under our Credit Agreement,which bear interest at a variable rate.

 

*Income Tax Expense*

 

Income tax expense for the third quarter of 2005 was $3.9 million, or 57.8%of pre-tax net income, and includes $2.7 million in charges for non-cashdeferred income taxes, including $2.3 million for tax benefits acquired fromMedSource which have been credited to goodwill and not benefited in thestatement of operations and $0.4 million of charges for the different book andtax treatment of goodwill.  The remaining$1.5 million of income tax expense for the third quarter of 2005 includes $1.4million for certain state and foreign income taxes and $0.1 million fordomestic federal income tax expense.  Weexpect to offset most of our 2005 domestic federal income taxes with netoperating loss carryforwards.  For thethird quarter of fiscal year 2004, income tax expense was $1.3 million on a pre-taxnet loss of $3.1 million, and as was comprised primarily of certain state andforeign income tax expense.

 

**Nine Months Ended September 30, 2005Compared to Nine Months Ended September 30, 2004**

 

*Net Sales*

 

Net sales for the first nine months of 2005 were $340.3 million, anincrease of $127.8 million or 60% compared to net sales of $212.5 millionfor the first nine months of 2004. Higher net sales was due to the acquisitionof MedSource, which increased net sales by $89.8 million, a $49.3 millionincrease primarily due to higher shipments as we were awarded new products

 

23

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and increases in unit shipments on existing products to customers thatserve the endoscopic, cardiology and orthopaedic markets as well as $0.7million from the acquisition of Campbell. These increases were partially offset by our facility rationalizationprogram, which included the closing or sale of select facilities, resulting ina reduction in net sales attributable to former MedSource facilities of $12.0million for the first nine months of 2005. Three customers, Boston Scientific, Johnson & Johnson andMedtronic each accounted for greater than 10% of net sales for the first ninemonths of 2005.  Two customers, BostonScientific and Johnson & Johnson each accounted for greater than 10%of net sales for the first nine months of 2004.

 

*Gross Profit*

 

Gross profit for the first nine months of 2005 was $106.1 millioncompared to $57.3 million for the first nine months of 2004.   The $48.8 million increase in gross profitwas primarily due to the MedSource acquisition and unit volume increases.  Additionally, gross profit for the first ninemonths of 2004 included a $3.4 million write-off of the step-up of inventoryrelated to the acquisition of MedSource, and gross profit for the first ninemonths of 2005 included a $0.1 million write-off of the step-up of inventoryrelated to the acquisition of Campbell.

 

Gross margin was 31.2% of net sales for the first nine months of 2005compared to 27.0% of net sales for the first nine months of 2004.  The increase in gross margins is due toincreased sales, which lead to improved leverage of our fixed cost of sales,and cost reduction efforts.  Also, grossmargin for the first nine months of 2004 included the write-off of the step-upof inventory related to the acquisition of MedSource, which reduced grossmargin by 1.6% in that period.

 

*Selling, General and Administration Expenses*

 

SG&A expenses, were $49.5 million for the first nine months of 2005compared to $30.7 million for the first nine months of 2004. The increase inSG&A costs were primarily due to the acquisition of MedSource andstock-based compensation charges of $3.6 million during the first nine monthsof 2005 as a result of our increased liability for phantom stock plans due tothe increase in value of our parent’s stock, and to amortize compensationexpense associated with restricted stock and stock options granted during thethird quarter of 2005.   In addition, our SG&A expenses for thefirst nine months of 2005 include $0.6 million of expenses related to the Merger.

 

SG&A expenses were 14.5% of net sales for the first nine months of2005 versus 14.4% of net sales for the first nine months of 2004. The higher2005 percentage was driven primarily by increased charges for stock-basedcompensation in the 2005 period.

 

*Research and Development Expenses*

 

R&D expenses for the first nine months of 2005 were$2.3 million or 0.7% of net sales, compared to $2.0 million or 1.0%of net sales for the first nine months of 2004. The lower 2005 percentage was driven by sales growth, which lead toimproved leverage of our fixed R&D costs.

 

*Restructuring and Other Charges*

 

We recognized $3.8 million of restructuring charges and acquisitionintegration costs during the first nine months of 2005, including $1.2 millionof severance costs and $2.1 million of other exit costs including costs to moveproduction processes from five facilities that are closing to our otherproduction facilities.  In addition tothe $3.3 million in restructuring charges incurred during first nine months of2005, we incurred $0.5 million of costs for the integration of MedSource.

 

*Amortization*

 

Amortization was $4.7 million for the first nine months of 2005compared to $3.9 million for the first nine months of 2004. The higheramortization was primarily due to the acquisition of MedSource.

 

*Interest Expense, net*

 

Interest expense, net was $23.7 million for the first nine monthsof 2005 compared to $19.4 million for the first nine months of 2004.  The increase was due to increased debtincurred to acquire MedSource.  Thisincrease was partially offset by

 

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$4.5 million of accelerated amortization of debt discounts and deferredfinancing costs incurred during the first nine months of 2004 due to therefinancing of our old senior secured credit facility and various seniorsubordinated indebtedness.

 

*Other expense*

 

Other expense was $0.1 million for the first nine months of 2005compared to $3.3 million for the first nine months of 2004.  The decrease is primarily due to debtprepayment penalties of $3.3 million incurred during the first nine months of2004.

 

*Income Tax Expense*

 

Income tax expense for the nine months ended September 30, 2005was $10.0 million on pre-tax income of $22.0 million, or 45.7% of pre-taxincome.  The effective rate is higherthan the statutory rate primarily due to $6.5 million in charges for non-cashdeferred income taxes, including $5.2 million for tax benefits acquired fromMedSource that have been credited to goodwill and not benefited in thestatement of operations and $1.3 million of charges for the different book andtax treatment for goodwill. The remaining $3.5 million of income tax expensefor the nine months ended September 30, 2005 includes $3.3 million forcertain state and foreign income taxes and $0.2 million for domestic federalincome taxes.  For the nine months ended September 30,2004, we recorded a tax provision of $2.3 million on a pre-tax net loss of $4.1million, primarily due to provisions for certain state and foreign incometaxes.

 

**Liquidity and Capital Resources**

 

Our principal sources of liquidity are cash provided by operations andborrowings under our Credit Agreement which includes a five-year$40.0 million revolving credit facility and a six-year $194.0 millionterm facility.   Additionally, we mayborrow up to $50.0 million in additional term loans, with the approval ofparticipating lenders.  Our CreditAgreement is described in greater detail under Part I, Item 1, Note 6 – “Short-termand long-term debt,” and under Part II, Item 7 “Management’s Discussionand Analysis of Financial Condition and Results of Operations – Liquidity andCapital Resources” in our Annual Report on Form 10-K for the fiscal yearended December 31, 2004.

 

At September 30, 2005, we had $5.8 million of letters ofcredit outstanding and $8.0 million of revolving loans that reduced the amountsavailable under the revolving credit portion of our Credit Agreement to $26.2million.  We received $12.5 million fromadditional terms loans in October 2005 in connection with our acquisitionof MTG.  In addition, we drew anadditional $21.5 million in revolving loans on our revolving credit facility inOctober 2005 in connection with our acquisition of MTG, leaving $4.7million available under the revolving credit facility under the CreditAgreement.

 

During the first nine months of 2005, cash provided by operatingactivities was $21.5 million compared to $6.2 million for the first ninemonths of 2004. The increase in cash provided by operations is primarily due toincreased profitability as a result of the acquisition of MedSource andincreased demand for our products.  Theincrease in profitability has been partially offset by increases in workingcapital for inventory and accounts receivable due to higher sales, paymentsrelated to our restructuring programs, and the timing of the semi-annualinterest payments on our Senior Subordinated Notes.

 

During the first nine months of 2005, cash used in investing activitiestotaled $35.6 million compared to $221.3 million for the first ninemonths of 2004.   The decrease in cashused in investing activities is attributable to the acquisition of MedSource,which used $204.4 million of cash during the first nine months of 2004, and anearn-out payment relating to our acquisition of Venusa, which used $9.6 millionof cash during the first nine months of 2004. These costs were partially offset by the acquisition of Campbell for$17.9 million in cash during the first nine months of 2005, the final Venusaearn-out payment of $2.2 million during the first nine months of 2005, andincreased capital expenditures of $6.9 million during the first nine months of2005 due to the acquisition of MedSource and increased demand for our products.

 

During the first nine months of 2005, cashprovided by financing activities was $5.7 million and consisted of $8.0 millionin proceeds from long-term debt to partially fund our Campbell acquisition,$1.5 million of scheduled debt payments pursuant to our Credit Agreement, and$0.8 million of deferred financing fees incurred in connection with theamendment of our Credit Agreement in March 2005.  Cash provided by financing activities was$218.6 million for the first nine months of 2004 and relate primarily to thefollowing financing transactions, which took place in conjunction with our June 30,2004 acquisition of MedSource:

 

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•                  The issuance of $369.0 million of indebtednessconsisting of our Credit Agreement, which is a $194.0 million six-yearterm facility, and $175.0 million of 10% Senior Subordinated Notes due July 15,2012.  We incurred $17.1 million of feesrelated to the new debt.

 

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

 

•                  The repayment of all MedSource debt and capitalleases totaling $36.1 million.

 

•                  The payment by our parent of $22.2 million ofdividends.

 

•                  The repurchase by our parent of $18.8 million of itsClass C Redeemable Preferred Stock.

 

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

 

We anticipate that we will spend approximately $8.0 to $10.0 millionon capital expenditures for the remainder of 2005. Our Credit Agreement containsrestrictions on our ability to make capital expenditures. Based on currentestimates, our management believes that the amount of capital expenditures permittedto be made under our Credit Agreement for the remainder of 2005 will beadequate to grow our business according to our business strategy and tomaintain our continuing operations.

 

Our principal uses of cash will be to meet debt service requirements,fund working capital requirements and finance capital expenditures andacquisitions.  Our ability to makepayments on our indebtedness and to fund planned capital expenditures andnecessary working capital will depend on our ability to generate cash in thefuture. This, to a certain extent, is subject to general economic, financial,competitive, legislative, regulatory and other factors that are beyond ourcontrol. For example, Boston Scientific has informed us that it intends totransfer a number of products currently assembled by us to its own assemblyoperation. Based on our current level of operations, we believe our cash flowfrom operations and available borrowings under our Credit Agreement will beadequate to meet our liquidity requirements for the next 12 months and theforeseeable future. No assurance can be given, however, that this will be thecase.

 

Consummationof the Merger will constitute a Change of Control (as defined in the Indenture)pursuant to the terms of the Indenture. Following a Change of Control, eachHolder currently has the right, at the option of the Holder, to require theCompany to purchase all or any portion of such Holder’s Senior SubordinatedNotes no later than 90 days following the Change of Control at a price equal to101% of the principal amount represented by such Senior Subordinated Notestogether with accrued but unpaid interest, if any, to the date ofpurchase.  In the event that consentsfrom the Holders of a majority of the aggregate principal amount of theoutstanding Senior Subordinated Notes (the “Requisite Consents”) are obtainedand the Company consummates the Offer and Solicitation, the Company will not berequired to comply with the foregoing requirements.

 

Inconnection with the Merger, we intend to consummate an offering of new seniorsubordinated notes and enter into a new senior secured credit facility, theproceeds of which will be used to repay certain of our outstandingindebtedness, including the Offer and Solicitation (the “New Financing”).  The commitments for the New Financing alsoprovide that in the event that the Requisite Consents are not obtained, acovenant defeasance of all of the Senior Subordinated Notes may be effected inaccordance with the terms of the Indenture. The completion of the New Financingmay, if the proposed Amendments are not adopted, violate certain covenants andother provisions in the Indenture.

 

Assumingthe Merger is consummated, the Requisite Consents are obtained and weconsummate the New Financing, we and our parent will experience a significantincrease in our long-term indebtedness. The high degree of leverage may, amongother things, make it more difficult for us to make payments on the SeniorSubordinated Notes that remain outstanding after the Offer, limit our abilityto obtain additional financing for working capital, capital expenditures andother general corporate purposes and limit our use of cash flows fromoperations for our operations, capital expenditures and future businessopportunities. In addition, the Senior Subordinated Notes that remainoutstanding after the Offer will remain our unsecured obligations. The SeniorSubordinated Notes will be effectively subordinated to the new senior securedcredit facility. In addition, we may incur or guarantee additional secured debtpursuant to the New Financing, and the Senior Subordinated Notes will beeffectively junior to any such additional secured debt we may incur orguarantee.

 

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**Off-Balance Sheet Arrangements**

 

We do not have any “off-balance sheet arrangements” (as such term isdefined in Item 303 of Regulation S-K) that are reasonably likely to havea current or future effect on our financial condition, changes in financialcondition, revenues or expenses, results of operations, liquidity, capitalexpenditures or capital resources.

 

**Contractual Obligations and Commitments**

 

The following table sets forth our long-term contractual obligations asof September 30, 2005 (in thousands):

 
| ** **                      | ** ** | **Payment due by period** | ** ** |
|---------------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **Total**                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Credit Agreement                |       | $                         | 191,575    |   | $ | 1,940 |   | $ | 3,880 |   | $ | 185,755 |   | $ | — |   |
| Senior Subordinated Notes       |       | 175,000                   |       | — |   | — |   | — |   | 175,000 |   |
| Capital Leases                  |       | 49                        |       | 21 |   | 14 |   | 14 |   | — |   |
| Operating Leases (1)            |       | 42,178                    |       | 5,622 |   | 9,398 |   | 8,021 |   | 19,137 |   |
| Purchase Commitments            |       | 27,347                    |       | 27,347 |   | — |   | — |   | — |   |
| Other long-term obligations (2) |       | 18,521                    |       | 276 |   | 1,746 |   | 277 |   | 16,222 |   |
| Total                           |       | $                         | 454,670    |   | $ | 35,206 |   | $ | 15,038 |   | $ | 194,067 |   | $ | 210,359 |   |

 

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(1)                                  Accruedfuture rental obligations of $6.7 million included in other long-termliabilities on our consolidated balance sheet as of September 30, 2005 areincluded in our operating leases in the table of contractual obligations.  The amounts shown as contractual obligationsfor operating leases include lease extensions options which we expect will beexercised.

 

(2)                                  Otherlong-term obligations include environmental remediation obligations of $4.7 million,accrued severance benefits of $1.5 million, accrued compensation and pensionbenefits of $7.2 million, deferred income taxes of $4.7 million and deferredrent expense of $0.4 million.

 

**Critical Accounting Policies**

 

Our unaudited consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial statements. The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. We base our estimates on historical experience, currentconditions and various other assumptions that are believed to be reasonableunder the circumstances. Estimates and assumptions are reviewed on an ongoingbasis and the effects of revisions are reflected in the unaudited consolidatedfinancial statements in the period they are determined to be necessary. Actualresults could differ materially from those estimates under differentassumptions or conditions. We believe the following critical accountingpolicies impact our judgments and estimates used in the preparation of ourconsolidated financial statements.

 

*Revenue Recognition.*  The amount of product revenue recognized in agiven period is impacted by our judgments made in establishing our reserve forpotential future product returns. We provide a reserve for our estimate offuture returns against revenue in the period the revenue is recorded. Our estimateof future returns is based on such factors as historical return data the timingof historical returns as compared to the sale date. The amount of revenue werecognize will be directly impacted by our estimates made to establish thereserve for potential future product returns.   Our provision for sales returns was $1.1 millionand $0.8 million at September 30, 2005 and December 31, 2004,respectively.

 

*Allowance for Doubtful Accounts.*  We estimate the collectibility of ouraccounts receivable and the related amount of bad debts that may be incurred inthe future. The allowance for doubtful accounts results from an analysis ofspecific customer accounts, historical experience, credit ratings and currenteconomic trends. Based on this analysis, we provide allowances for specificaccounts where collectibility is not reasonably assured.

 

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*Provision for Inventory Valuation.*  Inventory purchases and commitments are basedupon future demand forecasts. Excess and obsolete inventory are valued at theirnet realizable value, which may be zero. We periodically experience variancesbetween the amount of inventory purchased and contractually committed to andour demand forecasts, resulting in excess and obsolete inventory valuationcharges.

 

*Valuation of Goodwill.*  Goodwill is the excess of the purchase priceover the fair value of identifiable net assets acquired in businesscombinations. In accordance with SFAS No. 142, goodwill is assigned to thereporting unit expected to benefit from the synergies of the combination. Wehave assigned our goodwill to three reporting units. Goodwill for eachreporting unit is subject to an annual impairment test, or more often ifimpairment indicators arise, using a fair-value-based approach. In assessingthe fair value of goodwill, we make projections regarding future cash flow andother estimates, and may utilize third party appraisal services. If theseprojections or other estimates for one or all of these reporting units change,we may be required to record an impairment charge.

 

*Valuation of Long-lived Assets.*  Long-lived assets are comprised of property,plant and equipment and intangible assets with finite lives. We assess theimpairment of long-lived assets whenever events or changes in circumstancesindicate that the carrying value may not be recoverable through projectedundiscounted cash flows expected to be generated by the asset. When wedetermine that the carrying value of intangible assets and fixed assets may notbe recoverable, we measure impairment by the amount by which the carrying valueof the asset exceeds the related fair value. Estimated fair value is generallybased on projections of future cash flows and other estimates, and guidancefrom third party appraisal services.

 

*Self Insurance Reserves.*  We accrue for costs to provide self insured benefitsunder our workers’ compensation and employee health benefits programs.  With the assistance of third party workers’compensation experts, we determine the accrual for workers’ compensation lossesbased on estimated costs to resolve each claim. We accrue for self insured health benefits based on historical claimsexperience.  We maintain insurancecoverage to prevent financial losses from catastrophic workers’ compensation oremployee health benefit claims.  Ourfinancial position or results of operations could be impacted in a fiscalquarter due to a material increase in claims. Our accruals for self insured workers compensation and employee healthbenefits at September 30, 2005 and December 31, 2004 were $3.9million and $3.3 million, respectively.

 

*Environmental Reserves.*  We accrue for environmental remediation costswhen it is probable that a liability has been incurred and a reasonableestimate of the liability can be made. Our remediation cost estimates are basedon the facts known at the current time including consultation with a thirdparty environmental specialist and external legal counsel. Changes inenvironmental laws, improvements in remediation technology and discovery ofadditional information concerning known or new environmental matters couldaffect our operating results.

 

*Pension and Other Employee Benefits.*  Certain assumptions are used in thecalculation of the actuarial valuation of our defined benefit pension plans.These assumptions include the weighted average discount rate, rates of increasein compensation levels and expected long-term rates of return on assets. Ifactual results are less favorable than those projected by management,additional expense may be required.

 

*Income Taxes.*  We estimate our income taxes in each of thejurisdictions in which we operate. This process involves estimating our actualcurrent tax exposure together with assessing temporary differences resultingfrom differing treatment of items, such as goodwill amortization, for tax andaccounting purposes. These differences result in deferred tax assets andliabilities, which are included within our consolidated balance sheet. We thenassess the likelihood that our deferred tax assets will be recovered fromfuture taxable income and to the extent we believe that recovery is not likely,we establish a valuation allowance. To the extent we establish a valuationallowance or increase this allowance in a period, we increase or decrease ourincome tax provision in our consolidated statement of operations. If any of ourestimates of our prior period taxable income or loss prove to be incorrect,material differences could impact the amount and timing of income tax benefitsor payments for any period.

 

**New Accounting Pronouncements**

 

InNovember 2004, the FASB issued SFAS No. 151, “Inventory Costs, anamendment of ARB No. 43, Chapter 4.” SFAS No. 151 amendsAccounting Research Bulletin (“ARB”) No. 43, Chapter 4, to clarifythat abnormal amounts of idle facility expense, freight, handling costs andwasted materials (spoilage) should be recognized as current-period charges. Inaddition, SFAS No. 151 requires that allocation of fixed productionoverhead to inventory be based on the normal capacity of the productionfacilities. SFAS No. 151 is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005.

 

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Weare currently assessing the impact that SFAS No. 151 will have on ourresults of operations, financial position or cash flows.

 

OnDecember 16, 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment.”   SFAS 123R requires that compensation costrelated to share-based payment transactions be recognized in the financialstatements. Share-based payment transactions within the scope of SFAS 123Rinclude stock options, restricted stock plans, performance-based awards, stockappreciation rights, and employee share purchase plans. The provisions of SFAS123R are effective for our first annual period that begins after December 31,2005. Accordingly, we will implement the revised standard in the first quarterof fiscal year 2006. Currently, we account for share-based payment transactionsunder the provisions of APB 25, which does not necessarily require therecognition of compensation cost in the financial statements.   We are assessing the implications of thisrevised standard, which may materially impact our results of operations in thefirst quarter of fiscal year 2006 and thereafter.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

***Market Risk***

 

We are subject to market risk associated with change in interest ratesand foreign currency exchange rates.

 

***Interest Rate Risk***

 

We are subject to market risk associated with change in the LondonInterbank Offered Rate (LIBOR) and the Federal Funds Rate published by theFederal Reserve Bank of New York in connection with the Credit Agreement. Basedon the outstanding balance at September 30, 2005, a hypothetical 10%change in rates under the Credit Agreement would result in a change to ourannual interest expense of approximately $1.2 million.

 

***Foreign CurrencyRisk***

 

We operate several facilities in foreign countries. At September 30,2005, approximately $7.4 million of long-lived assets were located inforeign countries. Our principal currency exposures relate to the Euro, Britishpound and Mexican pesos. We consider the market risk to be low, as the majorityof transactions at our European locations are denominated in the Euro orBritish Pound, and our exposure to date in the Mexican peso has not beensignificant.

 

**ITEM4.  CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controls andProcedures. *Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed by us in the reports that we file orsubmit to the SEC under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), is recorded, processed, summarized and reported within the time periodsspecified by the SEC’s rules and forms, and that information isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure. Based on our management’s evaluation (with the participation of ourprincipal executive officer and principal financial officer), as of the end ofthe period covered by this report, our principal executive officer andprincipal financial officer have concluded that our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act ) are effective.

 

*Changes in InternalControl over Financial Reporting.*There was no change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during our third fiscal quarter that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

Under the direct supervision ofsenior management, the Company is currently undergoing a comprehensive effortto ensure compliance with the new regulations under Section 404 of theSarbanes-Oxley Act of 2002 that will be effective with respect to us for ourfiscal years ending December 31, 2007. Our effort includes identificationand documentation of internal controls in our key business processes, as wellas formalization of the Company’s overall control environment. We are currentlyin the process of documenting and evaluating these internal controls.

 

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**PART II.  OTHER INFORMATION**

 

**ITEM6.  EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description of Exhibits**                                                                                                                                                                                                                                                                                               |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.1                 |       | Supplemental  Indenture, dated as of September 9, 2005, among CE Huntsville Holdings  Corp., Accellent Corp. and U.S. Bank National Association, as trustee, with  respect to the 10% Senior Subordinated Notes due 2012                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.2                 |       | Pledge  Supplement, dated as of September 9, 2005, delivered by CE Huntsville  Holdings Corp. pursuant to the Pledge and Security Agreement                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.3                 |       | Consent  to Amendment of the Amended and Restated Shareholders’ Agreement, dated as of  September 2004, among Accellent Inc. and the shareholders listed on the  signature pages thereto                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.4                 |       | Consent  to Amendment to Anti-Dilution Agreement, dated as of February 27, 2003,  among Accellent Inc., DLJ Investment Partners II, L.P., DLJ Investment  Partners, L.P., DLJIP II Holdings, L.P., and Security Life of Denver  Insurance Company                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.1                |       | Form of  Non-Incentive Stock Option Agreement for use under the Amended and Restated  Accellent Inc. 2000 Stock Option and Incentive Plan                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.2                |       | Asset  Purchase Agreement, dated as of September 12, 2005 by and among  Accellent Corp., CE Huntsville Holdings Corp., Campbell Engineering, Inc.  and the shareholders of Campbell Engineering, Inc.                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.3                |       | Amended  and Restated Accellent Inc. 2000 Stock Option and Incentive Plan  (incorporated by reference to exhibit 10.1 to Accellent Corp.’s current  report on Form 8-K (Commission File No. 333-118675) filed on July 21,  2005)                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.4                |       | Form of  Incentive Stock Option Agreement for use under the Amended and Restated  Accellent Inc. 2000 Stock Option and Incentive Plan (incorporated by  reference to exhibit 10.2 to Accellent Corp.’s current report on Form 8-K  (Commission File No. 333-118675) filed on July 21, 2005) |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 31.1                |       | Rule 13a-14(a) Certification  of Chief Executive Officer                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 31.2                |       | Rule 13a-14(a) Certification  of Chief Financial Officer                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 32.1                |       | Section 1350  Certification of Chief Executive Officer                                                                                                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 32.2                |       | Section 1350  Certification of Chief Financial Officer                                                                                                                                                                                                                                                               |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized. 

 
|                  | Accellent Corp. |
|-----------------------|-----------------|
|                  |            |
| November 1, 2005 | By:             | /s/  Ron Sparks |
|                  |            | Ron Sparks*President and**Chief Executive Officer* |
|                  |            |   |
|                  | Accellent Corp. |
|                  |            |
| November 1, 2005 | By:             | /s/  Stewart A. Fisher |
|                  |            | Stewart A. Fisher*Chief Financial Officer, Vice President, Treasurer and Secretary* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description of Exhibits**                                                                                                                                                                                                                                                                                               |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.1                 |       | Supplemental  Indenture, dated as of September 9, 2005, among CE Huntsville Holdings  Corp., Accellent Corp. and U.S. Bank National Association, as trustee, with  respect to the 10% Senior Subordinated Notes due 2012                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.2                 |       | Pledge  Supplement, dated as of September 9, 2005, delivered by CE Huntsville Holdings  Corp. pursuant to the Pledge and Security Agreement                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.3                 |       | Consent  to Amendment of the Amended and Restated Shareholders’ Agreement, dated as of  September 2004, among Accellent Inc. and the shareholders listed on the  signature pages thereto                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 4.4                 |       | Consent  to Amendment to Anti-Dilution Agreement, dated as of February 27, 2003,  among Accellent Inc., DLJ Investment Partners II, L.P., DLJ Investment  Partners, L.P., DLJIP II Holdings, L.P., and Security Life of Denver  Insurance Company                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.1                |       | Form of  Non-Incentive Stock Option Agreement for use under the Amended and Restated  Accellent Inc. 2000 Stock Option and Incentive Plan                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.2                |       | Asset  Purchase Agreement, dated as of September 12, 2005 by and among  Accellent Corp., CE Huntsville Holdings Corp., Campbell Engineering, Inc.  and the shareholders of Campbell Engineering, Inc.                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.3                |       | Amended  and Restated Accellent Inc. 2000 Stock Option and Incentive Plan  (incorporated by reference to exhibit 10.1 to Accellent Corp.’s current  report on Form 8-K (Commission File No. 333-118675) filed on July 21,  2005)                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 10.4                |       | Form of  Incentive Stock Option Agreement for use under the Amended and Restated  Accellent Inc. 2000 Stock Option and Incentive Plan (incorporated by  reference to exhibit 10.2 to Accellent Corp.’s current report on Form 8-K  (Commission File No. 333-118675) filed on July 21, 2005) |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 31.1                |       | Rule 13a-14(a) Certification  of Chief Executive Officer                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 31.2                |       | Rule 13a-14(a) Certification  of Chief Financial Officer                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 32.1                |       | Section 1350  Certification of Chief Executive Officer                                                                                                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                      |
| 32.2                |       | Section 1350  Certification of Chief Financial Officer                                                                                                                                                                                                                                                               |

 

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