<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended October 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)
- --------------------------------------------------------------------------------
Minnesota 41-1526554
------------------------ ------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
2575 UNIVERSITY AVENUE, ST. PAUL, MINNESOTA 55114-1024
(Address of principal executive offices)
TELEPHONE NUMBER: (651) 603-3700
-------------------
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Common Stock Purchase Rights
-------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No______
----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of January 21, 2000, 8,975,383 shares of Common Stock of the Registrant were
outstanding, and the aggregate market value of the Registrant's outstanding
Common Stock (based upon the last reported sale price of the Common Stock on
that date by the Nasdaq National Market), excluding shares owned beneficially by
executive officers and directors, was approximately $25,141,000.
Parts I and II of this Annual Report on Form 10-K incorporate by reference
information (to the extent specific sections are referred to herein) from the
Registrant's Annual Report to Shareholders for the fiscal year ended October 31,
1999 (the "1999 Annual Report"). Part III of this Annual Report on Form 10-K
incorporates documents incorporated by reference (to the extent specific
sections are referred to herein) from the Registrant's Proxy Statement for its
Annual Meeting of Shareholders to be held February 22, 2000 (the "1999 Proxy
Statement").
<PAGE>
Tissue-Guard(TM), Supple Tissue-Guard(TM), Peri-Strips(R), Peri-Strips Dry(R),
PSD Gel(TM), Dura-Guard(R), Vascu-Guard(R), Supple Peri-Guard(R), Peri-Guard(R),
CV Peri-Guard(R), Ocu-Guard(TM), Biograft(R), Flo-Rester (R), Bio-Vascular
Probe(R) and Flo-Thru Intraluminal Shunt(TM) are trademarks of the Company.
Forward-Looking Statements
Certain statements contained in this Annual Report on Form 10-K are "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. For this purpose, any statements contained in this Form 10-
K that are not statements of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, words such as "may", "will",
"expect", "believe", "anticipate", "estimate" or "continue" or the negative or
other variations thereof or comparable terminology are intended to identify
forward-looking statements. All forward-looking statements in this document are
based on information available to the Company as of the date hereof, and the
Company assumes no obligation to update any 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, those factors set forth
under the heading "Important Factors".
PART I
ITEM 1 - Business
- -----------------
(a) General Development of Business
Introduction
Bio-Vascular, Inc. ("Bio-Vascular" or the "Company") develops, manufactures and
markets branded proprietary and patented specialty medical products for use in
thoracic, cardiac, neuro, vascular and ophthalmic surgery. The Company's
branded products include the Tissue-Guard product line, the Biograft peripheral
vascular graft, and surgical productivity tools used in cardiac and vascular
surgery. Tissue-Guard products are made from bovine pericardium (the membrane
surrounding the heart of cattle) processed using the Company's tissue-fixation
technology. The Tissue-Guard products, made in various configurations, are used
in a wide variety of surgical procedures and are designed to reinforce,
reconstruct and repair tissue and prevent leaks of air, blood and other body
fluids.
Through the Company's wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc.
(d/b/a Jerneen Micro Medical Technologies)("Jerneen"), the Company is a value
added original equipment manufacturer ("OEM") of micro precision wire-based
component products including precision coils, stylets and guidewire components
and subassemblies used in the medical industry. The Company acquired Jerneen
July 31, 1998.
History
Bio-Vascular was incorporated in July of 1985. In 1985, the Company was spun-
off to the shareholders of its then parent company, thereafter operating as a
separate public company. In the spin-off, the Company acquired the rights to
certain cardiovascular products, including Peri-Guard and Flo-Rester.
In 1994, the Company acquired Vital Images, Inc. ("Vital Images"), a company
involved in the development of software for three-dimensional visualization and
analysis of image data. In 1996, the Company made the decision to spin Vital
Images off. In 1997, the Company completed the spin-off distribution of all the
shares of Vital Images to the shareholders of Bio-Vascular, with Vital Images
thereafter operating as an independent company, with its own publicly traded
securities. The distribution was effected in order to allow each company to
maximize its individual strategic opportunities, as the direction of Vital
Images' business had begun to diverge from the core medical device business of
Bio-Vascular.
2
<PAGE>
Also in 1994, the Company's branded products segment introduced Peri-Strips
staple line buttress for use in lung surgical procedures, primarily lung volume
reduction surgery ("LVRS"). Sales from Peri-Strips fueled significant revenue
growth for the Company from late 1994 through fiscal 1995, increasing from
$685,000 in fiscal 1994 to $5,500,000 in fiscal 1995. In January 1996, the
Health Care Financing Administration ("HCFA"), the agency of the U.S. Government
that controls Medicare, put in place a national policy decision not to reimburse
for LVRS. This decision by HCFA adversely affected the Company's revenues
generated from the sales of Peri-Strips, which declined to $2,900,000 in fiscal
1997. Annual revenues from Peri-Strips have remained relatively stable since
fiscal 1997, with fiscal 1998 and 1999 Peri-Strips revenues of $3,200,000 and
$3,100,000, respectively.
In July 1998, the Company completed the acquisition of Jerneen. This
acquisition broadens the Company's participation in the medical device industry,
increases the Company's immediate and long-term revenue potential and achieves a
balance of market opportunities consistent with the strategic objectives
targeted by the Company.
The Company has continued to advance and execute its strategy for growth,
focusing on opportunities to grow through acquisition, licensing and
distribution, expansion of markets for its current products, and internal new
product research and development activities. (See Research and Development on
Page 11 of this Report.)
Bio-Vascular's principal executive offices are located at 2575 University
Avenue, St. Paul, Minnesota 55114-1024. The Company can be contacted by
telephone at (651) 603-3700, by facsimile at (651) 642-9018, or by electronic
mail at [email protected].
(b) Financial Information About Industry Segments
The information under the caption "Supplemental Financial Statement and Segment
Information" on page 17 of the Company's 1999 Annual Report is incorporated
herein by reference.
(c) Narrative Description of Business
The table below summarizes the revenue contributed by the Company's significant
products or product lines for the periods indicated. The component products
segment financial results are included in the fourth quarter of fiscal 1998
(since date of acquisition) and all four quarters of fiscal 1999.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Revenue Contribution by Significant Years Ended October 31,
Product or Product Line:
(In thousands) 1999 % 1998 % 1997 %
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Tissue-Guard Products:
Peri-Strips and Peri-Strips Dry $ 3,125 17% $ 3,233 27% $ 2,915 30%
Dura-Guard 2,550 13% 2,204 18% 1,832 19%
Other Tissue-Guard Products 2,689 14% 2,384 20% 2,020 21%
Surgical Productivity Tools 2,560 14% 2,051 17% 2,127 22%
Biograft 757 4% 748 6% 800 8%
------- --- ------- --- ------- ---
Total Branded Products 11,681 62% 10,620 88% 9,694 100%
Component Products 7,223 38% 1,397 12% - -
-----------------------------------------------------------------------
Total Net Revenue $18,904 100% $12,017 100% $ 9,964 100%
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
3
<PAGE>
Products, Markets and Competition
Description of the Branded Products Segment
- -------------------------------------------
The following table summarizes the Company's branded product lines and
associated products, and describes procedures in which such products are used.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Product Line Product Application/Representative Procedure
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Tissue-Guard Peri-Strips Stapling buttress for sealing air leaks in lung volume reduction/lung
resection procedures and prothesis for the repair of soft tissue
deficiencies
-------------------------------------------------------------------------------------------------
Peri-Strips Dry Stapling buttress for sealing air leaks in lung volume reduction/lung
resection procedures
-------------------------------------------------------------------------------------------------
Vascu-Guard Vascular patch used in carotid endarterectomy and other peripheral
vascular procedures when the artery must be repaired
-------------------------------------------------------------------------------------------------
Dura-Guard Repair patch used to seal the dura mater in neurosurgeries
-------------------------------------------------------------------------------------------------
Peri-Guard Tissue patch used for pericardial closure and soft tissue repair
-------------------------------------------------------------------------------------------------
Supple Peri-Guard More "supple" tissue patch used for pericardial closure and soft
tissue repair
-------------------------------------------------------------------------------------------------
CV Peri-Guard Tissue patch used for intracardiac patching and great vessel repair
in adults
-------------------------------------------------------------------------------------------------
Ocu-Guard Opthalmic wrapping material used in enucleation procedures
- --------------------------------------------------------------------------------------------------------------------
Surgical Bio-Vascular Probe Tool used to locate arterial blockage in surgical bypass procedures
Productivity Tools
-------------------------------------------------------------------------------------------------
Flo-Rester Internal vessel occluder used in coronary artery bypass graft surgery
-------------------------------------------------------------------------------------------------
Flo-Thru Intraluminal Internal vessel stent used during minimally invasive cardiac surgery
Shunt
- --------------------------------------------------------------------------------------------------------------------
Other Biograft Peripheral vascular bypass graft used in lower limb vascular
reconstruction
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
Tissue-Guard Product Line
The Company's core competency in its branded products business is the
development and manufacture of tissue-based implantable medical products for use
by surgeons in various surgical procedures where reinforcing, reconstructing and
repairing tissue and preventing leaks of air, blood or other body fluids is
necessary for the achievement of a favorable outcome. Historically, surgeons
primarily used autologous tissue in situations where tissue repair was
necessary. Harvesting autologous tissue requires the surgeon to excise the
tissue from another part of the patient's body. The second surgical site
increases the cost of the procedure and lengthens the time the patient is under
anesthesia, thereby increasing the risk of complication and resulting in
additional pain and recovery time for the patient. To the extent a surgeon is
confident that the performance of a readily available medical product, whether
tissue-based or synthetic, is equal to or better than the patient's own tissue,
the Company believes the surgeon will choose the tissue-based or synthetic
product to avoid a second surgical site as a means of reducing surgical costs
and improving patient outcomes.
4
<PAGE>
The Company's Tissue-Guard products are produced from bovine pericardium. Many
of the product characteristics and competitive advantages of this product line
are derived from the collagen configuration of the bovine pericardium.
Collagen, which is a fibrous protein found in all multi-cellular animals, makes
the pericardium durable and provides superior fluid interface properties,
similar to autologous tissue. These characteristics allow for effective host
tissue incorporation. Host cells deposit a collagen matrix on the surface of
the pericardial product allowing the Tissue-Guard product to integrate into the
host tissue. The Company believes this integration enhances the long-term
tensile strength (the maximum stress a material subjected to a stretching load
can withstand without tearing) of its Tissue-Guard products.
The bovine pericardium is processed using proprietary and patented tissue-
fixation technologies. The tissue is treated with glutaraldehyde and other
proprietary chemical treatments to prevent degradation of the tissue and to
render it biologically compatible with the host tissue. According to studies
commissioned by the Company, the tissue-fixation technologies used by the
Company reduce the level of residual glutaraldehyde remaining in the processed
tissue to one of the lowest levels documented in the industry, resulting in a
lower incidence of host tissue inflammatory response and promoting host tissue
incorporation similar to the body's natural healing process.
Peri-Strips and Peri-Strips Dry
Peri-Strips and Peri-Strips Dry soft tissue stapling buttresses are used in a
variety of pulmonary procedures including bullectomies, bronchial resections,
lobectomies, segmentectomies, wedge resections and LVRS. These products provide
for reapproximation and reinforcement of the surgical staple line to prevent air
leaks at the site. Peri-Strips and Peri-Strips Dry are customized to fit
disposable, reusable and endoscopic staplers of varying sizes made by a variety
of manufacturers.
LVRS is an alternative to traditional emphysema treatment such as medical
therapy or lung transplant. Lung transplantation is the only known cure for
emphysema, but like other transplant procedures, is extremely expensive
considering the high degree of risk associated with the procedure, the
inadequate supply of donor lungs and the requirement that the patient receive
anti-rejection drugs for the remainder of his or her lifetime. There are non-
surgical therapies, although less expensive than surgical alternatives, which
offer only temporary relief and become less effective as the disease progresses.
In LVRS, the surgeon uses a stapling device to remove sections of damaged
tissue, typically 20% to 30% of each lung. By removing the most diseased
tissue, the remaining lung tissue has room to expand, improving breathing
capacity by enabling the diaphragm muscles to regain their function and allow
the rib cage and diaphragm to return to their normal size and state. In 1994,
Dr. Joel Cooper, a pioneer in lung transplant surgery, modified LVRS using
strips of Supple Peri-Guard to reinforce the staple line to prevent air leakage
at the staple-line. Peri-Strips and Peri-Strips Dry were developed to suit the
types of surgical staplers most commonly used in LVRS. While LVRS is not a cure
for emphysema, the results from the procedure to date are very encouraging based
on the peer-reviewed published literature. Generally, the literature shows that
patients undergoing the procedure have reduced shortness of breath, improved
exercise tolerance and improved quality of life.
There are more than 30 clinical papers published regarding the use of bovine
pericardium medical products, such as Peri-Strips and Peri-Strips Dry, to reduce
air leaks and improve patient outcomes. According to a study commissioned by
the Company, using Peri-Strips Dry in surgical procedures to treat lung cancers
and other lung tumors improved the patient recovery times through decreased
duration of air leak, time to chest tube removal and hospital stay in comparison
to procedures completed without the product. The study's reported one-day
decrease in hospital stays could result in a net savings of up to $4,500 per
patient, as estimated by the Company.
Dura-Guard
Dura-Guard, a dural repair patch, is primarily used in craniotomy procedures
when the dura must be repaired and suturing without a patch is not deemed
sufficient. Craniotomies (surgical operations involving the brain and skull)
are typically performed to treat various brain conditions, such as tumors,
aneurysms, blood clots, head injuries and abscesses. The dura, the fibrous
layer below the skull which protects the brain and spinal cord must be cut with
a scalpel or scissors and resected to expose the brain during these procedures.
After the specific brain condition has been treated by the surgeon, the dura
must be closed to prevent leakage of cerebral spinal fluid. While the dura is
5
<PAGE>
frequently closed with direct suture, surgeons who consider the prevention of
fluid leakage to be critical to the outcome of the operation will use a dural
repair patch.
Dura-Guard is designed to close dural incisions by fusing with the patient's
dura but with little or no adhesion (an abnormal union between two tissue
surfaces not intended to be joined) to the underlying brain cortex, a
complicating factor following any cranial surgery. Studies commissioned by the
Company have shown that fibrous bone cells invade the Dura-Guard surface facing
the cranium, as they do the human dura, inviting good host tissue incorporation.
The collagen configuration of the processed bovine pericardium in Dura-Guard
reapproximates around the sutures used to affix the patch, thereby providing a
barrier between the skull and the tissue layers underlying the dura and
preventing the leakage of cerebral spinal fluid.
Vascu-Guard
Vascu-Guard, a vascular repair patch, is primarily used in carotid
endarterectomy and other peripheral vascular procedures in which an artery must
be repaired and closing the vessel without a patch is insufficient. Carotid
endarterectomy is a surgical procedure used to remove atherosclerotic plaque
build-up in carotid arteries, the principal arteries located in the neck that
supply blood to the brain.
The build-up of atherosclerotic plaque (fat deposits with a proliferation of
fibrous connective cells along the artery walls) in the carotid arteries
increases the risk of stroke. A substantial portion of strokes is caused by a
fragment of atherosclerotic plaque breaking away from the inner wall of the
carotid artery and becoming lodged in an artery in the brain. Drug therapy is
often prescribed to treat early indications of atherosclerotic plaque build-up.
If the condition progresses to a point where drug therapy is not effective,
surgical intervention is often required.
Although the artery often can be closed without a patch, use of a patch has been
shown to significantly reduce the risk of recurrent disease. Certain patients
require patching due to the small size of their carotid arteries, or to decrease
the incidence of post-operative occlusion. The Company has commissioned studies
that have shown that Vascu-Guard supports endothelialization (growth of a cell
layer normally lining the interior of blood vessels) and that its non-
thrombogenic blood flow surface imitates the blood flow characteristics of
autologous vessels. In addition, its pulsatility (ability to reflect movement
signifying the rhythmic pumping of the heart) allows a surgeon to readily verify
normal blood flow after implantation.
Ocu-Guard
Ocu-Guard, an orbital implant wrap, is used in enucleation (removal of the eye)
surgery. Enucleation is a procedure which removes a patient's eye as a result
of trauma, malignancy or end-stage diseases such as glaucoma or diabetes.
Following enucleation surgery, a patient commonly receives an orbital implant
from which the visible prosthetic eye is attached. The implant used in the
majority of these procedures requires a soft-tissue wrap, such as Ocu-Guard.
Ocu-Guard is manufactured in convenient, pre-formed configurations to fit the
most common orbital implant sizes. The preformed configuration reduces implant
preparation time, provides ease of insertion and a snug fit around the implant.
Ocu-Guard has excellent handling characteristics allowing for ease of suturing.
Ocu-Guard also has strength and durability for suture retention necessary for
muscle attachment, which provides the motility of the prosthetic eye and also
promotes vascular in-growth again promoting the motility of the prosthesis.
CV Peri-Guard
CV Peri-Guard, an intracardiac repair patch, is used in a variety of surgical
procedures performed on the heart. Specific procedures in which CV Peri-Guard
is used include aortic and atrial patching, atrial and ventricular septal defect
repair, valve annuloplasty, and ventricular aneurysm repair. The Company's Peri-
Guard products have over a 15 year history of clinical use as a cardiac patch,
but cardiac indications for use under the Company's FDA marketing clearance were
previously limited to pericardial closure. With CV Peri-Guard, marketing
clearance was received from the FDA for a much broader range of cardiac uses and
specifically for intracardiac repair. CV Peri-Guard is the first biological
product cleared by the FDA for intracardiac patching.
6
<PAGE>
Biograft
Biograft, a peripheral vascular graft manufactured from human umbilical veins,
is indicated for use in lower limb vascular reconstruction when a saphenous vein
is not available. Certain diseases, such as diabetes, can cause a restriction
or occlusion in the arteries which provide blood to the legs. If left
untreated, insufficient blood flow can ultimately result in the need for
amputation. If drug therapy is not deemed an effective treatment based upon the
severity of the restriction or blockage, the use of a graft in peripheral
vascular reconstructive surgery may be needed. In this type of surgical
procedure, the surgeon can bypass the blocked artery to regain blood
circulation, thereby saving the affected limb. Diabetics, in particular, are
often at risk for amputation of a lower limb due to insufficient blood flow in
the femoral artery in the thigh. By implanting a graft from the upper portion
of the femoral artery to either the lower femoral artery or to the popliteal
artery below the knee, the surgeon is able to increase blood flow below the site
of the restriction or blockage. Long-term patency (openness), and a thrombo-
resistant surface that provides smooth blood flow are essential qualities of an
effective graft.
Saphenous veins (autologous veins from the leg) typically provide the most
effective grafting material. In many instances, however, a suitable saphenous
vein may be unavailable in sufficient quantity or quality, and a substitute
graft must be used. The primary alternative substitute grafts involve synthetic
grafts made from PTFE, bio-synthetic materials or tissue-based grafts, such as
Biograft.
Biograft offers advantages over competitive vein grafts produced from synthetic
materials due to its thrombo-resistant surface, which provides smooth blood flow
and minimizes turbulence and risk of occlusion. Other competitive advantages of
Biograft include its long-term patency and its similarity to an autologous blood
vessel, minimizing intimal hyperplasia (a build up of cells on the interior of
the blood vessel, which results in restricted blood flow). In addition, a
knitted and supportive Dacron mesh placed around the graft allows for easier
handling and promotes tissue integration for strength and stability.
Surgical Productivity Tools: Bio-Vascular Probe, Flo-Rester and Flo-Thru
Intraluminal Shunt
Bio-Vascular Probe is a flexible shaft with varying sizes of bulbous tips on
either end. Surgeons use Bio-Vascular Probes to locate occlusions or blockages
in arteries and to ascertain the blood flow characteristics of arteries. A Bio-
Vascular Probe is inserted and fed into an artery. When the tip of the probe
meets resistance, the surgeon is able to identify the exact location of the
occlusion. The probe is then extracted and a bypass is completed below the
occlusion. In addition, a Bio-Vascular Probe can be used to atraumatically lift
the edge of the incision to assist the surgeon in the accurate placement of
sutures.
Flo-Rester, a vessel occluder, is manufactured from medical grade silicone.
Flo-Rester products are designed to interrupt blood flow. In surgical
procedures where continual blood flow is not required, Flo-Rester provides a
stented, blood-free, operative site during surgery. These products are
primarily used during coronary artery bypass graft surgeries in which blood is
routed past the heart through a heart / lung bypass machine in order to keep the
heart free of blood during surgery. During such procedures, incidental blood
flow can obstruct the surgeon's view of the operative site and interfere with
precise suturing. Flo-Rester consists of a flexible shaft with small bulbs at
each end that are inserted into the blood vessel to stop the blood flow at the
point where the artery bypass is sutured to the artery.
Flo-Thru Intraluminal Shunt is intended for use in minimally invasive beating
heart cardiac procedures where the patient is not placed on a heart / lung
bypass machine. The device enables a surgeon to perform a safe, easy and
precise anastomosis during coronary artery bypass by facilitating a bloodless,
stented operative field while maintaining distal blood flow. Flo-Thru
Intraluminal Shunt is a single-piece radiopaque silicone tube with atraumatic
bulbs, of varying size, on either ends of the silicone tube. Similar to Flo-
Rester, a radiopaque tab identifying the outer diameter of the bulbs is attached
to the shunt by a tether, which is used to facilitate positioning and removal.
7
<PAGE>
Competition
The Company's branded products compete primarily on the basis of product
performance, service and price. The surgical products market in which the
Company competes is characterized by intense competition. This market is
dominated by established manufacturers that have broader product lines, greater
distribution capabilities, substantially greater capital resources and larger
marketing, research and development staffs and facilities than the Company.
Many of these competitors offer broader product lines within the Company's
specific product market, particularly in the Company's surgical tool product
markets and/or in the general field of medical devices and supplies. Broad
product lines give many of the Company's competitors the ability to negotiate
exclusive, long-term medical device supply contracts and, consequently, the
ability to offer comprehensive pricing for their products, including those that
compete with the Company's products. By offering a broader product line in the
general field of medical devices and supplies, competitors may also have a
significant advantage in marketing competing products to group purchasing
organizations, health maintenance organizations and other managed care
organizations that increasingly seek to reduce costs by centralizing and
consolidating their purchasing functions.
Competition with Tissue-Guard products is primarily from synthetic materials,
other biological tissues and cadaveric tissue. The ability of these alternative
products to compete with Tissue-Guard products varies based on each such
product's indication for use, relative feature benefits and surgical preference.
There can be no assurance that competing products will not achieve greater
acceptance or that future products developed by competitors will not offer
similar or enhanced performance advantages relative to the Tissue-Guard
products.
Synthetic patches are generally cheaper to produce and to the extent that
comparable synthetic patches are available and effective in surgical procedures,
the Company faces significant price competition for its Tissue-Guard products.
W. L. Gore & Associates, Inc., manufacturer of Gore-Tex(R), is believed to have
a prominent position in the synthetic patch market. There are other multi-
purpose patches made from bovine and other types of animal tissue that compete
with the Company's products, including bovine pericardium products produced by
Baxter International Inc., Medtronic, Inc. and Shelhigh, Inc. The Company does
not believe that these alternative bovine pericardium products have specific FDA
marketing clearance for all surgical specialty markets in which the Company
competes. The Company believes that the collagen characteristics exclusive to
tissue, the special configuration of its Tissue-Guard products and the
proprietary and patented tissue-fixation technology it employs offer significant
product performance and it intends to continue to compete on these bases.
Cadaveric tissue from tissue banks is sometimes utilized in neurological and
ophthalmic surgery. Tissue-Guard products offer the distinct advantage of
availability, product uniformity and ideal handling characteristics.
Competitive products to Biograft include synthetic grafts and other biological
grafts. Surgeons generally prefer the patient's own vessels for lower limb
vascular reconstruction. When the patient's own vessels are not available in
sufficient quality or quantity, surgeons choose a prosthetic graft such as
Biograft, or synthetic grafts made from PTFE produced by W. L. Gore &
Associates, Inc., IMPRA, Inc. or other grafts made of biological materials, such
as the CryoVein(R) by CryoLife, Inc.
Description of the Component Products Segment
- ---------------------------------------------
The component products segment produces critical micro components primarily from
wire materials, which it supplies on an OEM basis according to customer
specifications. These products include micro precision coils, stylets and
related wire products and guidewire components and subassemblies. Each of these
component categories comprises approximately one third of the segment's revenues
according to customer specifications.
Micro precision coils
Micro precision coils are precision wire components, comprised normally of
several strands of specialty wire materials wound into specific configurations.
These coils are manufactured utilizing proprietary processes and typically
involve the use of specialty metals such as medical grade stainless steel,
silver, platinum, and other similar metals. These micro coils are used to either
carry the electrical current required for operation of a medical device or
8
<PAGE>
to assist the installation of the medical device within the patient's body.
Stylets and related wire products
Stylets and related wire products are produced through the use of proprietary
processes and medical grade stainless steel. This product category also
includes some plastic components. Stylets are typically used in the placement
of cardiovascular and vascular devices within the patient's body.
Guidewire components and subassemblies
Guidewire components and subassemblies are made of medical grade stainless
steel, and are manufactured through a combination of proprietary processes and
one critical, but adapted, grinding process. A guidewire is typically used at
the beginning of a surgical procedure to locate and provide a channel for the
placement of a diagnostic or therapeutic device.
There are two significant trends affecting the growth and development of the
Company's component product business. The first is the rapidly growing use of
implantable defibrillation devices in the treatment of sudden cardiac death.
The second trend is the development of less invasive diagnostic and therapeutic
procedures in the cardiovascular and interventional medicine segments. These
procedures require improved diagnostics, therapies, and placement of medical
devices such as stents. Significant international markets also exist in Europe
and Japan.
The primary companies involved in the industry segments mentioned above include
Medtronic, Inc., Guidant Corporation (which acquired Sulzer Intermedics during
fiscal 1999), St. Jude Medical (through its Pacesetter unit) and Boston
Scientific. In addition, numerous early stage companies are pursuing new
technologies in cardiovascular and interventional medicine, especially
neurological intervention. The Company anticipates that the cardiovascular and
interventional medicine industry will continue to experience significant
consolidation with the acquisition of earlier stage companies by the major
industry participants. Although there can be no assurance, the Company believes
that this consolidation will not hinder its component products segment growth
opportunity as the major participants are expected to continue to seek multiple
supply sources for critical device components such as those offered by the
Company.
Competition
The component products segment competes on the basis of superior quality of
processes and production, rapid and flexible customer response, and to a modest
degree, price. The component part usually comprises a minor portion of the total
device-level price. Accordingly, vendor performance and responsiveness are
generally more critical factors. There are four primary competitors to the
Company, all of which are privately held. One competitor is substantially
larger than the Company with annual revenues estimated in the range of $100
million. Given the concentration of the wire component product industry, the
Company believes that medical device customers are generally motivated to
promote healthy competition among their various suppliers in order to ensure
multiple supply sources for their critical device components.
Intellectual Property
Description of the Branded Products Segment
- -------------------------------------------
In its branded products business, the Company relies on patents, trade secrets
and proprietary know-how which it seeks to protect, in part, through
confidentiality agreements with employees, consultants and other parties.
Supple Peri-Guard, which is used in the manufacture of the majority of the
Company's Tissue-Guard products, is protected exclusively by trade secrets. The
Company owns United States patents related to Peri-Strips, Peri-Strips Dry and
Peri-Guard. During the year ended October 31, 1999, the Company filed two
patent applications to protect new and proprietary technologies. One of these
applications relates to the manufacturing and use of stent coverings formed of
biological tissues, and the other is for the Company's new "resorbable" line of
tissue implant materials. The Company currently has a United States patent
pending relating to Ocu-Guard. The Company also has an exclusive, worldwide,
perpetual license to make, use and sell its Flo-Rester product.
9
<PAGE>
Description of the Component Products Segment
- ---------------------------------------------
In its component products business, the Company relies exclusively on trade
secret protection for its processes. The Company seeks to practice strict trade
secret discipline with all employees, consultants, customers and other parties.
A non-disclosure protocol is maintained on behalf of each of its customers,
consistent with the highly competitive nature of these customers at the base
device-level. The technology and equipment utilized in the manufacturing process
is a combination of proprietary know-how, and the adaptation of and development
utilizing readily-available equipment.
Marketing and Customers
Description of the Branded Products Segment
- -------------------------------------------
The Company's branded products strategy is to ensure that the Company has
products of superior quality supported by innovative and effective sales and
marketing programs. These programs include surgical trade shows, support of the
gathering, publication and presentation of clinical data and new product
information by key surgeons and the development of strategic physician
alliances. The marketing and sales strategy of the Company also includes
developing and maintaining a close working relationship with the hospitals and
surgeons who purchase and use the Company's products in order to assess and
satisfy their needs.
The Company sells its products through a combination of third-party distributors
and independent sales representatives. The Company's marketing and sales
function works closely with these distributors and representatives on the
implementation of marketing strategy and sales assistance including product
knowledge, training and presentation. The Company generally has written
agreements with its distribution partners. These agreements generally impose
limited geographic exclusivity and minimum purchase obligations. These
agreements are typically terminable upon breach of the agreement by the
distributor, including breach of the minimum sales obligations imposed by the
agreement.
Description of the Component Products Segment
- ---------------------------------------------
The component products segment's strategy is to proactively seek significant
partnerships with each of the primary participants in the medical device markets
it serves. The primary marketing strategy is to provide a rapid, flexible and
creative response to customer needs, coupled with state of the art, high quality
production response. The Company utilizes its Technology Development Center and
Rapid Response Unit for design, development and prototype services. The
utilization of these highly-technical solutions and timely, effective delivery
of development prototypes is believed to provide a key competitive advantage to
both the customer and the component products business. The component products
segment has also achieved ISO 9002 certification as a further demonstration to
its customers of its quality commitment. The segment's internal sales and
marketing function is supplemented by the capabilities of an external third
party sales representative group.
Information regarding the Company's significant customers under the caption
"Major Customers and Net Revenue by Geographic Area" on page 23 of the Company's
1999 Annual Report is incorporated herein by reference.
Information Regarding Both Segments
Backlog
- -------
The branded products segment normally does not experience significant backlogs.
Because the component products business is "build-to-order", the component
products segment typically has firm customer orders awaiting manufacture and
future release. The component products order backlog was $1,406,000 at October
31, 1999 as compared to $1,051,000 at October 31, 1998. The component products
segment does not expect any difficulty fulfilling these backlog orders as
scheduled in fiscal 2000. The Company does not believe that its backlog is a
meaningful indicator of its future business in the component products segment.
10
<PAGE>
Raw Materials
- -------------
The Company acquires bovine pericardium for use in the Tissue-Guard product line
from United States Department of Agriculture ("USDA") inspected meat packing
facilities. The Company acquires human umbilical cords for use in Biograft from
various hospitals throughout the United States. The supply of wire, plastics
and plastic components required for the branded surgical productivity tools and
component products is currently adequate. The Company has not experienced any
product shortages arising from interruptions in the supply of any raw materials
or components, and has identified alternative sources of supply for significant
raw materials and components.
Research and Development
- ------------------------
As a component of the Company's business growth strategy, the Company continues
to make a significant investment in new product development in both its branded
and component products businesses.
The majority of the Company's investment is on branded product opportunities
applying both existing and newly developed technological expertise in the
processing of biological tissues. Current branded product development efforts
are primarily directed towards a sling for the surgical treatment of female
urinary stress incontinence, a small diameter graft and a stent covering
utilizing biological tissue. All three of these projects involve new and
advanced tissue formats which have been under development for approximately two
years. The animal feasibility testing phase for each of these projects was
begun in early fiscal 2000. These are projects with long development timelines,
but potentially very large returns.
The Company also targets research resources to the design and engineering of
development stage solutions to meet its component products customers'
specifications. This is a partnership to resolve problems and achieve high
performance solutions, typically occurring when the customer's program is
entering the prototype stage. During fiscal 1999, the component products
business opened its Technology Development Center (TDC), which was established
to provide creative solutions for their customers in addition to rapid response
prototyping. The design rights to the components produced by the component
products segment accrue to the customer in the vast majority of cases.
Governmental Regulation
General
- -------
The medical device industry in which the Company's branded products segment and
the customers of the Company's component product segment operate is subject to
extensive and rigorous regulation by the Food and Drug Administration ("the
FDA") and by comparable agencies in foreign countries. In the United States,
the FDA regulates the introduction, manufacturing, labeling and record keeping
procedures for medical devices including the Company's branded products and
medical devices incorporating the Company's component products.
Food and Drug Administration
- ----------------------------
FDA regulations classify medical devices as either Class I, II or III devices,
which are subject to general controls, special controls or pre-market approval
("PMA") requirements, respectively. While most Class I devices are exempt from
pre-market submission, it is necessary for most Class II devices, as well as
some Class I devices to be cleared by a 510(k) pre-market notification prior to
marketing. This establishes that the device is ''substantially equivalent'' to
a device that was legally marketed prior to May 28, 1976, the date on which the
Medical Device Amendments of 1976 became effective. The 510(k) pre-market
notification must be supported by data establishing the claim of substantial
equivalence to the satisfaction of the FDA. The process of obtaining a 510(k)
clearance typically can take several months to a year or longer. If substantial
equivalence cannot be established, or if the FDA determines that the device or
the particular application for the device requires a more rigorous review, the
FDA will require the manufacturer to submit a PMA application for a Class III
device that must be reviewed and approved by the FDA prior to sale and marketing
of the device in the United States. The PMA application must contain the
11
<PAGE>
results of clinical trials and relevant prototype tests, laboratory and animal
studies. It must also contain a complete description of the device , its
components and a detailed description of the methods, facilities and controls
used for manufacturing, including the method of sterilization. In addition, the
submission must include the proposed labeling, advertising literature and
training methods, if applicable. The process of obtaining PMA can be expensive,
uncertain, lengthy and frequently requires anywhere from one to several years
from the date of FDA submission, if approval is obtained at all. Moreover, PMA,
if granted, may include significant limitations on the indicated uses for which
a product may be marketed. FDA enforcement policy strictly prohibits the
marketing of approved medical devices for unapproved uses. In addition, product
approvals can be withdrawn for failure to comply with regulatory standards or
the occurrence of unforeseen problems following initial marketing.
Of the Company's current branded products, Biograft is a Class III device.
Biograft received marketing clearance from the FDA pursuant to the PMA process.
All other branded products have all been classified as Class II medical devices
and have received 510(k) marketing clearance from the FDA.
The Company's branded products manufacturing operation is subject to periodic
inspections by the FDA, whose primary purpose is to audit the Company's
compliance with the Quality System Regulations (''QSR'') published by the FDA
and other applicable government standards. Strict regulatory action may be
initiated in response to audit deficiencies or to product performance problems.
The Company believes that its manufacturing and quality control procedures are
in compliance with the requirements of the FDA regulations.
International Regulation
- -------------------------
International regulatory bodies have established varying regulations governing
product standards, packaging and labeling requirements, import restrictions,
tariff regulations and duties and tax. Many of these regulations are similar to
those of the FDA. In Japan, a potentially significant market for the Company's
branded products, clinical trials of certain branded products are required
before such products can be cleared for sale in the Japanese market. To date,
this has delayed the Company's market entry in some cases, but has not
ultimately prevented sales in Japan of any of the Company's branded products.
The Company relies on its independent distributors to comply with the majority
of the foreign regulatory requirements, including registration of the Company's
branded products with the appropriate governmental authorities. To date, the
Company has been successful in complying with the regulatory requirements in
most foreign countries in which its branded products are marketed. (See
Important Factors - Bovine Tissue Products on Page 14 of this Report.)
The registration system in the European Union ("EU") for the Company's branded
products requires that the Company's quality system conform with the ISO 9001
international quality standard and that its branded products conform with
"essential requirements" set forth by the Medical Device Directive ("MDD"). The
Company's manufacturing facilities and processes under which the Company's
branded products are produced were inspected and audited by the British
Standards Institute ("BSI") to verify the Company's compliance with the
essential requirements of the MDD. BSI also verified that the Company's quality
system conforms with the ISO 9001 international quality standard and that its
products conform with the "essential requirements" set forth by the MDD for the
class of branded products produced by the Company. BSI certified the Company's
conformity with both the ISO 9001 standard and the MDD essential requirements,
entitling the Company to place the "CE" mark on all the Company's current
branded products, except Biograft which is exempt. (See Important Factors -
Human Tissue Products on Page 13 of this Report.)
Third Party Reimbursement
The Company's branded products are purchased primarily by hospitals and other
end-users, and its unbranded component products are sold directly to medical
device manufacturers which distribute finished medical devices to hospitals and
other end-users. Hospitals and end-users of such products, in turn, bill
various third party payers for the services provided to the patients. These
payers, which include Medicare, Medicaid, private health insurance plans and
managed care organizations, reimburse all or part of the costs and fees
associated with the procedures utilizing the Company's products.
The availability and level of reimbursement from third-party payers is
significant to the Company's business. For
12
<PAGE>
Medicare carriers, HCFA may establish a national coverage policy, including the
amount to be reimbursed, for coverage of claims submitted for reimbursement
related to a specific procedure. Private health insurance plans and managed care
organizations make their own determinations regarding coverage and reimbursement
based either upon "usual and customary" fees or, increasingly, upon a similar
prospective payment system.
In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be, proposals by legislators and regulators
and third party payers to curb these costs. The development or increased use of
more cost effective treatments for diseases requiring surgeries currently
utilizing the Company's branded products could cause such payers to decrease or
deny reimbursement for such surgeries or to favor non-surgical alternatives.
There has also been a significant increase in the number of Americans enrolling
in some form of managed care plan. Higher managed care utilization typically
drives down the payments for health care procedures, which in turn places
pressure on medical supply prices. This causes hospitals to implement tighter
vendor selection and certification processes, by reducing the number of vendors
used, purchasing more products from fewer vendors and trading discounts on price
for guaranteed higher volumes to vendors. Hospitals have also sought to control
and reduce costs over the last decade by joining group purchasing organizations
or purchasing alliances. The Company cannot predict what continuing or future
impact these practices, the existing or proposed legislation, or such third-
party payer measures may have on its future business, financial condition or
results of operations.
Employees
At October 31, 1999, the Company employed approximately 220 full-time and part-
time individuals. The Company's employees are not represented by a union, and
the Company considers its relationship with its employees to be good.
(d) Financial Information About Foreign and Domestic Operations and Export Sales
The information under the caption "Major Customers and Net Revenue by Geographic
Area" on page 23 of the Company's 1999 Annual Report is incorporated herein by
reference.
ITEM 1A - Important Factors
- ---------------------------
The following factors are important and should be considered carefully in
connection with any evaluation of the Company's business, financial condition,
results of operations and prospects. Additionally, the following factors could
cause the Company's actual results to materially differ from those reflected in
any forward-looking statements of the Company.
Health Care Industry: Health care industry factors, including the
unpredictability of reductions and limitations on third-party (governmental
health programs, private health insurance, managed care organizations and other
similar programs) reimbursement levels for procedures using the Company's
products and increased customer demands for price concessions.
Competitive Industry: Competitive industry factors including the Company's and
its component business' customer's ability to contend with rapid product
innovation and technological change in the medical device industry, and its
ability to effectively compete with larger, well-established manufacturers of
competing products.
Intellectual Property: Intellectual property factors, including the protection
of intellectual property through trade secrets, propriety know-how,
confidentiality agreements and patents, both owned and licensed, and the
Company's ability to ensure such protective measures are obtained and remain
effective to keep competitors from using similar technologies or from marketing
comparable products. Litigation may be necessary to enforce such protective
measures or to defend the Company's technology that a competitor claims
infringes upon their product.
Human Tissue Product: Human tissue product factors include recently focused
attention on the safety of tissue banks, spurred by incidents of the
transmission of human disease during tissue transplantation. In the United
States,
13
<PAGE>
regulations drafted by the FDA have outlined requirements for tissue banks.
Although the current regulations have specifically excluded from regulation
medical devices subject to FDA review, including preserved umbilical cord vein
grafts such as Biograft (the Company's only product derived from human tissue),
proposed rules indicate that medical devices containing human tissue products
may be subject to additional controls. Also, the long-term future regulatory
environment for Biograft in Europe is uncertain. The MDD issued by the EU
explicitly excludes medical devices from human tissue; however, there is an
effort developing to include such devices under a comprehensive regulatory
program. This effort is in the early stages, and the Company understands that a
consensus on such a directive could take several years. As a result, Biograft
may be subject to additional regulations in the United States and Europe, which
could make it uneconomical to sell Biograft under a regulatory program.
Bovine Tissue Products: Bovine Tissue Product factors include Bovine Spongiform
Encephalopathy ("BSE"), which has been endemic in cattle in the United Kingdom
and has received much publicity in Europe regarding beef for dietary
consumption. Under the direction of the USDA, the U.S. government has had an
active program of surveillance and import controls since the late 1980's,
designed to prevent the introduction of BSE into U.S. cattle. To date all
evidence indicates that U.S. cattle are free of BSE. The Company obtains all of
its raw pericardium for its Tissue-Guard products from USDA-inspected
slaughterhouses. The World Health Organization (WHO) has categorized the the
levels of BSE infectivity of tissue and fluids on a scale of 1 to 4, with
category 4 representing no detectable infectivity. The WHO has classified raw
pericardium in category 4. The Company's notified body under the MDD, the BSI,
and French authorities have specifically reviewed Tissue-Guard sourcing and
manufacturing processes and have then certified the Company's bovine pericardium
products. Although the Company does not anticipate that countries will prohibit
the sale of Tissue-Guard products as a result of concerns related to BSE, such
prohibition by certain countries could have a material adverse effect on the
Company's business, financial condition and results of operations.
Governmental Regulation: Governmental regulation factors, including the laws
and regulations, policies and judicial decisions that affect the regulation of
the Company's products, and delays and uncertainties in the regulatory approval
process in the United States and other countries, which could result in lost
market opportunities.
Product Liability Claims and Product Recall: Product liability claims and
product recall factors, including unexpected safety, performance and efficacy
concerns with the Company's products, which could lead to product recalls,
withdrawals, loss of sales and significant liability claims against the Company.
Also, the risk that the Company's product liability insurance coverages would
not be adequate to cover product liability claims made against the Company.
Dependence on Distributors and Sales Representatives: The risk factors
pertaining to the Company's dependence on domestic and international
distributors and sales representatives, which are utilized to transact a
significant portion of the Company's current business related to its branded
products, and the effects on the Company's operations due to a loss of a
significant distributor or a significant number of other distributors or sales
representatives.
Euro Conversion: The Euro conversion factors, including the uncertain impact of
the conversion on the competitive environment in which the Company operates and
its relationships with international distributors. The Company currently
denominates all of its foreign transactions in U.S. dollars.
Dependence on Significant Customer: The risk factors associated with the
Company's significant dependence on one component products customer, and the
effects on the Company's operations and financial results with changes in the
customer's ordering patterns or loss of the customer.
ITEM 2 - Properties
- -------------------
The Company leases approximately 36,000 square feet of office and manufacturing
space for its general offices and branded products business at 2575 University
Avenue, St. Paul, Minnesota. The base rent of this lease, which commenced
August 1, 1995 and expires July 31, 2005, is approximately $255,000 annually.
The Company also has two leases on two facilities for its component products
business totaling 29,000 square feet at 471 and 475 Apollo
14
<PAGE>
Drive, Lino Lakes, Minnesota. The base rent of the first lease for 25,000 square
feet, which commenced December 1, 1997 and expires five years from that date
with a subsequent five year option, is approximately $103,000 annually. The base
rent of the second lease for 4,000 square feet, which commenced April 1, 1999
and expires five years from that date with a subsequent five year option, is
approximately $26,500 annually. The Company pays apportioned real estate taxes
and common costs on all leased facilities. The Company believes that its current
space is adequate for the foreseeable future.
ITEM 3 - Legal Proceedings
- --------------------------
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 its insurance
coverage, are reasonably adequate to protect against potential material product
liability losses.
ITEM 4 - Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matter was submitted to a vote of security holders during the fourth quarter
of the fiscal year covered by this Report.
ITEM 4A - Executive Officers of the Registrant
- ----------------------------------------------
The Company's executive officers, their ages, and their offices held as of
December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Name Age Title
- ---- --- -----
<S> <C> <C>
M. Karen Gilles............. 57 President, Chief Executive Officer and Director
David A. Buche.............. 38 Vice President of Marketing and Sales
Connie L. Magnuson.......... 38 Vice President of Finance, Chief Financial Officer
and Corporate Secretary
B. Nicholas Oray, Ph.D...... 48 Vice President of Research and Development
James F. Pfau............... 56 President of Jerneen
</TABLE>
M. Karen Gilles. Ms. Gilles has served as President and Chief Executive Officer
of the Company since July 1997 and as a Director of the Company since August
1997. Prior to July 1997, Ms. Gilles held the positions of Chief Financial
Officer of the Company from December 1990, Vice President of Finance from 1989,
and Secretary of the Company from November 1991. Ms. Gilles served as the
Director of Finance and Administration of the Company from April 1989 to
December 1989. Ms. Gilles also serves on the Board of Directors of Reuter
Manufacturing, Inc.
David A. Buche. Mr. Buche has served as Vice President of Marketing and Sales
since January 1998. Prior to January 1998, Mr. Buche held the positions of
Director of Marketing from November 1997 and Director of International Marketing
and Sales from March 1995. From 1988 to February 1995, Mr. Buche held various
product
15
<PAGE>
and sales management positions at Spectranetics Corporation, a company that
develops and markets technology for interventional cardiovascular therapy.
Connie L. Magnuson. Ms. Magnuson joined the Company as Chief Financial Officer
and Vice President of Finance in November 1997 and has served as Corporate
Secretary since February 1998. From March 1997 to November 1997, Ms. Magnuson
served as Treasurer of Northern Technologies International Corporation. From
1996 to March 1997, Ms. Magnuson served as a private financial consultant. From
1983 to 1996, Ms. Magnuson held a series of positions with Deloitte and Touche
LLP, a public accounting firm, including Audit Senior Manager and Director of
Human Resources for their Minneapolis office.
B. Nicholas Oray, Ph.D. Dr. Oray joined the Company as Vice President of
Research and Development in April 1998. From 1997 to April 1998, he served as
Director of Research and Development at Seatrace Pharmaceuticals Inc. From 1993
to 1996, Dr. Oray held a series of positions with CryoLife Inc., including
Director of Bioadhesive Manufacturing and Associate Director of Biomedical
Products Laboratory. From 1991 to 1993, he held several positions with
F.A.C.T., a clinical research organization, including Director of Regulatory
Affairs and Associate Director of Clinical Trials Operations. From 1988 to
1990, Dr. Oray served as Director of Manufacturing, Director of Sterile
Manufacturing and Director of Purification and Production Group at Carrington
Laboratories, Inc.
James F. Pfau. Upon the completion of the Company's acquisition of Jerneen in
July 1998, Mr. Pfau was named President of Jerneen, having previously served as
Managing Director of Jerneen since October 1994. From 1990 to 1994, Mr. Pfau
was a business consultant and, for a period during that time, served as CEO and
President of a medical software start-up company.
16
<PAGE>
PART II
ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters
- ------------------------------------------------------------------------------
The information under the caption "Common Stock Information" on page 24 of the
Company's 1999 Annual Report is incorporated herein by reference.
ITEM 6 - Selected Financial Data
- --------------------------------
The financial information in the table under the caption "Financial Highlights"
on page 1 of the Company's 1999 Annual Report is incorporated herein by
reference.
ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
- -------------
The information under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" on pages 7-10 of the Company's
1999 Annual Report is incorporated herein by reference.
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
The Company's quantitative and qualitative disclosures about market risk are
included in Item 7.
ITEM 8 - Financial Statements and Supplementary Data
- ----------------------------------------------------
The Company's Consolidated Financial Statements and related Notes thereto on
pages 11-23 and the Report of Independent Accountants on page 24 of the
Company's 1999 Annual Report are incorporated herein by reference, as is the
unaudited information set forth under the caption "Quarterly Results" on page 24
of the Company's 1999 Annual Report.
ITEM 9 - Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure
- --------------------
None.
PART III
ITEM 10 - Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
(a) Directors of the Registrant:
The information under the caption "Election of Directors - Information
About Nominees" and "Election of Directors - Other Information About
Nominees" in the Registrant's 2000 Proxy Statement is incorporated herein
by reference.
(b) Executive Officers of the Registrant:
Information concerning Executive Officers of the Company is included in
this Report on page 15 under Item 4A, "Executive Officers of the
Registrant."
(c) Compliance with Section 16(a) of the Exchange Act:
The information under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Registrant's 2000 Proxy Statement is
incorporated by reference herein.
17
<PAGE>
ITEM 11 - Executive Compensation
- --------------------------------
The information under the captions "Executive Compensation" and "Election of
Directors - Directors' Compensation" in the Registrant's 2000 Proxy Statement is
incorporated by reference herein.
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
The information under the caption "Principal Shareholders and Beneficial
Ownership of Management" in the Registrant's 2000 Proxy Statement is
incorporated by reference herein.
ITEM 13 - Certain Relationships and Related Transactions
- --------------------------------------------------------
The information under the caption "Executive Compensation - Certain
Transactions" in the Registrant's 2000 Proxy Statement is incorporated by
reference herein.
PART IV
ITEM 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------------------------------------------------------------------------
(a) List of documents filed as part of this Report:
1) Financial Statements, Related Notes and Report of Independent
Accountants:
The following items are incorporated herein by reference from the
pages indicated in the Company's 1999 Annual Report:
<TABLE>
<CAPTION>
Page
----
<S> <C>
- Consolidated Balance Sheets as of October 31, 1999 and 1998 11
- Consolidated Statements of Operations for the years ended
October 31, 1999, 1998 and 1997 12
- Consolidated Statements of Comprehensive Income and
Shareholders' Equity for the years ended
October 31, 1999, 1998 and 1997 13
- Consolidated Statements of Cash Flows for the years ended
October 31, 1999, 1998 and 1997 14
- Notes to Consolidated Financial Statements 15-23
- Report of Independent Accountants 24
</TABLE>
The unaudited selected quarterly financial data included under the
caption "Quarterly Results" on page 24 of the Company's 1999 Annual
Report is incorporated herein by reference.
2) Financial Statement Schedules:
The following financial statement schedule and Report of Independent
Accountants thereon are included herein and should be read in
conjunction with the Consolidated Financial Statements referred to
above (page numbers refer to pages in this Annual Report on Form 10-
K):
<TABLE>
<CAPTION>
Page
----
<S> <C>
- Report of Independent Accountants on Financial Statement Schedule 21
- Schedule II - Valuation and Qualifying Accounts 22
</TABLE>
18
<PAGE>
All other financial statement schedules not listed have been omitted
because the required information is included in the Consolidated
Financial Statements or the Notes thereto, or is not applicable.
3) Exhibits:
The exhibits to this Annual Report on Form 10-K are listed in the
Exhibit Index on pages E-1 to E-3 of this Report.
The Company will furnish a copy of any exhibit to a shareholder who
requests a copy in writing upon payment to the Company of a fee of
$5.00 per exhibit. Requests should be sent to: Connie L. Magnuson,
Vice President of Finance and Chief Financial Officer, Bio-Vascular,
Inc., 2575 University Avenue, St. Paul, Minnesota 55114-1024.
The following is a list of each management contract or compensatory
plan or arrangement required to be filed as an exhibit to this Annual
Report of Form 10-K pursuant to Item 14(c):
A. 1988 Stock Option Plan, as amended, (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended April 30,
1992 (File No. 0-13907)).
B. 1995 Stock Incentive Plan, as amended (incorporated by
reference to Exhibit 10.15 to the Company's Annual
Report of Form 10-K for the year ended October 31, 1998
(File No. 0-13907)).
C. Employee Stock Purchase Plan, as amended (incorporated
by reference to Exhibit 10.18 to the Company's Annual
Report of Form 10-K for the year ended October 31, 1997
(File No. 0-13907)).
D. Form of Change in Control Agreement entered into
between the Company and Ms. M. Karen Gilles
(incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended
October 31, 1994 (File No. 0-13907)).
E. Form of Change in Control Agreement entered into
between the Company and each of Ms. Connie L. Magnuson
dated January 12, 1998 and Mr. David A. Buche dated
January 29, 1998 (incorporated by reference to Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for
the period ended January 31, 1998 (File No. 0-13907)).
F. Employment Agreement dated July 31, 1998 among the
Company, Jer-Neen Manufacturing Co., Inc. and James F.
Pfau (incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the period
ended July 31, 1998 (File No. 0-13907)).
G. Change in Control Agreement dated July 31, 1998 between
the Company and Mr. James F. Pfau (incorporated by
reference to Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the period ended July 31, 1998
(File No. 0-13907)).
19
<PAGE>
H. Change in Control Agreement dated February 1, 1999
between the Company and Dr. B. Nicholas Oray
(incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the period
ended January 31, 1999 (File No. 0-13907)).
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the fiscal quarter
ended October 31, 1999.
(c) Exhibits:
The response to this portion of Item 14 is included as a separate
section of this Annual Report on pages E-1 through E-3 of the Form 10-
K.
(d) Financial Statement Schedules:
The response to this portion of Item 14 is included as a separate
section of this Annual Report on page 22 of the Form 10-K.
20
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Shareholders and Board of Directors
of Bio-Vascular, Inc.
Our audits of the consolidated financial statements referred to in our report
dated December 3, 1999 appearing in the 1999 Annual Report to Shareholders of
Bio-Vascular, Inc. (which report and consolidated financial statements are
incorporated by reference in this Annual Report on Form 10-K) also included an
audit of the financial statement schedule listed in Item 14(a)(2) of this Form
10-K. In our opinion, this financial statement schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
/s/ PRICEWATERHOUSECOOPERS LLP
PRICEWATERHOUSECOOPERS LLP
Minneapolis, Minnesota
December 3, 1999
21
<PAGE>
SCHEDULE II
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
BIO-VASCULAR, INC.
VALUATION AND QUALIFYING ACCOUNTS
- -------------------------------------------------------------------------------------------------------
Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended October 31, 1999............ $ 128,000 $ 14,000 $ 44,000 $ 98,000
Year ended October 31, 1998............ 21,000 113,000 6,000 128,000
Year ended October 31, 1997............ 21,000 - - 21,000
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reserve for obsolete inventories:
Year ended October 31, 1999............ $ 479,000 $ 118,000 $ 19,000 $ 578,000
Year ended October 31, 1998............ 373,000 194,000 88,000 479,000
Year ended October 31, 1997............ 368,000 116,000 111,000 373,000
</TABLE>
22
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
BIO-VASCULAR, INC.
By /s/ M. Karen Gilles
----------------------------------------------------------
M. Karen Gilles, President and Chief Executive Officer
(Principal Executive Officer)
Dated: January 28, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on January 28, 2000 by the following persons on behalf of
the registrant and in the capacities indicated.
/s/ M. Karen Gilles
- --------------------------------------------------------------------------------
M. Karen Gilles
President, Chief Executive Officer and Director
/s/ Connie L. Magnuson
- --------------------------------------------------------------------------------
Connie L. Magnuson
Vice President of Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ Timothy M. Scanlan
- --------------------------------------------------------------------------------
Timothy M. Scanlan
Chairman, Board of Directors
/s/ Richard W. Perkins
- --------------------------------------------------------------------------------
Richard W. Perkins, Director
/s/ Anton R. Potami
- --------------------------------------------------------------------------------
Anton R. Potami, Director
/s/ William G. Kobi
- --------------------------------------------------------------------------------
William G. Kobi, Director
/s/ Edward E. Strickland
- --------------------------------------------------------------------------------
Edward E. Strickland, Director
23
<PAGE>
BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
2.1 Acquisition Agreement and Plan of Reorganization by and among the
Company, Jer-Neen Acquisition, Inc., Jer-Neen Manufacturing Co., Inc.,
George Nelson, Jr., Ronald Breckner, James Pfau, Willard Sykes and
Catherine Sykes dated July 31, 1998 (incorporated by reference to
Exhibit 2.1 to the Company's Quarterly Report on Form 10-Q for the
period ended July 31, 1998 (File No. 0-13907)).
3.1 Restated Articles of Incorporation of the Company, as amended,
(incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended April 30, 1997 (File No. 0-
13907)).
3.2 Amendment to Restated Articles of Incorporation of the Company, as
amended, dated March 20, 1997 (incorporated by reference to Exhibit 3.2
to the Company's Quarterly Report on Form 10-Q for the quarter ended
April 30, 1997 (File No. 0-13907)).
3.3 Amended and Restated Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Registration Statement on Form S-4 (File
No. 33-74750)).
4.1 Form of common stock Certificate of the Company (incorporated by
reference to Exhibit 4.1 to the Company's registration statement on Form
10 (File No. 0-13907)).
4.2 Form of Rights Agreement, dated as of June 12, 1996, between Bio-
Vascular, Inc. and American Stock Transfer & Trust Company, which
includes as Exhibit A the form of Rights Certificate (incorporated by
reference to Exhibit 4.1 to the Company's Current Report on Form 8-K
dated June 12, 1996 (File No. 0-13907)).
4.3 Restated Articles of Incorporation of the Company, as amended (see
Exhibit 3.1).
4.4 Amendment to Restated Articles of Incorporation of the Company, as
amended, dated March 20, 1997 (see Exhibit 3.2).
4.5 Amended and Restated Bylaws of the Company (see Exhibit 3.3).
10.1 Agreement dated as of July 31, 1985 among Genetic Laboratories, Inc.,
Vascular Services Diversified, Inc., and the Company, including first
amendment thereto, dated September 25, 1985 (incorporated by reference
to Exhibit 2.1 to the Company's registration statement on Form 10 (File
No. 0-13907)).
10.2 Amendment No. 2 to the Agreement referred to in Exhibit 10.1, effective
July 31, 1985 (incorporated by reference to Exhibit 19.1 to the
Company's Quarterly Report on Form 10-Q for the period ended April 30,
1986 (File No. 0-13907)).
10.3 License Agreement dated September 25, 1985 between the Company and
Genetic Laboratories, Inc. (incorporated by reference to Exhibit 10.1 to
the Company's registration statement on Form 10 (File No. 0-13907)).
10.4 Amendment to License Agreement dated June 13, 1986 between the Company
and Genetic Laboratories, Inc. (incorporated by reference to Exhibit
10.4 to the Company's Current Report on Form 8-K dated June 15, 1986
(File No. 0-13907)).
10.5 Debt and Royalty Restatement Agreement dated June 16, 1986 among Genetic
Laboratories, Inc., Vascular Services Diversified, Inc. and the Company
(incorporated by reference to Exhibit 19.3 to the Company's Quarterly
Report on Form 10-Q for the period ended April 30, 1986 (File No. 0-
13907)).
E-1
<PAGE>
BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
10.6 Purchase Agreement dated February 17, 1986, between the Company and
Genetic Laboratories, Inc. including Bill of Sale and Assignment
(incorporated by reference to Exhibit 19.4 to the Company's Quarterly
Report on Form 10-Q (File No. 0-13907)).
10.7 Purchase and sale agreement dated October 30, 1989 and closed December
28, 1989 between the Company and Meadox Medicals, Inc. (incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form 8-K
dated January 11, 1990 (File No. 0-13907)).
10.8 Assignment and Assumption Agreement dated July 31, 1985 between the
Company and Genetic Laboratories, Inc., including the Purchase Agreement
dated June 4, 1984 between Genetic Laboratories, Inc. and Xomed, Inc.
(incorporated by reference to Exhibit 19.5 to the Company's Quarterly
Report on Form 10-Q for the period ended April 30, 1986 (File No. 0-
13907)).
10.9 Assignment dated June 13, 1986 by Genetic Laboratories, Inc. to the
Company (incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated June 15, 1986 (File No. 0-13907)).
10.10 Confirmatory Assignment dated June 13, 1986 by Genetic Laboratories,
Inc., to the Company (incorporated by reference to Exhibit 10.2 to the
Company's Current Report on Form 8-K dated June 15, 1986 (File No. 0-
13907)).
10.11 Confirmatory Assignment dated June 13, 1986 by Genetic Laboratories,
Inc., to the Company (incorporated by reference to Exhibit 10.3 to the
Company's Current Report on Form 8-K dated June 15, 1986 (File No. 0-
13907)).
10.12 Trademark Assignment Agreement dated June 19, 1986 between the Company
and Genetic Laboratories, Inc. (incorporated by reference to Exhibit
19.10 to the Company's Quarterly Report on Form 10-Q for the period
ended April 30, 1986 (File No. 0-13907)).
10.13 Assignment dated June 26, 1986 between the Company and Genetic
Laboratories, Inc. (incorporated by reference to Exhibit 19.11 to the
Company's Quarterly Report on Form 10-Q for the period ended April 30,
1986 (File No. 0-13907)).
10.14 1988 Stock Option Plan, as amended, (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended April 30, 1992 (File No. 0-13907)).
10.15 1995 Stock Incentive Plan, as amended (incorporated by reference to
Exhibit 10.15 to the Company's Annual Report of Form 10-K for the year
ended October 31, 1998 (File No. 0-13907)).
10.16 Employee Stock Purchase Plan, as amended (incorporated by reference to
Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1997 (File No. 0-13907)).
10.17 Form of Change in Control Agreement entered into between the Company and
Ms. M. Karen Gilles (incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1994
(File No. 0-13907)).
10.18 Form of Change in Control Agreement entered into between the Company and
each of Ms. Connie L. Magnuson dated January 12, 1998 and Mr. David A.
Buche dated January 29, 1998 (incorporated by reference to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the period ended
January 31, 1998 (File No. 0-13907)).
E-2
<PAGE>
BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
10.19 Employment Agreement dated July 31, 1998 among the Company, Jer-Neen
Manufacturing Co., Inc. and Mr. James F. Pfau (incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
period ended July 31, 1998 (File No. 0-13907)).
10.20 Change in Control Agreement dated July 31, 1998 between the Company and
Mr. James F. Pfau (incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the period ended July 31,
1998 (File No. 0-13907)).
10.21 Change in Control Agreement dated February 1, 1999 between the Company
and Dr. B. Nicholas Oray (incorporated by reference to Exhibit 10.2 to
the Company's Quarterly Report on Form 10-Q for the period ended January
31, 1999 (File No. 0-13907)).
10.22 Lease Agreement effective August 1, 1995 between the Company and CMS
Investors, Inc. (incorporated by reference to Exhibit 10.25 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).
10.23 Purchase and Sale Agreement dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to
Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1995 (File No. 0-13907)).
10.24 License Agreement dated December 1, 1995 between the Company and
Uroplasty, Inc. (incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).
10.25 Assignment of U.S. Patent dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to
Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1995 (File No. 0-13907)).
10.26 Lease Agreement effective August 27, 1997 between Jer-Neen Manufacturing
Co., Inc. and F&G Incorporated (incorporated by reference to Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the period ended
January 31, 1999 (File No. 0-13907)).
13.1 Portions of the Company's 1999 Annual Report to Shareholders
incorporated herein by reference (filed herewith electronically).
21.1 List of Subsidiaries of the Company (filed herewith electronically).
23.1 Consent of PricewaterhouseCoopers LLP (filed herewith electronically).
27.1 Financial Data Schedule for the year ended October 31, 1999 (filed
herewith electronically).
E-3
<PAGE>
Exhibit 13.1
The following information appears on pages 7-10 of the Company's 1999 Annual
Report to Shareholders.
Management's Discussion and Analysis of Financial Condition and Results of
- --------------------------------------------------------------------------
Operations
- ----------
Forward-Looking Statements: Certain statements contained in this Annual Report
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 on information currently available to the Company as of
the date hereof, and the Company assumes no obligation to update any forward-
looking statements. Forward-looking 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, vascular and
ophthalmic 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. The Company's wholly-
owned subsidiary, Jer-Neen Manufacturing Co., Inc. (Jerneen) is a value-added,
original equipment manufacturer of micro-precision wire-based component
products, including precision coils, stylets and guidewire components and sub-
assemblies used in the medical industry.
The acquisition of Jerneen was completed July 31, 1998, the end of the Company's
fiscal 1998 third quarter. Jerneen's financial results were included in the
Company's consolidated results of operations during the fourth quarter of 1998
and all four quarters of 1999. The Company believes that the addition of
Jerneen's medical component business broadens the Company's participation in the
medical device industry, increases the Company's immediate and long-term revenue
potential and achieves a balance of market opportunities consistent with the
strategic objectives targeted by the Company.
The Company's consolidated net revenue in fiscal 1999 increased to a record
$18,904,000, up $6,887,000 or 57% from fiscal 1998 net revenue of $12,017,000.
The branded products business reported revenues of $11,681,000, up $1,061,000 or
10% from the 1998 revenue level of $10,620,000. Total 1999 branded product net
revenue represents the highest annual revenue in the Company's history recorded
by this business segment. The Jerneen component business contributed net
revenues of $7,223,000 in 1999, up $5,826,000 from revenues of $1,397,000
contributed during the fourth quarter of 1998. The Company reduced its
operating loss for the year by $621,000 from $1,415,000 in fiscal 1998 to
$794,000 in fiscal 1999. The consolidated net loss for fiscal 1999 was
$520,000, or $0.06 per share, as compared with a fiscal 1998 net loss of
$483,000, or $0.05 per share, due in part to a $563,000 decrease in net interest
income from fiscal 1998 to fiscal 1999 which offset the Company's operating
income improvements. The Company used cash primarily for stock repurchases,
capital equipment and the July 1998 purchase of Jerneen, lowering the Company's
interest-bearing balances.
The Company has continued to advance its strategy for growth at both business
units, focusing on opportunities to grow through acquisition, licensing and
distribution, expansion of markets for its current products, and internal new
product research and development (R&D) activities.
The Company's 1999 product development activities included a number of projects,
including a small diameter graft, a sling for the surgical treatment of female
urinary stress incontinence and a stent covering. All three of these projects
involve new and advanced tissue formats which have been in R&D for almost two
years. The animal testing phases for each of these projects will be continuing
in fiscal 2000. During fiscal 1999, the component products business opened its
Technology Development Center (TDC), which was established to provide creative
solutions for their customers in addition to rapid response prototyping. Also,
the Company's product development
1
<PAGE>
efforts resulted in the filing of two patents during fiscal 1999 to protect new
and proprietary technologies. One of the applications related to the manufacture
and use of stent coverings formed of biological tissues, and the other pertains
to the Company's new "resorbable" line of tissue implant materials. The
Company's R&D activities are expected to increase as projects under development
continue to progress.
Results of Operations
Years Ended October 31, 1999 and 1998
Consolidated net revenue in fiscal 1999 increased to a record $18,904,000, up
$6,887,000 or 57% from fiscal 1998 net revenue of $12,017,000. The branded
products business reported revenues of $11,681,000, up $1,061,000 from the 1998
revenue level of $10,620,000. The Jerneen component business contributed net
revenues of $7,223,000 in 1999, as compared to revenues of $1,397,000
contributed during the fourth quarter of 1998. Jerneen's net revenues in 1999
represent a 31% increase over 1998 revenues of $5,560,000, of which the first
three quarters were not included in the Company's 1998 results. The 31% revenue
growth of the component business unit is attributable to both increased sales
unit volume as well as new products resulting from its quick turn prototyping
emphasis.
The branded products business experienced 25% revenue growth from its surgical
productivity tools to $2,560,000 in 1999 from $2,051,000 in 1998. Revenue from
the Flo-Thru Intraluminal Shunt(TM), which received market clearance in August
1998, accounted for approximately 57% of the increase in surgical productivity
tools revenue during the year. The Tissue-Guard product line, exclusive of
Peri-Strips(R), contributed 14% revenue growth in 1999 over 1998 driven by sales
of Vascu-Guard(R) and Dura-Guard(R). While Peri-Strips revenue increased in
each of the last three quarters of 1999 compared to the same periods in 1998,
competitive activities in the first quarter of the year resulted in a 3%
decrease in Peri-Strips revenue in fiscal 1999. Sales of Biograft increased 1%
to $756,000 in 1999 from $748,000 in 1998 as a result of the Company's efforts
to bring attention to the excellent efficacy of this product in limb salvage.
The Company's consolidated gross margin percentage decreased to 50% in fiscal
1999 from 57% in fiscal 1998, due primarily to the inclusion of the component
products business in the consolidated operating results for the full year in
1999 as compared to one quarter in 1998. In 1999, the component products
business gross margin was 38% while the branded products business gross margin
was 57%. In fiscal 2000, the Company expects an increase in branded business
gross margins associated with the positive leverage of existing production fixed
costs and a decrease, in percentage terms, in the component business gross
margins primarily associated with precious metals handling agreements with key
customers. Late in fiscal 1999, Jerneen agreed to purchase critical precious
metals on behalf of certain customers for use in Jerneen's manufacturing of
products for which it will be paid a handling fee for the incremental personnel
and working capital resource commitments it is undertaking. Although the impact
is a reduction in the gross margin percentage, the substance of the transactions
adds in absolute dollars to the gross margin of the business unit. As a result,
the Company expects a decreased consolidated gross margin percentage in fiscal
2000 as compared to 1999. This forward-looking statement is influenced
primarily by the Company's current estimate of production forecasts and costs
and would be impacted by significant increases or decreases in production
volumes of the Company's products, by material changes in the Company's product
mix and by the accuracy of the Company's estimates of production and other
manufacturing costs.
Selling, general and administrative (SG&A) expense increased $1,928,000, or 29%,
from 1998 to 1999. The full year inclusion of the component business accounts
for approximately 73% of the overall period-to-period increase in SG&A expense.
Since Jerneen has less SG&A infrastructure than does the branded products
business, SG&A as a percentage of net revenues decreased from 55% for the 1998
period to 45% for the 1999 period. The remaining SG&A increase is primarily due
to increased sales and marketing costs within the branded products segment.
R&D expense for the period increased $117,000, or 8%, between 1999 and 1998, to
$1,665,000. The inclusion of the engineering and development activities of the
component business was the primary reason for the overall period-to-period
increase in R&D expense. The Company continued to focus its efforts on new
product development, as demonstrated through its allocation of significant
resources to R&D at both its branded and component products businesses. The
Company's 1999 product development activities included a number of projects,
including a small
2
<PAGE>
diameter graft, a sling for the surgical treatment of female urinary stress
incontinence and a stent covering. All three of these projects involve new and
advanced tissue formats which have been in R&D for almost two years. The animal
testing phases for each of these projects will be continuing in fiscal 2000.
During fiscal 1999, the component products business opened its Technology
Development Center (TDC), which was established to provide creative solutions
for their customers in addition to rapid response prototyping. Also, the
Company's product development efforts resulted in the filing of two patents
during fiscal 1999 to protect new and proprietary technologies. One of the
applications related to the manufacture and use of stent coverings formed of
biological tissues, and the other pertains to the Company's new "resorbable"
line of tissue implant materials. The Company's R&D activities and expense are
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 consolidated operating loss in 1999 was reduced by $621,000, or 44%, to
$794,000 from an operating loss of $1,415,000 in 1998. The component business
contributed $617,000 to operating income in 1999, up $555,000 from operating
income of $62,000 contributed in the fourth quarter of 1998.
Other income, primarily net interest income, was $183,000 in 1999 and $746,000
in 1998. The $563,000 decrease in net interest income is related to
significantly lower average cash and investment balances in 1999, primarily due
to cash expenditures for the Company's stock repurchase program, capital
additions and the July 1998 Jerneen acquisition, and an increase in interest
expense related to acquired capital equipment leases and other liabilities. The
Company's loss before income taxes was $611,000 in 1999 as compared to a loss of
$669,000 in 1998.
The Company recorded a benefit from income taxes of $91,000 in 1999,
representing an effective tax rate of 15%, as compared to an effective tax rate
of 28% in 1998. The 1999 effective tax rate is less than the statutory rates
primarily due to the impact of permanent differences, including nondeductible
goodwill associated with the acquisition of Jerneen, partially offset by the
impact of research and experimentation credits. The decrease in the effective
tax rate from 1998 to 1999 is primarily due to a lower operating loss before tax
benefit combined with an increase in nondeductible goodwill amortization in 1999
as compared to 1998. At October 31, 1999, the Company has recorded $165,000 of
deferred tax assets as a result of the net operating loss carryforwards
generated in recent years. In addition, the Company has $417,000 of deferred
tax assets related to certain credit carryforwards, primarily research and
experimentation credits, and $265,000 of other net deferred tax assets. The
Company expects to fully apply its net deferred tax assets against future
taxable income. The Company expects it would have to generate at least
$2,400,000 in taxable income in future years to realize the full benefit of the
net deferred tax assets recorded at October 31, 1999. Net operating loss
carryforwards expire from 2012-2014 and credit carryforwards expire from 2009-
2014. The 1999 net loss was $520,000, or $0.06 per share, compared to a net
loss of $483,000, or $0.05 per share in 1998.
Years Ended October 31, 1998 and 1997
Consolidated net revenue increased $2,323,000, or 24%, to $12,017,000 from
$9,694,000. The Jerneen component business contributed $1,397,000 to 1998
revenue. Branded product growth came from the Tissue-Guard product line, which
grew at a 19% pace, led by sales of Vascu-Guard and Dura-Guard. Aided by
international growth of 27%, Peri-Strips revenue increased $318,000, or 11%.
Domestic Peri-Strips revenue increased 6% with only a minimal contribution from
the National Emphysema Treatment Trial (NETT). Bio-Graft revenue decreased
$52,000, or 7%, to $748,000 from $800,000, continuing a trend. Revenue from
sales of surgical productivity tools decreased 4% to $2,051,000 from $2,127,000.
The Company's gross margin percentage was 57% for 1998 as compared to 59% for
1997. In 1998, the component product line margin was 37%, while the branded
products' margin was 59%. The gross margin in the fourth quarter of 1998, the
first quarter including the operations of both businesses, was 52%.
SG&A expense increased $888,000, or 15%, between 1998 and 1997. The inclusion
of the component business beginning in the fourth quarter of 1998 accounted for
nearly half of the overall year-to-year increase in SG&A
3
<PAGE>
expense. The remaining increase was due to the continuing investment in
personnel in the areas of regulatory and clinical affairs, product development,
and sales and marketing required to advance the Company's revenue growth
initiatives. SG&A expense as a percentage of net revenues, however, decreased
from 60% in 1997 to 55% in 1998, due mainly to Jerneen having less SG&A
infrastructure as compared to the branded products business.
R&D expense increased $290,000, or 23%, between 1998 and 1997 to $1,548,000.
The product development activities in 1998 focused on both near and long-term
opportunities. The near-term opportunities included leveraging current tissue
expertise through product line expansions while long-term projects included a
focus on proactively seeking to obsolete current technology. During fiscal
1998, the Company's product development efforts resulted in 510(k) marketing
clearance from the FDA for three new products.
The operating loss in 1998 was $1,415,000 as compared to an operating loss of
$1,305,000 for 1997. The component business contributed $62,000 to operating
income in 1998.
Other income, primarily net interest income, was $746,000 in 1998 and $1,066,000
in 1997. The $320,000 decrease in interest income is related to lower average
investment balances in 1998, primarily due to 1998 cash expenditures of
$4,095,000 for the Company's stock repurchase program and $5,224,000 associated
with the Jerneen acquisition. As a result, continuing operations had a loss
before income taxes of $669,000 in 1998 as compared to $239,000 in 1997.
Operating activities generated positive cash flow of $322,000 in 1998.
The Company's benefit for income taxes in 1998 was $186,000. The 1998 effective
tax rate of 28% was less than the statutory rates primarily due to the impact of
permanent differences including nondeductible goodwill, partially offset by the
impact of research and experimentation credits. The Company recorded a tax
provision of $365,000 in 1997 due to a $421,000 write-off of an income tax asset
associated with net operating loss carryforwards of its former subsidiary, Vital
Images.
The 1998 loss from continuing operations was $483,000, or $0.05 per share,
compared to $604,000, or $0.06 per share in 1997. In 1997, the Company also
recorded a loss from discontinued operations of $920,000, or $0.10 per share.
Liquidity and Capital Resources
Cash, cash equivalents and marketable securities were $5,596,000 at October 31,
1999, as compared to $8,374,000 at October 31, 1998, a reduction of $2,778,000.
Major uses of available cash during 1999 totaling $2,738,000 were the repurchase
of common stock and the purchase of equipment and leasehold improvements.
Operating activities provided cash of $740,000 in 1999 as compared to providing
cash of $322,000 in 1998, with the component products business incrementally
providing $678,000 in operating cash flow during 1999 over the prior year.
Operating cash flows provided by the branded products business decreased from
1998 to 1999 primarily as a result of changes in working capital activities.
Cash was provided by operations in 1999 through non-cash expenses in excess of
the loss from operations, partially offset by increases in working capital used
for inventories and accounts receivable.
The Company invested $1,334,000 in equipment and leasehold improvements,
primarily related to manufacturing processes. As a result of interest rate
yield curves during 1999, net investments in marketable securities totaling
$3,991,000 were liquidated and invested in short-term, highly liquid cash
equivalents. The cash reserves are maintained to provide for current and future
financing and other investing activities.
Financing activities used $2,024,000 of cash during 1999, including $616,000
used to repay a bank note and other long-term obligations and $1,404,000 used to
repurchase 484,834 shares of Company common stock under the Company's stock
repurchase program. The repurchase program was completed during fiscal 1999.
The program will have a positive impact on earnings per share in periods of
profitability. However, while the Company is generating losses, the stock
repurchases have a dilutive impact on current earnings per share. The Company
has long-term obligations of $686,000 at October 31, 1999, requiring payments
through 2004.
4
<PAGE>
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 R&D priorities, acquisition
opportunities and the growth and profitability of the business.
Year 2000 Matters
The "Year 2000" problem refers to the potential for computational errors or
system malfunctions by computer hardware or software that fail to properly
recognize dates beginning with January 1, 2000, or which fail to recognize the
year 2000 as a leap year. In anticipation of this problem, the Company
instituted and followed a Year 2000 readiness program intended to identify,
evaluate and address its Year 2000 exposure.
At the time that this report was prepared (shortly after the new year), the
Company had not experienced any material Year 2000 problems with its internal
systems, and was not aware of any such problems experienced by its customers,
vendors and other service providers. As a result, no material adverse impact of
the Year 2000 problem on the Company's business and operations was expected,
based upon the information then available to the Company. However, this
forward-looking statement will be impacted by the extent to which latent Year
2000 problems remain undiscovered, or, in the case of Year 2000 problems with
business partners, undisclosed, and the extent of any future problems caused by
the failure of computer hardware or software to recognize the year 2000 as a
leap year. There can be no assurance that any such issues will not result in
material cost to the Company or have a material, adverse impact on its business,
financial condition or results of operations.
Inflation
Management believes inflation has not had a material effect on the Company's
operations or on its consolidated financial condition.
Foreign Currency Transactions
Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars. Fluctuations in currency exchange rates in other
countries may therefore reduce the demand for the Company's products by
increasing the price of the Company's products in the currency of the countries
in which the products are sold.
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-collectibility of assets and establishment of
appropriate allowances in connection with the Company's internal controls and
policies.
New Accounting Standards
In fiscal 1999, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 130, Comprehensive Income, and SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. (See Note 1 to consolidated
financial statements for further information). 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 and
hedging activities. SFAS No. 133 is effective for all fiscal years beginning
after June 15, 2000. The Company's management is currently evaluating the
potential impact of adopting SFAS No. 133 on the Company's consolidated
financial statements.
5
<PAGE>
The following consolidated financial statements and related notes appears on
pages 11-23 of the Company's 1999 Annual Report to Shareholders.
BIO-VASCULAR, INC.
CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in thousands, except share and per share data)
1999 1998
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 5,596 $ 4,383
Marketable securities............................................................ - 3,991
Accounts receivable, net......................................................... 3,123 2,456
Inventories, net................................................................. 2,576 2,306
Deferred income taxes............................................................ 307 220
Other............................................................................ 398 527
-------- -------
Total current assets......................................................... 12,000 13,883
Equipment and leasehold improvements, net........................................ 4,936 4,354
Goodwill and other intangible assets, net........................................ 6,594 7,241
Deferred income taxes............................................................ 540 504
-------- --------
Total assets................................................................. $ 24,070 $ 25,982
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................. $ 680 $ 460
Accrued expenses................................................................. 1,551 1,421
Current maturities of long-term obligations...................................... 369 616
-------- --------
Total current liabilities.................................................... 2,600 2,497
Capital lease obligations........................................................ 159 393
Other liabilities................................................................ 527 662
-------- --------
Total liabilities............................................................ 3,286 3,552
-------- --------
Commitments (Note 7)
Shareholders' equity:
Preferred stock: authorized 5,000,000 shares of $.01 par value;
none issued or outstanding at October 31, 1999 and 1998...................... - -
Common stock: authorized 20,000,000 shares of $.01 par value;
issued and outstanding, 8,960,633 and 9,317,183
at October 31, 1999 and 1998, respectively................................... 90 93
Additional paid-in capital....................................................... 27,661 28,696
Unearned compensation............................................................ (601) (514)
Unrealized marketable securities holding gain.................................... - 1
Accumulated deficit.............................................................. (6,366) (5,846)
-------- --------
Total shareholders' equity................................................... 20,784 22,430
-------- --------
Total liabilities and shareholders' equity................................... $ 24,070 $ 25,982
======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
6
<PAGE>
BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in thousands, except per share data)
1999 1998 1997
----- ----- ----
<S> <C> <C> <C>
Net revenue.................................... $ 18,904 $12,017 $ 9,694
Cost of revenue................................ 9,443 5,222 3,967
--------- ------- -------
Gross margin................................... 9,461 6,795 5,727
Operating expenses:
Selling, general and administrative............ 8,590 6,662 5,774
Research and development....................... 1,665 1,548 1,258
--------- ------- -------
Operating loss................................. (794) (1,415) (1,305)
Other income, net, primarily interest.......... 183 746 1,066
--------- ------- -------
Loss from continuing operations
before provision for (benefit from)
income taxes................................. (611) (669) (239)
Provision for (benefit from) income taxes...... (91) (186) 365
--------- ------- -------
Loss from continuing operations................ (520) (483) (604)
Discontinued operations:
Loss on disposal of discontinued
business, net of income taxes................ - - (920)
--------- ------- -------
Net loss....................................... $ (520) $ (483) $(1,524)
========= ======= =======
Basic and diluted earnings per share:
Continuing operations.......................... $ (0.06) $ (0.05) $ (0.06)
Discontinued operations........................ - - (0.10)
--------- ------- -------
Net loss....................................... $ (0.06) $ (0.05) $ (0.16)
========= ======= =======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
7
<PAGE>
BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME AND SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED OCTOBER 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in thousands, except share data) Unrealized
Marketable
Additional Unearned Securities
Common Stock Paid -In Compen- Holding Accumulated
Shares Par Value Capital sation Gain (Loss) Deficit Total
------ --------- ------- ------ ---------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at October 31, 1996......... 9,484,898 $ 95 $ 39,500 $ (485) $ (51) $ (3,839) $ 35,220
Stock option activity, net of tax
benefit........................... 48,236 1 655 (332) 324
Employee Stock Purchase Plan
activity.......................... 9,190 37 37
Employee restricted stock
activity.......................... 22,185 63 23 86
Non-employee restricted stock
activity............................ 36,000 1 143 (113) 31
Stock repurchased by the Company.... (36,900) (1) (149) (150)
Distribution of net investment in
Vital Images........................ (10,584) 460 (10,124)
Comprehensive loss:
Unrealized marketable securities
holding gain, net................... 52 52
Net loss............................ (1,524) (1,524)
----------
Comprehensive loss.................. (1,472)
--------- --------- -------- ------- --------- --------- ----------
Balance at October 31, 1997......... 9,563,609 96 29,665 (447) 1 (5,363) 23,952
Stock option activity, net of tax
benefit........................... 80,760 1 248 23 272
Employee Stock Purchase Plan
activity............................ 8,247 25 25
Employee restricted stock
activity.......................... 56,961 1 248 (135) 114
Non-employee restricted stock
activity.......................... 45 45
Stock repurchased by the Company.... (978,266) (10) (4,085) (4,095)
Stock issued in conjunction with
the acquisition of Jerneen.......... 585,872 5 2,595 2,600
Net and comprehensive loss.......... (483) (483)
--------- --------- -------- ------- --------- --------- ----------
Balance at October 31, 1998......... 9,317,183 93 28,696 (514) 1 (5,846) 22,430
Stock option activity, net of tax
benefit........................... (1) (1)
Employee Stock Purchase Plan
activity.......................... 22,396 1 44 45
Employee restricted stock
activity.......................... 100,888 1 307 (124) 184
Non-employee restricted stock
activity.......................... 5,000 14 37 51
Stock repurchased by the Company.... (484,834) (5) (1,399) (1,404)
Comprehensive loss:
Unrealized marketable securities
holding loss, net................. (1) (1)
Net loss............................ (520) (520)
----------
Comprehensive loss.................. (521)
--------- --------- -------- ------- --------- --------- ----------
Balance at October 31, 1999 8,960,633 $ 90 $ 27,661 $ (601) $ - $ (6,366) $ 20,784
========= ========= ======== ======= ========= ========= ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
8
<PAGE>
BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED OCTOBER 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In thousands) 1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITES:
Net loss ................................................................................. $ (520) $ (483) $ (1,524)
Net loss from discontinued operations .................................................... -- -- (920)
-------- -------- --------
Loss from continuing operations .......................................................... (520) (483) (604)
Adjustments to reconcile loss from continuing
operations to net cash provided by (used in)
operating activities:
Depreciation and amortization of equipment
and leasehold improvements ........................................................... 861 494 354
Amortization of goodwill and other intangible assets ..................................... 748 384 266
Provision for uncollectible accounts ..................................................... 14 88 --
Provision for inventory obsolescence ..................................................... 118 179 116
Non-cash compensation .................................................................... 283 220 212
Deferred income taxes .................................................................... (123) (166) 239
Changes in operating assets and liabilities:
Accounts receivable ...................................................................... (681) 139 (380)
Inventories .............................................................................. (388) (485) 237
Other assets ............................................................................. 129 17 314
Accounts payable and accrued expenses .................................................... 299 (65) 297
-------- -------- --------
Net cash provided by continuing operations ........................................... 740 322 1,051
Net cash used in discontinued operations ............................................. -- -- (1,861)
-------- -------- --------
Net cash provided by (used in) operating activities .................................. 740 322 (810)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITES:
Purchase of equipment and improvements ................................................... (1,334) (964) (654)
Investments in marketable securities ..................................................... (987) (8,675) (9,000)
Proceeds upon maturity of marketable securities .......................................... 4,978 13,159 13,750
Proceeds upon sale of marketable securities .............................................. -- 2,750 --
Purchase of Jerneen, net of cash acquired (Note 2)........................................ (59) (2,816) --
Investments in patents and trademarks..................................................... (101) (67) (43)
Discontinued operations, net ............................................................. -- -- (2,328)
-------- -------- --------
Net cash provided by investing activities ............................................ 2,497 3,387 1,725
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITES:
Proceeds from issuance of bank note ...................................................... -- 275 --
Repayments on bank note .................................................................. (261) (14) --
Net proceeds related to stock-based compensation plans ................................... (4) 236 265
Repurchase of the Company's common stock ................................................. (1,404) (4,095) (150)
Repayment of capital lease obligations ................................................... (230) (53) --
Repayments of other long-term obligations ................................................ (125) (34) --
Repayment of debt in conjunction with the acquisition
of Jerneen ........................................................................... -- (2,408) --
-------- -------- --------
Net cash (used in) provided by financing activities .................................. (2,024) (6,093) 115
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS .................................................. 1,213 (2,384) 1,030
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR .............................................................................. 4,383 6,767 5,737
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR ................................................. $ 5,596 $ 4,383 $ 6,767
======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
9
<PAGE>
BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS DESCRIPTION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business Description:
Bio-Vascular, Inc. ("Bio-Vascular" or the "Company") develops, manufactures and
markets branded proprietary and patented specialty medical products for use in
thoracic, cardiac, neuro, vascular and ophthalmic 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 Tissue-Guard products, made in various
configurations, are used in a wide variety of surgical procedures and are
designed to reinforce, reconstruct and repair tissue and prevent leaks of air,
blood and other body fluids.
The Company's wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc.
("Jerneen"), is a value-added, original equipment manufacturer of micro-
precision wire-based component products, including precision coils, stylets and
guidewire components and sub-assemblies used in the medical industry. The
Company acquired Jerneen in July 1998.
Basis of Consolidation:
The consolidated financial statements include the accounts of Bio-Vascular, Inc.
and its wholly-owned subsidiary, Jerneen, after elimination of intercompany
accounts and transactions.
Use of Estimates:
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Cash and Cash Equivalents:
Cash and cash equivalents consist of cash and highly liquid investments
purchased with an original maturity of three months or less. Cash equivalents
at October 31, 1999 and 1998 consisted primarily of commercial paper and one
money market fund.
Marketable Securities:
Investments having original maturities in excess of three months are classified
as marketable securities and generally consist of commercial paper, U.S.
Government or U.S. Government-backed obligations. Investments are classified as
short-term or long-term in the balance sheet based on their maturity date. At
October 31, 1999, the Company did not have any marketable securities. At
October 31, 1998, all of the Company's marketable securities were classified as
available-for-sale. Available-for-sale investments are recorded at market value
with net unrealized holding gains and losses included as a separate component of
shareholders' equity.
Inventories:
Inventories, which are comprised of component parts, subassemblies and finished
goods, are valued at the lower of first-in, first-out (FIFO) cost or market. On
a quarterly basis, the Company compares the amount
10
<PAGE>
of the inventories on hand with its latest forecasted requirements to determine
its reserves for excess or obsolete inventories.
Equipment and Leasehold Improvements:
Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are calculated using the straight-line method over the estimated
useful lives of the related assets. Furniture, fixtures and computer equipment
are depreciated over a 3- to 7-year life and manufacturing equipment is
depreciated over a 5- to 10-year life. Leasehold improvements are amortized
over the life of the related facility leases or the assets, whichever is
shorter. Major replacements and improvements are capitalized and maintenance
and repairs which do not improve or extend the useful lives of the respective
assets are charged to operations. The asset and related accumulated
depreciation or amortization accounts are adjusted for asset retirements and
disposals with the resulting gain or loss, if any, recorded in the Consolidated
Statements of Operations at the time of disposal.
Long-Lived Assets:
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset in
question may not be recoverable. Impairment losses are recorded whenever
indicators of impairment are present.
Goodwill and Other Intangible Assets:
Goodwill and other intangible assets are recorded at cost and are amortized
using the straight-line method over their estimated useful lives, ranging from
10 to 17 years. The Company evaluates the net realizability of goodwill and
other intangible assets on an ongoing basis based on current and anticipated
undiscounted cash flows.
Revenue Recognition:
Revenue is recognized upon shipment of goods to customers, net of estimated
returns.
Research and Development:
Research and development costs are expensed as incurred.
Income Taxes:
The Company accounts for income taxes using the asset and liability method. The
asset and liability method provides that deferred tax assets and liabilities are
recorded based on the differences between the tax basis of assets and
liabilities and their carrying amounts for financial reporting purposes
("temporary differences"). Temporary differences relate primarily to operating
and capital loss carryforwards, research and experimentation tax credit
carryforwards, depreciation, non-compete obligations, and receivable and
obsolete inventory reserves.
Net Income (Loss) Per Common Share:
Basic earnings per share ("EPS") is computed based on the weighted average
number of common shares outstanding, while diluted EPS is computed based on the
weighted average number of common shares outstanding adjusted by the weighted
average number of additional shares that would have been outstanding had the
potential dilutive common shares been issued. Potential dilutive shares of
common stock include stock options and other stock-based awards granted under
the Company's stock-based compensation plans, when their impact is not anti-
dilutive.
11
<PAGE>
Adoption of New Accounting Pronouncements:
In June 1997, Statement of Financial Accounting Standards ("SFAS") No. 130,
Comprehensive Income, was issued by the Financial Accounting Standards Board,
which the Company adopted in fiscal year 1999. SFAS No. 130 establishes
standards for reporting and displaying comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general purpose
financial statements and requires that all items required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. The Consolidated Statements of Comprehensive Income and
Shareholders' Equity reflects the adoption of SFAS No. 130. For the Company,
comprehensive income included net income and unrealized marketable securities
holding gains and losses.
In fiscal 1999, the Company adopted SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. See Note 4 for the required segment
disclosures under SFAS No. 131. 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 and
hedging activities. SFAS No. 133 is effective for all 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.
(2) ACQUISITION OF BUSINESS:
On July 31, 1998, the Company completed the acquisition of Jerneen of Lino
Lakes, Minnesota, which was accounted for as a purchase. Pursuant to the terms
of the acquisition agreement, all of the issued and outstanding shares of common
stock of Jerneen were exchanged for 585,872 shares of Bio-Vascular common stock,
valued at $2,600,000, and an aggregate of $1,750,000 in cash, excluding
transaction costs. The Company also paid $950,000 for a 10-year non-compete
agreement covering the former Jerneen shareholders. Goodwill acquired by the
Company amounted to $5,200,000 and is being amortized using the straight-line
method over 15 years. The Company acquired $2,400,000 of Jerneen's outstanding
debt, which was paid immediately upon completion of the transaction. The
remaining fair value of net identifiable assets of Jerneen acquired in the
transaction totaled $1,772,000, including equipment and improvements of
$2,217,000, patents of $387,000, receivables of $848,000, inventories of
$381,000, less capital lease obligations of $677,000, accounts payable and
accrued expenses of $713,000 and other long-term obligations of $815,000.
The acquisition occurred on July 31, 1998, therefore only the results of
Jerneen's operations for the three-month period ended October 31, 1998 are
included in the Company's Consolidated Statement of Operations for 1998. The
Company's Consolidated Statement of Operations for 1999 includes the full year
results of Jerneen's operations.
The following unaudited pro forma financial information reflects the combined
results of the Company and Jerneen had the acquisition occurred at the beginning
of each of the fiscal periods presented. The pro forma financial information
presented is not necessarily indicative of either the future consolidated
operations of the Company or the actual results that would have occurred had the
acquisition of Jerneen been consummated on November 1, 1997 or 1996.
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Net revenue $16,180,000 $13,828,000
Operating loss (1,158,000) (1,099,000)
Loss from continuing operations (561,000) (769,000)
Basic and diluted earnings per share (0.06) (0.08)
</TABLE>
12
<PAGE>
(3) DISCONTINUED OPERATIONS:
On May 12, 1997, the Company completed the spin-off distribution of all shares
of Vital Images, Inc. ("Vital Images") to shareholders of Bio-Vascular, Inc.,
with Vital Images thereafter operating as an independent company with its own
publicly-traded securities. All Bio-Vascular shareholders of record received
one share of Vital Images common stock for every two shares of Bio-Vascular
common stock held, with cash issued in lieu of fractional shares. The spin-off
distribution was recorded by reducing shareholders' equity by $10,124,000, which
represents $10,000,000 of cash and investments, plus the carrying value of Vital
Images' net assets. A loss on disposal of $920,000 recorded in 1997 represents
additional losses and costs associated with the spin-off transactions, which
took longer to complete than anticipated and which exceeded amounts previously
estimated and recorded prior to fiscal 1997.
13
<PAGE>
(4) SUPPLEMENTAL FINANCIAL STATEMENT AND SEGMENT INFORMATION:
<TABLE>
<CAPTION>
October 31,
1999 1998
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
MARKETABLE SECURITIES:
Commercial paper - $ 1,999,000
U.S. Government and
government agency obligations - 1,992,000
- -----------------------------------------------------------------------------------------------
- $ 3,991,000
===============================================================================================
ACCOUNTS RECEIVABLE, NET:
Trade receivables $ 3,221,000 $ 2,584,000
Less allowance for doubtful accounts (98,000) (128,000)
- -----------------------------------------------------------------------------------------------
$ 3,123,000 $ 2,456,000
===============================================================================================
INVENTORIES, NET:
Raw materials and supplies $ 1,534,000 $ 1,242,000
Work in process 549,000 519,000
Finished goods 1,071,000 1,024,000
Less reserve for inventory obsolescence (578,000) (479,000)
- -----------------------------------------------------------------------------------------------
$ 2,576,000 $ 2,306,000
===============================================================================================
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET:
Furniture, fixtures and computer equipment $ 1,412,000 $ 1,101,000
Manufacturing equipment 2,934,000 1,999,000
Leasehold improvements 1,929,000 1,759,000
Equipment in process 256,000 235,000
Furniture, fixtures and computer equipment under
capital leases 154,000 154,000
Manufacturing equipment under capital leases 604,000 604,000
Less accumulated depreciation and leasehold
improvement amortization (2,230,000) (1,474,000)
Less accumulated amortization of capital leases (123,000) (24,000)
- -----------------------------------------------------------------------------------------------
$ 4,936,000 $ 4,354,000
===============================================================================================
GOODWILL AND OTHER INTANGIBLE ASSETS, NET:
Goodwill $ 6,764,000 $ 6,756,000
Patents and other intangibles 1,266,000 1,163,000
Non-compete agreement 950,000 950,000
Less accumulated amortization (2,386,000) (1,628,000)
- -----------------------------------------------------------------------------------------------
$ 6,594,000 $ 7,241,000
===============================================================================================
ACCRUED EXPENSES:
Payroll, other employee benefits and related taxes $ 827,000 $ 599,000
Accrued income taxes 239,000 281,000
Other accrued expenses 485,000 541,000
- -----------------------------------------------------------------------------------------------
$ 1,551,000 $ 1,421,000
===============================================================================================
</TABLE>
During fiscal year 1999, the Company adopted SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information. SFAS No. 131 supersedes SFAS
No. 14, Financial Reporting for Segments of a Business Enterprise, replacing the
"industry segment" approach with the "management" approach. The "management"
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and
14
<PAGE>
major customers. The adoption of SFAS No. 131 did not affect the Company's
consolidated results of operations or financial position.
The Company's operations, which are based mainly in Minnesota, are comprised of
two segments, "branded products" and "component products," based upon the
similarities of the underlying business operations and products of each.
Branded products business develops, manufactures and markets proprietary and
patented specialty medical products for use in thoracic, cardiac, neuro,
vascular and ophthalmic surgery. Component products business represents the
value-added, original equipment manufacturing of micro-precision wire-based
component products, including precision coils, stylets and guidewire components
and sub-assemblies used in the medical industry. The Company evaluates the
performance of its business segments and allocates resources to them based upon
their respective earnings contribution to the consolidated earnings of the
Company or based on the segment's product R&D efforts in process at that time.
Information for the business segments for fiscal years 1999, 1998 and 1997 is
presented in the table below.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
1999 1998 1997
<S> <C> <C> <C>
Net revenue
Branded $11,681,000 $10,620,000 $ 9,694,000
Component 7,223,000 1,397,000 -
----------- ----------- -----------
Total 18,904,000 12,017,000 9,694,000
Operating income (loss)
Branded (1,411,000) (1,477,000) (1,305,000)
Component 617,000 62,000 -
----------- ----------- -----------
Total (794,000) (1,415,000) (1,305,000)
Depreciation and amortization
Branded 784,000 690,000 620,000
Component 825,000 188,000 -
----------- ----------- -----------
Total 1,609,000 878,000 620,000
Capital expenditures
Branded 443,000 848,000 654,000
Component 1,000,000 116,000 -
----------- ----------- -----------
Total 1,443,000 964,000 654,000
Identifiable assets
Branded 16,704,000 16,114,000 25,134,000
Component 7,366,000 9,868,000 -
----------- ----------- -----------
Total 24,070,000 25,982,000 25,134,000
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
See Note 12 - Major Customers and Net Revenue by Geographic Area, for additional
information regarding concentrations.
Supplemental Cash Flow Information:
The Company paid interest of $129,000, $39,000 and $0 during fiscal 1999, 1998
and 1997, respectively. Income tax payments made by the Company totaled
$107,000, $3,000 and $6,000 for the years ended October 31, 1999, 1998 and 1997,
respectively. Also, at October 31, 1999, the Company recorded $109,000 in
accounts payable for equipment purchases made during the year then ended.
15
<PAGE>
(5) INCOME TAXES:
Provision for (Benefit from) Income Taxes:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------
1999 1998 1997
----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CURRENT:
Federal $ 21,000 $ (22,000) $ 96,000
State 11,000 2,000 44,000
----------------------------------------------------------------------------------------------
32,000 (20,000) 140,000
----------------------------------------------------------------------------------------------
DEFERRED:
Federal (101,000) (143,000) 286,000
State (22,000) (23,000) (61,000)
----------------------------------------------------------------------------------------------
(123,000) (166,000) 225,000
----------------------------------------------------------------------------------------------
Total $ (91,000) $(186,000) $365,000
===============================================================================================
</TABLE>
Reconciliation of effective income tax rate:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Loss from continuing operations
before income taxes $ (611,000) $ (669,000) $ (239,000)
========================================================================================================
Statutory federal rate (208,000) (227,000) (81,000)
State taxes, net of federal benefit (7,000) (14,000) (11,000)
Permanent differences 194,000 101,000 26,000
Research and experimentation credits (65,000) (45,000) (46,000)
Write-off of deferred tax asset associated
with discontinued operations 421,000
Increase (decrease) in valuation allowance 2,000 (3,000) 69,000
Other, net (7,000) 2,000 (13,000)
--------------------------------------------------------------------------------------------------------
Provision for (benefit from) income taxes $ (91,000) $ (186,000) $ 365,000
========================================================================================================
</TABLE>
Components of Deferred Tax Assets (Liabilities):
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Inventory reserve $ 213,000 $ 173,000 $ 138,000
Other, net 94,000 47,000 7,000
--------- --------- ---------
Net current deferred tax assets $ 307,000 $ 220,000 $ 145,000
Operating loss carryforwards $ 165,000 $ 228,000 $ 170,000
Capital loss carryforwards 143,000 141,000 149,000
Credit carryforwards 417,000 325,000 269,000
Depreciation (238,000) (220,000) (36,000)
Non-compete obligation 247,000 240,000 -
Other, net (51,000) (69,000) (26,000)
Less valuation allowance (143,000) (141,000) (144,000)
--------- --------- ---------
Net long-term deferred tax assets $ 540,000 $ 504,000 $ 382,000
==============================================================================================================
Net deferred tax assets $ 847,000 $ 724,000 $ 527,000
===============================================================================================================
</TABLE>
16
<PAGE>
A tax benefit of $8,000, $12,000 and $78,000 related to the exercise of stock
options was recorded to additional paid-in capital in 1999, 1998 and 1997,
respectively.
In conjunction with the acquisition of Jerneen, the Company acquired net
deferred tax assets of $31,000.
The valuation allowance relates solely to capital loss carry-forwards, which
have been determined to be unrealizable. Net operating loss carryforwards
expire from 2012-2014 and credit carryforwards expire from 2009-2014.
Management expects to fully utilize its remaining deferred tax assets against
future taxable income.
(6) CAPITAL LEASES AND LONG-TERM OBLIGATIONS:
Long-term obligations consist of the following at October 31:
<TABLE>
<CAPTION>
1999 1998
-----------------------------------------------------------------------------------
<S> <C> <C>
Capital leases $ 393,000 $ 623,000
Term note payable to bank - 261,000
Contractual obligations to landlord 245,000 306,000
Contractual obligations to former shareholder of
Jerneen 417,000 477,000
Other note payable to bank - 4,000
-----------------------------------------------------------------------------------
1,055,000 1,671,000
Less current portion (369,000) (616,000)
-----------------------------------------------------------------------------------
$ 686,000 $1,055,000
===================================================================================
</TABLE>
The Company is the lessee of certain machinery and equipment under capital lease
obligations expiring from 2000 through 2002. The assets and liabilities under
capital leases have been recorded at the fair value of the asset when placed in
service. Interest rates on capitalized leases vary from 9.75% to 15.24% and are
imputed based on the lessor's implicit rate of return.
During fiscal 1999, the Company repaid the term note payable in full.
The contractual obligations to the landlord relate to leasehold improvements and
are payable in monthly installments of $8,000 through January 2003. The
obligations were financed at fixed interest rates ranging from 10% to 12%.
The contractual obligation to a former shareholder of Jerneen is payable in
monthly installments of $8,000 through October 2004. The interest is imputed
based on the Company's borrowing rate of 10%.
Aggregate maturities of capital leases and long-term obligations are as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------
Year Ending October 31 Amount
<S> <C>
2000 $ 369,000
2001 294,000
2002 181,000
2003 107,000
2004 104,000
-------------------------------------------------------------------------------
$1,055,000
===============================================================================
</TABLE>
17
<PAGE>
(7) COMMITMENTS:
Operating Leases:
The Company is committed under non-cancelable operating leases for the rental of
its office and production facilities. At October 31, 1999, the remaining terms
on the leases range from three to six years. The component products business
facility leases include a renewal option for one additional five-year term. In
addition to base rent charges, the Company also pays apportioned real estate
taxes and common costs on its leased facilities. Total facilities rent expense,
including real estate taxes and common costs, was $525,000, $458,000 and
$383,000 for the years ended October 31, 1999, 1998 and 1997, respectively. The
Company paid real estate taxes and common costs of $149,000 during fiscal 1999.
As of October 31, 1999, future minimum lease payments, excluding real estate
taxes and common costs, due under existing non-cancelable operating leases are
as follows:
<TABLE>
<CAPTION>
------------------------------------------------------
Year Ending October 31
<S> <C>
2000 $ 459,000
2001 446,000
2002 413,000
2003 308,000
2004 270,000
Thereafter 192,000
------------------------------------------------------
$2,088,000
======================================================
</TABLE>
Royalties:
In connection with the acquisition of product licenses and product manufacturing
rights, the Company is obligated for the payment of royalties as follows:
* 5% on net sales of Peri-Strips and Peri-Strips Dry until the expiration of the
related patents through May 2015.
* 3% of the net sales of the Bio-Vascular Probe through 2001.
Royalty expense was approximately $185,000, $203,000 and $191,000 for the
years ended October 31, 1999, 1998 and 1997, respectively, and is included
in cost of revenue.
(8) SHAREHOLDERS' EQUITY:
Authorized Shares and Designation of Preferred Class of Stock:
In 1997, the shareholders approved an increase in authorized shares of capital
stock from 20,000,000 shares to 25,000,000 shares and reserved 5,000,000 such
shares as undesignated shares of preferred stock, having such rights,
preferences and designations as determined by the Board of Directors. As a
result, the Company's authorized capital stock consists of 20,000,000 shares of
common stock and 5,000,000 shares of undesignated preferred stock.
Stock Repurchase Plan:
In 1997, the Company's Board of Directors adopted a stock repurchase plan and
authorized the purchase of up to 500,000 shares of its common stock. During
1998, the Company's Board of Directors amended the plan to authorize the
repurchase of up to 1,500,000 common shares. As of October 31, 1999, the
Company had completed its repurchase of 1,500,000 shares of its common stock for
an aggregate cash outlay of $5,649,000 since the inception of the plan.
18
<PAGE>
Warrants:
Warrants issued to an underwriter in fiscal 1995 to purchase 90,000 shares of
the Company's common stock at an exercise price of $16.375 expired in fiscal
1999.
Shareholder Rights Plan:
In June 1996, the Company's Board of Directors declared a dividend distribution
of one common stock purchase right (a "Right") for each outstanding share of the
Company's common stock on July 15, 1996. The Company also entered into a Rights
Agreement governing the terms of the Rights, and each share of common stock
issued subsequent to July 15, 1996, has been issued with an attached Right
pursuant to the terms of the Rights Agreement.
Upon exercise, each Right entitles the holder thereof to purchase one-tenth of a
share of common stock at a purchase price currently set at $6.00 per share,
subject to adjustment to reflect the value of the Company following the spin-off
of Vital Images, Inc. Upon the occurrence of certain events in connection with:
(i) a person or group acquiring 15% or more of the Company's outstanding common
stock; (ii) a third party announcing an offer to purchase a 15% or greater stake
in the Company; or (iii) the Board of Directors declaring a person to be an
"adverse person" based upon such person being a holder of 10% or more of the
Company's outstanding stock and the Board's belief that such person's shares
were acquired for short-term financial gain or that the shareholder might
otherwise adversely affect the Company's business or prospects, the Rights
become exercisable and entitle each holder thereof (other than the acquiring
person or "adverse person") to purchase, for a price equal to 10 times the then-
current purchase price of the Right, shares of common stock (or other securities
of the Company) or equity securities of the acquiring company, as the case may
be, having a market value equal to 20 times the then-current purchase price of
the Right. In general, the Company is entitled to redeem the Rights in whole at
a price of $.001 per Right (payable in cash, stock or other consideration deemed
appropriate by the Board of Directors) prior to the first to occur of any such
events. Each Right will expire on June 11, 2006, if not previously redeemed or
exercised.
Stock-Based Compensation:
The Company has various stock award and stock option plans and an employee stock
purchase plan ("ESPP"). Under the stock award and stock option plans, the
Company is authorized to grant up to 1,907,636 shares of its common stock for
issuance under these plans, which includes 400,000 new shares of common stock
for grant approved by the Company's shareholders in fiscal 1999. At October 31,
1999, 382,802 shares remained available for grant under these plans. Under the
ESPP, the Company is authorized to sell and issue up to 300,000 shares of its
common stock to its full-time employees. At October 31, 1999, 254,452 shares
remained available for purchase under the ESPP.
At October 31, 1999, the Company has also reserved and granted 191,720 shares of
its common stock for issuance in connection with outstanding stock option grants
that were not made pursuant to a formal stock incentive plan.
The Company applies Accounting Principles Board ("APB") No. 25, Accounting for
Stock Issued to Employees, and related interpretations to account for its stock-
based compensation plans, when applicable, but has adopted the disclosure-only
provisions of SFAS No. 123, Accounting for Stock-Based Compensation, which
requires pro forma disclosures regarding the Company's stock-based compensation
plans.
19
<PAGE>
Stock Awards:
Under certain compensation agreements, an arrangement which provides for awards
of common stock to key management was adopted in 1992. These awards of common
stock are subject to forfeiture if employment terminates prior to the end of the
prescribed periods. Vesting periods range from three to five years. The market
value of the shares at the time of grant is recorded as unearned stock
compensation. The unearned amount is amortized to compensation expense over the
periods during which the vesting lapses. As part of these same compensation
agreements, the Company agreed to buy back the number of shares which would
allow the employees to meet their income tax obligations arising from the non-
cash compensation related to the earned shares. The number of shares bought
back by the Company from employees totaled 10,831, 7,911 and 10,655 during 1999,
1998 and 1997, respectively. Stock awards granted to employees are summarized
as follows:
<TABLE>
<CAPTION>
Unearned Stock
Awards Market Value
Balance Shares at Grant
--------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance October 31, 1996 $ 311,000 49,333 $3.25 - $ 14.50
Granted 220,000 46,545 4.25 - 6.50
Earned (134,000) (27,101) 3.25 - 14.50
Cancelled / Forfeited (109,000) (13,705) 4.75 - 14.50
--------------------------------------------------------------------------------------------
Balance October 31, 1997 288,000 55,072 4.25 - 14.00
Granted 428,000 99,548 3.50 - 5.13
Earned (142,000) (27,937) 3.50 - 14.00
Cancelled / Forfeited (151,000) (34,676) 3.69 - 4.75
--------------------------------------------------------------------------------------------
Balance October 31, 1998 423,000 92,007 3.50 - 14.00
Granted 424,000 124,351 2.69 - 3.63
Earned (231,000) (53,464) 2.69 - 14.00
Cancelled / Forfeited (70,000) (12,632) 4.05 - 11.88
--------------------------------------------------------------------------------------------
Balance at October 31, 1999 $ 546,000 150,262 $2.69 - $ 5.13
============================================================================================
</TABLE>
Shares of common stock have also been awarded to certain medical professionals
as compensation for services provided in the Company's product development
activities. These awards vest in accordance with the service agreement and
totaled 36,000 shares granted in 1997 and 5,000 shares granted in 1999. There
were no such awards in 1998.
The weighted average market value at grant date for stock awards was $3.20,
$4.29 and $4.41 for 1999, 1998 and 1997, respectively.
Stock Options:
The exercise price of each stock option generally equals 100% of the market
price of the Company's stock on the date of grant and has a maximum term of up
to 10 years. Employee option grants generally vest ratably over four to five
years, while options granted to non-employee directors of the Company generally
vest ratably over three years.
20
<PAGE>
The following table summarizes information about stock options outstanding at
October 31, 1999:
<TABLE>
<CAPTION>
============================================================================================
--------------------------------------------------------------------------------------------
Weighted
Weighted Average
Weighted Average Exercise
Number of Average Remaining Number of Price of
Options Exercise Contractual Options Exercisable
Range of Prices Outstanding Price Life (years) Exercisable Options
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$1.87 - $3.50 266,277 $2.78 4.35 163,673 $2.67
3.63 - 4.25 353,838 3.80 5.25 185,404 3.82
4.37 - 4.85 275,384 4.47 6.28 161,668 4.50
4.92 - 7.54 391,376 5.36 5.40 174,209 5.79
8.53 - 12.21 84,929 9.08 4.33 84,929 9.08
------------ --------- ----- ---- ------- -----
$1.87 -$12.21 1,371,804 $4.51 5.27 769,883 $4.74
---------------------------------------------------------------------------------------------
</TABLE>
A summary of the status of the Company's stock options for the years ended
October 31 is as follows:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 1,221,539 $4.82 1,305,106 $5.43 1,148,764 $5.60
Granted 296,936 3.44 463,989 4.50 419,262 5.16
Exercised (80,760) 2.91 (48,236) 3.23
Cancelled (146,671) 5.25 (466,796) 6.52 (214,684) 5.20
-------------------------------------------------------------------------------------------------------------
Outstanding at end of year 1,371,804 4.51 1,221,539 4.82 1,305,106 5.43
-------------------------------------------------------------------------------------------------------------
Options exercisable at end of year 769,883 4.74 669,920 4.99 794,743 4.98
=============================================================================================================
</TABLE>
Employee Stock Purchase Plan:
The Company sponsors an employee stock purchase plan ("ESPP") under which
300,000 shares of common stock were reserved for future issuance. The ESPP was
established to enable employees of the Company to invest in Company stock
through payroll deduction. Options are granted to employees to purchase shares
of stock at a price that is the lower of 85% of the fair market value of the
stock on the first or last day of each offering period. There were 22,396,
8,247 and 9,190 shares purchased through the ESPP in 1999, 1998 and 1997,
respectively.
For the years ended October 31, compensation expense recorded for stock-based
compensation awards (stock awards and stock options) was as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
1999 1998 1997
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Employee $209,000 $135,000 $150,000
Non-employee 74,000 85,000 62,000
-----------------------------------------------------------------------------------------------
Total $283,000 $220,000 $212,000
-----------------------------------------------------------------------------------------------
</TABLE>
Non-employee compensation expense includes amounts related to performance option
awards for up to 37,000 shares.
21
<PAGE>
SFAS No. 123 Disclosure:
Had compensation expense for the Company's stock-based compensation plans been
determined based on the fair market value at the grant dates consistent with
SFAS No. 123, the Company's net loss and loss per share would have been
increased to the pro forma amounts indicated below for the years ended
October 31:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1999 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
NET LOSS
As reported $ (520,000) $(483,000) $(1,524,000)
Pro forma (1,128,000) (946,000) (4,634,000)
BASIC AND DILUTED LOSS PER SHARE
As reported
Pro forma (0.06) (0.05) (0.16)
(0.12) (0.10) (0.49)
- -------------------------------------------------------------------------------
</TABLE>
The pro forma information includes stock options granted and purchases under the
ESPP in 1999, 1998 and 1997. Additionally, the 1997 pro forma information
reflects the impact of the modification of previously granted stock options
occurring as part of the spin-off of Vital Images, Inc., a former subsidiary of
the Company.
The weighted average fair value per option granted during 1999, 1998 and 1997
was $0.76, $1.40 and $2.18, respectively, for the ESPP and $1.98, $3.04 and
$2.99 for all other options. The weighted average fair value was calculated by
using the fair value of each option on the date of grant. The fair value of the
ESPP options was based on the 15% purchase discount. The fair value of all
other options for the years ended October 31 was estimated using the Black-
Scholes option pricing model with the following weighted average assumptions:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1999 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Expected option term 5.0 years 6.4 years 4.2 years
Expected volatility factor 67% 69% 72%
Expected dividend yield 0% 0% 0%
Risk-free interest rate 5.17% 5.73% 6.33%
- --------------------------------------------------------------------------------
</TABLE>
22
<PAGE>
(9) EARNINGS PER SHARE:
The Company adopted SFAS No. 128 during the first quarter of fiscal year 1998.
Earnings per share for all periods presented have been prepared in accordance
with the provisions of SFAS No. 128. The following table sets forth the
computation of basic and diluted shares outstanding for the years ended October
31:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1999 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
NUMERATOR:
Loss from continuing operations $ (520,000) $ (483,000) (604,000)
Loss on disposal of discontinued
business, net of income taxes (920,000)
- --------------------------------------------------------------------------------
Net loss $ (520,000) $ (483,000) (1,524,000)
================================================================================
DENOMINATOR:
Denominator for basic earnings
per share -
weighted average
common shares 9,025,823 9,228,265 9,498,827
- --------------------------------------------------------------------------------
Denominator for diluted earnings
per share -
weighted average common
shares and dilutive
potential common shares 9,025,823 9,228,265 9,498,827
================================================================================
</TABLE>
In fiscal 1999, 1998 and 1997, none of the options outstanding or unearned
restricted stock awards ("awards") were included in the computation of diluted
earnings per share for the year then ended because the Company had incurred net
losses during those periods and the inclusion of the options and awards would
have been anti-dilutive. Additionally, none of the awards are included in the
computation of basic earnings per share for any of the years then ended.
(10) RELATED PARTY TRANSACTIONS:
In fiscal 1997, the Company entered into a distribution agreement with Scanlan
International, Inc., a medical and surgical products distributor. The Chairman
of the Board of Directors of the Company is President and Chief Executive
Officer of the Scanlan Group of Companies, the parent company of Scanlan
International. The agreement grants Scanlan International the exclusive right,
acting as a sales representative of Bio-Vascular, to solicit orders, work with
distributors and market listed products within Latin America until October 31,
2000, subject to annual renewal thereafter. Scanlan International receives a
commission of 20% on net sales to Latin America during the term of the
agreement. Commissions paid to Scanlan International totaled $4,000 and $2,000
for 1999 and 1998, respectively. There was no sales activity resulting from
this agreement in 1997.
23
<PAGE>
(11) EMPLOYEE BENEFIT PLANS:
Salary Reduction Plan:
The Company sponsors salary reduction defined contribution benefit plans for all
full-time employees which qualify under Section 401(k) of the Internal Revenue
Code. Employee contributions are limited to 15% of their annual compensation,
subject to annual limitations. At its discretion, the Company may make matching
contributions equal to a percentage of the salary reduction or other
discretionary amount. The Company has made no contributions to the plans since
inception.
(12) 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
customers and international net revenues by geographic area:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
1999 1998 1997
- ----------------------------------------------------------------------------------------------
PERCENT OF ACCOUNTS RECEIVABLE BY SIGNIFICANT
CUSTOMERS
<S> <C> <C> <C>
A. 16% 13% -
B. 15% 9% 20%
C. 12% 11% 13%
D. 9% 11% 10%
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
PERCENT OF NET REVENUES BY SIGNIFICANT CUSTOMERS
A. 25% 6% -
B. 12% 16% 19%
C. 9% 12% 14%
D. 8% 11% 11%
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------------------------
INTERNATIONAL NET REVENUES BY GEOGRAPHIC
AREA
Europe $2,052,000 $1,531,000 $1,355,000
Asia and Pacific region 552,000 825,000 666,000
Canada 278,000 217,000 206,000
Other 183,000 56,000 68,000
- ------------------------------------------------------------------------------------------------
Total $3,065,000 $2,629,000 $2,295,000
- ------------------------------------------------------------------------------------------------
Percent of total net revenue 16% 22% 24%
- ------------------------------------------------------------------------------------------------
</TABLE>
The Company does not require collateral from its customers to support their
accounts receivable. Customer A is a customer of the component products segment
and B, C and D are customers of the branded products segment. The Company's
international net revenues are primarily generated from the branded products
business segment. All of the Company's long-lived assets are located in the
United States.
24
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Bio-Vascular, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, comprehensive income and shareholders'
equity, and cash flows present fairly, in all material respects, the financial
position of Bio-Vascular, Inc. as of October 31, 1999, and 1998, and the results
of its operations and its cash flows for each of the three years in the period
ended October 31, 1999, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of Bio-Vascular,
Inc.'s management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statement are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
December 3, 1999
25
<PAGE>
The following information appears on page 24 of the Company's 1999 Annual Report
to Shareholders.
COMMON STOCK INFORMATION
Price Range
The Company's common stock is currently traded on the Nasdaq National Market
under the symbol "BVAS." The following table sets forth, for each of the fiscal
periods indicated, the range of high and low closing sale prices per share as
reported by the Nasdaq National Market. These prices do not include adjustments
for retail mark-ups, mark-downs or commissions.
<TABLE>
<CAPTION>
1999 1998
Quarter Ended High Low High Low
- --------------- ------ ------ ------ ------
<S> <C> <C> <C> <C>
January 31 $4.375 $3.125 $4.188 $3.250
April 30 3.375 2.375 5.375 4.063
July 31 3.719 2.438 5.125 4.375
October 31 3.281 2.250 4.500 3.000
</TABLE>
Dividends
The Company has not declared or paid any cash dividends on its common stock
since its inception, and the Board of Directors presently intends to retain all
earnings for use in the business for the foreseeable future.
Shareholders
As of November 30, 1999, there were approximately 4,600 beneficial owners and
1,100 record shareholders of the Company's common stock.
26
<PAGE>
The following information appears on page 24 of the Company's 1999 Annual Report
to Shareholders.
Bio-Vascular, Inc.
Quarterly Results
<TABLE>
<CAPTION>
Fiscal 1999 First Second Third Fourth
(unaudited) Quarter Quarter Quarter Quarter
- ------------------------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenue $3,829,000 $4,893,000 $5,169,000 $5,013,000
Gross margin 1,917,000 2,497,000 2,584,000 2,463,000
Operating income (loss) (441,000) (291,000) 23,000 (85,000)
Net income (loss) (318,000) (202,000) 42,000 (42,000)
Net income (loss)
per share (0.03) (0.02) 0.00 (0.00)
Fiscal 1998
(unaudited)
- -------------------------------------------------------------------------------
Net revenue $2,462,000 $2,727,000 $2,760,000 $4,068,000
Gross margin 1,424,000 1,650,000 1,618,000 2,103,000
Operating income (loss) (554,000) (366,000) (276,000) (219,000)
Net income (loss) (205,000) (101,000) (43,000) (134,000)
Net income (loss)
per share (0.02) (0.01) (0.00) (0.01)
</TABLE>
Quarterly calculations of net income (loss) per share are made independently
during the fiscal year.
27
<PAGE>
The following information appears on page 1 of the Company's 1999 Annual Report
to Shareholders.
Bio-Vascular, Inc. - Financial Highlights
Summary Statements of Operations Data:
<TABLE>
<CAPTION>
For the Year Ended October 31 1999 1998 1997 1996 1995
- ------------------------------ ------------------ ------------------ ------------------ ----------------- -----------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net revenue $18,904 $12,017 $ 9,694 $10,125 $10,426
Gross margin 9,461 6,795 5,727 6,682 6,964
Operating income (loss) (794) (1,415) (1,305) 571 2,121
Income (loss) from continuing
operations (520) (483) (604) 1,219 1,659
Income (loss) per share from
continuing operations:
Basic (0.06) (0.05) (0.06) 0.13 0.22
Diluted (0.06) (0.05) (0.06) 0.12 0.21
Weighted average shares outstanding:
Basic 9,026 9,228 9,499 9,387 7,509
Diluted 9,026 9,228 9,499 9,876 8,062
</TABLE>
The above information includes the Company's acquisition of Jerneen in July 1998
and excludes discontinued operations; see Notes 2 and 3, respectively, to the
financial statements.
Earnings per share amounts have been presented for all years pursuant to the
provisions of Statement of Financial Accounting Standard No. 128, Earnings Per
Share; see Note 9 to the financial statements.
Summary Balance Sheet Data:
<TABLE>
<CAPTION>
At October 31 1999 1998 1997 1996 1995
- ------------------------------ ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Working capital $ 9,400 $11,386 $16,906 $22,107 $24,060
Total assets 24,070 25,982 25,134 37,881 37,303
Long-term debt 686 1,055 - - -
Shareholders' equity 20,784 22,430 23,952 35,221 35,355
</TABLE>
In connection with the 1997 spin-off of Vital Images Inc., Shareholders' Equity
was reduced by $10,124,000, which represents the contribution of cash
equivalents and marketable securities plus the carrying value of Vital Images'
net assets.
28
<PAGE>
Exhibit 21.1
BIO-VASCULAR, INC.
LIST OF SUBSIDIARIES OF THE COMPANY
FOR THE YEAR ENDED OCTOBER 31, 1999
Name of Subsidiary Jurisdiction/State of Incorporation
- ------------------ -----------------------------------
(1) Jer-Neen Manufacturing Co., Inc. Minnesota
(2) Bio-Vascular B.V., Breda Netherlands
(3) BVI - (Barbados), Inc. Barbados
<PAGE>
Exhibit 23.1
CONSENT OF PRICEWATERHOUSECOOPERS LLP
-------------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Registration Nos. 333-80259; 33-85394; 33-22302; 33-
94588; 333-14093; 333-14137; and 333-26783) and the Registration Statement of
Form S-3 (Registration No. 333-64563) of Bio-Vascular, Inc. of our report dated
December 3, 1999 relating to the consolidated financial statements of Bio-
Vascular, Inc., which appears in the Annual Report to Shareholders, which is
incorporated by reference in this Annual Report on Form 10-K. We also consent
to the incorporation by reference of our report dated December 3, 1999 relating
to the financial statement schedule of Bio-Vascular, Inc., which appears in this
Form 10-K. We also consent to the references to our firm under the captions
"Experts," "Incorporation of Documents by Reference" and "Incorporation of
Certain Documents by Reference" in certain Registration Statements on Form S-8
of Bio-Vascular, Inc. (Registration Nos. 33-94588; 333-14093; 333-14137; and
333-26783) and under the caption "Experts" in the Registration Statement on Form
S-3 of Bio-Vascular, Inc. (Registration No. 333-64563).
PRICEWATERHOUSECOOPERS LLP
Minneapolis, Minnesota
January 28, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES FOR THE PERIOD ENDED OCTOBER
31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> OCT-31-1999
<PERIOD-START> NOV-01-1998
<PERIOD-END> OCT-31-1999
<CASH> 5,596,000
<SECURITIES> 0
<RECEIVABLES> 3,221,000
<ALLOWANCES> 98,000
<INVENTORY> 2,576,000
<CURRENT-ASSETS> 12,000,000
<PP&E> 7,289,000
<DEPRECIATION> 2,353,000
<TOTAL-ASSETS> 24,070,000
<CURRENT-LIABILITIES> 2,600,000
<BONDS> 0
0
0
<COMMON> 90,000
<OTHER-SE> 20,694,000
<TOTAL-LIABILITY-AND-EQUITY> 24,070,000
<SALES> 18,904,000
<TOTAL-REVENUES> 18,904,000
<CGS> 9,443,000
<TOTAL-COSTS> 3,651,000
<OTHER-EXPENSES> 6,604,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (611,000)
<INCOME-TAX> (91,000)
<INCOME-CONTINUING> (520,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (520,000)
<EPS-BASIC> (.06)
<EPS-DILUTED> (.06)
</TABLE>
