SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30, 1999 Commission File Number 0-8672
ST. JUDE MEDICAL, INC.
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(Exact name of Registrant as specified in its charter)
MINNESOTA 41-1276891
- --------------------------------- ------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
One Lillehei Plaza, St. Paul, Minnesota 55117
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(Address of principal executive offices)
(651) 483-2000
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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; and (2) has been subject to such filing
requirements for the past 90 days.
YES _X_ NO ___
The number of shares of common stock, par value $.10 per share, outstanding on
October 29, 1999 was 84,152,345.
The Exhibit Index to this Form 10-Q is set forth on page 20.
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<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales $ 275,814 $ 248,822 $ 833,207 $ 767,542
Cost of sales 94,285 90,704 287,495 284,955
---------- ---------- ---------- ----------
Gross profit 181,529 158,118 545,712 482,587
Selling, general & administrative 94,586 83,266 295,391 264,093
Research & development 31,378 24,984 91,608 74,265
In-process research & development 67,453 -- 115,228 --
Special charges 9,754 -- 9,754 --
---------- ---------- ---------- ----------
Operating profit (loss) (21,642) 49,868 33,731 144,229
Other income (expense), net (6,360) (7,494) (14,825) (2,273)
---------- ---------- ---------- ----------
Income (loss) before taxes (28,002) 42,374 18,906 141,956
Income tax provision 8,992 12,924 30,752 43,297
---------- ---------- ---------- ----------
Net income (loss) $ (36,994) $ 29,450 $ (11,846) $ 98,659
========== ========== ========== ==========
Earnings (loss) per common share:
Basic $ (0.44) $ 0.35 $ (0.14) $ 1.14
========== ========== ========== ==========
Diluted $ (0.44) $ 0.35 $ (0.14) $ 1.14
========== ========== ========== ==========
Average shares outstanding:
Basic 84,586 84,025 84,397 86,202
Diluted 84,586 84,267 84,397 86,727
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
(Unaudited) (See Note)
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 8,707 $ 3,775
Marketable securities 80,658 84,215
Accounts receivable, less allowances
(1999 - $11,272; 1998 - $12,352) 296,868 282,071
Inventories
Finished goods 126,882 126,927
Work in process 31,677 35,130
Raw materials 81,285 83,522
------------ ------------
Total inventories 239,844 245,579
Other current assets 68,557 66,824
------------ ------------
Total current assets 694,634 682,464
Property, plant and equipment - at cost 569,455 512,390
Less accumulated depreciation (220,607) (184,131)
------------ ------------
Net property, plant and equipment 348,848 328,259
Other assets, net 517,013 373,889
------------ ------------
TOTAL ASSETS $ 1,560,495 $ 1,384,612
============ ============
LIABILITIES & SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 252,339 $ 203,397
Long-term debt 529,895 374,995
Commitments and contingencies -- --
Shareholders' equity:
Preferred stock, par value $1.00 per share -
25,000,000 shares authorized; no shares issued -- --
Common stock, par value $.10 per share -
250,000,000 shares authorized; issued and
outstanding: 1999 - 84,228,902 shares;
1998 - 84,174,699 shares 8,423 8,417
Additional paid-in capital 5,226 6,656
Retained earnings 805,094 816,940
Accumulated other comprehensive income:
Cumulative translation adjustment (48,022) (33,242)
Unrealized gain on available-for-sale securities 7,540 7,449
------------ ------------
Total shareholders' equity 778,261 806,220
------------ ------------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 1,560,495 $ 1,384,612
============ ============
</TABLE>
NOTE: The balance sheet at December 31, 1998 has been derived from the audited
financial statements at that date. See notes to condensed consolidated financial
statements.
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<PAGE>
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1999 1998
---------- ----------
<S> <C> <C>
Operating Activities:
Net income (loss) $ (11,846) $ 98,659
Depreciation and amortization 59,985 52,783
In-process research & development 115,228 --
Special charges 9,754 --
Net investment gain (829) (15,624)
Working capital change, net of business acquisitions (3,253) (77,159)
---------- ----------
Net cash provided by operating activities 169,039 58,659
---------- ----------
Investing Activities:
Purchases of property, plant and equipment (58,659) (54,818)
Proceeds from sale or maturity of marketable securities 11,210 77,879
Business acquisitions, net of cash acquired (242,071) --
Other investing activities (20,605) 1,164
---------- ----------
Net cash provided by (used in) investing activities (310,125) 24,225
---------- ----------
Financing Activities:
Proceeds from exercise of stock options and stock issued 8,882 7,022
Common stock repurchased (16,625) (304,887)
Borrowings on lines of credit 432,800 762,700
Payments on lines of credit (277,900) (560,200)
Repurchase of convertible subordinated debentures -- (5,005)
---------- ----------
Net cash provided by (used in) financing activities 147,157 (100,370)
---------- ----------
Effect of currency exchange rate changes on cash (1,139) (222)
---------- ----------
Increase (decrease) in cash and cash equivalents 4,932 (17,708)
Cash and cash equivalents at beginning of year 3,775 28,530
---------- ----------
Cash and cash equivalents at end of period $ 8,707 $ 10,822
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
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<PAGE>
ST. JUDE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 1 - 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 Rule 10-01 of
Regulation S-X. 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 adjustments) considered necessary for a fair presentation
have been included. Operating results for the interim periods are not
necessarily indicative of the results that may be expected for the full year.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1998.
Certain 1998 amounts have been reclassified to conform to the 1999 presentation.
NOTE 2 - CONTINGENCIES
The Company is involved in various product liability lawsuits, claims and
proceedings of a nature considered normal to its business. Subject to
self-insured retentions, the Company has product liability insurance sufficient
to cover such claims and suits. The Company's product liability insurance
policies exclude coverage for two discontinued Pacesetter lead models. These
discontinued lead models were the subject of class action product liability
suits that have been settled. Management believes losses that might be sustained
from any such future actions would not have a material adverse effect on the
Company's liquidity or financial condition, but could potentially be material to
the income of a particular future period if resolved unfavorably.
NOTE 3 - COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) consists of unrealized gains or losses on
available-for-sale marketable securities and foreign currency translation
adjustments, net of taxes. Other comprehensive income (loss) was $6,714 and
$(4,741) for the third quarter of 1999 and 1998, and $(14,689) and $(15,907) for
the first nine months of 1999 and 1998. Total comprehensive income (loss)
combines reported net income (loss) and other comprehensive income (loss). Total
comprehensive income (loss) was $(30,280) and $24,709 for the third quarter of
1999 and 1998, and $(26,535) and $82,752 for the first nine months of 1999 and
1998.
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<PAGE>
NOTE 4 - SPECIAL CHARGES
The Company restructured its international operations during the third quarter
of 1999 to improve both the effectiveness and efficiency of its international
business by clarifying business unit accountabilities, focusing the operations
of its business units outside the U.S., and removing administrative redundancies
in the Company's management structure. This restructuring resulted in the
elimination of certain administrative management positions. The Company recorded
a $9,754 charge in the third quarter of 1999 related to the elimination of
certain administrative management positions ($8,046) and to other restructuring
activities ($1,708), of which $1,536 has been paid through September 30, 1999.
The Company recorded special charge accruals of $58,669 in 1997. These special
charge accruals have decreased by $54,510 since the dates recorded as a result
of cash payments or asset impairments.
NOTE 5 - EARNINGS (LOSS) PER SHARE
The table below sets forth the computation of basic and diluted earnings (loss)
per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) $ (36,994) $ 29,450 $ (11,846) $ 98,659
========== ========== ========== ==========
Denominator:
Basic-weighted shares outstanding 84,586 84,025 84,397 86,202
Effect of dilutive securities:
Employee stock options -- 209 -- 492
Restricted shares -- 33 -- 33
---------- ---------- ---------- ----------
Diluted-weighted shares outstanding 84,586 84,267 84,397 86,727
========== ========== ========== ==========
Basic earnings (loss) per share $ (.44) $ .35 $ (.14) $ 1.14
========== ========== ========== ==========
Diluted earnings (loss) per share $ (.44) $ .35 $ (.14) $ 1.14
========== ========== ========== ==========
</TABLE>
Diluted weighted shares outstanding for the three and nine months ended
September 30, 1999 and 1998 exclude certain employee stock options, restricted
shares, and convertible debentures that were anti-dilutive.
NOTE 6 - SHAREHOLDERS' EQUITY
During the third quarter of 1999, the Company's Board of Directors authorized
the repurchase of up to $250,000 of the Company's outstanding common stock over
a three-year period. The Company re-acquired 500 shares of its common stock for
$16,625 during the third quarter of 1999.
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<PAGE>
NOTE 7 - ACQUISITIONS
On March 16, 1999, the Company purchased the Angio-Seal business of Tyco
International Ltd. for $167,000 in cash. Angio-Seal produces and sells
hemostatic puncture closure devices. Total consideration for Angio-Seal,
including the fair value of the net liabilities assumed, was $175,185, which was
allocated to in-process research and development ($47,775), various other
identifiable intangible assets ($90,025), and goodwill ($37,385). Valuation of
the in-process research and development and other identifiable intangible assets
were based upon an independent appraisal.
On September 27, 1999 the Company purchased Vascular Science, Inc. (VSI) for
$75,071 in cash, net of cash acquired, plus additional contingent consideration
related to product development milestones for regulatory approvals and to future
sales. VSI is a development-stage company focused on the development of
suture-free devices to facilitate coronary artery bypass graft anastomosis.
Consistent with the approach used in connection with the Angio-Seal acquisition,
the Company engaged an independent appraisal firm to value VSI's identifiable
intangible assets ($580) and in-process research and development ($95,500).
Total consideration, including the net present value of future estimated
contingent consideration, is approximately $142,000. Summarized below is an
allocation of the cash paid at closing and the first $28,047 of future
contingent consideration payments utilizing these appraised amounts:
<TABLE>
<CAPTION>
Cash Future
Paid at Contingent
Closing Consideration Total
------------- ------------- -------------
<S> <C> <C> <C>
Fair value of net assets acquired, excluding cash $ 7,038 $ -- $ 7,038
Assembled workforce 580 -- 580
In-process research and development 67,453 28,047 95,500
------------- ------------- -------------
$ 75,071 $ 28,047 $ 103,118
============= ============= =============
</TABLE>
The future contingent consideration will be recorded in the Company's financial
statements when payment of such amounts is assured beyond a reasonable doubt.
All future contingent consideration in excess of the $28,047 will be capitalized
as goodwill.
The above acquisitions have been recorded using the purchase method of
accounting. The operating results of each of these acquisitions are included in
the Company's consolidated statement of income from the date of each
acquisition. The values assigned to in-process research and development were
expensed at close, except as noted above, since technological feasibility had
not been established and there were no alternative future uses for the
technology. Pro forma results of operations have not been presented since the
effects of these business acquisitions were not material to the Company on
either an individual or aggregate basis. Goodwill and other intangible assets
associated with these acquisitions will be amortized using lives ranging from 18
to 20 years.
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<PAGE>
NOTE 8 - SEGMENT INFORMATION
The Company has two reportable segments: Cardiac Rhythm Management (CRM) and
Heart Valve Disease Management (HVDM). The CRM segment develops, manufactures
and distributes bradycardia pulse generators and leads, tachycardia implantable
cardioverter defibrillators and leads, electophysiology catheters and cardiology
catheters. The HVDM segment develops, manufactures and distributes mechanical
and tissue heart valves and valve repair products. HVDM is also developing
suture-free devices to facilitate coronary artery bypass graft anastomosis.
Certain financial information relating to the Company's reportable segments is
as follows:
<TABLE>
<CAPTION>
CRM HVDM All Other(1) Total
------------------------------------------------------
<S> <C> <C> <C> <C>
Quarter ended September 30, 1999
Net sales to external customers $ 211,578 $ 64,236 $ -- $ 275,814
Operating profit (loss) (2) 26,779 35,129 (83,550) (21,642)
Quarter ended September 30, 1998
Net sales to external customers 181,279 67,543 -- 248,822
Operating profit (loss) 20,403 35,412 (5,947) 49,868
Nine months ended September 30, 1999
Net sales to external customers 622,112 211,095 -- 833,207
Operating profit (loss) (2) 68,259 113,764 (148,292) 33,731
Nine months ended September 30, 1998
Net sales to external customers 552,707 214,835 -- 767,542
Operating profit (loss) 49,389 111,888 (17,048) 144,229
</TABLE>
(1) Amounts relate to Corporate, in-process research and development and
special charges.
(2) All Other includes $67,453 and $115,228 of in-process research and
development charges for the three and nine months ended September 30,
1999, and $9,754 of special charges for the three and nine months ended
September 30, 1999.
During 1999, CRM's segment assets increased by approximately $135,000 related to
the acquisition of Angio-Seal and HVDM's segment assets increased by
approximately $10,000 related to the acquisition of VSI.
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<PAGE>
NOTE 9 - OTHER INCOME (EXPENSE)
Other income (expense), net consists of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Interest income $ 716 $ 939 $ 2,198 $ 3,313
Interest expense (6,937) (6,940) (19,482) (18,027)
Net investment gain 829 650 829 15,624
Foreign exchange gain (loss) (459) (1,999) 2,145 (2,006)
Other (509) (144) (515) (1,177)
--------- --------- --------- ---------
Other income (expense), net $ (6,360) $ (7,494) $ (14,825) $ (2,273)
========= ========= ========= =========
</TABLE>
NOTE 10 - NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This
Statement requires a company to recognize all derivatives on the balance sheet
at fair value. Derivatives that are not hedges must be adjusted to fair value
through the statement of 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
firm commitments through income or recognized in other comprehensive income
until the hedged item is recognized in income. The ineffective portion of a
derivative's change in fair value will be immediately recognized in income.
Statement No. 133 is required to be adopted for years beginning after June 15,
1999. In June 1999, the FASB issued Statement No. 137, which deferred the
effective date of Statement No. 133 for one year. The Company has not yet
determined what the effect of Statement No. 133 will be on the income and
financial position of the Company.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
RESULTS OF OPERATIONS:
ACQUISITIONS. The Company acquired the Angio-Seal business of Tyco International
Ltd. on March 16, 1999 and the outstanding common stock of Vascular Science,
Inc. (VSI) on September 27, 1999. Angio-Seal produces and sells hemostatic
puncture closure devices. VSI is a development-stage company focused on the
development of suture-free devices to facilitate coronary artery bypass graft
anastomosis. These acquisitions have been recorded using the purchase method of
accounting. The operating results of each of these acquisitions are included in
the Company's consolidated statement of income from the date of each
acquisition. VSI's results of operations were immaterial during the third
quarter of 1999 but are expected to be dilutive to the Company's operating
results during the remainder of 1999 and during the year 2000. Angio-Seal's
results are discussed below.
NET SALES. Net sales for the third quarter of 1999 totaled $275,814, a 10.8%
increase over the $248,822 reported in the third quarter of 1998. For the first
nine months of 1999, net sales totaled $833,207, an 8.6% increase over the
$767,542 reported in the first nine months of 1998. Unfavorable foreign currency
effects due to a stronger U.S. dollar reduced 1999 net sales as compared with
1998 by approximately $4,500 for the third quarter and $5,700 year-to-date.
Cardiac rhythm management (CRM) net sales for the third quarter of 1999 were
$211,578, a 16.7% increase over the $181,279 recorded in the third quarter of
1998. CRM net sales for the first nine months of 1999 were $622,112, a 12.6%
increase over the $552,707 recorded in 1998. The 1999 third quarter and nine
month CRM net sales include $12,452 and $27,285 of Angio-Seal net sales. The
increase in CRM net sales for the third quarter and for the first nine months of
1999, exclusive of Angio-Seal, was primarily attributable to increased
bradycardia net sales and to an increase in electrophysiology (EP) catheter unit
sales. The increase in bradycardia net sales is due to the Company's
introduction of the Affinity(R) pacemaker in the second quarter of 1999 and to
an expanded domestic sales organization.
Heart valve disease management (HVDM) net sales for the third quarter of 1999
were $64,236, a 4.9% decrease from the $67,543 recorded in the third quarter of
1998. HVDM net sales for the first nine months of 1999 were $211,095 compared
with $214,835 recorded in 1998. The decrease in HVDM net sales was attributable
to the effects of the stronger U.S. dollar, reduced sales to certain
distributors in emerging markets, and a slight clinical preference shift from
mechanical valves to tissue valves in the U.S. market where HVDM holds
significant mechanical valve market share and a smaller share of the tissue
valve market.
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<PAGE>
GROSS PROFIT. Gross profit for the third quarter of 1999 totaled $181,529 or
65.8% of net sales, as compared with $158,118, or 63.5% of net sales, during the
third quarter of 1998. For the first nine months of 1999 and 1998, gross profit
was $545,712, or 65.5% of net sales, and $482,587, or 62.9% of net sales. The
higher gross profit percentages for both the third quarter and the first nine
months of 1999 were primarily attributable to improved manufacturing
efficiencies and higher manufacturing volumes at the Company's CRM division and
to geographic sales mix.
SELLING, GENERAL & ADMINISTRATIVE. Selling, general and administrative (SG&A)
expenses for the third quarter of 1999 totaled $94,586, a 13.6% increase over
the $83,266 reported in the third quarter of 1998. For the first nine months of
1999, SG&A expenses totaled $295,391, an 11.9% increase over the $264,093
reported in the first nine months of 1998. The increase in SG&A expenses during
1999 was primarily attributable to increased sales activities, increased
litigation and Year 2000 expenses, and to increased intangible asset
amortization related to Angio-Seal.
RESEARCH & DEVELOPMENT. Research and development (R&D) expenses in the third
quarter of 1999 totaled $31,378, or 11.4% of net sales, compared with $24,984,
or 10.0% of net sales, for the third quarter of 1998. For the first nine months
of 1999, R&D expenses totaled $91,608, or 11.0% of net sales, compared with
$74,265, or 9.7% of net sales, for the first nine months of 1998. The increase
in R&D expenses as a percentage of net sales is primarily attributable to an
increase in R&D activities at the Company's CRM division relating primarily to
implantable cardioverter defibrillators (ICDs) and other development projects.
IN-PROCESS RESEARCH & DEVELOPMENT. The Company recorded in-process research and
development charges of $47,775 and $67,453 during the first quarter and third
quarter of 1999, respectively, in connection with the acquisitions of Angio-Seal
and VSI. The in-process research and development valuations were computed by an
independent third-party appraisal company and were expensed at close, except as
noted below, since technological feasibility had not been established and there
were no alternative future uses for the technology.
The values assigned to in-process research and development were determined by
estimating the contribution of the purchased in-process technology in developing
a commercially viable product, estimating the resulting net cash flows from the
expected sales of such products, and discounting the net cash flows to their
present value using appropriate discount rates ranging from 25% to 35%. Certain
other factors considered in these valuations included the stage of development
of each project, which ranged from 35% to 90%, complexity of the work completed
at the valuation date, costs already incurred, projected costs to complete the
projects, target markets and associated risks of achieving technological
feasibility and market acceptance of the products.
The purchased in-process research and development technology requires additional
development to create commercially viable products. This development includes
completion of design, prototyping, and testing to ensure the technologies meet
their design specifications, including functional, technical and economic
performance requirements. In addition, the technology is required to undergo
both international and domestic regulatory reviews and approvals prior to being
commercially released to the market.
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<PAGE>
The appraised value of the VSI in-process research and development was $95,500,
of which $67,453 was recorded at close. The remaining portion of the $95,500
in-process research and development valuation is expected to be recorded as a
charge to earnings in future periods as additional contingent consideration
related to product development milestones and sales are recorded in the
Company's financial statements.
SPECIAL CHARGES. The Company restructured its international operations during
the third quarter of 1999 to improve both the effectiveness and efficiency of
its international business by clarifying business unit accountabilities,
focusing the operations of its business units outside the U.S., and removing
administrative redundancies in the Company's management structure. The Company
recorded a $9,754 charge in the third quarter of 1999 related to the elimination
of certain administrative management positions ($8,046) and to other
restructuring activities ($1,708). Although the Company anticipates this
restructuring will reduce certain administrative management costs in the future,
the impact on any quarter or annual period is not expected to be material to the
Company's consolidated results of operations.
INCOME TAX PROVISION. The Company's effective income tax rate was 25% for the
three and nine months ended September 30, 1999, exclusive of the in-process
research and development and special charges, compared with 30.5% for the
comparable periods in 1998. The decrease in the effective income tax rate in
1999 is primarily attributable to the implementation of a revised corporate
structure during the third quarter of 1998 associated with the Company's Puerto
Rican operations. The 1999 Angio-Seal in-process research and development charge
was recorded in a taxing jurisdiction with a 4% income tax rate and the VSI
charge was not deductible for income tax purposes. The 1999 special charge is
taxed at applicable federal, state and foreign country tax rates.
OUTLOOK. The Company expects that market demands, government regulation and
societal pressures will continue to change the health care industry worldwide
resulting in further business consolidations and alliances. To meet customer
needs, the Company intends to continue to pursue diversification opportunities
in the form of acquisitions, joint ventures, partnerships and strategic business
alliances. In addition, the Company will participate with industry groups to
promote the introduction and use of advanced medical device technology within a
cost conscious environment. Customer service in the form of cost-effective
clinical outcomes will continue to be a primary focus for the Company.
The Company's heart valve disease management business is in a highly competitive
market. During the first nine months of 1999, the Company estimates it
maintained its share of the worldwide heart valve industry. The market is
segmented between mechanical heart valves, tissue heart valves and repair
products. During 1999, the U.S. market continued its slight shift to tissue
valve and repair products. Competition is anticipated to place pressure on
pricing and terms and health care reform is expected to result in further
hospital consolidations over time.
The Company's cardiac rhythm management business is also in a highly competitive
industry that is undergoing consolidation. The number of principal competitors
has decreased from four to three. The Company's two principal competitors each
have substantially more assets, sales and sales personnel than the Company. In
addition, several new ICDs were introduced to the market. The Company's two
principal competitors in the ICD market have introduced dual chamber ICDs that
represent an increasing percentage of the ICD market. The Company has a dual
chamber
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<PAGE>
ICD in development. However, until the Company introduces its dual chamber ICD,
the growth of dual chamber ICDs at the expense of single chamber ICDs could
adversely affect the Company. Rapid technological change is expected to
continue, requiring the Company to invest heavily in R&D and to effectively
market its products.
The medical device market is highly competitive. Competitors, in the past and
may in the future, employ litigation to gain a competitive advantage. In
addition, the Company's products must continually improve technologically due to
the competitive nature of the industry.
Group purchasing organizations (GPOs) in the U.S. have emerged to consolidate
the purchasing of Company products for some hospitals. One such GPO, Premier,
recently executed exclusive contracts with the Company's two principal cardiac
rhythm management competitors. This contract, if enforced, may adversely affect
the Company's sales of cardiac rhythm management products to members of this
GPO.
As provided for in the Private Securities Litigation Reform Act of 1995, the
Company cautions investors that a number of factors could cause actual future
results of operations to vary from those anticipated in previously made
forward-looking statements and any other forward-looking statements made in this
document and elsewhere by or on behalf of the Company. Net sales could be
materially affected by legislative or administrative reforms to the U.S.
Medicare and Medicaid systems or other non-U.S. reimbursement systems in a
manner that would significantly reduce reimbursement for procedures using the
Company's medical devices, the acquisition of key patents by competitors that
would have the effect of excluding the Company from new market segments, health
care industry consolidation resulting in customer demands for price concessions,
products introduced by competitors with advanced technology and better features
and benefits or lower prices, fewer procedures performed in a cost-conscious
environment, and the lengthy approval time by the FDA or other government
authorities to clear implantable medical devices for commercial release. Cost of
sales could be materially affected by unfavorable developments in the area of
products liability and price increases from the Company's suppliers of critical
components, a number of which are sole sourced. Operations could be affected by
the Company's ability to execute its diversification strategy or to integrate
acquired companies, a serious earthquake affecting the Company's Pacesetter
facilities in Sylmar or Sunnyvale, California, adverse developments in the
litigation arising from the acquisitions of Telectronics and Ventritex,
unanticipated product failures and attempts by competitors to gain market share
through aggressive marketing programs.
The IRS has proposed adjustments of approximately $58,200 in additional taxes
relating primarily to the Company's Puerto Rican operations in years 1990
through 1994. It is likely that similar adjustments may be proposed for 1995
(see Part II, Item 1, Legal Proceedings).
FINANCIAL CONDITION:
The financial condition of the Company remains strong at September 30, 1999. The
Company's current assets to current liabilities ratio was 2.75 to 1 at September
30, 1999.
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During the third quarter of 1999, the Company's Board of Directors authorized
the repurchase of up to $250,000 of the Company's outstanding common stock over
a three-year period. The Company re-acquired 500 shares of its common stock for
$16,625 during the third quarter of 1999.
Accounts receivable increased $14,797 from December 31, 1998 due to higher sales
offset partially by a decrease in average days to collect the receivables. Other
assets increased $143,124 due primarily to the addition of certain intangible
assets from the Angio-Seal acquisition. Interest bearing debt increased $154,900
during the nine months ended September 30, 1999 related primarily to additional
borrowings for the Angio-Seal and VSI acquisitions, offset partially by the
repayment of debt from cash generated from operations.
During the third quarter of 1999, the Company increased its available revolving
credit facilities by $100,000. This increased borrowing capacity is available
through March 2000. Any borrowings on this increased borrowing capacity will
bear interest at a floating rate tied to the London Interbank Offered Rate.
Management believes that cash generated from operations and cash available under
its debt agreements will be sufficient to meet the Company's working capital and
share repurchase plan needs in the near term. Should suitable investment
opportunities arise, management believes that the Company's earnings, cash flows
and balance sheet will permit the Company to obtain additional debt or equity
capital.
YEAR 2000 READINESS. The Company is preparing for the impact of the arrival of
the Year 2000 on its business, as well as on the businesses of its customers,
suppliers and business partners. The "Year 2000 Issue" is a term used to
describe the problems created by systems that are unable to accurately interpret
dates after December 31, 1999. These problems are derived predominantly from the
fact that many software programs have historically categorized the "year" in a
two-digit format. The Year 2000 Issue creates potential risks for the Company
because the Company relies heavily on information technology (IT) systems and
other systems, facilities and suppliers to conduct its business. The Company may
also be exposed to risks from third parties with which the Company interacts who
fail to adequately address their own Year 2000 Issues.
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THE COMPANY'S STATE OF READINESS
While the Company's Year 2000 efforts have been underway for several years, the
Company centralized its focus on addressing the Year 2000 Issue in 1998 by
forming a Year 2000 project team, which is currently chaired by the Company's
Chief Financial Officer. The Company's Board of Directors also receive a monthly
status report on the Company's Year 2000 readiness program.
The Year 2000 project team developed a phased approach to identifying and
remediating Year 2000 Issues, with many of these phases overlapping one another
or conducted simultaneously.
The first phase was to develop a corporate-wide, uniform strategy for addressing
the Year 2000 Issue and to assess the Company's current state of Year 2000
readiness. This included a review of all business critical IT and non-IT
systems, including Company products and internal operating systems for potential
Year 2000 Issues. The Company completed this phase during the first quarter of
1999.
The second phase of the Company's Year 2000 readiness program (begun
simultaneously with the first phase) was to define a Year 2000 "Readiness"
standard and to begin remediation of the business critical systems requiring
correction, building on work done by the Company's Year 2000 external consulting
partner. The defining of a Year 2000 Readiness Standard was completed in the
first quarter of 1999. The following paragraphs provide further discussion on
the status of the Company's business critical systems for its products, internal
IT and non-IT systems, and suppliers, service providers and business partners.
The Company has completed an assessment of its Year 2000 compliance for its
products. With the exception of certain pacemaker and ICD programmers, all the
Company's products are Year 2000 ready. The affected programmers require simple
corrective actions by the user. The Year 2000 Issue affecting these programmers
would not affect potential health or safety but could result in an erroneous
date on a printout. The Company's implantable pacemakers and ICDs do not have
internal clocks and are not susceptible to Year 2000 Issues.
The Company undertook a review of its internal IT and non-IT systems to identify
potential Year 2000 Issues. In 1995, the Company began the process of
implementing a uniform worldwide business and accounting information system to
improve internal reporting processes. This new IT system replaced the Company's
order entry, distribution, purchasing and inventory management systems, as well
as the Company's general financial systems. Implementation of this system was
substantially completed in 1998. The Company also replaced its human resource
information system during the second quarter 1999. Based upon representations
from these software manufacturers and upon the Company's internal testing, these
business information systems appear to be Year 2000 ready. Replacement of older
legacy business systems with these new systems has significantly reduced the
effort required to remediate the Company's business systems. With respect to
non-IT systems, the Company has analyzed its manufacturing equipment and other
critical non-IT facility and internal systems with date sensitive operating
controls for Year 2000 Issues. No material problems were discovered in these
reviews. At this time, the Company has remediated substantially all of the Year
2000 issues identified with these systems.
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Any remaining identified Year 2000 issues are scheduled to be remediated by the
end of 1999.
The Company has inquired of each of its principal suppliers, service providers
and business partners as to their Year 2000 status, utilizing, in part, a
questionnaire and Year 2000 certification form. As of December 31, 1998, the
Company had contacted all critical suppliers, service providers and business
partners about their Year 2000 readiness. Based upon representations from the
Company's critical suppliers, service providers and business partners and other
testing performed by the Company to date, it does not appear the Company will be
materially impacted by its critical suppliers, service providers and business
partners for Year 2000 matters. However, there can be no assurance that the
Company's critical suppliers, service providers and business partners will
achieve a Year 2000 conversion in a timely fashion, or that such failure to
convert by another company will not have a material adverse effect on the
Company.
THE COMPANY'S CONTINGENCY PLANS
The Company has identified 1,171 business critical systems that may require a
written contingency plan, including business systems impacted by the Company's
critical suppliers, service providers and business partners. The Company has
evaluated 1,084 of these business critical systems and completed contingency
plans as it was deemed appropriate. The remaining business critical systems are
scheduled to be reviewed by the end of November 1999 with contingency plans
prepared before the end of 1999 if necessary. The Company will continue to
monitor its Year 2000 status and prepare additional contingency plans, as the
need arises.
THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
The total cost associated with the Company's Year 2000 remediation has not been
nor is expected to be material to the Company's financial condition or results
of operations. Substantially all of the $3,500 total estimated Year 2000
remediation costs have been incurred and reflected in the Company's historical
results of operations. The cost of implementing the Company's uniform worldwide
business and accounting information system (approximately $45,000) has not been
included in this figure since replacement of the previous systems was not
accelerated due to Year 2000 Issues.
THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES
There can be no assurance that the Company will be completely successful in its
efforts to address Year 2000 Issues. If some of the Company's products or
systems are not Year 2000 ready, the Company could suffer manufacturing delays,
lost sales or other negative consequences, including, but not limited to,
diversion of resources, damage to the Company's reputation, increased service
and warranty costs and litigation, any of which could materially adversely
affect the Company's business operations.
The Company cannot predict the consequences of failure of its customers or
government health payers and providers, such as the U.S. Health Care Financing
Administration, to adopt Year 2000 ready software in a timely manner. The
Company is also dependent on third parties such as its suppliers, service
providers and other business partners. If these or other third parties fail to
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<PAGE>
adequately address Year 2000 Issues, the Company could experience a negative
impact on its business operations or financial statements. For example, the
failure of certain of the Company's principal suppliers to have Year 2000 ready
internal systems could impact the Company's ability to manufacture and/or ship
its products or to maintain adequate inventory levels for production.
YEAR 2000 FORWARD-LOOKING STATEMENTS
The foregoing Year 2000 discussion contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, anticipated costs and the dates by
which the Company expects to complete certain actions, are based on management's
best current estimates, which were derived utilizing numerous assumptions about
future events, including the continued availability of certain resources,
representations received from third parties and other factors. However, there
can be no guarantee that these estimates will be achieved, and actual results
could differ materially from those anticipated. Specific factors that might
cause such material differences include, but are not limited to, the ability to
identify and remediate all product and relevant IT and non-IT systems, results
of Year 2000 testing, adequate resolution of Year 2000 Issues by businesses and
other third parties who are service providers, suppliers or customers of the
Company, unanticipated system costs, the adequacy of and ability to develop and
implement contingency plans and similar uncertainties. The "forward-looking
statements" made in the foregoing Year 2000 discussion speak only as of the date
on which such statements are made, and the Company undertakes no obligation to
update any forward-looking statements to reflect events or circumstances after
the date on which such statements are made or to reflect the occurrence of
unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes since December 31, 1998 in the
Company's foreign currency related market risk. During the third quarter of
1999, the Company entered into an interest rate swap contract to hedge a
substantial portion of the variable interest rate risk on $138,000 of the
Company's revolving credit facility borrowings. This swap contract becomes
effective in October 1999 and matures in January 2000.
For further information on market risk, refer to Item 7A in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998.
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<PAGE>
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
GUIDANT LITIGATION
On November 26, 1996, Guidant Corporation (a competitor of Pacesetter and
Ventritex) ("Guidant") and related parties filed a lawsuit against St. Jude
Medical, Inc. ("St. Jude Medical"), Pacesetter, Inc. ("Pacesetter"), Ventritex,
Inc. ("Ventritex") and certain members of the Telectronics Group in State
Superior Court in Marion County, Indiana (the "Telectronics Action"). The
lawsuit alleges, among other things, that, pursuant to an agreement entered into
in 1993, certain Guidant parties granted Ventritex intellectual property
licenses relating to cardiac stimulation devices, and that such licenses would
terminate upon the consummation of the merger of Ventritex into Pacesetter (the
"Merger"). The lawsuit further alleges that, pursuant to an agreement entered
into in 1994 (the "Telectronics Agreement"), certain Guidant parties granted the
Telectronics Group intellectual property licenses relating to cardiac
stimulation devices. The lawsuit seeks declaratory and injunctive relief, among
other things, to prevent and invalidate the transfer of the Telectronics
Agreement to Pacesetter in connection with Pacesetter's acquisition of
Telectronics' assets (the "Telectronics Acquisition") and the application of
license rights granted under the Telectronics Agreement to the manufacture and
sale by Pacesetter of Ventritex's products following the consummation of the
Merger. The court overseeing this case issued a stay of this matter in July 1998
so that the issues could be addressed in an arbitration requested by the
Telectronics Group and Pacesetter.
Guidant and related parties also filed suit against St. Jude Medical,
Pacesetter and Ventritex on November 26, 1996 in the United States District
Court for the Southern District of Indiana. This second lawsuit seeks (i) a
declaratory judgment that Pacesetter's manufacture, use or sale of cardiac
stimulation devices of the type or similar to the type which Ventritex
manufactured and sold at the time the Guidant parties filed their complaint
would, upon consummation of the Merger, be unlicensed and constitute an
infringement of patent rights owned by certain Guidant parties, (ii) to enjoin
the manufacture, use or sale by St. Jude Medical, Pacesetter or Ventritex of
cardiac stimulation devices of the type which Ventritex manufactured at the time
the Guidant parties filed their complaint, and (iii) certain damages and costs.
This second lawsuit was stayed by the court in July 1998 given the order to
arbitrate which is mentioned below.
St. Jude Medical and Pacesetter believe that the foregoing state and
federal court complaints contain a number of significant factual inaccuracies
concerning the Telectronics Acquisition and the terms and effects of the various
intellectual property license agreements referred to in such complaints. For
these reasons and others, St. Jude Medical and Pacesetter believe that the
allegations set forth in the complaints are without merit. St. Jude Medical and
Pacesetter have vigorously defended their interests in these cases, and will
continue to do so.
As a result of the state and federal lawsuits brought by Guidant and
related parties, the Telectronics Group and Pacesetter filed a lawsuit in the
United States District Court for the District of Minnesota seeking (i) a
declaratory judgment that the Guidant parties' claims, as reflected in the
Telectronics Action, are subject to arbitration pursuant to the arbitration
provisions of the Telectronics Agreement, (ii) an order that the defendants
arbitrate their claims
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<PAGE>
against the Telectronics Group and Pacesetter in accordance with the arbitration
provisions of the Telectronics Agreement, (iii) to enjoin the defendants
preliminarily and permanently from litigating their dispute with the
Telectronics Group and Pacesetter in any other forum, and (iv) certain costs.
After the Eighth Circuit Court of Appeals ruled on an appeal in favor of the
Telectronics Group and Pacesetter in May 1998, the United States District Court
for the District of Minnesota issued an order on July 8, 1998 directing the
arbitration requested by the Telectronics Group and Pacesetter to proceed.
An arbitrator for the arbitration has been selected by the parties. The
arbitrator has issued some interim rulings, including that Pacesetter and St.
Jude Medical should not participate in the initial arbitration proceeding
concerning whether the Telectronics Agreement transferred to Pacesetter. The
Telectronics Group and the Guidant parties will be involved in this initial
arbitration proceeding. This proceeding is now scheduled for March 2000.
IRS LITIGATION
The Internal Revenue Service ("IRS") completed an audit examination of the
Company's 1990-1991 corporate income tax returns and issued deficiency notices
in early 1997 for taxes of $16,400. In addition, the IRS completed an audit
examination of the Company's 1992-1994 income tax returns in early 1998 and
proposed an adjustment of $41,800 in additional taxes. Both adjustments relate
primarily to the Company's Puerto Rican operations. The deficiency amounts do
not include interest, state taxes or offsetting Puerto Rico tax refunds, the net
effect of which is not material. It is likely that a similar additional
adjustment will be proposed for 1995. The Company is vigorously contesting these
adjustments. The Company is refuting the IRS deficiency for 1990-1991 and
asserting the Company is in fact owed a refund in a petition filed in Tax Court
on June 24, 1997. The Company expects that the ultimate resolution will not have
material adverse effect on its financial position or liquidity, but could
potentially be material to the net income of a particular future period if
resolved unfavorably.
OTHER LITIGATION AND PROCEEDINGS
On December 16, 1998, the Company began a lawsuit in federal court in Los
Angeles seeking a declaration that it was permitted to hire certain sales
representatives who previously had worked for Sulzer Intermedics, Inc., which
was acquired by Guidant. The Company has hired many such representatives as of
November 10, 1999. The court has granted the Company's motion for a preliminary
injunction permitting the Company to hire such representatives and this decision
was upheld by the U.S. Court of Appeals. Guidant has filed a counterclaim in the
lawsuit seeking damages from the Company for the hiring of these representatives
and for their activities as sales representatives of the Company. The Company
intends to vigorously assert its position in this litigation.
The Company is unaware of any other pending legal proceedings that it
regards as likely to have a material adverse effect on its business.
19 of 21
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Exhibit
------ -------
27 Financial data schedule
(b) Reports on Form 8-K The Company filed a Form 8-K on September 9, 1999,
and an amendment to such Form 8-K on September 10,
1999, which discussed a court's ruling in relation
to certain litigation involving the Company.
20 of 21
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed in its behalf by the
undersigned thereunto duly authorized.
ST. JUDE MEDICAL, INC.
November 10, 1999 /s/ JOHN C. HEINMILLER
- -------------------- --------------------------------
DATE JOHN C. HEINMILLER
Vice President - Finance
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
21 of 21
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