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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 1O-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 26, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________________ to _________________
Commission file number 000-21517
XOMED SURGICAL PRODUCTS, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 06-1393528
- - ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6743 SOUTHPOINT DRIVE N., JACKSONVILLE, FL 32216-0980
- - ------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
(904) 296-9600
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address and former fiscal year,
if changed since last report)
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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares
outstanding of each of the issuer's classes of common stock as of the latest
practicable date.
Common stock, $.01 par value - 8,088,724 shares as of October 29, 1998
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<PAGE>
XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES
INDEX
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
September 26, 1998 and December 31, 1997....................... 2
Condensed Consolidated Statements Of Operations
Three Months Ended September 26, 1998
and September 27, 1997, and Nine Months Ended
September 26, 1998 and September 27, 1997...................... 3
Condensed Consolidated Statements Of Cash Flows
Nine Months Ended September 26, 1998 and September 27, 1997.... 4
Notes To Condensed Consolidated Financial Statements
September 26, 1998............................................. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 10
Item 6. Exhibits and Reports on Form 8-K................................... 10
SIGNATURES 11
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
SEPTEMBER 26, DECEMBER 31,
1998 1997
------------- ------------
ASSETS (UNAUDITED)
Current assets:
Cash and cash equivalents ............... $ 1,606 $ 1,712
Accounts receivable, less allowance ..... 14,072 13,277
Other receivables ....................... 237 620
Inventories ............................. 20,553 16,238
Prepaid expenses ........................ 980 1,083
Deferred income taxes ................... 2,099 1,404
--------- ---------
Total current assets ....................... 39,547 34,334
Investments ................................ 20,806 --
Notes receivable from officers ............. 826 724
Property, plant and equipment, net ......... 18,511 15,403
Cost in excess of net assets acquired, net . 40,905 42,399
Other assets ............................... 4,411 2,867
--------- ---------
Total assets ............................... $ 125,006 $ 95,727
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................ $ 4,858 $ 3,493
Accrued expenses ........................ 4,662 2,403
Accrued payroll & commissions ........... 2,368 2,332
--------- ---------
Total current liabilities .................. 11,888 8,228
Deferred credits ........................... 373 990
Redeemable preferred stock - -0- shares
issued and outstanding................... -- --
Shareholders' equity :
Common stock, voting, $.01 par value;
30,000,000 shares authorized,
shares issued and outstanding ......... 81 73
Retained earnings (deficit) ............. 2,632 (3,459)
Additional paid-in capital .............. 110,652 90,264
Cumulative translation adjustments ...... (29) (88)
Unearned compensation ................... (197) (281)
Unrealized loss on investments .......... (394) --
--------- ---------
Total shareholders' equity .............. 112,745 86,509
--------- ---------
Total liabilities and shareholders' equity . $ 125,006 $ 95,727
========= =========
Note: The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. See notes to condensed consolidated financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- ------------------------------
SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Sales, net ..................... $ 21,912 $ 18,650 $ 65,462 $ 55,657
Cost of sales .................. 8,402 7,413 25,394 22,141
-------- -------- -------- --------
Gross margin ................... 13,510 11,237 40,068 33,516
Operating expenses:
Selling, general and
administrative .............. 8,302 7,367 25,104 22,412
Research and development ....... 1,195 1,015 3,531 3,018
Amortization of intangibles .... 616 585 1,784 1,789
-------- -------- -------- --------
Total operating expenses ....... 10,113 8,967 30,419 27,219
-------- -------- -------- --------
Operating income ............... 3,397 2,270 9,649 6,297
Interest and dividend income
(expense), net .............. 210 (14) 302 (121)
Other income, net .............. 18 20 86 120
-------- -------- -------- --------
Income before income tax expense 3,625 2,276 10,037 6,296
Income tax expense ............. 1,414 907 3,946 2,513
-------- -------- -------- --------
Net income ..................... $ 2,211 $ 1,369 $ 6,091 $ 3,783
======== ======== ======== ========
Per share:
Net income - basic ............. $ 0.28 $ 0.19 $ 0.81 $ 0.52
======== ======== ======== ========
Net income - diluted ........... $ 0.27 $ 0.18 $ 0.77 $ 0.50
======== ======== ======== ========
Weighted average common shares
outstanding - basic ............ 7,888 7,334 7,527 7,319
======== ======== ======== ========
Weighted average common shares
outstanding - diluted .......... 8,303 7,569 7,873 7,495
======== ======== ======== ========
</TABLE>
See notes to condensed consolidated financial statements
3
<PAGE>
<TABLE>
<CAPTION>
XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 26, SEPTEMBER 27,
1998 1997
------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES
Net cash provided by operating activities..... $ 5,610 $ 3,805
INVESTING ACTIVITIES
Purchases of property, plant and equipment ... (4,911) (1,800)
Proceeds from certificates of deposit ........ -- 11
Purchase of other assets ..................... -- 140
Purchase of investments ...................... (21,200) --
-------- --------
Net cash used in investing activities ........ (26,111) (1,649)
FINANCING ACTIVITIES
Proceeds from revolving line of credit ....... -- 10,109
Payments on revolving line of credit ......... -- (13,245)
Payments on term notes payable and
capital lease obligations ................. -- (77)
Proceeds from exercise of stock option ....... 238 634
Proceeds from issuance of stock .............. 20,157 --
-------- --------
Net cash provided by (used in) financing
activities ................................ 20,395 (2,579)
-------- --------
Net decrease in cash and cash equivalents .... (106) (423)
Cash and cash equivalents at beginning of
period .................................... 1,712 629
-------- --------
Cash and cash equivalents at end of period ... $ 1,606 $ 206
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid during the period for:
Interest ................................. $ 58 $ 202
======== ========
Taxes .................................... $ 4,189 $ 736
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X and should be read in conjunction
with the audited financial statements for the years ended December 31, 1997,
1996, and 1995 of Xomed Surgical Products, Inc. (the Company) in the
Company's 1997 Annual Report on Form 10-K. Accordingly, they do not include
all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the nine-month period ended September 26, 1998 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 1998.
NOTE B - INVENTORIES
The components of inventory consist of the following:
SEPTEMBER 26, DECEMBER 31,
1998 1997
------------- ------------
Raw Materials $ 6,518 $ 5,818
Work-In-Process 2,656 1,447
Finished Products 11,379 8,973
------- -------
$20,553 $16,238
======= =======
NOTE C - INVESTMENTS AND DERIVATIVE FINANCIAL INSTRUMENTS
Investments consist of marketable preferred stocks and variable rate
corporate and educational institution bonds both of which are designated as
available for sale. Accordingly, the securities and bonds are marked to
market and the unrealized gains and losses are included, net of taxes, as a
separate component of shareholders equity. The investments consist of the
following:
AVAILABLE FOR SALE COST MARKET
------- -------
Preferred Stock...... $16,388 $16,305
Bonds................ 4,235 4,235
Other................ 789 789
------- -------
$21,412 $21,329
======= =======
Gross unrealized losses as of September 26, 1998 were $83.
In order to manage the interest rate risk on the preferred stock, the
Company has entered into derivative financial instruments with off-balance
sheet risk. The Company enters into short sales of futures contracts on US
Treasury Bonds in order to hedge the effect of interest rate risk on its
preferred stock portfolio. The futures contracts are designated at inception
as a hedge of the interest rate risk on the preferred stock and are monitored
to determine if it remains an effective hedge. The effectiveness of the
futures contract as a hedge is based on changes in its market value being
highly correlated inversely with changes in the market value of the
underlying hedged item. The Company defers any realized or unrealized gains
or losses on the futures contract as a separate component of shareholders
equity until the hedged items (preferred stock) are sold at which time the
gain or loss will be recorded in the statement of operations. In the event
that it is determined that a hedge is ineffective, including if and when the
hedged transactions no longer exist, the Company recognizes in income the
change in market value of the instrument beginning on the date it was no
longer an effective hedge. As of September 26, 1998, the Company has deferred
realized and unrealized losses on its short sales of $307 and $255,
respectively.
5
<PAGE>
XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(in thousands, except per share data)
(Unaudited)
NOTE D - EARNINGS PER SHARE
The following table sets forth the computation of shares for purposes of the
earnings per share calculation:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- ------------------------------
SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Weighted average shares
outstanding ................... 7,888 7,334 7,527 7,319
Net effect of dilutive stock
options - based on the treasury
stock method .................. 415 235 346 176
----- ----- ----- -----
Totals ........................... 8,303 7,569 7,873 7,495
===== ===== ===== =====
</TABLE>
NOTE E - COMPREHENSIVE INCOME
The Financial Accounting Standards Board has issued Statement No. 130,
"Reporting Comprehensive Income" effective for fiscal years beginning after
December 15, 1997. The standard requires companies to report another measure
of operations called Comprehensive Income. This measure, in addition to "Net
Income," includes as income or loss the following items, which if present are
included in the equity section of the Balance Sheet: 1) unrealized gains and
losses on certain investments in debt and equity securities; 2) foreign
currency translation; and 3) minimum pension liability adjustments. The
following table depicts comprehensive income.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------- --------------------------------
SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income .............. $ 2,211 $ 1,369 $ 6,091 $ 3,783
Foreign currency
translation adjustment 77 -- 59 --
Investment holding
gains(losses) ........ (394) -- (394) --
------- ------- ------- -------
Comprehensive income .... $ 1,894 $ 1,369 $ 5,756 $ 3,783
======= ======= ======= =======
</TABLE>
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD LOOKING
STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, INCLUDING RISK ASSOCIATED WITH THE
EAR, NOSE AND THROAT ("ENT") SURGICAL PRODUCTS INDUSTRY AND OTHER RISKS DETAILED
FROM TIME TO TIME IN THE FILINGS OF XOMED SURGICAL PRODUCTS, INC. (THE COMPANY)
WITH THE SECURITIES AND EXCHANGE COMMISSION. SUCH RISKS MAY ALSO INCLUDE GENERAL
ECONOMIC AND BUSINESS CONDITIONS, COMPETITION, CHANGING TRENDS IN CUSTOMER
PROFILES, OUTCOMES OF OUTSTANDING LITIGATION, AND CHANGES IN GOVERNMENT
REGULATIONS. ALTHOUGH THE COMPANY BELIEVES THAT ITS EXPECTATIONS WITH RESPECT TO
THE FORWARD-LOOKING STATEMENTS ARE BASED UPON REASONABLE ASSUMPTIONS WITHIN THE
BOUNDS OF ITS KNOWLEDGE OF ITS BUSINESS AND OPERATIONS, THERE CAN BE NO
ASSURANCE THAT ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY WILL
NOT DIFFER MATERIALLY FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS.
RESULTS OF OPERATIONS
SALES BY MARKET. The Company derives sales from various markets within the
ENT industry. Sinus and rhinology, head and neck and otology are the three core
ENT markets in which the Company operates. In addition to products for these
markets, the Company has other product offerings, including lines of ophthalmic,
orthopaedic and other products. The following table summarizes the Company's
worldwide product line sales during the periods indicated (in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------- ------------------------------
PRODUCT LINE SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Sinus & Rhinology.... $ 9,211 $ 7,021 $27,510 $20,235
Head & Neck.......... 5,447 4,551 15,241 12,582
Otology.............. 3,189 3,018 11,283 10,879
------- ------- ------- -------
Total Core ENT
Business........ 17,847 14,590 54,034 43,696
Ophthalmic & Other... 4,065 4,060 11,428 11,961
------- ------- ------- -------
Total Company..... $21,912 $18,650 $65,462 $55,657
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------- ------------------------------
GEOGRAPHIC SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Domestic............. $15,934 $13,248 $46,639 $38,804
International........ 5,978 5,402 18,823 16,853
------- ------- ------- -------
$21,912 $18,650 $65,462 $55,657
======= ======= ======= =======
</TABLE>
SALES, NET. For the three months ended September 26, 1998, net sales
increased 17.5% to $21.9 million from $18.7 million in the comparable quarter of
1997. Sales, net increased 17.6% to $65.5 million in the first nine months of
1998 from $55.7 million in the comparable period in 1997. In the core ENT
business of sinus and rhinology, head and neck and otology, sales increased
22.3% and 23.7% for the three and nine-month periods ended September 26, 1998,
respectively, compared to the 1997 comparable periods. Domestic core ENT sales
increased by 24.1% to $12.9 million and by 25.6% to $38.4 million for the three
and nine-months ended September 26, 1998, respectively, over the comparable
periods in 1997. International core ENT sales increased by 18.0% to $5.0 million
for the three-month period and by 19.1% to $15.7 million for the nine-month
period ended September 26, 1998 as compared to the same periods in 1997. The
increase in core ENT business sales was primarily the result of sales generated
from several new products introduced principally over the last 18 months,
including within sinus and rhinology, the XPS tissue removal system and within
head and neck, the NIM XL2 nerve monitoring system, the Company's Powerforma(R)
surgical drill system and several new cutter blades. The increase in domestic
core ENT sales was led by the Company's sinus and rhinology product line, which
increased by 32.5% to $6.5 million for the three-months and by 41.1% to $19.0
million for the nine-months ended September 26, 1998. Total international sales
increased by 10.7% and 11.7% for the three and nine-months ended September 26,
1998, respectively, over the comparable period in 1997. Excluding the
unfavorable effects of foreign currency comparisons on foreign currency
translations, international sales increased by 12.8% for the three-months and by
14.7% for the nine-months ended September 26, 1998. Strong sales increases were
reported in Japan, the U.K., Germany and Italy, as well as several other
European countries, in the nine-month period ended September 26, 1998.
International sales were negatively impacted by a 28.2% and 37.7% decrease in
the Asia/Pacific region (excluding Japan) for the three-months and nine-months
ended September 26, 1998, respectively, as compared to the same periods in 1997.
International sales accounted for 28.8% of the Company's total sales for the
nine-months ended
7
<PAGE>
September 26, 1998 and 30.3% of total sales for the nine months ended on
September 27, 1997. Sales in the ophthalmic and other category were flat in the
quarter compared to the prior comparable quarter ended September 27, 1997 and
decreased 4.5% for the nine-months ended September 26, 1998 as compared to the
1997 comparable period, primarily due to a decrease of approximately $590,000 in
sales of orthopaedic instruments in 1998 as compared to the prior year, which
included a large initial stocking order to an OEM distributor.
GROSS MARGIN. Gross margin as a percent of sales was 61.7% and 61.2% for
the three and nine-month periods ended September 26, 1998, respectively,
compared to 60.3% and 60.2%, respectively, in the 1997 comparable periods. The
increase in the gross margin percentage relates partially to a higher mix of the
Company's higher margin core products during the current periods and partially
to lower per unit manufacturing cost due to a higher volume of production.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 12.7% and 12.0% to $8.3 million and $25.1
million in the three-month and nine-month periods ended September 26, 1998,
respectively, from the comparable periods in 1997. As a percent of sales,
selling, general and administrative expenses were 37.9% and 38.3% in the three
and nine-month periods ended September 26, 1998, respectively, as compared to
39.5% and 40.3%, respectively, in the 1997 comparable periods. The decrease in
selling, general and administrative expenses as a percent of sales relates to a
higher base of sales in 1998 and certain fixed expenses.
RESEARCH AND DEVELOPMENT. Research and development expenses increased
17.7% and 17.0% to $1.2 million and $3.5 million in the three-month and
nine-month periods ended September 26, 1998, respectively, from the comparable
periods in 1997. As a percent of sales, research and development expenses for
the three and nine-months ended September 26, 1998 were 5.5% and 5.4%,
respectively, as compared to 5.4% in both 1997 comparable periods.
INTEREST AND OTHER. The Company had net interest and dividend income of
$210,000 and $302,000 in the three months and nine months ended September 26,
1998, respectively. This compares favorably to net interest expense of $14,000
and $121,000 in the comparable 1997 periods. This favorability relates to having
an average invested amount during the first nine months of 1998 as compared to
an average borrowed amount during the comparable 1997 period. Also benefiting
the third quarter of 1998 are interest and dividends from the invested proceeds
of the Company's follow-on stock offering in late July. Other income was $18,000
for the three months and $86,000 for the nine months ended September 26, 1998.
This compares to other income of $20,000 and $120,000 in the comparable periods
in 1997.
INCOME TAXES. The Company's effective tax rate was 39.3% for the first
nine months of 1998 compared to an effective tax rate of 40.0% for the
comparable period of 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company historically has financed its operations (including capital
expenditures) through cash flows from operations. Since the Company's
acquisition of Xomed, Inc. in April 1994, which was financed in part by the
incurrence of $45.9 million of debt under the Company's secured term loan
facility (the "Term Loan") and its secured revolving credit facility (the
"Revolving Credit Facility"), all cash flow generated from operations had been
applied to repay the outstanding principal on the Term Loan or the Revolving
Credit Facility. In October 1996, the Company completed its initial public stock
offering, the proceeds of which were used to repay the entire Term Loan and the
majority of the Revolving Credit Facility. As of September 26, 1998, the Company
has no outstanding long-term debt.
During the nine-months ended September 26, 1998, the Company generated
cash of $5.6 million in operating activities as compared with $3.8 million cash
generated from operating activities in the prior comparable period. In the first
nine months of 1998, the Company had a net use of cash of $1.1 million within
inventory, accounts receivable and accounts payable as compared to a net use of
cash within these components of operations of $3.8 million in the comparable
1997 period, which included a use of cash related to payments of accounts
payable related to the Company's IPO completed in the fourth quarter of 1996.
The use of cash within the working capital accounts, except for the use related
to the IPO, stems primarily from the Company's growth in sales and related
increase in inventories offset somewhat by cash provided by an increase in
accounts payable. Additionally, in 1998 the Company made payments of $1.5
million under product distribution agreements.
Cash used in investing activities in the first nine months of 1998 is
comprised of purchases of investments totaling $21.2 million and purchase of
property, plant and equipment of $4.9 million, the majority of which relates to
the Company's plant expansion in Jacksonville. This compares to purchases of
property, plant and equipment of $1.8 million in the first nine months of 1997.
Cash to be used in investing activities related to the Company's headquarters
expansion in 1999 is expected to be approximately $6 million. Cash provided by
financing activities of $20.4 million related principally to the Company's net
proceeds from its follow-on stock offering of $20.2 million.
8
<PAGE>
Based on the Company's ability to generate cash from operations and with
the availability of borrowing under its Amended and Restated Credit Agreement,
which allows borrowings up to $25 million, the Company believes it will be able
to finance its working capital needs for at least the next 24 months.
FINANCIAL INSTRUMENTS AND MARKET RISK MANAGEMENT
The Company is exposed to interest rate risk stemming from its preferred
stock portfolio. The Company has entered into short sales of US Treasury Bond
futures in order to hedge the effect of the interest rate risk on its preferred
stock portfolio. The Company believes that the value of the US Treasury Bond
futures correlates inversely to the value of the preferred stocks upon changes
in interest rates. Therefore, the Company expects that any loss or gain on the
fair value of the derivatives would generally be offset by an increase or
decrease in the fair value of the underlying exposures. The Company does not use
derivatives for trading or speculative purposes. As of September 26, 1998, the
Company had an unrealized loss of $83 on its preferred stock portfolio, and a
realized loss of $307 and an unrealized loss of $255 on its short sales of US
Treasury Bonds. These losses have been recorded, net of taxes, as a separate
component of shareholders' equity.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
No. 133), which is required to be adopted for fiscal years beginning after June
15, 1999, although earlier application is permitted as of the beginning of any
fiscal quarter. This statement will require the company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not hedges
must be adjusted to fair value through income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
will either be offset against the change in fair value of the hedged assets,
liabilities, or until the hedged item is recognized in earnings. The company is
in the process of determining what effect the adoption of SFAS No. 133 will have
on the company's results of operations, cash flows or financial position.
RECENT EVENTS
THREE-FOR-TWO STOCK SPLIT. The Board of Directors of the Company has
approved a three-for-two stock split. The split will be accomplished through a
stock dividend of one additional share of common stock for every two shares of
Xomed common stock held at the close of business on the record date of November
16, 1998. The additional shares will be distributed on November 30, 1998. As a
result of the stock split, the Company's outstanding shares will increase 50%
from approximately 8.1 million shares to approximately 12.1 million shares.
WARBURG, PINCUS INVESTORS, L.P. STOCK DISTRIBUTION.Warburg, Pincus
Investors, L.P. (Warburg) informed the Company that, on November 4, 1998, it
distributed to its partners approximately 1.2 million shares of Xomed common
stock, representing approximately 51% of Warburg's holdings in the Company and
15% of the Company's outstanding stock. Warburg also informed the Company that
the distribution is consistent with Warburg's practice of distributing the
shares of investments it deems successful directly to its partners. The partners
receiving the distribution consist primarily of institutional investors
including several large public and private pension funds. After the
distribution, Warburg, Pincus Investors, L.P.'s remaining holdings represented
approximately 14% of the Company's outstanding stock.
MEROCEL FACILITY RESTRUCTURING. The Board of Directors of the Company, in
October 1998, approved a restructuring of its manufacturing operations at its
Merocel facility in Mystic, Connecticut. The Merocel facility produces surgical
sponge material for post-operative sinus packing. Due to an ongoing shortage of
available labor in the Mystic, Connecticut area, most of the secondary
operations, which include packaging, assembly and warehousing functions, will be
transferred to the Company's main facility in Jacksonville, Florida where
similar activities for other products currently take place. Approximately 44
people in the Merocel facility will be displaced due to the product transfer. As
a result, the Company plans to incur a restructuring charge in the fourth
quarter of 1998 of approximately $1.0 million related to anticipated severance
payments and asset write-offs. The transfer is expected to be substantially
complete by the second quarter of 1999 and fully implemented by the end of 1999.
The Merocel facility will continue with its primary operations related to the
chemical processes involved in the production of surgical sponge material. To
date, the operation has not had difficulty in retaining the more highly skilled
labor involved with these processes.
EUROPEAN UNION CONVERSION TO A COMMON CURRENCY
Eleven European Countries have entered into agreements that include a
process of converting to a common currency, the "euro". On January 1, 1999, the
eleven European Countries will establish a fixed conversion rate for
transactions between their existing currencies ("legacy currencies"). For a
three-year transition period following this date the legacy currencies remain
legal tender. Beginning January 1, 2002, the participating countries will issue
euro-demoninated bills for use in transactions and will withdraw all bills
denominated in the legacy currencies by July 1, 2002. The Company has two
distribution sites that operate in these countries (France and Germany). Sales
from these sites totaled $4.0 million or 6.0% of consolidated sales for the
nine-months ended September 26, 1998. The Company has begun an internal analysis
to address euro-related issues and plan for the conversion, including review of
information systems, current contracts, foreign currency hedging activities and
physical conversion procedures. Based on existing information, the Company does
not believe that the impact to the Company of the conversion to a common
currency by these eleven countries will be material to its results of
operations, financial position or cash flows.
9
<PAGE>
Year 2000
The Company has undertaken an internal assessment of its operations,
including its information systems, financial systems and its manufacturing
processes, in order to determine the extent to which the Company may be
adversely affected by Year 2000 issues. The Company's focus on this issue is to
avoid any adverse effect on business operations and ensure that transactions
with customers, suppliers, and financial institutions are fully supported. This
internal assessment is approximately 90% complete at present and the Company
expects to finish the assessment process by June 1999. The Company plans to
devote the necessary resources to resolve any significant Year 2000 issues in a
timely manner. To date, the Company has performed limited testing of systems,
and may conduct further testing and/or an external audit following the
conclusion of its assessment. To date, only internal time and costs have been
incurred related to investigation into and testing related to the Year 2000
issue. These costs are immaterial to date. Present estimates for further
expenditures of both employee time and expenses to address Year 2000 issues are
between $50,000 and $100,000, respectively.
The Company has surveyed its significant suppliers, customers and other
third parties to determine their Year 2000 readiness and, to date, has received
responses from approximately 60% of those surveyed, a majority of whom has
certified they are compliant. The Company has conferred with significant
customers to assure that various systems used for data and information exchanges
between them will be compatible following December 31, 1999. The Company has
also initiated a formal program to advise customers, distributors and suppliers
of the Year 2000 issue; however, the Company believes it has no material
exposure to contingencies related to the Year 2000 issue for the products it has
sold.
Based on its assessments to date, the Company believes it will not
experience any material disruption as a result of Year 2000 issues in internal
manufacturing processes, information processing or interface with key customers,
or with processing orders and billing. Although the Company expects its
remediation efforts will be completed on a timely basis, failure to do so could
have a material adverse effect on the Company's systems and results of
operations which could lead to an inability to process customer orders, ship
products, bill customers and collect payments. While the Company has taken the
steps outlined above, there can be no certainty that the systems and products of
other companies on which the Company relies will not have a material adverse
effect on the Company's operations. In addition, if certain third party service
providers, such as those supplying electricity, water or telephone service,
experience difficulties resulting in disruption of service to the Company, a
shutdown of the Company's facilities could occur for the duration of the
disruption. At present, the Company has not developed contingency plans but
intends to determine whether to develop any such plan in fiscal year 1999. Based
on existing information, the Company believes the anticipated spending to become
Year 2000 compliant will not have a material adverse effect on the Company's
financial condition, cash flows or results of operations. Nevertheless, there
can be no assurance that Year 2000 issues will not have a material adverse
effect on the Company's business, results of operation and financial condition.
Certain statements in this discussion constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such forward-looking statements involve known and unknown risks,
including, but not limited to, general economic and business conditions,
competition, changing trends in customer profiles, outcomes of outstanding
litigation, and changes in government regulations. Although the Company believes
that its expectations with respect to the forward-looking statements are based
upon reasonable assumptions within the bounds of its knowledge of its business
and operations, there can be no assurance that actual results, performance or
achievements of the Company will not differ materially from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Economic, competitive, governmental, technological, and other
factors which may affect the Company's operations are discussed in the Company's
reports on Forms 10-Q and 10-K, including Exhibit 99.1, filed with the
Securities and Exchange Commission.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is currently involved in certain legal proceedings incidental
to the normal conduct of its business. The Company does not believe that any
liabilities relating to the legal proceedings to which it is a party are likely
to be, individually or in the aggregate, material to its consolidated financial
position or results of operations.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are included herein:
27 1998 Financial Data Schedule
27.1 1997 Financial Data Schedule
(b) The Company did not file any reports on Form 8-K during the quarter ended
September 26, 1998.
10
<PAGE>
XOMED SURGICAL PRODUCTS, INC. AND SUBSIDIARIES
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 on the dates indicated.
XOMED SURGICAL PRODUCTS, INC.
-----------------------------
(Registrant)
Date NOVEMBER 6, 1998 /s/ JAMES T. TREACE
---------------- ------------------------
James T. Treace, Chairman, President
and Chief Executive Officer (duly
authorized officer)
Date NOVEMBER 6, 1998 /s/ THOMAS E. TIMBIE
---------------- ------------------------------------
Thomas E. Timbie, Vice President and
Chief Financial Officer (principal
financial officer)
11
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION PAGE
- - ------- ----------- ----
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> SEP-26-1998 SEP-27-1997
<CASH> 1,606 206
<SECURITIES> 0 0
<RECEIVABLES> 15,670 12,310
<ALLOWANCES> 876 593
<INVENTORY> 20,553 16,461
<CURRENT-ASSETS> 39,547 32,044
<PP&E> 29,942 23,820
<DEPRECIATION> 10,611 8,538
<TOTAL-ASSETS> 125,006 93,798
<CURRENT-LIABILITIES> 11,888 9,423
<BONDS> 0 0
0 0
0 0
<COMMON> 81 73
<OTHER-SE> 112,664 84,302
<TOTAL-LIABILITY-AND-EQUITY> 125,006 93,798
<SALES> 65,462 55,657
<TOTAL-REVENUES> 65,462 55,657
<CGS> 25,394 22,141
<TOTAL-COSTS> 25,394 22,141
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 201 193
<INTEREST-EXPENSE> 0 121
<INCOME-PRETAX> 10,037 6,296
<INCOME-TAX> 3,946 2,513
<INCOME-CONTINUING> 6,091 3,783
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 6,091 3,783
<EPS-PRIMARY> 0.81 0.52
<EPS-DILUTED> 0.77 0.50
</TABLE>
