UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
Commission file number 0-27802
ARTERIAL VASCULAR ENGINEERING, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3144218
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3576 Unocal Place, Santa Rosa, California 95403
(Address of principal executive offices) (Zip code)
(707) 525-0111
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding
Common Stock, $0.001 par value 31,218,177 as of October 31, 1997
<PAGE>
<TABLE>
INDEX TO FORM 10-Q
<CAPTION>
Page
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<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 1997 3
and June 30, 1997
Condensed Consolidated Statements of Operations for the three 4
months ended September 30, 1997 and 1996
Condensed Consolidated Statements of Cash Flows for the 5
three months ended September 30, 1997 and 1996
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition 12
and Results of Operations
PART II OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Change in Securities and Use of Proceeds 17
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
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2
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
<CAPTION>
September 30, June 30,
1997 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 27,666 $ 25,036
Short-term investments 57,596 62,192
Trade accounts receivable, net 26,605 22,850
Inventories 10,754 7,302
Deferred income tax 2,413 2,413
Prepaid expenses and other current assets 7,907 4,472
--------- ---------
Total current assets 132,941 124,265
Deferred income tax 1,598 1,598
Property, plant and equipment, net 31,070 21,759
Purchased technology and other intangible assets, net 325 357
--------- ---------
Total assets $ 165,934 $ 147,979
========= =========
LIABILITIES
Current liabilities:
Short-term borrowings $ 2,449 $ --
Accounts payable 8,852 4,035
Accrued expenses 6,276 5,744
Income taxes payable 2,912 --
--------- ---------
Total current liabilities 20,489 9,779
--------- ---------
STOCKHOLDERS' EQUITY
Common stock 31 31
Additional paid-in capital 94,669 93,021
Treasury stock (390) (390)
Cumulative translation adjustment (1,477) (1,364)
Retained earnings 52,612 46,902
--------- ---------
Total stockholders' equity 145,445 138,200
--------- ---------
Total liabilities and stockholders' equity $ 165,934 $ 147,979
========= =========
<FN>
See accompanying notes
</FN>
</TABLE>
3
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
Three months ended
September 30,
---------------------
1997 1996
------- -------
Net sales $26,263 $18,568
Cost of sales 5,489 2,911
------- -------
Gross profit 20,774 15,657
------- -------
Operating expenses:
Research and development 5,478 1,855
Selling, general and administrative 7,517 3,132
------- -------
Total operating expenses 12,995 4,987
------- -------
Operating income 7,779 10,670
Interest and other income 1,006 1,275
------- -------
Income before provision for income taxes 8,785 11,945
Provision for income taxes 3,075 4,180
------- -------
Net income $ 5,710 $ 7,765
======= =======
Net income per share $ 0.18 $ 0.25
Shares used in per share calculation 32,237 31,632
See accompanying notes
4
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
<CAPTION>
Three Months Ended
September 30,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,710 $ 7,765
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 662 339
Provision for doubtful accounts 246 22
Provision for obsolete inventory 104 (1)
Amortization of deferred compensation -- 12
Income tax reduction relating to stock plans 1,016 --
Changes in assets and liabilities:
Short-term investments 4,594 (48,479)
Accounts receivable (4,119) (2,062)
Inventories (3,549) (1,260)
Prepaids and other current assets (3,719) (1,291)
Accounts payable 4,815 550
Accrued liabilities 563 (534)
Income taxes payable 3,195 3,633
-------- --------
Net cash provided by (used in) operating activities 9,518 (41,306)
-------- --------
Cash flows from investing activities:
Acquisition of property, plant and equipment (9,943) (3,017)
-------- --------
Net cash used in investing activities (9,943) (3,017)
-------- --------
Cash flows from financing activities:
Increase in short-term borrowings 2,449 --
Proceeds from issuance of common stock 632 --
-------- --------
Net cash provided by financing activities 3,081 --
-------- --------
Effect of exchange rate changes on cash and cash equivalents (26) (8)
Net increase (decrease) in cash and cash equivalents 2,630 (44,331)
Cash and cash equivalents, at beginning of period 25,036 59,238
======== ========
Cash and cash equivalents, at end of period $ 27,666 $ 14,907
======== ========
<FN>
See accompanying notes
</FN>
</TABLE>
5
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The condensed consolidated financial statements included
herein have been prepared by the Company, without audit, in
accordance with generally accepted accounting principles for interim
financial information and pursuant to the rules and regulations of
the Securities and Exchange Commission. In the opinion of management,
all adjustments (consisting of only normal recurring adjustments)
considered necessary to present fairly the financial position,
results of operations and cash flows have been included. These
consolidated financial statements should be read in conjunction with
the audited consolidated financial statements contained in the
Company's Form 10-K for the fiscal year ended June 30, 1997.
Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted. The year-end balance sheet data was derived from audited
financial statements, but does not include disclosures required by
generally accepted accounting principles.
Operating results for the three months ended September 30,
1997 are not necessarily indicative of the results to be expected for
any other interim period or for the full fiscal year.
2. Inventories (in thousands):
September 30, June 30,
1997 1997
------------ -----------
Raw materials $ 1,441 $ 925
Work in process 5,589 3,044
Finished goods 3,724 3,333
------------ -----------
$ 10,754 $ 7,302
============ ===========
3. Computation of Net Income Per Share
Net income per share is computed using the weighted average
number of common and common stock equivalent shares, when dilutive,
outstanding during the period. Common equivalent shares comprise
stock options using the treasury stock method.
In February 1997, the Financial Accounting Standards Board
issued Statement No. 128, "Earnings per Share (SFAS No. 128)," which
is effective for both interim and annual financial statements for
periods ended after December 15, 1997. The Company will be required
to change the method currently used to compute earnings per share and
to restate all prior periods. Under the new requirements for
calculating primary (or basic) earnings per share, the dilutive
effect of stock options will be excluded. The impact is expected to
result in an increase in primary earnings per share. The impact of
Statement 128 on the calculation of fully diluted earnings per share
is not expected to be material.
6
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
4. Stock Repurchase Program
During the first quarter of fiscal 1997, the Board of
Directors authorized a stock repurchase program pursuant to which
the Company could repurchase shares of its common stock with an
aggregate value of up to $10 million. The repurchases were made from
time to time on the open market at prevailing market prices or in
negotiated transactions off the market. In November 1997 the program
was discontinued by the Board of Directors. As of September 30,
1997, the Company had repurchased 30,000 shares of its common stock
at an aggregate cost of $390,000.
5. Contingencies
ESS Litigation. Effective as of October 1992, a subsidiary of
the Company purchased substantially all the assets of Endothelial
Support Systems, Inc. (subsequently known as Endovascular Support
Systems, Inc.) ("ESS") in consideration of certain royalty payments
payable by the Company based on the net sales of products using or
adapted from such assets. The Company was informed that the
shareholders of ESS ratified the transaction on May 27, 1993. The
purchased assets included an application for a stent patent which
resulted in a patent owned by the Company. Following such asset
purchase, the Company between June 1993 and March 1995 purchased in
several transactions 100% of the shares of capital stock of ESS from
its shareholders in consideration of shares of common stock of the
Company and, in certain instances, other consideration, and ESS was
merged into the Company. In June 1996, the Company received notice of
a lawsuit filed by Dr. Azam Anwar and Benito Hidalgo, each of whom is
a former shareholder of ESS (who together held approximately 48% of
ESS's outstanding shares of common stock) and each of whom currently
holds shares of common stock of the Company, in the District Court of
Dallas County, Texas. The suit names as defendants the Company,
Bradly A. Jendersee and John D. Miller, each a director, officer and
principal stockholder of the Company, Dr. Simon H. Stertzer, a
director and principal stockholder of the Company, and Dr. Gerald
Dorros, a principal stockholder of the Company. In January 1997, the
plaintiffs filed an amended petition alleging common law fraud,
negligent misrepresentation, securities fraud pursuant to the Texas
Securities Act, fraud pursuant to the Texas Business and Commercial
Code, control person liability, aider and abetter liability of the
individual defendants, civil conspiracy, breach of fiduciary duty,
and constructive fraud in connection with the Company's acquisition
of ESS and the Company's acquisition of shares of ESS capital stock
from the plaintiffs. The plaintiffs seek unspecified damages,
rescission of the Company's acquisition of the ESS assets and its
subsequent acquisition of the ESS stock, reconstitution of ESS,
punitive damages, interest and attorneys' fees and other relief. On
February 10 and 12, 1997, the court overruled defendants' special
appearances and denied motions objecting to jurisdiction, motions to
dismiss based on forum non conveniens, and motions to abate or stay
the Texas proceedings. The
7
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
defendants, including the Company, have filed an answer denying the
plaintiffs' claims, and also filed a counterclaim against the
plaintiffs. The counterclaim alleges claims against Mr. Hidalgo for
specific performance, breach of contract, breach of the implied
covenant of good faith and fair dealing, and declaratory relief based
on comparative indemnity, contribution and absence of fraud. The
counterclaim alleges claims against Dr. Anwar for intentional and
negligent interference with contract, equitable estoppel and
declaratory relief based on absence of fraud. A trial date of
February 1, 1998 has been scheduled for the Texas action. The Company
believes it has meritorious defenses to the claims alleged by the
plaintiffs, and that it has meritorious claims against the
plaintiffs, in the Texas action. However, no assurance can be given
as to the outcome of the action. The inability of the Company to
prevail in the action, including the loss or impairment of the right
to produce products based on the Company's issued patents, could have
a material adverse effect on the Company's business, financial
condition and results of operations.
The Company also received notice in August 1996 of a lawsuit
filed by Messrs. Anwar and Hidalgo in the Superior Court of Sonoma
County, California, which names the same defendants as in the Texas
action and alleges claims for securities fraud and unregistered
securities under the California securities laws, breach of fiduciary
duty and fraud. The plaintiffs seek unspecified damages, rescission
of the Company's acquisition of the ESS assets and its subsequent
acquisition of the ESS stock, reconstitution of ESS and other relief.
The defendants, including the Company, have filed an answer denying
plaintiff's claims, and also filed a cross-complaint against the
plaintiffs. The cross-complaint alleges claims against Mr. Hidalgo
for specific performance, breach of contract, breach of the implied
covenant of good faith and fair dealing, and declaratory relief based
on comparative indemnity, contribution and absence of fraud. The
cross-complaint alleges claims against Dr. Anwar for intentional and
negligent interference with contract, equitable estoppel and
declaratory relief based on absence of fraud. Mr. Hidalgo and Dr.
Anwar have filed an answer generally denying the claims contained in
the cross-complaint.
On July 11, 1996, the Company, along with the individual
defendants named in the Texas and Sonoma County actions, filed two
actions against Mr. Hidalgo in the Superior Court of San Mateo
County, California. The first action alleges claims for specific
performance, breach of contract, breach of the implied covenant of
good faith and fair dealing, and declaratory relief based on
indemnity. These claims arise out of a stock exchange agreement
entered into between Mr. Hidalgo and the Company, and out of Mr.
Hidalgo's actions as a director of ESS. The second action alleges
claims for specific performance, breach of contract, and breach of
the implied covenant of good faith and fair dealing. These claims
arise out of a separation and release agreement entered into between
Mr. Hidalgo and the Company.
On December 6, 1996, the Superior Court of Sonoma County,
California, pursuant to the stipulation of the parties, transferred
the Sonoma County action to the Superior Court of San Mateo County.
On December 11, 1996, the Superior Court of San Mateo County,
pursuant to the stipulation of the parties, consolidated all three
pending
8
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
California actions into a single action (the "Consolidated Action"),
and ordered that the pleadings from the Sonoma County action shall be
the operative pleadings in the Consolidated Action. A motion by the
Company and the individual defendants for summary judgment against
Mr. Hidalgo in the Consolidated Action was denied by the Superior
Court of San Mateo County on May 5, 1997 with respect to each of the
plaintiffs' claims. A trial date of March 2, 1998 has been scheduled
for the Consolidated Action. The Company believes that it has
meritorious defenses to the claims alleged by the plaintiffs, and
that it has meritorious claims against the plaintiffs, in the
Consolidated Action. However, no assurance can be given as to the
outcome of the Consolidated Action. The inability of the Company to
prevail in the Consolidated Action, including the loss or impairment
of the right to produce products based on the Company's issued
patents, could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company has agreed to indemnify each of the individuals
named as defendants in the lawsuits against the Company relating to
the ESS transaction.
Claims of Terminated Distributors. In connection with the
Company's termination of certain distributor relationships, several
of such distributors have filed, or have threatened to file, claims
against the Company with respect to such terminations.
In November 1996, in connection with the Company's termination
of its distribution relationship with Alfatec-Medicor N.V.
("Alfatec-Medicor") and Medicor Nederland B.V. ("Medicor Nederland")
in Belgium and The Netherlands, respectively, effective September 30,
1996, the Company received notice of a lawsuit filed by
Alfatec-Medicor in the Second Chamber of the Commercial Court of
Brussels, Belgium, alleging insufficient notice of termination of a
distribution agreement between the parties, promotion costs,
personnel restructuring claims and additional compensation.
Alfatec-Medicor seeks compensation of BF189,389,135 (approximately
$5.3 million using current exchange rates), of which BF30,000,000
(approximately $843,000) is sought as a provisional payment. The
Company has entered counterclaims for $257,000 in unpaid accounts
receivable and has requested from Alfatec-Medicor information that
would support its claims for indemnification, but has not yet
received such information. Following a hearing on April 18, 1997, the
court postponed further consideration of the matter until the parties
have conducted an appropriate exchange of information and prepared
written pleadings. On February 20, 1997, the Company commenced an
action against Medicor Nederland before the Amsterdam District Court
for payment of $269,000 in unpaid accounts receivable. On July 23,
1997, Medicor Nederland filed a statement of defense and entered a
counterclaim for DG2,284,379 (approximately $1.2 million using
current exchange rates) on the grounds of insufficient notice of
termination of a distribution agreement between the parties and
unjust enrichment. On October 29, 1997, the Company filed a reply and
answer to the counterclaim.
On August 19, 1996, in connection with the Company's
termination of its distribution relationship in Switzerland with
Medicor AG, effective September 30, 1996, such distributor filed an
action against the Company in the United States District Court for
the Northern District of California alleging breach of written, oral
and implied-in-fact
9
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
contracts, inducement to breach an employment contract with one of
such distributor's employees, intentional interference with
contractual relations, intentional and negligent interference with
prospective economic advantage, misappropriation of trade secrets,
and intentional and negligent misrepresentation. On October 11, 1996,
the court denied the distributor's request for preliminary and
temporary injunctive relief. On January 30, 1997, the court entered
an order dismissing the entire action on forum non conveniens
grounds. As part of the dismissal, AVE has agreed to submit to the
jurisdiction of the appropriate forum in Switzerland, waive any
defense of statute of limitations to any substantially similar claims
made there, make available witnesses and documents there and satisfy
any judgment entered against it there. The distributor has appealed
the court's dismissal of the action. On January 27, 1997, the Company
filed an action in the debt collection office of Cham, Switzerland
against the distributor for $93,000 plus accrued interest in
connection with unpaid accounts receivable from the distributor
relationship. The distributor obtained a preliminary stay on the debt
collection proceedings and a hearing with respect to the Company's
motion to lift such stay was held on March 11, 1997. On July 14,
1997, the District Court of Zug denied the Company's motion to lift
such stay in a summary proceeding. The Company intends in November
1997 to file a claim in ordinary court proceedings with the District
Court of Zug to have the stay lifted.
In connection with the Company's termination of its
distribution relationship in France with Medi Service,
S.A.R.L./Fournitures Hospitalieres S.A. effective September 30, 1996,
the Company received notice from such distributor that it had filed
an action before the Tribunal de Grande Instance of Mulhouse in
France seeking compensation for breach of an alleged exclusive
distribution agreement for an indeterminate period between the
parties. The action included a claim for compensation equal to the
total value of such distributor's business, which the distributor
valued at FF400,000,000 (approximately $69 million using current
exchange rates). The Company counterclaimed for unpaid accounts
receivable of approximately $1.8 million and for damages for abusive
legal proceedings. On September 23, 1996, the Tribunal rejected the
distributor's claims for damages for unlawful termination as well as
the Company's counterclaim for abusive legal proceedings. The
Tribunal reserved judgement with respect to the repurchase of the
distributor's inventory of AVE products and the payment of unpaid
accounts receivable sought by the Company. The parties have submitted
briefs on these issues and a procedural hearing was held on March 10,
1997, at which time the distributor filed an additional brief. A
procedural hearing was held on May 9, 1997, at which time the Company
added a counterclaim for unfair competition. The Tribunal has closed
the procedural phase of the action and has scheduled oral arguments
for December 1, 1997. On February 10, 1997, the distributor filed an
appeal of the Tribunal's decision of September 23, 1996 with the
Court of Appeals of Colmar, and the parties have exchanged briefs in
the appellate proceeding.
The Company is also in ongoing discussions with its
distributor in South Korea regarding the status of such distributor
relationship and of approximately $491,000 in accounts receivable due
the Company from such distributor.
10
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ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
With respect to each of the aforementioned distributors, the
Company has consulted with local counsel in the applicable country
and believes that the termination (or potential termination) of each
of the distributor relationships was (or will be) lawful. The Company
understands that under the laws of certain countries, including
Belgium and The Netherlands, under certain circumstances, certain
indemnities may be claimed by distributors for insufficient notice of
termination and/or goodwill compensation. The Company intends to
vigorously defend itself against pending claims and any other claims
that may be brought by such distributors and to pursue claims for
unpaid accounts receivable against such distributors. However, no
assurance can be given as to the outcome of any pending or threatened
litigation, and any successful claim for damages or injunctive relief
by one or more of such distributors, or the failure by the Company to
succeed on its claims against its former French distributor, could
have a material adverse effect on the Company's business, financial
condition and results of operations.
Former Cordis Employee Litigation. On October 6, 1997, the
Company received notice that Cordis Corporation, a subsidiary of
Johnson & Johnson ("Cordis"), had filed a claim in federal district
court in Buffalo, New York against the Company and Charles J. Soles
in connection with the Company's hiring of Mr. Soles and several
other former Cordis employees. The complaint alleges breach of
contract by Mr. Soles and tortious interference with Cordis'
contractual rights by the Company. Cordis seeks preliminary and
permanent injunctive relief, compensatory and punitive damages,
attorneys' fees and other relief. The Company has answered the
complaint and moved for summary judgment on the grounds that the
agreement at issue is inapplicable and unenforceable as a matter of
law. The District Court held a hearing on Cordis' motion for
preliminary injunction in late October 1997, and further briefs and
oral arguments are scheduled to be completed in December 1997. The
Company has agreed to limit its contact with Mr. Soles pending the
District Court's determination on preliminary injunctive relief.
U.S. Patent Litigation. On October 21, 1997, the Company
received notice that it had been joined in a lawsuit by Cordis
against Advanced Cardiovascular Systems, Inc., Guidant Corporation,
Boston Scientific Corporation and SCIMED Life Systems, Inc. in
federal district court in Delaware. Cordis alleges, among other
things, that the Company, upon receipt of regulatory approvals, will
begin selling in the United States stents which infringe on certain
patents of Cordis. The complaint seeks declaratory and injunctive
relief, unspecified damages, attorneys fees and other relief. On
November 6, 1997, the Company filed a motion to dismiss Cordis'
complaint. The Company believes that it has meritorious defenses to
the claims alleged by Cordis in the action. However, no assurance can
be given as to the outcome of the action. The inability of the
Company to prevail in the action, including the loss or impairment of
the right to produce products in the United States, could have a
material adverse effect on the Company's business, financial
condition and results of operations.
From time to time, the Company is involved in other legal
proceedings arising in the ordinary course of its business. As of the
date hereof, the Company is not a party to any other legal
proceedings with respect to which an adverse outcome would, in
management's opinion, have a material adverse effect on the Company's
business, financial condition or results of operations.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The statements contained in this Form 10-Q that are not
historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding
the future. Forward-looking statements made herein include, without
limitation, statements regarding the extent and timing of new
product introductions, competition, regulatory approvals,
manufacturing scale-up, expenditures and margin levels, and the
establishment of direct sales forces in targeted countries. All
forward-looking statements in this document are based on information
available to the Company as of the date hereof, and the Company
assumes no obligation to update any such forward-looking statement.
It is important to note that the Company's actual results could
differ materially from those in such forward-looking statements.
Additional risk factors include those discussed in the reports filed
by the Company from time to time on Forms 10-K, 10-Q and 8-K.
The Company is engaged in the design, development,
manufacturing and marketing of stent systems and percutaneous
transluminal coronary angioplasty ("PTCA") catheters designed to be
utilized in connection with less invasive treatment of
cardiovascular disease. The Company began commercial sales of its
PTCA catheters in October 1993, its coronary stent systems in
October 1994, and its peripheral stent systems in December 1996. The
Company's products are currently commercially sold only outside of
the United States, primarily in Europe and Japan. In April 1996, the
Company began its first direct sales operation in Europe, and
currently it has direct operations in each of France, Germany, the
Netherlands (servicing the Benelux countries), Switzerland and the
United Kingdom. In June 1997, the Company's Japanese distributor
received regulatory approval for the sale in Japan of the Company's
coronary stent systems; however, as of the date hereof, such
distributor had not yet received the related reimbursement approval.
The Company does not expect reimbursement approval in Japan prior to
December 1997, and there can be no assurance when or if such
approval will be obtained.
In August 1997, the Company submitted a pre-market approval
("PMA") application to the United States Food and Drug
Administration (the "FDA") in connection with its ongoing efforts to
gain approval to begin commercial sales of its coronary stent
systems in the United States. Clinical studies under an
investigational device exemption are ongoing with certain of the
Company's products. The Company does not expect FDA approval of its
coronary stent systems for sale in the United States prior to 1998,
and there can be no assurance when or if such approval will be
obtained. As a result, the Company expects international sales to
account for substantially all of its revenues until at least 1998.
The Company has incurred, and expects to continue to incur,
substantial clinical research and other costs in connection with
obtaining regulatory approvals for its stent systems in the United
States and other countries.
The Company has a limited history of operations. The increase
in the Company's sales to date has been due to greater demand for the
Company's stent systems and, to a lesser degree, its PTCA balloon
catheter systems. The Company believes that it is
12
<PAGE>
currently one of the leading providers of stent systems
internationally. In order to support increased levels of sales in the
future and to augment its long term competitive position, the Company
anticipates that it will be required to make continuing significant
additional expenditures in manufacturing, research and development
(including clinical study and regulatory costs), sales and marketing
and administration, both in absolute dollars and as a percentage of
net sales. The Company has also experienced higher administrative
expenses resulting from its obligations as a public reporting
company.
Until April 1996, substantially all of the Company's sales
were to international distributors who resell products to health
care providers. The Company terminated its relationship with
distributors in Germany and the United Kingdom in April and May
1996, respectively, and in France, Switzerland, Belgium and The
Netherlands effective September 30, 1996. Moreover, in October 1997
the Company established a direct sales force in Canada and largely
completed the development of a sales force in the United States for
the direct sales of its coronary stent systems there if and when
such sales are approved by the FDA. The Company believes that the
establishment and maintenance of direct sales forces in Canada,
France, Germany, the Netherlands (servicing the Benelux countries),
Switzerland, the United Kingdom and the United States has required
and will continue to require significant ongoing expenditures,
additional management resources and has resulted, and may continue
to result, in additional costs to eliminate existing distributor
relationships (including costs relating to litigation with former
distributors). See Note 5 to the unaudited Condensed Consolidated
Financial Statements in Item 1.
Generally, the Company manufactures and ships product shortly
after the receipt of orders, and anticipates that it will do so in
the future. The Company developed a significant short-term backlog
during January 1997 in connection with the scale-up of manufacturing
of its GFX(TM) stent product. Such backlog was significantly reduced
during the same fiscal quarter in which it arose. Upon receipt of
the necessary regulatory approvals, the Company intends to market
over-the-wire models of its stent systems in the United States,
unlike the rapid exchange models generally manufactured for
international markets. There can be no assurance that the Company
will be successful in scaling up production of new or modified
products or that it will not experience manufacturing difficulties
or develop backlogs in the future, particularly with respect to the
potentially significant demands of the U.S. market. The Company has
begun to produce inventory for the short-term supply of the
potential U.S. market, and it has begun construction of a 130,000
square foot building adjacent to its corporate headquarters in Santa
Rosa, California, at an estimated cost of $20 million, which, when
completed, will be largely devoted to manufacturing activities.
However, there can be no assurance that such new manufacturing
facility will be completed in time to allow the Company to
adequately supply the potentially significant demands of the U.S.
market on a long-term basis, nor that such new facility will pass
regulatory inspection for compliance with applicable U. S. and
international regulations.
The Company anticipates that its results of operations may
fluctuate for the foreseeable future due to several factors,
including variations in operating expenses, the costs and the
outcome of litigation, competition (including pricing pressures),
costs and the timing of establishing direct sales operations, the
timing of research and development expenses (including clinical
trial related expenditures), the timing of new product introductions
or transitions to new products, sales by distributors, the mix of
sales
13
<PAGE>
among distributors and the Company's direct sales force, timing of
regulatory and third party reimbursement approvals, the level of
third-party reimbursement, the Company's ability to manufacture its
products efficiently, and seasonal factors impacting the number of
elective angioplasty procedures. In addition, the Company's results
of operations could be affected by the timing of orders from
distributors, changes in the Company's distributor network
(including expenses in connection with termination of former
distributors), the ability of the Company's distributors to
effectively promote the Company's products and the ability of the
Company to quickly and cost-effectively establish an effective
direct sales force in targeted countries. The Company's limited
operating history makes accurate prediction of future operating
results difficult or impossible. Although the Company has
experienced growth in recent years, there can be no assurance that,
in the future, the Company will sustain revenue growth or remain
profitable on a quarterly or annual basis or that its growth will be
consistent with predictions made by securities analysts. The Company
has experienced, and may experience in one or more future quarters,
operating results that are below the expectations of public market
analysts and investors. In such event, the price of the Company's
common stock has been, and would likely be, materially and adversely
affected.
Results of Operations - Three Months Ended September 30, 1997 and
1996
Net sales. For the three months ended September 30, 1997, net
sales increased to $26.3 million from $18.6 million in the
comparable period in fiscal 1997. The increase in net sales was due
to significant increases in sales of the Company's stent systems,
particularly the GFX family of products. The GFX was released in
certain countries internationally in September 1996, and the GFX
2.5(TM) and the GFX XL(TM) were released in certain countries
internationally in June 1997.
The Company anticipates that stent system sales will continue
to constitute the vast majority of total net sales. In the second
quarter of fiscal 1997 the Company began selling directly in France,
Switzerland, and the Netherlands (to service the Benelux countries).
In the three months ended September 30, 1997, these direct sales
operations, together with those established previously in Germany
and the United Kingdom, produced a significant portion of the
Company's total net sales. All other commercial sales made by the
Company were to unaffiliated distributors, with a significant
portion of total net sales for the three months ended September 30,
1997 attributable to stocking orders by the Company's Japanese
distributor.
The increasing number of devices in the international stent
market and the desire of companies to obtain market share has
resulted in increased price competition, particularly in the second
and third quarters of fiscal 1997. Such competition has, in the
past, caused the Company to reduce prices on its stent systems. If
the Company is forced to effect further price reductions, such
reductions would reduce net sales in future periods if not offset by
increased unit sales or other factors.
Cost of Sales. Cost of sales increased to $5.5 million in the
three months ended September 30, 1997 from $2.9 million in the
comparable period in fiscal 1997, and increased as a percentage of
net sales to 21% in the fiscal 1998 period from 16% in the fiscal
1997 period. The increase in absolute dollars during the three-month
period was primarily a result of the increased volume of products
sold and to a lesser extent, the costs of additional manufacturing
capacity and personnel necessary to support increased
14
<PAGE>
sales volume. The increase as a percentage of net sales during the
three-month period was primarily the result of lower unit pricing
compared to the prior period.
The Company expects cost of sales to continue to increase in
absolute dollars as the Company increases the volume of products
sold and adds additional manufacturing capacity and personnel.
Research and Development. Research and development expenses,
which include clinical study and regulatory costs, increased to $5.5
million in the three months ended September 30, 1997 from $1.9
million in the comparable period in fiscal 1997, and increased as a
percentage of net sales to 21% in the fiscal 1998 period from 10% in
the fiscal 1997 period. The increase in absolute dollars and as a
percentage of net sales during the three-month period was primarily
due to the addition of research and development personnel, increased
levels of spending in connection with clinical studies relating to
the GFX, the Micro Stent II and Micro Stent II XL systems and costs
incurred in connection with the development of additional products.
The Company expects research and development expenses to
continue to increase in absolute dollars as the Company increases
clinical trial activities and pursues development of next generation
products.
Selling, General and Administrative. Selling, general and
administrative expenses increased in absolute dollars to $7.5
million in the three months ended September 30, 1997 from $3.1
million in the comparable period in fiscal 1997, and increased as a
percentage of net sales to 29% in the 1998 period from 17% in the
1997 period. The increase during the three-month period in absolute
dollars and as a percentage of sales primarily reflected additional
costs of marketing and other personnel necessary to support the
Company's higher level of operations, including the commencement of
direct sales operations in France, The Netherlands (servicing the
Benelux countries), and Switzerland in the second quarter of fiscal
1997. Additionally, the increase reflects increased legal costs
relating primarily to litigation with former shareholders of
Endothelial Support Systems, Inc., subsequently known as
Endovascular Support Systems, Inc. ("ESS"), and certain distributor
terminations, which together resulted in related legal expenses of
$1.3 million during the quarter.
The Company expects selling, general and administrative costs
to continue to increase in absolute dollars in the future primarily
due to increased levels of sales, product support and manufacturing
operations (particularly with respect to increased levels of sales
operations in the United States already developed in anticipation of
FDA approval, although there can be no assurance of such approval),
as well as increases in finance, legal and administrative costs
relating to public company obligations, and ongoing litigation.
Interest and Other Income. The Company had interest and other
income of $1.0 million in the three months ended September 30, 1997,
compared to $1.3 million in the comparable period in fiscal 1997.
The decrease during the three-month period was primarily due to
certain real property rental income earned, and greater short-term
investment balances, in the prior period.
Provision for Income Taxes. The Company's provision for income
taxes was $3.1 million in the three months ended September 30, 1997,
compared to $4.2 million in the comparable period in fiscal 1997.
The decrease in this provision during the three-
15
<PAGE>
month period was a result of the Company's lower earnings during the
fiscal 1998 period.
Net Income. The Company had net income of $5.7 million, or
21.7% of net sales, in the three months ended September 30, 1997
compared to net income of $7.8 million, or 41.9% of net sales, for
the comparable period in fiscal 1997.
Liquidity and Capital Resources
Net cash provided by operating activities was $9.5 million for
the three months ended September 30, 1997. Excluding the effect of
transactions in short-term investments, the Company had net cash
provided by operating activities of $4.9 million for the three-month
period, principally arising as a result of positive net income for
the period. Cash, cash equivalents and short-term investments
totaled $85.3 million at September 30, 1997 as compared to $87.2
million at June 30, 1997. Working capital decreased to $112.5
million at September 30, 1997 as compared to $114.5 million at June
30, 1997. Inventories increased to $10.8 million at September 30,
1997 from $7.3 million at June 30, 1996, primarily due to increased
product inventories in preparation for the commencement of
commercial sales in Japan and the United States. Included in
accounts receivable at September 30, 1997 is approximately $2.4
million due from former distributors of the Company that have
threatened or commenced litigation in connection with the
termination of distribution relationships. The Company has commenced
litigation against such terminated distributors to collect such
amounts. See Note 5 to the Condensed Consolidated Financial
Statements in Item 1. The Company expects accounts receivable and
inventories to increase in absolute dollar amounts as sales
increase.
In August 1997, the Company entered into a bank credit
agreement for a revolving credit facility of $20 million. Such
revolving credit facility is secured by certain of the Company's
short-term investments and is due and payable on August 31, 1998.
The bank credit agreement contains no material restrictive
covenants. As of September 30, 1997, the Company had drawn down
approximately $2.4 million of such revolving credit facility. The
interest rate on such facility is LIBOR plus one-half of one
percent.
The Company expects to incur substantial additional costs,
including costs relating to capital equipment and other costs
associated with expansion of the Company's manufacturing
capabilities, increased sales and marketing activities (including
the establishment of direct sales forces internationally), and
increased research and development expenditures in connection with
seeking regulatory approvals and conducting additional clinical
trials. Among other things, the Company expects to spend
approximately $20 million on a new manufacturing facility currently
under construction in Santa Rosa, California. The Company may
require additional equity or debt financing to address its working
capital needs or to provide funding for capital expenditures in the
future. Furthermore, any additional equity financing may be dilutive
to stockholders, and debt financing, if available, may involve
restrictive covenants. However, there can be no assurance that
events in the future will not require the Company to seek additional
capital or, if so required, that it will be available on terms
acceptable to the Company.
16
<PAGE>
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to Note 5 to the Condensed
Consolidated Financial Statements in this Form
10-Q.
Item 2. Change in Securities and Use of Proceeds
The effective date of the Company's
registration statement filed on Form S-1 under the
Securities Act of 1933 (No. 333-00824) was April 2,
1996 (the "Registration Statement"). The class of
securities registered was Common Stock. The
offering commenced on April 2, 1996 and all
securities were sold in the offering. The managing
underwriters for the offering were Cowen & Company,
Bear, Stearns & Co. Inc. and J.P. Morgan & Co.
Pursuant to the Registration Statement, the
Company sold 4,250,000 shares of Common Stock for
its own account, for an aggregate offering price of
$89,250,000, and 1,500,000 shares of Common Stock
for the account of certain selling stockholders,
for an aggregate offering price of $31,500,000.
The Company incurred expenses of
approximately $7,897,500 in connection with the
offering, of which $6,247,500 represented
underwriting discounts and commissions and
$1,650,000 represented estimated other expenses.
All such expenses were direct or indirect payments
to others. The net offering proceeds to the Company
after total expenses was approximately $81,352,000.
The Company has used approximately
$12,800,000 of the net proceeds of the offering, of
which $6,200,000 represents payments relating to
the construction of plant, building and facilities
and $6,600,000 represents payments relating to the
purchase of real estate. All such payments were
direct or indirect payments to others. All other
net proceeds of the offering have been invested in
various short-term investments. The use of the
proceeds of the offering does not represent a
material change in the use of proceeds described in
the prospectus that formed a part of the
Registration Statement.
17
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11.1 Statement regarding calculation of net
income per share.
27 Financial Data Schedule.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three
months ended September 30, 1997.
On October 23, 1997, the Company filed a Form 8-K
with respect to its being named as an additional
defendant, along with Boston Scientific Corporation
and SciMed Life Systems, Inc., in a lawsuit
originally filed by Cordis Corporation against
Guidant Corporation and Advanced Cardiovascular
Systems, Inc. in federal district court in
Delaware. The lawsuit alleges infringement or
potential infringement of one or more U.S. patents
held by Cordis.
Report Date: October 21, 1997
Filing Date: October 23, 1997
Item 5 - Other Events
Item 7 - Exhibits
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ARTERIAL VASCULAR ENGINEERING, INC.
Date: November 11, 1997 /s/ John D. Miller
-------------------------------------------
John D. Miller
Vice President of Finance, Chief Financial Officer
(Principal Financial and Accounting Officer)
19
<PAGE>
INDEX TO EXHIBITS
Exhibit
- -------
11.1 Statement regarding computation of net income per share.
27 Financial Data Schedule
EXHIBIT 11.1
ARTERIAL VASCULAR ENGINEERING, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
(In thousands, except per share data)
Three Months Ended
September 30,
-------------------------
1997 1996
----------- ----------
Primary
Weighted average common shares
outstanding 31,065 30,862
Weighted average common equivalent
shares assuming conversion of stock
options under the treasury stock method 1,172 770
------- -------
Shares used in per share calculation 32,237 31,632
------- -------
Net income $ 5,710 $ 7,765
======= =======
Net income per share $ 0.18 $ 0.25
======= =======
Net income per share is presented under the primary basis as the effect of
dilution under the fully diluted basis is less than 3%.
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