<PAGE>
________________________________________________________________________________
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________________________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For quarterly period ended July 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___ to ____
Commission File Number 0-13907
___________________________________________________
BIO-VASCULAR, INC.
(Exact name of Registrant as specified in its charter)
State of Incorporation: Minnesota
I.R.S. Employer Identification No.: 41-1526554
Principal Executive Offices: 2575 University Avenue
St. Paul, Minnesota 55114
Telephone Number: (651) 603-3700
___________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ______
---------
On September 7, 1999, there were 8,959,739 shares of the Registrant's common
stock, par value $.01 per share, outstanding.
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
BIO-VASCULAR, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JULY 31, 1999 AND OCTOBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
July 31, October 31,
1999 1998
---- ----
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................................... $ 5,898,321 $ 4,383,366
Marketable securities....................................................... -- 3,990,839
Accounts receivable, net.................................................... 2,811,262 2,456,018
Inventories, net............................................................ 2,461,953 2,305,924
Deferred income taxes....................................................... 239,754 219,754
Other....................................................................... 385,413 527,402
----------- -----------
Total current assets...................................................... 11,796,703 13,883,303
Equipment and leasehold improvements, net................................... 4,786,560 4,353,876
Goodwill and other intangible assets, net................................... 6,765,390 7,240,772
Deferred income taxes....................................................... 549,821 504,268
----------- -----------
Total assets.............................................................. $23,898,474 $25,982,219
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................ $ 594,171 $ 460,337
Accrued expenses............................................................ 1,403,273 1,421,054
Current maturities of long-term obligations................................. 369,104 615,961
----------- -----------
Total current liabilities................................................. 2,366,548 2,497,352
Capital lease obligations................................................... 215,248 392,845
Other noncurrent liabilities................................................ 561,821 661,648
----------- -----------
Total liabilities......................................................... 3,143,617 3,551,845
----------- -----------
Contingencies (Note 6)
Shareholders' equity:
Preferred stock: authorized 5,000,000 shares of $.01 par value;
none issued or outstanding at July 31, 1999 and
October 31, 1998.......................................................... -- --
Common stock: authorized 20,000,000 shares of $.01 par value;
8,959,232 issued and outstanding at July 31, 1999 and
9,317,183 at October 31, 1998............................................. 89,592 93,172
Additional paid-in capital.................................................. 27,699,364 28,695,840
Unearned compensation....................................................... (710,836) (514,538)
Accumulated other comprehensive income...................................... -- 1,103
Accumulated deficit......................................................... (6,323,263) (5,845,203)
----------- -----------
Total shareholders' equity................................................ 20,754,857 22,430,374
----------- -----------
Total liabilities and shareholders' equity................................ $23,898,474 $25,982,219
=========== ===========
</TABLE>
The accompanying notes are an integral part of the interim unaudited condensed
consolidated financial statements.
2
<PAGE>
BIO-VASCULAR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE-MONTH PERIODS ENDED JULY 31, 1999 AND 1998 (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 31, July 31,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue..................................... $5,169,431 $2,759,920 $13,891,788 $ 7,949,516
Cost of revenue................................. 2,585,227 1,141,466 6,893,144 3,256,855
---------- ---------- ----------- -----------
Gross margin.................................... 2,584,204 1,618,454 6,998,644 4,692,661
Operating expenses:
Selling, general and administrative............. 2,099,727 1,542,014 6,467,088 4,709,853
Research and development........................ 461,300 352,473 1,240,217 1,178,294
---------- ---------- ----------- -----------
Operating income (loss)......................... 23,177 (276,033) (708,661) (1,195,486)
Other income, net, primarily interest........... 35,756 211,140 143,337 671,392
---------- ---------- ----------- -----------
Income (loss) before provision for (benefit
from) income taxes............................ 58,933 (64,893) (565,324) (524,094)
Provision for (benefit from)
income taxes.................................. 16,917 (22,273) (87,264) (175,082)
---------- ---------- ---------- -----------
Net income (loss)............................... $ 42,016 $ (42,620) $ (478,060) $ (349,012)
========== ========== =========== ===========
Basic and diluted earnings per share:
Net income (loss)............................... $ 0.00 $ (0.00) $ (0.05) $ (0.04)
========== ========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the interim unaudited condensed
consolidated financial statements.
3
<PAGE>
BIO-VASCULAR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE-MONTH PERIODS ENDED JULY 31, 1999 AND 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended
July 31,
1999 1998
---- ----
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES............................. $ 638,581 $ 30,917
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and improvements................................ (1,055,617) (721,366)
Investments in marketable securities.................................. (986,805) (7,683,856)
Proceeds upon sale or maturities of marketable securities............. 4,977,644 10,659,270
Purchase of Jer-Neen, net of cash acquired............................ - (2,708,899)
Payment of transaction costs related to acquisition of Jer-Neen....... (58,859) -
Investments in patents and trademarks................................. (81,013) (47,697)
----------- -----------
Net cash provided by (used in) investing activities................... 2,795,350 (502,548)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds related to stock-based compensation plans.................... 9,445 271,532
Repurchase of the Company's common stock.............................. (1,404,140) (2,994,102)
Repayment of debt in conjunction with the acquisition of Jer-Neen..... - (2,407,386)
Repayments of capital lease obligations............................... (170,180) -
Repayments of other long-term obligations............................. (354,101) -
----------- -----------
Net cash used in financing activities................................. (1,918,976) (5,129,956)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................. 1,514,955 (5,601,587)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD...................... 4,383,366 6,766,687
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD............................... $ 5,898,321 $ 1,165,100
=========== ===========
</TABLE>
The accompanying notes are an integral part of the interim unaudited condensed
consolidated financial statements.
4
<PAGE>
BIO-VASCULAR INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(1) BASIS OF PRESENTATION:
The accompanying unaudited condensed consolidated financial statements of Bio-
Vascular, Inc. ("Bio-Vascular" or "the Company") have been prepared by the
Company 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. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's 1998 Annual
Report to Shareholders and incorporated by reference in the Company's Form 10-K
for the year ended October 31, 1998.
In the opinion of management, all adjustments considered necessary, consisting
only of items of a normal recurring nature, for a fair presentation of the
financial position, results of operations and cash flows of the Company as of
and for the interim periods presented have been included. Operating results and
cash flows for the nine month period ended July 31, 1999 are not necessarily
indicative of the results of operations and cash flows of the Company that may
be expected for the fiscal year ending October 31, 1999.
(2) ACQUISITION OF BUSINESS:
On July 31, 1998, the Company completed the acquisition of Jer-Neen
Manufacturing Co., Inc. ("Jer-Neen") of Lino Lakes, Minnesota. Jer-Neen is a
value-added manufacturer of precision component products used within the medical
device industry. Jer-Neen's product line includes micro coils, wire forms and
spring components used in implantable defibrillation, interventional medicine
and other surgical applications. The acquisition has been accounted for as a
purchase.
Since the acquisition occurred on July 31, 1998 and was accounted for as a
purchase, the results of operations for the three and nine-month periods ended
July 31, 1998, and the cash flows for the nine-month period ended July 31, 1998
do not include Jer-Neen's results of operations and cash flows for those
periods.
(3) SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION:
<TABLE>
<CAPTION>
July 31, October 31,
1999 1998
---- ----
(Unaudited)
<S> <C> <C>
Inventories, net:
Raw materials and supplies................................ $1,411,011 $1,304,031
Work in process........................................... 622,567 457,396
Finished goods............................................ 990,406 1,024,317
Reserve for inventory obsolescence........................ (562,031) (479,820)
---------- ----------
$2,461,953 $2,305,924
========== ==========
</TABLE>
Condensed Consolidated Statements of Cash Flows:
In 1997, the Company's Board of Directors adopted a stock repurchase plan (the
"Plan") and authorized the purchase of up to 500,000 shares of its common stock.
In 1998, the Company's Board of Directors amended the Plan to authorize the
repurchase of up to 1,500,000 shares. As of July 31, 1999, the Company had
completed its repurchase of 1,500,000 shares of its common stock for an
aggregate cash outlay of $5,648,000 since the inception of the Plan.
5
<PAGE>
BIO-VASCULAR INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
(4) EARNINGS PER SHARE:
The following table sets forth the computation of shares outstanding used in the
calculation of basic and diluted earnings per share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 31, July 31,
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Denominator for basic earnings per share -
weighted-average common shares........................... 8,861,073 8,891,624 9,053,779 9,145,669
Effect of dilutive securities:
Shares associated with deferred compensation................ 186,018 -- -- --
Shares associated with option plans......................... 12,461 -- -- --
--------- --------- --------- ---------
Dilutive potential common shares............................ 198,479 -- -- --
--------- --------- --------- ---------
Denominator for diluted earnings per share -
weighted-average common shares and dilutive
potential common shares.................................. 9,059,552 8,891,624 9,053,779 9,145,669
========= ========= ========= =========
Options outstanding with exercise prices greater than the
average market price of the Company's common stock....... 1,275,285 684,080 1,247,765 872,062
Restricted stock awards outstanding......................... 232,219 155,944 232,219 155,944
</TABLE>
<TABLE>
<CAPTION>
As of July 31,
1999 1998
---- ----
(Unaudited)
<S> <C>
Options outstanding......................................... 1,442,899 1,280,090
Exercise prices............................................. $1.87 - $13.03 $1.87 - $13.03
Expiration dates............................................ 1999 - 2008 1998 - 2006
</TABLE>
For the nine-month periods ended July 31, 1999 and 1998, and the three-month
period ended July 31, 1998, none of the options outstanding were included in the
computation of diluted earnings per share for those periods because the Company
had incurred net losses, thus the inclusion of options would have been anti-
dilutive.
6
<PAGE>
BIO-VASCULAR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
(5) MAJOR CUSTOMERS AND NET REVENUE BY GEOGRAPHIC AREA:
Substantially all of the Company's international net revenues are negotiated,
invoiced and paid in U.S. dollars. The following tables summarize significant
customer information and international net revenues by geographic area:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 31, July 31,
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Percent of net revenues by significant customers:
A............................................... 11% 18% 12% 19%
B............................................... 9% 14% 8% 14%
C............................................... 8% 11% 8% 11%
D............................................... 31% -- 26% --
</TABLE>
<TABLE>
<CAPTION>
July 31, October 31,
1999 1998
---- ----
(Unaudited)
<S> <C> <C>
Percent of accounts receivable by significant
customers:
A............................................... 9% 9%
B............................................... 10% 11%
C............................................... 8% 11%
D............................................... 18% 13%
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 31, July 31,
1999 1998 1999 1998
---- ---- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
International net revenues by geographic area:
Europe.......................................... $495,736 $397,012 $1,484,180 $1,142,071
Asia and Pacific Region......................... 161,385 222,411 397,358 627,487
Canada.......................................... 76,992 58,641 226,512 167,541
Other........................................... 50,962 17,313 154,491 42,493
-------- -------- ---------- ----------
Total........................................... $785,075 $695,377 $2,262,541 $1,979,592
======== ======== ========== ==========
Percent of total net revenues................... 15% 25% 16% 25%
</TABLE>
In June 1997, Statement of Financial Accounting Standards (SFAS) No. 131,
Disclosures about Segments of an Enterprise and Related Information, was issued
by the Financial Accounting Standards Board. SFAS No. 131 establishes new
standards for the way public business enterprises report information about
operating segments. The Company must adopt SFAS No. 131 for fiscal year end
1999. Management is in the process of evaluating the effect on its financial
reporting.
7
<PAGE>
BIO-VASCULAR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
(6) CONTINGENCIES:
The Company is currently involved in litigation which is ordinary and incidental
to its business. Management believes losses, if any, that might eventually be
sustained from such litigation would not be material to the Company's
consolidated financial position, results of operations or cash flows for any
period. Further, product liability claims may be asserted in the future relative
to events not known to management at the present time. Management believes that
the Company's risk management practices, including insurance coverage, are
reasonably adequate to protect against potential material product liability
losses.
(7) COMPREHENSIVE INCOME:
Effective November 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income, which establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
in the financial statements. The Company's only component of other
comprehensive income is the unrealized gain/loss on available-for-sale
investments.
(8) NEW ACCOUNTING PRONOUNCEMENT
In June 1998, SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, was issued. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments embedded in other contracts, and for
hedging activities. SFAS No. 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 2000. The Company's management has not yet fully
evaluated the potential impact of adopting SFAS No. 133 on the Company's
consolidated financial statements.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
Forward-Looking Statements:
Certain statements contained in this Form 10-Q include "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. All forward-looking statements in this document are based upon
information available to the Company as of the date hereof, and the Company
assumes no obligation to update any forward-looking statements. Such statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results to differ materially from any future results, performance or
achievements expressed or implied by such forward-looking statements. Such
factors may include, among others, the risk factors listed from time to time in
the Company's filings with the Securities and Exchange Commission, such as the
year-end Annual Report on Form 10-K.
Overview
The Company develops, manufactures, and markets branded proprietary and patented
specialty medical products for use in thoracic, cardiac, neuro, ophthalmic, and
vascular surgery. The Company's branded products include the Tissue-Guard(TM)
product line, the Biograft(R) peripheral vascular graft and surgical
productivity tools used in cardiac and vascular surgery. Tissue-Guard products
are made from bovine pericardium, the thin membrane surrounding the heart of
cattle, processed using proprietary tissue-fixation technology. The Company's
wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc. ("Jer-Neen"), is a
value added manufacturer of precision, unbranded wire component products such as
micro coils, wire forms and spring components used in implantable
defibrillation, interventional medicine and other surgical applications within
the medical industry. Jer-Neen was purchased by the Company on July 31, 1998,
the end of the Company's fiscal 1998 third quarter.
Results of Operations
Comparison of the Three Months Ended July 31, 1999 with
the Three Months Ended July 31, 1998
Revenue increased $2,409,000, or 87%, to $5,169,000 from $2,760,000. The Jer-
Neen component business contributed net revenues of $2,098,000, and continued to
exceed management's expectations. The branded products business reported
revenues of $3,071,000 up $311,000 from the 1998 revenue level of $2,760,000.
This was the third-highest quarterly revenue amount ever recorded by the
Company's branded products business since the fourth quarter of fiscal 1995 when
sales of the Company's Peri-Strips(R) product were at their peak.
The branded products business experienced 39% revenue growth from its surgical
productivity tools to $706,000 in the third quarter of 1999 compared to revenue
of $507,000 for the same quarter in 1998. Revenue from the Flo-Thru Intraluminal
Shunt(TM), which received FDA market clearance in August 1998, accounted for
approximately 47% of the overall period to period increase in surgical
productivity tools revenue during the quarter. The Tissue-Guard product line,
exclusive of Peri-Strips, contributed 5% revenue growth in 1999 over the same
period in 1998. Dura-Guard(R) and Vascu-Guard(R), both products within the
Tissue-Guard family, continued their strong momentum. Dura-Guard revenue
increased 11% over third quarter 1998 to $661,000 from $593,000. Vascu-Guard
revenues were up 25% to $220,000 from $176,000 in the prior year quarter. Peri-
Strips third-quarter revenue of $805,000 was higher than the fiscal 1998 third
quarter revenue of $790,000. Biograft revenue experienced a 17% increase in
revenue to $214,000 from $183,000, as a result of the Company's efforts to
reverse the downward trend previously experienced in this market.
The Company's gross margin percentage was 50% for the 1999 quarter as compared
to 59% for the 1998 quarter. In
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
the 1999 quarter, the component product line margin was 40%, while the branded
products' margin was 57%. The Company expects the gross margin percentage for
fiscal year 1999 to be lower than the fiscal 1998 level primarily because the
component product business will be included in the consolidated operating
results for the full year in 1999 rather than one quarter as in 1998.
Selling, general and administrative (SG&A) expense increased $558,000, or 36%,
to $2,100,000 from $1,542,000 between the 1999 and 1998 third quarters. The
inclusion of the component business accounts for approximately 82% of the
overall quarter to quarter increase in SG&A expense. The remaining SG&A increase
is primarily due to increased sales and marketing costs within the branded
products segment, which are required to advance the Company's revenue growth
initiatives. Increased sales and marketing costs were primarily related to
increased personnel costs, conventions costs, including the related employee
travel, and marketing materials with the new Bio-Vascular corporate logo and
image.
Research and development (R&D) expense for the third quarter increased $109,000,
or 31%, to $461,000 for the 1999 quarter from $352,000 for the 1998 quarter. The
inclusion of the component business accounts for approximately 82% of the
overall quarter to quarter increase in R&D expense. Product development
activities in the third quarter of 1999 continued to focus on a number of both
near- and long-term opportunities. The near-term opportunities focused on
furthering the Company's current tissue expertise through product line
expansions and enhancements. Long-term projects focused on product designs that
utilize new tissue technologies. R&D expense is expected to increase as projects
under development continue to progress. This forward-looking statement will be
influenced primarily by the number of projects and the related R&D personnel
requirements, development and regulatory approval path, expected costs and the
timing of those costs for each project.
Operating income in the 1999 quarter was $23,000 as compared to an operating
loss of $276,000 for the third quarter of 1998. The component business
contributed $298,000 in operating income to the fiscal 1999 third quarter.
Other income, primarily net interest income, was $36,000 in 1999 and $211,000 in
1998. The decrease in net interest income is related to significantly lower cash
and investment balances in 1999, primarily due to cash expenditures for the
Company's stock repurchase program and the Jer-Neen acquisition, and interest
expense related to acquired liabilities and capital equipment leases. Operations
had income before income taxes of $59,000 in 1999 as compared to a loss of
$65,000 in 1998.
The Company recorded a provision for income taxes of $17,000 in 1999, an
effective tax rate of 29%, as compared to benefit from income taxes of $22,000
in 1998. The 1999 effective tax rate is less than the statutory rates primarily
due to the impact of permanent differences, including nondeductible amortization
of goodwill acquired in the acquisition of Jer-Neen, partially offset by the
impact of research and experimental credits.
Comparison of the Nine Months Ended July 31, 1999 with
the Nine Months Ended July 31, 1998
Revenue increased $5,942,000 or 75%, to $13,892,000 from $7,950,000. The Jer-
Neen component business contributed net revenues of $5,296,000 in 1999. The
branded products business reported revenues of $8,596,000, up $646,000 from the
1998 revenue level of $7,950,000.
The branded products business experienced 20% revenue growth from its surgical
productivity tools to $1,865,000 in the 1999 period from $1,558,000 in the
comparable 1998 period. Revenue from the Flo-Thru Intraluminal Shunt(TM), which
received market clearance in August 1998, accounted for approximately 66% of the
increase in surgical productivity tools revenue during the period. The Tissue-
Guard product line, exclusive of Peri-Strips(R), contributed 14% revenue growth
in the 1999 period over the same period in 1998. Peri-Strips revenue decreased
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
6% when comparing the 1999 and 1998 period revenues of $2,317,000 and
$2,466,000, respectively, primarily as a result of increased competition
(including price competition) in the domestic marketplace during the first
quarter of fiscal 1999. The Company expects to regularly contend with a strong
element of competition in attractive markets, such as Lung Volume Reduction
Surgery. Additionally, the Japanese acceptance of Lung Volume Reduction Surgery
has been much lower than expected, thereby affecting the near-term expected
growth potential for Peri-Strips. In the second quarter of fiscal 1999, the
Company utilized non price driven sales strategies to respond to this
competitive environment. Biograft revenue experienced a 4% increase in revenue
to $568,000 from $546,000.
The Company's gross margin percentage was 50% in the 1999 period as compared to
59% in the 1998 period. In the 1999 period, the component product line margin
was 40%, while the branded products' margin was 57%. The Company expects the
gross margin percentage for fiscal year 1999 to be lower than the fiscal 1998
level as the component product business will be included in the consolidated
operating results for the full year in 1999 rather than one quarter as in 1998.
Selling, general and administrative (SG&A) expense increased $1,757,000, or 37%,
between the 1999 and 1998 periods. The inclusion of the component business
accounts for approximately 75% of the overall period to period increase in SG&A
expense. Since Jer-Neen has less SG&A infrastructure than does the branded
products business, SG&A as a percentage of net revenues decreased from 59% for
the 1998 period to 47% for the 1999 period. The remaining SG&A increase is
primarily due to increased sales and marketing costs within the branded products
segment. Increased sales and marketing costs resulted primarily from increased
personnel costs, convention costs (including the related employee travel) and
the cost of marketing materials with the new Bio-Vascular corporate logo and
image.
Research and development (R&D) expense for the period increased $62,000, or 5%,
between 1999 and 1998. The inclusion of the R&D activities of the component
business was the primary reason for the overall period to period increase in R&D
expense. Product development activities in 1999 continued to focus on a number
of both near- and long-term opportunities. The near-term opportunities focused
on furthering the Company's current tissue expertise through product line
expansions and enhancements. Long-term projects focused on product designs that
utilize new tissue technologies. R&D expense is expected to increase as
projects under development continue to progress. This forward-looking statement
will be influenced primarily by the number of projects and the related R&D
personnel requirements, development and regulatory approval path, expected costs
and the timing of those costs for each project.
The operating loss in the 1999 period was $709,000 as compared to an operating
loss of $1,195,000 for the same period in 1998. The component business
contributed $557,000 in operating income to the fiscal 1999 period.
Other income, primarily net interest income, was $143,000 in 1999 and $671,000
in 1998. The decrease in net interest income is related to significantly lower
cash and investment balances in 1999, primarily due to cash expenditures for the
Company's stock repurchase program and the Jer-Neen acquisition, and interest
expense related to acquired liabilities and capital equipment leases.
Operations had a loss before income taxes of $565,000 in 1999 as compared to a
loss of $524,000 in 1998.
The Company recorded a benefit from income taxes of $87,000 in 1999, an
effective tax rate of 15%, as compared to an effective tax rate of 33% in 1998.
The 1999 effective tax rate is less than the statutory rates primarily due to
the impact of permanent differences, including nondeductible goodwill acquired
in the acquisition of Jer-Neen, partially offset by the impact of research and
experimental credits.
The 1999 nine-month period had a net loss from operations of $478,000, or $0.05
per share, compared to a net loss of $349,000, or $0.04 per share in 1998.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
Cash, cash equivalents and marketable securities were $5,898,000 at July 31,
1999 as compared to $8,374,000 at October 31, 1998, a reduction of $2,476,000.
Operating activities provided cash of $639,000 during the first nine-months of
1999, as compared to providing cash of $31,000 in the same period of fiscal
1998. Cash was provided by operations through non-cash expenses in excess of the
loss from operations, partially offset by increases in working capital used for
inventories and accounts receivable.
Investing activities included $1,056,000 used for the purchase of equipment and
leasehold improvements, primarily related to manufacturing processes. Other
investing activities included $81,000 invested in intangible assets and $59,000
used for acquisition costs related to Jer-Neen.
Financing activities used $1,919,000 of cash during the first nine-months of
fiscal 1999, including $1,404,000 used to repurchase 484,834 shares of Company
common stock under the Company's stock repurchase program. Additional uses of
cash included $524,000 to repay a bank note and other long-term obligations
acquired in the purchase of Jer-Neen. The Company has long-term obligations of
$777,000 at July 31, 1999. Payments are required through 2004.
The Company believes existing cash and cash equivalents will be sufficient to
satisfy its cash requirements for the foreseeable future. This forward looking
statement, as well as the Company's long-term cash requirements, will be a
function of a number of variables, including research & development priorities,
acquisition opportunities and the growth and profitability of the business.
New Accounting Standards
Effective November 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income, which establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
in the financial statements. The Company's only component of other
comprehensive income is the unrealized gain/loss on available-for-sale
investments.
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes new standards for the way public business enterprises
report information about operating segments. The Company must adopt SFAS No.
131 for fiscal year end 1999 and management is in the process of evaluating the
effect on its financial reporting.
In June 1998, SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, was issued. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments embedded in other contracts, and for
hedging activities. SFAS No. 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 2000. The Company's management has not yet fully
evaluated the potential impact of adopting SFAS No. 133 on the Company's
consolidated financial statements.
Year 2000 Readiness Disclosure
The following Year 2000 disclosure update is required by the rules and
regulations of the Securities and Exchange Commission and constitutes a "Year
2000 Readiness Disclosure" as defined in the Year 2000 Information and Readiness
Disclosure Act.
12
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
The "Year 2000" or "Y2K" problem refers to the problem caused by computer
systems that have historically been written using two digits rather than four
digits to define the applicable year. Additionally, Y2K includes a problem
calculating leap year if a computer system does not correctly identify the year
2000 as being a leap year. Company computer systems and other equipment and
technology having date sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000 and may not recognize the year 2000 as a
leap year. The Company has instituted a Year 2000 readiness program (the "Y2K
Plan") in order to identify, evaluate and address its exposure to these
problems.
For purposes of its Y2K Plan, the Company defines "Year 2000 compliant" to mean
that a product or service accurately process dates and times into and between
the twentieth and twenty-first centuries, into and between the years 1900 and
2000, performs correct leap year calculations and properly exchanges date and
time information with other products or services when used in combination. The
goal of the Y2K Plan is to ensure that the Company's equipment, systems and
processes and those of its significant business partners are sufficiently Year
2000 compliant such that no date/time issue will have any adverse impact on the
services or products that the Company provides its customers or the timely and
accurate processing of transactions.
State of Readiness. As part of the Company's Y2K Plan, management has
completed its evaluation of its information technology ("IT") and non-
information technology ("non-IT") systems, including manufacturing equipment,
telephone and mechanical systems and other equipment and systems having
embedded, date sensitive technology for Year 2000 compliance. The Company's Y2K
Plan is focused on assessing and assuring compliance in the following areas: IT
and non-IT hardware, operating systems, software applications and custom
applications. Additionally, the Company is in the process of reviewing the Year
2000 compliance status of its customers, vendors and other service providers.
Hardware. The Company has completed its assessment of its current IT and non-IT
hardware for Y2K compliance. Substantially all of the Company's IT and non-IT
hardware has either been upgraded for Y2K compliance or has been certified
internally or through the appropriate vendor to be compliant. The Company has
completed preliminary tests of its upgraded and/or certified IT and non-IT
hardware to ensure for Y2K compliance and will continue to monitor and test the
systems on an ongoing basis.
Operating Systems. The Company's operating systems are Novell Netware,
Microsoft NT and Microsoft Windows 95/98. Novell has certified Netware to be
Y2K compliant. Microsoft has certified Windows 95/98 to be compliant.
Microsoft has certified that its NT software is compliant upon installation of
the most recent service patches released or the installation of a software
upgrade released in December 1998. The Company installed the Microsoft NT
software upgrade in the second quarter of fiscal 1999.
Software Applications. The Company's primary information system applications
consist of Micro-MAX MRP system, Great Plains Accounting and DataWorks Vantage.
Micro-MAX released a service upgrade in 1998 that addressed its Y2K compliance.
Great Plains Accounting software has been certified Y2K compliant, and DataWorks
has certified Vantage to be Y2K compliant. The Company's secondary software
systems consist of "off-the-shelf" software. The Company has completed the
process of assessing whether or not its secondary systems are dependent upon
date/time accuracy and if they need to be replaced. For the systems that have
been determined as dependent upon date/time accuracy, the Company has obtained
from its vendors certification that each secondary software package is compliant
or intends to replace the system by October 31, 1999. None of these secondary
software programs are critical to the Company's ability to accurately and timely
process transactions.
Custom Applications. The Company has only a few custom applications written in
"off-the-shelf" software. These applications were written in versions of
software which have been determined not to be Y2K compliant. In each instance
the Company has determined that date/time is either not essential to the
functioning of the application, or can be worked around, or that the
application's function can either be accomplished manually or completed in
13
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
another manner using alternative software. Accordingly, the Company may choose
not to address the Y2K issues related to these custom applications.
Third Party Relationships. Y2K issues may also impact the Company by affecting
the business and operations of the Company's critical vendors, customers and
other business partners. The Company has substantially completed the process of
communicating with these parties in order to determine their Y2K compliant
status. However, the Company has not been able to determine if the failure of a
third-party to be Y2K compliant will have a material adverse affect on the
Company. The Company anticipates that this part of its Y2K plan will be
substantially complete by September 30, 1999.
Costs to Address Year 2000 Issues. Although the ultimate cost of attaining Year
2000 compliance is not fully known at this time, management anticipates that
external costs will not be material. These costs will be funded from
operations. The Company does not track internal personnel time spent on IT
projects, including the Y2K project. To date, no IT projects have been delayed
as a result of the Company's Y2K project. In the event the Company's Y2K Plan is
not successful or timely implemented, the Company may need to devote more
resources to the process and additional costs may be incurred. Such a situation
is not expected to have a material adverse effect on the Company's financial
condition and results of operations.
The costs of Year 2000 compliance and the expected completion dates are the best
estimates of Company management. Estimated costs of the Company's Y2K project
and projected completion dates are forward-looking statements that may be
impacted by the Company's current belief as to the extent of its internal
exposure to the Y2K problem, the timeliness and accuracy of information provided
by the Company's significant vendors, customers and other business partners in
response to Y2K compliance inquiries by the Company, the cost and availability
of upgrades, corrections or replacements for IT and non-IT systems identified as
non-compliant, and the cost of and the Company's ability to procure the services
of consultants or qualified personnel to assist with its Y2K Plan.
Worst Case Scenario. The Company believes that its most reasonably likely,
worst case scenario as a result of the Year 2000 problem will be the failure of
one or more significant vendors, customers or business partners to become Year
2000 complaint and the inability of the Company to determine or react on a
timely basis in order to mitigate the effects on the Company. If the operations
of any significant vendor, customer or other business partner are disrupted due
to the Year 2000 problem and the Company is unable to develop and implement an
effective contingency plan, the Company's ability to carry on essential
activities could be materially impacted. Even though the Company is undertaking
its Y2K Plan in an effort to mitigate its risks, there can be no assurance that
this scenario or any other impact of the Y2K problem will not have a material
adverse effect on the Company's business, financial condition and results of
operations.
Contingency Plans. The Company is in the process of developing contingency
plans to address potential Year 2000 compliance deficiencies. However, the
plans will not be completed until Company has received responses from its
significant customers, vendors and other business partners regarding their Year
2000 compliance. To the extent that the Company identifies Year 2000 compliance
issues that cannot be addressed on a timely basis, it will seek to develop and
refine appropriate contingency plans in order to mitigate its risks.
The forward looking statements contained in this section under the meaning "Year
2000 Readiness Disclosure" should be read in conjunction with the Company's
disclosure under the heading "Forward-Looking Statements".
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The principal financial instruments the Company maintains are in accounts
receivable and long-term obligations. The Company believes that the interest
rate, credit and market risk related to these accounts is not significant. The
Company manages the risk associated with these accounts through periodic reviews
of the carrying value for non-
14
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
collectibility of assets and establishment of appropriate allowances in
connection with the Company's internal controls and policies.
15
<PAGE>
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS
The Company is currently involved in litigation which is ordinary and incidental
to its business. In the opinion of management, the ultimate resolution of the
pending legal proceeding will not have a material adverse effect on the
Company's future business, financial condition, results of operations, or cash
flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The exhibits to this quarterly report on Form 10-Q are listed
--------
in the exhibit index beginning on page 18.
(b) Form 8-K. No reports on Form 8-K were filed by the Company during the
--------
quarter ended July 31, 1999.
16
<PAGE>
SIGNATURES
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
BIO-VASCULAR, INC.
Dated: September 9, 1999. /s/ Connie L. Magnuson
----------------------
Connie L. Magnuson
Vice-President of Finance and Chief
Financial Officer
(Principal Financial Officer)
17
<PAGE>
BIO-VASCULAR, INC.
INDEX TO EXHIBITS
- --------------------------------------------------------------------------------
27.1 Financial Data Schedule for the nine-month period ended July 31, 1999
(filed herewith electronically).
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM "THE
FINANCIAL STATEMENTS AND RELATED NOTES FOR THE PERIOD ENDED JULY 31, 1999" AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-31-1999
<PERIOD-START> NOV-01-1999
<PERIOD-END> JUL-31-1999
<CASH> 5,898,321
<SECURITIES> 0
<RECEIVABLES> 2,934,958
<ALLOWANCES> (123,696)
<INVENTORY> 2,461,953
<CURRENT-ASSETS> 11,796,703
<PP&E> 6,908,441
<DEPRECIATION> (2,121,881)
<TOTAL-ASSETS> 23,898,474
<CURRENT-LIABILITIES> 2,366,548
<BONDS> 0
0
0
<COMMON> 89,592
<OTHER-SE> 20,665,265
<TOTAL-LIABILITY-AND-EQUITY> 23,898,474
<SALES> 13,891,788
<TOTAL-REVENUES> 13,891,788
<CGS> 6,893,144
<TOTAL-COSTS> 2,769,102
<OTHER-EXPENSES> 4,938,203
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (565,324)
<INCOME-TAX> (87,264)
<INCOME-CONTINUING> (478,060)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (478,060)
<EPS-BASIC> (0.05)
<EPS-DILUTED> (0.05)
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