SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------------------------------
FORM 10-Q
(mark one)
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarter Ended October 3, 1998.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number 1-10114
THERMO CARDIOSYSTEMS INC.
(Exact name of Registrant as specified in its charter)
Massachusetts 04-3027040
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
470 Wildwood Street, P.O. Box 2697
Woburn, Massachusetts 01888-2697
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (781) 622-1000
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 the number of shares outstanding of each of the issuer's classes
of Common Stock, as of the latest practicable date.
Class Outstanding at October 30, 1998
---------------------------- -------------------------------
Common Stock, $.10 par value 38,489,090
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
- -----------------------------
THERMO CARDIOSYSTEMS INC.
Consolidated Balance Sheet
(Unaudited)
Assets
October 3, January 3,
(In thousands) 1998 1998
- --------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents (includes $22,643
and $70,488 under repurchase agreement with
affiliated party) $ 23,326 $ 71,158
Short-term available-for-sale investments, at
quoted market value (amortized cost of
$73,528 and $45,443) 73,650 45,589
Accounts receivable, less allowances of $922
and $833 10,869 11,377
Inventories:
Raw materials 2,698 3,420
Work in process and finished goods 9,052 11,099
Prepaid and refundable income taxes 3,960 3,962
Prepaid expenses and other current assets 755 342
-------- --------
124,310 146,947
-------- --------
Property, Plant, and Equipment, at Cost 18,753 17,861
Less: Accumulated depreciation and amortization 10,926 9,380
-------- --------
7,827 8,481
-------- --------
Long-term Available-for-sale Investments, at
Quoted Market Value (amortized cost of $38,860
and $12,655) 38,901 12,665
-------- --------
Prepaid Income Taxes 2,749 2,749
-------- --------
Other Assets 2,119 2,366
-------- --------
$175,906 $173,208
======== ========
2
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THERMO CARDIOSYSTEMS INC.
Consolidated Balance Sheet (continued)
(Unaudited)
Liabilities and Shareholders' Investment
October 3, January 3,
(In thousands except share amounts) 1998 1998
- --------------------------------------------------------------------------
Current Liabilities:
Accounts payable $ 2,376 $ 2,291
Accrued payroll and employee benefits 2,828 2,749
Accrued warranty expenses 1,257 1,100
Accrued income taxes 4,122 912
Accrued interest 1,238 406
Payable for repurchase of Company common stock 4,386 -
Other accrued expenses 2,927 2,479
Due to parent company and affiliated companies 140 308
-------- --------
19,274 10,245
-------- --------
Subordinated Convertible Debentures 70,000 70,000
-------- --------
Shareholders' Investment:
Common stock, $.10 par value, 100,000,000
shares authorized; 40,521,121 and 40,520,521
shares issued 4,052 4,052
Capital in excess of par value 98,258 98,252
Retained earnings 37,692 32,096
Treasury stock at cost, 1,997,031 and
1,502,474 shares (53,506) (41,563)
Accumulated other comprehensive income (Note 3) 136 126
-------- --------
86,632 92,963
-------- --------
$175,906 $173,208
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
3
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THERMO CARDIOSYSTEMS INC.
Consolidated Statement of Income
(Unaudited)
Three Months Ended
-------------------------
October 3, September 27,
(In thousands except per share amounts) 1998 1997
- --------------------------------------------------------------------------
Revenues $15,798 $14,727
------- -------
Costs and Operating Expenses:
Cost of revenues 7,060 6,053
Selling, general, and administrative expenses 4,686 4,011
Research and development expenses 2,708 1,978
------- -------
14,454 12,042
------- -------
Operating Income 1,344 2,685
Interest Income 1,894 1,804
Interest Expense (898) (898)
------- -------
Income Before Provision for Income Taxes 2,340 3,591
Provision for Income Taxes 902 1,363
------- -------
Net Income $ 1,438 $ 2,228
======= =======
Basic and Diluted Earnings per Share (Note 2) $ .04 $ .06
======= =======
Weighted Average Shares (Note 2):
Basic 38,796 39,026
======= =======
Diluted 38,964 39,276
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
4
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THERMO CARDIOSYSTEMS INC.
Consolidated Statement of Income
(Unaudited)
Nine Months Ended
-------------------------
October 3, September 27,
(In thousands except per share amounts) 1998 1997
- --------------------------------------------------------------------------
Revenues $48,416 $45,560
------- -------
Costs and Operating Expenses:
Cost of revenues 20,836 20,210
Selling, general, and administrative expenses 13,826 12,141
Research and development expenses 7,728 6,048
------- -------
42,390 38,399
------- -------
Operating Income 6,026 7,161
Interest Income 5,687 4,489
Interest Expense (2,693) (1,347)
Gain on Sale of Investments, Net 20 -
------- -------
Income Before Provision for Income Taxes 9,040 10,303
Provision for Income Taxes 3,444 3,978
------- -------
Net Income $ 5,596 $ 6,325
======= =======
Basic and Diluted Earnings per Share (Note 2) $ .14 $ .16
======= =======
Weighted Average Shares (Note 2):
Basic 38,918 39,639
======= =======
Diluted 39,134 39,933
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
THERMO CARDIOSYSTEMS INC.
Consolidated Statement of Cash Flows
(Unaudited)
Nine Months Ended
-------------------------
October 3, September 27,
(In thousands) 1998 1997
- --------------------------------------------------------------------------
Operating Activities:
Net income $ 5,596 $ 6,325
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,162 1,921
Provision for losses on accounts
receivable 90 90
Gain on sale of investments, net (20) -
Other noncash items (69) (13)
Changes in current accounts:
Accounts receivable 422 769
Inventories 2,774 (2,086)
Other current assets (413) (48)
Accounts payable 84 (554)
Other current liabilities 4,553 2,447
--------- ---------
Net cash provided by operating activities 15,179 8,851
--------- ---------
Investing Activities:
Proceeds from sale and maturities of
available-for-sale investments 115,549 72,857
Purchases of available-for-sale investments (169,820) (63,430)
Purchases of property, plant, and equipment (1,363) (1,817)
Other 172 13
--------- ---------
Net cash provided by (used in) investing
activities (55,462) 7,623
--------- ---------
Financing Activities:
Net proceeds from issuance of Company
common stock 518 543
Payment of withholding taxes related to
stock option exercises (728) (129)
Purchases of Company common stock (7,341) (32,765)
Net proceeds from issuance of subordinated
convertible debentures - 68,030
International Technidyne transfer of cash
from Thermo Electron - 350
--------- ---------
Net cash provided by (used in) financing
activities $ (7,551) $ 36,029
--------- ---------
6
<PAGE>
THERMO CARDIOSYSTEMS INC.
Consolidated Statement of Cash Flows (continued)
(Unaudited)
Nine Months Ended
-------------------------
October 3, September 27,
(In thousands) 1998 1997
- ---------------------------------------------------------------------------
Exchange Rate Effect on Cash $ 2 $ 44
--------- ---------
Increase (Decrease) in Cash and Cash
Equivalents (47,832) 52,547
Cash and Cash Equivalents at Beginning of
Period 71,158 1,157
--------- ---------
Cash and Cash Equivalents at End of Period $ 23,326 $ 53,704
========= =========
Noncash Activities:
Conversions of convertible debentures $ - $ 3,755
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
THERMO CARDIOSYSTEMS INC.
Notes to Consolidated Financial Statements
1. General
The interim consolidated financial statements presented have been prepared
by Thermo Cardiosystems Inc. (the Company) without audit and, in the opinion of
management, reflect all adjustments of a normal recurring nature necessary for a
fair statement of the financial position at October 3, 1998, the results of
operations for the three- and nine-month periods ended October 3, 1998, and
September 27, 1997, and the cash flows for the nine-month periods ended October
3, 1998, and September 27, 1997. Interim results are not necessarily indicative
of results for a full year.
The consolidated balance sheet presented as of January 3, 1998, has been
derived from the consolidated financial statements that have been audited by the
Company's independent public accountants. The consolidated financial statements
and notes are presented as permitted by Form 10-Q and do not contain certain
information included in the annual financial statements and notes of the
Company. The consolidated financial statements and notes included herein should
be read in conjunction with the financial statements and notes included in the
Company's Annual Report on Form 10-K for the fiscal year ended January 3, 1998,
filed with the Securities and Exchange Commission.
2. Earnings per Share
Basic and diluted earnings per share were calculated as follows:
Three Months Ended Nine Months Ended
------------------- -------------------
(In thousands except Oct. 3, Sept. 27, Oct. 3, Sept. 27,
per share amounts) 1998 1997 1998 1997
- --------------------------------------------------------------------------
Basic
Net Income $ 1,438 $ 2,228 $ 5,596 $ 6,325
------- ------- ------- -------
Weighted Average Shares 38,796 39,026 38,918 39,639
------- ------- ------- -------
Basic Earnings per Share $ .04 $ .06 $ .14 $ .16
======= ======= ======= =======
Diluted
Net Income $ 1,438 $ 2,228 $ 5,596 $ 6,325
------- ------- ------- -------
Weighted Average Shares 38,796 39,026 38,918 39,639
Effect of:
Convertible debentures - - - 3
Stock options 168 250 216 291
------- ------- ------- -------
Weighted Average Shares,
as Adjusted 38,964 39,276 39,134 39,933
------- ------- ------- -------
Diluted Earnings per Share $ .04 $ .06 $ .14 $ .16
======= ======= ======= =======
8
<PAGE>
2. Earnings per Share (continued)
The computation of diluted earnings per share excludes the effect of
assuming the exercise of certain outstanding stock options because the effect
would be antidilutive. At October 3, 1998, there were 893,600 such options
outstanding, with exercise prices ranging from $22.28 to $48.97 per share. In
addition, the computation of diluted earnings per share for all periods
presented excludes the effect of assuming the conversion of $70,000,000
principal amount of 4 3/4% subordinated convertible debentures, convertible at
$31.415 per share, because the effect would be antidilutive.
3. Comprehensive Income
During the first quarter of 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This
pronouncement sets forth requirements for disclosure of the Company's
comprehensive income and accumulated other comprehensive income. In general,
comprehensive income combines net income and "other comprehensive income," which
represents certain items that are reported as components of shareholders'
investment in the accompanying balance sheet, including foreign currency
translation adjustments and unrealized net of tax gains and losses from
available-for-sale investments. During the third quarter of 1998 and 1997, the
Company's comprehensive income totaled $1,465,000 and $2,310,000, respectively.
During the first nine months of 1998 and 1997, the Company's comprehensive
income totaled $5,606,000 and $6,439,000, respectively.
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-looking statements, within the meaning of Section 21E of the
Securities Exchange Act of 1934, are made throughout this Management's
Discussion and Analysis of Financial Condition and Results of Operations. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "anticipates," "plans," "expects," "seeks,"
"estimates," and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause the results
of the Company to differ materially from those indicated by such forward-looking
statements, including those detailed under the heading "Forward-looking
Statements" contained herein.
Overview
The Company is a leader in the research, development, and manufacture of
implantable left ventricular-assist systems (LVAS). Its HeartMate(R) devices are
designed to perform substantially all or part of the pumping function of the
left ventricle of the natural heart for patients suffering from cardiovascular
disease.
9
<PAGE>
Overview (continued)
In general, a profit cannot be earned from the sale of an LVAS in the United
States until approval of the device has been received from the U.S. Food and
Drug Administration (FDA) for commercial sale. Until such approval is obtained,
only the direct and indirect costs, including research and development expenses,
of the LVAS can be recovered, which are included in the Company's revenues. With
the FDA's approval of the air-driven LVAS, the Company began earning a profit on
the sale of such systems in 1994. In September 1998, the Company announced that
the FDA granted approval for commercial sale in the U.S. of the electric LVAS as
a bridge to transplant, and as a result the Company has become eligible to earn
a profit on the sale of the electric LVAS. In addition, in September 1998,
Baxter Healthcare Corporation announced that the FDA had granted approval for
commercial sale in the U.S. of its Novacor(R) LVAS as a bridge to transplant.
The Company's Nimbus Medical Inc. subsidiary, acquired in 1996, has been
involved in artificial-heart technology for over 20 years and has carried out
research in two primary fields: ventricular-assist devices and total artificial
hearts. Nimbus was instrumental in developing the basic technology for
high-speed rotary blood pumps, which is the basis for the HeartMate II, the next
generation of the Company's LVAS. Because of its smaller size, the HeartMate II
may potentially be used to provide cardiac support in small adults and in
children. The Company expects to begin clinical trials with the HeartMate II by
the end of 1999.
The Company's International Technidyne Corporation subsidiary is a leading
manufacturer of near-patient, whole-blood coagulation testing equipment and
related disposables, and also manufactures premium-quality, single-use,
skin-incision devices.
Results of Operations
Third Quarter 1998 Compared With Third Quarter 1997
Revenues in the third quarter of 1998 were $15,798,000, compared with
$14,727,000 in the third quarter of 1997. The increase in revenues was primarily
due to an increase in revenues from the Company's electric LVAS. This increase
was offset in part by a slight decrease in revenues from International
Technidyne to $9,024,000 in the third quarter of 1998 from $9,089,000 in the
third quarter of 1997.
The gross profit margin decreased to 55% in the third quarter of 1998 from
59% in the third quarter of 1997, primarily due to an increase in revenues from
the lower-margin electric LVAS and, to a lesser extent, a decrease in the gross
profit margin at International Technidyne. As a result of the FDA's approval of
the electric LVAS, the Company has announced a 13% price increase in the
electric LVAS product line in the U.S., effective November 1, 1998.
Selling, general, and administrative expenses as a percentage of revenues
increased to 30% in the third quarter of 1998 from 27% in the
10
<PAGE>
Third Quarter 1998 Compared With Third Quarter 1997 (continued)
third quarter of 1997, primarily due to an increase in sales and marketing staff
in anticipation of increased electric LVAS sales following the FDA's approval.
Research and development expenses increased to $2,708,000 in the third
quarter of 1998 from $1,978,000 in the third quarter of 1997. This increase was
primarily due to expenses associated with a clinical trial being conducted by
the Company to evaluate the electric LVAS as an alternative to medical therapy,
which commenced in December 1997, as well as expenses associated with the
development of its HeartMate II system. The Company expects research and
development expenses to continue to increase over the life of the trial,
estimated at two to three years. There can be no assurance that the Company will
complete this study or that it will receive FDA approval of the electric LVAS as
an alternative to medical therapy during this time period, or at all.
Interest income was $1,894,000 and $1,804,000 in the third quarter of 1998
and 1997, respectively. Interest expense was $898,000 in the third quarter of
1998 and 1997.
The effective tax rates were 39% and 38% in the third quarter of 1998 and
1997, respectively. The effective tax rates exceeded the statutory federal
income tax rate primarily due to the impact of state income taxes.
First Nine Months 1998 Compared With First Nine Months 1997
Revenues in the first nine months of 1998 were $48,416,000, compared with
$45,560,000 in the first nine months of 1997. The increase in revenues was
primarily due to a $2,126,000 increase in revenues from the Company's air-driven
LVAS and, to a lesser extent, an increase in revenues from International
Technidyne to $27,409,000 from $26,171,000. These increases were offset in part
by a decrease in revenues from Nimbus.
The gross profit margin increased to 57% in the first nine months of 1998
from 56% in the first nine months of 1997, primarily due to an increase in
revenues from the higher-margin air-driven LVAS and, to a lesser extent, an
increase in revenues from higher-margin International Technidyne products.
Selling, general, and administrative expenses as a percentage of revenues
increased to 29% in the first nine months of 1998 from 27% in the first nine
months of 1997, primarily due to the reason discussed in the results of
operations for the third quarter.
Research and development expenses increased to $7,728,000 in the first nine
months of 1998 from $6,048,000 in the first nine months of 1997, primarily due
to the reasons discussed in the results of operations for the third quarter.
11
<PAGE>
First Nine Months 1998 Compared With First Nine Months 1997 (continued)
Interest income increased to $5,687,000 in the first nine months of 1998
from $4,489,000 in the first nine months of 1997, primarily as a result of
higher average invested balances. In May 1997, the Company issued and sold at
par $70,000,000 principal amount of 4 3/4% subordinated convertible debentures
due 2004, for net proceeds of $68,030,000.
Interest expense increased to $2,693,000 in the first nine months of 1998
from $1,347,000 in the first nine months of 1997, primarily due to interest
expense incurred as a result of the issuance of the 4 3/4% subordinated
convertible debentures.
The effective tax rates were 38% and 39% in the first nine months of 1998
and 1997, respectively. The effective tax rates exceeded the statutory federal
income tax rate primarily due to the impact of state income taxes.
Liquidity and Capital Resources
Consolidated working capital was $105,036,000 at October 3, 1998, compared
with $136,702,000 at January 3, 1998. Cash, cash equivalents, and short- and
long-term available-for-sale investments were $135,877,000 at October 3, 1998,
compared with $129,412,000 at January 3, 1998. During the first nine months of
1998, $15,179,000 of cash was provided by operating activities. Cash of
$4,553,000 was provided by an increase in other current liabilities, primarily
due to the timing of tax payments. Cash of $2,774,000 was provided by a decrease
in inventories, primarily due to improved inventory management.
Excluding available-for-sale investments activity, the Company's investing
activities primarily consisted of capital additions. During the first nine
months of 1998, the Company expended $1,363,000 on purchases of property, plant,
and equipment. During the remainder of 1998, the Company expects to make capital
expenditures of approximately $1,000,000, principally for manufacturing and
tooling equipment and leasehold improvements.
During the first nine months of 1998, the Company's financing activities
used $7,551,000 of cash. Through a series of transactions commencing in June
1997, the Company's Board of Directors authorized the repurchase, through August
14, 1999, of up to $40,000,000 of its own common stock in the open market, or in
negotiated transactions. Any repurchases under the Company's authorizations are
funded from working capital. Through October 3, 1998, the Company had committed
$25,746,000 under these authorizations. Of this amount, $7,341,000 was paid
during the first nine months of 1998, and $4,386,000 was payable as of October
3, 1998, in settlement of trades executed prior to that date.
The Company believes that it has adequate resources to meet its financial
needs for the foreseeable future.
12
<PAGE>
Year 2000
The Company continues to assess the potential impact of the year 2000 on the
Company's internal business systems, products, and operations. The Company's
year 2000 initiatives include (i) testing and upgrading internal business
systems and facilities; (ii) testing and developing necessary upgrades for the
Company's current products and certain discontinued products; (iii) contacting
key suppliers, vendors, and customers to determine their year 2000 compliance
status; and (iv) developing contingency plans.
The Company's State of Readiness
The Company is in the process of testing and evaluating its critical
information technology systems for year 2000 compliance, including its
significant computer systems, software applications, and related equipment. The
Company is also currently in the process of upgrading or replacing its
noncompliant systems. The Company expects that all of its material information
technology systems will be year 2000 compliant by the end of 1999. The Company
is also evaluating the potential year 2000 impact on its facilities, including
its buildings and utility systems. Any problems that are identified will be
prioritized and remediated based on their assigned priority. The Company will
continue periodic testing of its critical internal business systems and
facilities in an effort to minimize operating disruptions due to year 2000
issues.
The Company believes that all of the material products that it currently
manufactures and sells will be year 2000 compliant. However, as many of the
Company's products are complex, interact with third party products, and operate
on computer systems that are not under the Company's control, there can be no
assurance that the Company has identified all of the year 2000 problems with its
current products. The Company believes that certain of its older products, which
it no longer manufactures or sells, may not be year 2000 compliant. The Company
is continuing to test and evaluate such products and may offer upgrades or
alternative products where reasonably practicable.
The Company is in the process of identifying and contacting suppliers,
vendors, and customers that are believed to be significant to the Company's
business operations in order to assess their year 2000 readiness. As part of
this effort, the Company is developing and will be distributing questionnaires
relating to year 2000 compliance to its significant suppliers, vendors, and
customers. The Company intends to follow-up and monitor the year 2000 compliant
progress of significant suppliers, vendors, and customers that indicate that
they are not year 2000 compliant or that do not respond to the Company's
questionnaires.
Contingency Plans
The Company intends to develop a contingency plan that will allow its
primary business operations to continue despite disruptions due to year 2000
problems. These plans may include identifying and securing other
13
<PAGE>
Year 2000 (continued)
suppliers, increasing inventories, and modifying production facilities and
schedules. As the Company continues to evaluate the year 2000 readiness of its
business systems and facilities, products and significant suppliers, vendors,
and customers, it will modify and adjust its contingency plan as may be
required.
Estimated Costs to Address the Company's Year 2000 Issues
To date, costs incurred in connection with the year 2000 issue have not been
material. The Company does not expect total year 2000 remediation costs to be
material, but there can be no assurance that the Company will not encounter
unexpected costs or delays in achieving year 2000 compliance.
Risks of the Company's Year 2000 Issues
While the Company is attempting to minimize any negative consequences
arising from the year 2000 issue, there can be no assurance that year 2000
problems will not have a material adverse impact on the Company's business,
operations, or financial condition. While the Company expects that upgrades to
its internal business systems will be completed in a timely fashion, there can
be no assurance that the Company will not encounter unexpected costs or delays.
Despite its efforts to ensure that its material current products are year 2000
compliant, the Company may see an increase in warranty and other claims,
especially those related to Company products that incorporate, or operate using,
third-party software or hardware. In addition, certain of the Company's older
products, which it no longer manufactures or sells, may not be year 2000
compliant, which may expose the Company to claims. If any of the Company's
material suppliers, vendors, or customers experience business disruptions due to
year 2000 issues, the Company might also be materially adversely affected. The
Company's research and development, production, distribution, financial,
administrative, and communications operations might be disrupted. There is
expected to be a significant amount of litigation relating to the year 2000
issue and there can be no assurance that the Company will not incur material
costs in defending or bringing lawsuits. Any unexpected costs or delays arising
from the year 2000 issue could have a significant adverse impact on the
Company's business, operations, and financial condition.
Forward-looking Statements
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company wishes to caution readers that the
following important factors, among others, in some cases have affected, and in
the future could affect, the Company's actual results and could cause its actual
results in the remainder of 1998 and beyond to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company.
14
<PAGE>
Forward-looking Statements (continued)
Uncertainty of Regulatory Approval for Biomedical Devices. The Company's
biomedical devices, including its left ventricular-assist systems (LVAS), are
subject to approval by the U.S. Food and Drug Administration (FDA) before
commercial sale of such devices may commence in the U.S. The Company is also
subject to regulatory requirements in foreign countries in which the Company
markets its devices. The process of obtaining regulatory approvals is lengthy,
expensive, and inherently uncertain. Even after FDA and other regulatory
approvals have been obtained, such approvals can be suspended or revoked if the
Company's products do not continue to satisfy regulatory requirements. Failure
to comply with applicable regulatory requirements can result in, among other
things, fines, suspensions of approvals, recalls of products, operating
restrictions, and criminal prosecutions.
In October 1994, the Company received FDA approval for the commercial sale
of its pneumatic LVAS. In April 1994, the Company received the CE Mark for
commercial sale of the pneumatic LVAS in all European Union countries. The
Company's HeartPak(TM) portable console received the CE Mark in February 1995
and the HeartPak is currently in Phase I clinical trials in the U.S. In
September 1998, the Company's electric LVAS received premarket approval by the
FDA for use as a bridge to transplant. The electric LVAS received the CE Mark in
August 1995 for use as a bridge to transplant and as an alternative to
transplant. The Company's electric LVAS is currently in use in clinical trials
in the U.S. testing the safety and efficacy of the device as an alternative to
transplant.
Significant design changes to the Company's LVAS, including use of the
portable console for the pneumatic LVAS, must be approved pursuant to a
supplement to an approved PMA application. Failure of the Company to obtain FDA
approval for the commercial sale of the electric LVAS as an alternative to
transplant would have a material adverse effect on the Company's long-term
growth prospects. In addition, failure of the Company to obtain approval for the
HeartPak portable console would likely require patients supported by the
pneumatic LVAS to remain hospitalized. This could materially restrict the market
for the pneumatic LVAS.
Uncertainty of Patient Reimbursement. The cost of implanting a cardiac
support system is substantial. In addition, the Company's coagulation testing
equipment can cost several thousand dollars per instrument. Without the
financial support of the government or third-party insurers, the market for the
Company's devices and equipment will be limited. Medicare and Medicaid limit the
reimbursement that U.S. hospitals receive for treating certain medical
conditions by setting maximum fees that can be charged to their patients. Under
these systems, hospitals are paid a fixed amount for treating each patient with
a particular diagnosis. Private insurers also have initiated reimbursement
systems designed to slow the escalation of healthcare costs. In addition, the
federal government is considering, and certain state governments are
15
<PAGE>
Forward-looking Statements (continued)
considering or have adopted, new healthcare policies intended to curb rising
costs. Such policies include rationing of government-funded reimbursement for
healthcare services and imposing price controls upon providers of medical
products and services. These policies could have the effect of limiting the
availability of reimbursement for procedures, such as the implantation of an
LVAS, that involve prolonged treatment of critically ill patients.
In November 1995, the U.S. Health Care Finance Administration (HCFA) issued
a decision that extends Medicare coverage to LVAS devices used as a bridge to
heart transplant, which fulfill certain Medicare coverage criteria. This
decision, updated in April 1998, has applied to the Company's pneumatic LVAS and
is expected to extend to the electric LVAS. Several major non-government
insurers have also agreed to offer coverage for LVAS devices. This coverage has
been applied to the pneumatic LVAS and is expected to extend to the electric
LVAS; however, no assurance can be given that third party payers will cover the
electric LVAS immediately because of the device's intended out-patient use. Even
though reimbursement has been established by HCFA and by certain non-government
insurers for LVAS devices, the Medicare coverage criteria could be amended or
revised by HCFA, the amount of available reimbursement may change, and
reimbursement may be denied by an insurer under certain circumstances, including
if it is determined that a procedure was not the most cost-effective treatment
method, was experimental, or was used for an unapproved indication. No assurance
can be given that additional third-party reimbursement for the LVAS devices will
be granted within a reasonable period of time, or at all. The unavailability of
third-party reimbursement for procedures involving the Company's systems or for
the Company's biomedical devices would have a material adverse effect on the
Company's business.
Uncertainty of Opinion Leader Acceptance and Support. A limited number of
cardiac surgeons and cardiologists influence medical device selection and
purchase decisions for a large portion of the target patient population. The
Company will achieve its business objectives only if its LVAS are recommended
for use by such opinion leaders. In addition, acceptance by these physicians of
the Company's whole-blood coagulation monitoring systems and Coumadin monitors
is also important to the success of the Company's business. The Company has
developed working relationships with a number of leading medical centers, and
its existing and proposed LVAS and its blood coagulation monitoring systems have
been well received by opinion leaders in cardiac surgery and cardiology.
Moreover, since the inception of its work on cardiac support systems in 1966,
the Company has relied upon surgical teams at medical institutions to perform
clinical trials that are necessary for obtaining FDA approvals. A continuing
working relationship with those and other institutions will be important to the
success of the Company. No assurance can be given that existing relationships
and arrangements can be maintained or that new relationships will be
established. Furthermore, economic, psychological, ethical, and other concerns
may limit acceptance
16
<PAGE>
Forward-looking Statements (continued)
of heart-assist devices in general, and there can be no assurance that markets
of sufficient size will develop for the Company's LVAS.
Technological Change and Competition. The Company is aware of one other
company that has received a premarket approval from the FDA for an implantable
LVAS that competes with the Company's LVAS. Also, there are many organizations
engaged in the development of various types of cardiac support systems,
including a total artificial heart. As other organizations realize the
commercial potential for LVAS, the Company believes that competition will
intensify. Further, the Company has several competitors in the coagulation
monitoring instrument market. Although the length of the regulatory approval
process for medical equipment and devices such as LVAS is a barrier to entry
into these markets, the Company's products could be rendered obsolete or
uneconomical by technological advances by one or more of the Company's present
competitors or by future entrants into the markets in which the Company
competes. Many manufacturers of medical devices have greater research and
development, manufacturing, and marketing resources than those of the Company.
Availability of Components and Raw Materials. The Company relies on a number
of custom-designed components and materials supplied by other companies to
manufacture its LVAS. The Company is making efforts to minimize the risks
associated with sole sources and ensure long-term availability, including
qualifying alternative materials and components or developing alternative
sources for materials and components supplied by a single source. Although the
Company believes that it has adequate supplies of materials and components to
meet demand for its products for the foreseeable future, no assurance can be
given that the Company will not experience shortages of certain materials or
components in the future that could delay shipments of its products. The cost to
the Company to evaluate and test alternative materials and components and the
time necessary to obtain FDA approval for these materials are inherently
difficult to determine because both time and cost are dependent on at least two
factors: the similarity of the alternative material or component to the original
material or component, and the amount of third-party testing that may have
already been completed on alternative materials or components. There can be no
assurance that the substitution of alternative materials or components would not
cause delays in the Company's LVAS development programs or adversely affect the
Company's ability to manufacture and ship LVAS to meet demand.
Intellectual Property Rights. The Company relies principally upon trade
secret protection and, to a lesser extent, patents to protect its proprietary
rights with respect to its LVAS and its reagents, however, with respect to its
coagulation equipment and skin-incision products, the Company relies principally
on patents to protect its proprietary rights. No assurance can be given that the
Company will be able to effectively protect its patents and trade secrets, or
that competitors will not independently develop equivalent technology or design
around the
17
<PAGE>
Forward-looking Statements (continued)
Company's patents. The Company's competitive position could be adversely
affected if the Company is unable to protect adequately its proprietary rights.
In addition, there can be no assurance that third parties will not assert claims
against the Company that the Company infringes the intellectual property rights
of such parties. The Company could incur substantial costs and diversion of
management resources with respect to the defense of any such claims, which could
have a material adverse effect on the Company's business, financial condition,
and results of operations. Furthermore, parties making such claims could secure
a judgment awarding substantial damages, as well as injunctive or other
equitable relief, which could effectively block the Company's ability to make,
use, sell, distribute, or market its products and services in the U.S. or
abroad. In the event that a claim relating to intellectual property is asserted
against the Company, the Company may seek licenses to such intellectual
property. There can be no assurance, however, that such licenses could be
obtained on commercially reasonable terms, if at all. The failure to obtain the
necessary licenses or other rights could preclude the sale, manufacture, or
distribution of the Company's products and, therefore, could have a material
adverse effect on the Company's business, financial condition, and results of
operations. The Company has received correspondence from a third party alleging
that the textured surface of the LVAS infringes certain patent rights of such
third party. The Company believes that it has meritorious defenses to the claims
of the third party. However, no assurance can be given that the Company would be
successful if litigation was commenced or that others will not claim that the
Company infringes their intellectual property rights.
Limited Manufacturing and Marketing Experience. Prior to FDA approval of
commercial sale of the pneumatic LVAS, the Company's LVAS business was engaged
only in research and development. Since that time, the Company has been building
its manufacturing, marketing, and sales capabilities. Although the Company has
not experienced difficulties in manufacturing its LVAS at volume, cost, and
quality levels sufficient to satisfy the increased demand resulting from
commercial approval, no assurance can be given that the Company will not
encounter difficulties as sales volumes increase or new products and/or
components are approved for commercial sale. The Company does not have
experience in the large-scale commercialization of LVAS medical devices.
Although the Company has added sales and marketing staff and is expanding its
distribution capabilities worldwide, no assurance can be given that the Company
will be able to market and sell its LVAS products successfully in high volumes.
Product Liability. The Company faces an inherent business risk of exposure
to product liability claims relating to the use of its products. Although the
Company currently maintains product liability insurance against this risk, there
can be no assurance that it will continue to be able to obtain such coverage at
economically feasible rates, if at all, or that such coverage will be adequate
in terms and scope to completely protect the Company in the event of a
successful product liability claim.
18
<PAGE>
Forward-looking Statements (continued)
International Operations and International Sales. In 1997, sales originating
outside the U.S. and U.S. export sales accounted for approximately 19% of the
Company's total revenues. The Company anticipates that sales outside the U.S.
and U.S. export sales will continue to account for a significant percentage of
the Company's total revenues. The Company intends to continue to expand its
presence in international markets. International revenues are subject to a
number of risks, including the following: agreements may be difficult to enforce
and receivables difficult to collect through a foreign country's legal system;
foreign customers may have longer payment cycles; foreign countries may impose
additional withholding taxes or otherwise tax the Company's foreign income,
impose tariffs or adopt other restrictions on foreign trade; U.S. export
licenses may be difficult to obtain; the protection of intellectual property in
foreign countries may be more difficult to enforce; and fluctuations in exchange
rates may affect product demand and may adversely affect the profitability in
U.S. dollars of products and services provided by the Company in foreign markets
where payment for the Company's products and services is made in the local
currency. There can be no assurance that any of these factors will not have a
material effect on the Company's business and results of operations.
Potential Impact of Year 2000 on Processing of Date-Sensitive Information.
While the Company is attempting to minimize any negative consequences arising
from the year 2000 issue, there can be no assurance that year 2000 problems will
not have a material adverse impact on the Company's business, operations or
financial condition. While the Company expects that upgrades to its internal
business systems will be completed in a timely fashion, there can be no
assurance that the Company will not encounter unexpected costs or delays.
Despite its efforts to ensure that its material current products are year 2000
compliant, the Company may see an increase in warranty and other claims,
especially those related to Company products that incorporate, or operate using,
third-party software or hardware. In addition, certain of the Company's older
products, which it no longer manufactures or sells, may not be year 2000
compliant, which may expose the Company to claims. If any of the Company's
material suppliers, vendors, or customers experience business disruptions due to
year 2000 issues, the Company might also be materially adversely affected. The
Company's research and development, production, distribution, financial,
administrative, and communications operations might be disrupted. There is
expected to be a significant amount of litigation relating to the year 2000
issue and there can be no assurance that the Company will not incur material
costs in defending or bringing lawsuits. Any unexpected costs or delays arising
from the year 2000 issue could have a significant adverse impact on the
Company's business, operations, and financial condition.
19
<PAGE>
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
See Exhibit Index on the page immediately preceding exhibits.
(b) Reports on Form 8-K
On September 30, 1998, the Company filed a Current Report on Form 8-K for
events occurring on September 29, 1998, pertaining to approval by the U.S. Food
and Drug Administration of the Company's electric LVAS for commercial sale as a
bridge to transplant.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized as of the 6th day of November 1998.
THERMO CARDIOSYSTEMS INC.
Paul F. Kelleher
----------------------------
Paul F. Kelleher
Chief Accounting Officer
John N. Hatsopoulos
----------------------------
John N. Hatsopoulos
Chief Financial Officer and
Senior Vice President
21
<PAGE>
THERMO CARDIOSYSTEMS INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- -----------------------------------------------------------------------------
27 Financial Data Schedule.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THERMO
CARDIOSYSTEMS INC.'S REPORT ON FORM 10-Q FOR THE PERIOD ENDED OCTOBER 3, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-END> OCT-03-1998
<CASH> 23,326
<SECURITIES> 73,650
<RECEIVABLES> 11,791
<ALLOWANCES> 922
<INVENTORY> 11,750
<CURRENT-ASSETS> 124,310
<PP&E> 18,753
<DEPRECIATION> 10,926
<TOTAL-ASSETS> 175,906
<CURRENT-LIABILITIES> 19,274
<BONDS> 70,000
0
0
<COMMON> 4,052
<OTHER-SE> 82,580
<TOTAL-LIABILITY-AND-EQUITY> 175,906
<SALES> 48,416
<TOTAL-REVENUES> 48,416
<CGS> 20,836
<TOTAL-COSTS> 20,836
<OTHER-EXPENSES> 7,728
<LOSS-PROVISION> 90
<INTEREST-EXPENSE> 2,693
<INCOME-PRETAX> 9,040
<INCOME-TAX> 3,444
<INCOME-CONTINUING> 5,596
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,596
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.14
</TABLE>
