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 June 30, 1999 Commission File Number 0-8672
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ST. JUDE MEDICAL, INC.
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(Exact name of registrant as specified in its charter)
MINNESOTA 41-1276891
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(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
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The number of shares of common stock, par value $.10 per share, outstanding at
August 6, 1999 was 84,656,775.
The Exhibit Index to this Form 10-Q is set forth on page 18.
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
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1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Net sales $ 290,659 $261,232 $ 557,393 $518,720
Cost of sales 99,749 96,025 193,210 194,251
--------- -------- --------- --------
Gross profit 190,910 165,207 364,183 324,469
Selling, general & administrative 104,382 88,763 200,805 180,827
Research & development 33,087 27,068 60,230 49,281
In-process research & development - - 47,775 -
--------- -------- --------- --------
Operating profit 53,441 49,376 55,373 94,361
Other income (expense), net (3,834) 5,322 (8,465) 5,221
--------- -------- --------- --------
Income before taxes 49,607 54,698 46,908 99,582
Income tax provision 12,402 14,664 21,760 30,373
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Net income $ 37,205 $ 40,034 $ 25,148 $ 69,209
========= ======== ========= ========
Earnings per common share:
Basic $ 0.44 $ 0.48 $ 0.30 $ 0.79
========= ======== ========= ========
Diluted $ 0.44 $ 0.47 $ 0.30 $ 0.79
========= ======== ========= ========
Average shares outstanding:
Basic 84,387 83,975 84,289 87,276
Diluted 84,851 84,819 84,580 88,065
</TABLE>
See notes to condensed consolidated financial statements.
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ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
JUNE 30 DECEMBER 31
1999 1998
(Unaudited) (See Note)
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,293 $ 3,775
Marketable securities 85,632 84,215
Accounts receivable, less allowances
(1999 - $10,599; 1998 - $12,352) 300,792 282,071
Inventories
Finished goods 121,084 126,927
Work in process 37,762 35,130
Raw materials 82,987 83,522
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Total inventories 241,833 245,579
Other current assets 71,484 66,824
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Total current assets 704,034 682,464
Property, plant and equipment 545,681 512,390
Less accumulated depreciation (206,165) (184,131)
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Net property, plant and equipment 339,516 328,259
Other assets 504,664 373,889
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TOTAL ASSETS $ 1,548,214 $ 1,384,612
=========== ===========
LIABILITIES & SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 246,386 $ 203,397
Long-term debt 485,495 374,995
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 - 84,419,273 shares;
1998 - 84,174,699 shares 8,442 8,417
Additional paid-in capital 12,999 6,656
Retained earnings 842,088 816,940
Accumulated other comprehensive income:
Cumulative translation adjustment (53,248) (33,242)
Unrealized gain on available-for-sale securities 6,052 7,449
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Total shareholders' equity 816,333 806,220
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TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 1,548,214 $ 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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ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30
1999 1998
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<S> <C> <C>
Operating Activities:
Net income $ 25,148 $ 69,209
Depreciation and amortization 40,201 35,976
In-process research and development 47,775 -
Net gain on sale of marketable securities - (8,514)
Working capital change (6,843) (83,581)
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Net cash provided by operating activities 106,281 13,090
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Investing Activities:
Purchases of property, plant and equipment (37,770) (46,978)
Proceeds from sale or maturity of marketable securities - 59,602
Acquisition of business (167,000) -
Other investing activities (15,788) 1,120
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Net cash provided by (used in) investing activities (220,558) 13,744
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Financing Activities:
Proceeds from exercise of stock options and stock issued 5,760 6,635
Common stock repurchased - (304,887)
Borrowings under long-term lines of credit 327,500 668,700
Payments under long-term lines of credit (217,000) (398,200)
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Net cash provided by (used in) financing activities 116,260 (27,752)
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Effect of currency exchange rate changes on cash (1,465) (380)
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Increase (decrease) in cash and cash equivalents 518 (1,298)
Cash and cash equivalents at beginning of year 3,775 28,530
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Cash and cash equivalents at end of period $ 4,293 $ 27,232
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
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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.
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 $48 and
$(27,170) for the second quarter of 1999 and 1998, and $(21,403) and $(11,166)
for the first six months of 1999 and 1998. Total comprehensive income (loss)
combines reported net income and other comprehensive income (loss). Total
comprehensive income was $37,253 and $12,864 for the second quarter of 1999 and
1998, and $3,745 and $58,043 for the first six months of 1999 and 1998.
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NOTE 4 - SPECIAL CHARGE UPDATE
The Company recorded special charge accruals of $52,926 in 1996 and $58,669 in
1997. These special charges have decreased by $51,075 and $50,647, respectively,
for cash payments since the date they were recorded.
NOTE 5 - EARNINGS PER SHARE
The table below sets forth the computation of basic and diluted earnings per
share.
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Numerator:
Net income $37,205 $40,034 $25,148 $69,209
======= ======= ======= =======
Denominator:
Basic-weighted shares outstanding 84,387 83,975 84,289 87,276
Effect of dilutive securities:
Employee stock options 431 796 258 741
Restricted shares 33 48 33 48
------- ------- ------- -------
Diluted-weighted shares outstanding 84,851 84,819 84,580 88,065
======= ======= ======= =======
Basic earnings per share $ .44 $ .48 $ .30 $ .79
======= ======= ======= =======
Diluted earnings per share $ .44 $ .47 $ .30 $ .79
======= ======= ======= =======
</TABLE>
Diluted weighted shares outstanding have not been adjusted for certain employee
stock options and the Company's convertible debentures because the result would
have been anti-dilutive.
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NOTE 6 - 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, electophysiology catheters and cardiology
catheters. The HVDM segment develops, manufactures and distributes mechanical
and tissue heart valves and valve repair products.
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 June 30, 1999
Net sales to external customers $218,093 $ 72,566 $ - $290,659
Operating profit 23,221 38,741 (8,521) 53,441
Quarter ended June 30, 1998
Net sales to external customers 187,096 74,136 - 261,232
Operating profit 16,318 38,045 (4,987) 49,376
Six months ended June 30, 1999
Net sales to external customers 410,534 146,859 - 557,393
Operating profit (2) 41,480 78,635 (64,742) 55,373
Six months ended June 30, 1998
Net sales to external customers 371,428 147,292 - 518,720
Operating profit 28,986 76,476 (11,101) 94,361
</TABLE>
(1) Amounts relate primarily to Corporate and in-process research and
development.
(2) All Other includes $47,775 of an in-process research and development charge
recorded in the first quarter of 1999.
During March 1999, the CRM segment acquired the assets of Angio-Seal, increasing
the segment's assets by approximately $135,000, relating primarily to goodwill.
There have been no other material changes in segment assets since December 31,
1998.
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NOTE 7 - 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 was 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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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
RESULTS OF OPERATIONS:
ACQUISITION. The Company acquired the assets of Angio-Seal, a manufacturer of
puncture wound management products, effective March 16, 1999. This transaction
was accounted for under the purchase accounting method and the Company's
reported results for 1999 include the results of Angio-Seal subsequent to March
16, 1999.
NET SALES. Net sales for the second quarter of 1999 totaled $290,659, an 11.3%
increase over the $261,232 reported in the second quarter of 1998. For the first
six months of 1999, net sales totaled $557,393, a 7.5% increase over the
$518,720 reported in the first six months of 1998. Unfavorable foreign currency
effects due to a stronger U.S. dollar reduced 1999 net sales as compared with
1998 by approximately $3,600 for the second quarter and $1,200 for the first six
months.
Cardiac rhythm management (CRM) net sales for the second quarter of 1999 were
$218,093, a 16.6% increase over the $187,096 recorded in the second quarter of
1998. CRM net sales for the first six months of 1999 were $410,534, a 10.5%
increase over the $371,428 recorded in 1998. The 1999 second quarter and six
month net sales include approximately $12,500 and $14,800 of Angio-Seal net
sales. The increase in CRM net sales for the second quarter of 1999, exclusive
of Angio-Seal, was primarily attributable to increased bradycardia net sales,
due to the introduction of the Affinity pacemaker in the second quarter of 1999
and an expanded domestic sales organization, and to an increase in
electrophysiology (EP) catheter unit sales. The increase in CRM net sales for
the first six months of 1999, exclusive of Angio-Seal, was primarily
attributable to the increases in bradycardia net sales and EP catheter unit
sales, along with increased implantable cardioverter defibrillator (ICD) unit
sales.
Heart valve disease management (HVDM) net sales for the second quarter of 1999
were $72,566, a 2.1% decrease from the $74,136 recorded in the second quarter of
1998. HVDM net sales for the first six months of 1999 were $146,859 compared
with $147,292 recorded in 1998. The decrease in HVDM net sales was attributable
to the effects of the stronger U.S. dollar, inventory management by domestic
hospitals 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 only a modest share of the tissue valve market.
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<PAGE>
GROSS PROFIT. Gross profit for the second quarter of 1999 totaled $190,910 or
65.7% of net sales, as compared with $165,207, or 63.2% of net sales, during the
second quarter of 1998. For the first six months of 1999 and 1998, gross profit
was $364,183, or 65.3% of net sales, and $324,469, or 62.6% of net sales. The
higher gross profit percentages for both the second quarter and the first six
months of 1999 were primarily attributable to improved manufacturing
efficiencies and to higher manufacturing volumes at our CRM division due to
higher sales volume.
SELLING, GENERAL & ADMINISTRATIVE. Selling, general and administrative (SG&A)
expenses for the second quarter of 1999 totaled $104,382, a 17.6% increase over
the $88,763 reported in the second quarter of 1998. For the first six months of
1999, SG&A expenses totaled $200,805, an 11.0% increase over the $180,827
reported in the first six months of 1998. The increase in SG&A expenses during
1999 was primarily attributable to increased sales activities, higher litigation
and Year 2000 expenses, and to increased goodwill amortization related to the
Angio-Seal acquisition.
RESEARCH AND DEVELOPMENT. Research and development (R&D) expenses in the second
quarter of 1999 totaled $33,087, or 11.4% of net sales, compared with $27,068,
or 10.4% of net sales, for the second quarter of 1998. For the first six months
of 1999, R&D expenses totaled $60,230, or 10.8% of net sales, compared with
$49,281, or 9.5% of net sales, for the first six 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 our CRM division relating primarily to ICD and
other development projects.
IN-PROCESS RESEARCH AND DEVELOPMENT. The Company recorded a $47,775 in-process
research and development charge during the first quarter of 1999 in connection
with its acquisition of Angio-Seal. An independent appraisal firm completed an
appraisal of the intangible assets that were acquired from Angio-Seal, including
in-process research and development. Based on this appraisal, under generally
accepted accounting principles for purchase accounting, the Company expensed the
value of the in-process research and development.
OTHER INCOME (EXPENSE): Other income (expense), net consisted of the following:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
------- -------- -------- --------
<S> <C> <C> <C> <C>
Interest income $ 763 $ 1,071 $ 1,482 $ 2,374
Interest expense (6,723) (7,299) (12,545) (11,087)
Net gain on sale of marketable securities - 12,075 - 13,945
Foreign exchange gain (loss) 1,922 (562) 2,604 (7)
Other 204 37 (6) (4)
------- -------- -------- --------
Other income (expense), net $(3,834) $ 5,322 $ (8,465) $ 5,221
======= ======== ======== ========
</TABLE>
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<PAGE>
INCOME TAX PROVISION. The Company's effective income tax rate was 25.0% for the
three and six months ended June 30, 1999, exclusive of the 1999 in-process
research and development charge, compared with 26.8% and 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 in-process research and development charge is
recorded in a taxing jurisdiction with a 4% income tax rate, thus increasing the
Company's effective income tax rate to 46.4% for the six months ended June 30,
1999.
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 business is in a highly competitive market. During the
first six months of 1999, the Company estimates it maintained its share of the
worldwide heart valve market. The market is segmented between mechanical heart
valves, tissue heart valves and repair products. During 1999, the U.S. market
continued its shift slightly 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
market which 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 implantable cardioverter defibrillators were introduced to
the market. The Company's two principal competitors in the ICD segment of the
cardiac rhythm management market have introduced dual chamber ICDs that
represent an increasing percentage of the ICD market. The Company has a dual
chamber ICD in development. Until the Company introduces a 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.
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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 also Part II, Item 1, Legal Proceedings).
FINANCIAL CONDITION:
The financial condition of the Company remains strong at June 30, 1999. The
Company's current assets to current liabilities ratio was 2.9 to 1 at June 30,
1999.
Accounts receivable increased $18,721 from December 31, 1998 due to higher
sales, offset partially by a decrease in average days to collect the
receivables. Other assets increased $130,775 due primarily to the addition of
goodwill from the Angio-Seal acquisition. Interest bearing debt increased
$110,500 during the six months ended June 30, 1999 related primarily to
additional borrowings for the Angio-Seal acquisition, offset partially by the
repayment of debt from cash generated from operations.
Management believes that cash generated from operations and cash available under
its debt agreements will be sufficient to meet the Company's working capital
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.
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<PAGE>
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.
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, chaired by the Company's Chief Financial
Officer. The Board of Directors receives 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 with 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. Remediation and testing is expected to be completed by
the end of the third quarter of 1999.
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 compliant. 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 has also undertaken 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. The internal IT systems replaced
included order entry systems, distribution, purchasing and inventory management
systems, and the Company's general financial systems. Based upon
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<PAGE>
representations from the manufacturer, this uniform information system is Year
2000 compliant. Replacement of older legacy business systems with this new
system has significantly reduced the effort required to remediate business
systems. The Company replaced its Human Resource Information System during the
second quarter 1999 with a Year 2000 compliant system. With respect to non-IT
systems, the Company is actively analyzing its manufacturing equipment in order
to assess any Year 2000 Issues. To date, no material problems have been
discovered. The Company will continue to review, test and remediate (if
necessary) such equipment. The Company is also evaluating its other critical
non-IT facility and internal systems with date sensitive operating controls for
Year 2000 Issues. While the Company believes that most of these systems will
function without substantial Year 2000 readiness problems, the Company will
continue to review, test and remediate (if necessary) such systems. Based on the
testing results, the Company expects to complete the remediation of identified
problems by the end of the third quarter of 1999. Our assessment to date has not
identified any non-compliant high cost or high business risk systems which might
cause business interruption or product failure.
The Company is presently evaluating each of its principal suppliers, service
providers and other business partners to determine each of such party's Year
2000 status. The Company has developed a questionnaire and a Year 2000
certification for use with such third parties, and, as of December 31, 1998, the
Company had contacted key suppliers and service providers about their Year 2000
readiness. This includes many of the suppliers that the Company has identified
as critical suppliers. The Company anticipates that this evaluation will be
on-going through the remainder of 1999.
The Company is working jointly with customers, strategic vendors and business
partners to identify and resolve any Year 2000 issues that may impact the
Company. However, there can be no assurance that the companies with which the
Company does business 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 Costs to Address the Company's Year 2000 Issues
The total cost associated with the Company's Year 2000 remediation is not
expected to be material to the Company's financial condition or results of
operations. The estimated total cost of the Company's Year 2000 remediation is
not expected to exceed $5 million. Through June 30, 1999, the Company has spent
almost $2.5 million in connection with Year 2000 Issues. The cost of
implementing the uniform worldwide business and accounting information system
(approximately $45 million) has not been included in this figure since the
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 compliant, 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
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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 compliant 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
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
compliant internal systems could impact the Company's ability to manufacture
and/or ship its products or to maintain adequate inventory levels for
production.
The Company's Contingency Plans
The Company has identified various business systems which may require a written
contingency plan. To date, sixty contingency plans have been prepared for
certain business critical systems. The Company will continue to prepare
contingency plans, as deemed prudent.
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
statement" made in the foregoing Year 2000 discussion speaks only as of the date
on which such statements are made, and the Company undertakes no obligation to
update any forward-looking statement to reflect events or circumstances after
the date on which such statement is made or to reflect the occurrence of
unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the Company's market
risk since December 31, 1998. For further information, 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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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 $16.4 million. In addition, the
IRS completed an audit examination of the Company's 1992-1994 income tax returns
in early 1998 and has proposed an adjustment of $41.8 million in 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 this adjustment. 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 a 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 August 12, 1999. The court has granted the Company's motion for a
preliminary injunction permitting the hiring of such representatives. 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
which it regards as likely to have a material adverse effect on its business.
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<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
COURT RULING. On August 12, 1999 a jury in federal district court in Austin,
Texas rendered a $10 million verdict against St. Jude Medical in a lawsuit
brought by CMI, a manufacturer of heart valves. $2 million of the verdict was
for actual damages and $8 million was for punitive damages. CMI alleged that by
hiring a CMI valve distributor, St. Jude had wrongfully interfered with his
contract. The jury found in CMI's favor on that claim. Certain motions are
pending before the trial judge that would reduce or eliminate the damage awards.
Rulings on those motions are expected in September 1999. The Company expects the
ultimate resolution of this matter will not have a material adverse effect on
its financial position or liquidity, but could potentially be material to the
net income of a particular future period if the matter is resolved unfavorably.
PRODUCT ADVISORY. On July 19, 1999, the Company announced it had distributed a
letter and technical memo to physicians advising that premature battery
depletion can occur in a very small number of its Trilogy(R) family of
pacemakers. There have been no patient injuries associated with this situation.
A routine follow-up procedure can identify whether a pacemaker may experience
premature battery depletion. The Company has worked closely with regulatory
agencies since the problem was first identified and received the required
approvals for a manufacturing modification to resolve it. The voluntary advisory
to physicians does not have an impact on any other Company pacemaker or ICD
product or product shipments. The Company believes this matter will have an
immaterial impact on its consolidated financial statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Exhibit
------- -------
27 Financial data schedule
(b) Reports on Form 8-K None
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<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.
August 13, 1999 /s/ JOHN C. HEINMILLER
- -------------------- ----------------------------------
DATE JOHN C. HEINMILLER
Vice President - Finance
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
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