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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the Quarter Ended September 30, 1999
[ ] 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 0-19880
ENDOSONICS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 68-0028500
(State or other jurisdiction of (I.R.S. Employer
incorporated or organization) Identification No.)
2870 Kilgore Road, Rancho Cordova, California 95670
(Address of principal executive offices)
Registrant's telephone number, including area code (916) 638-8008
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No __
On November 2, 1999, the registrant had 17,636,039 outstanding shares of Common
Stock of $.001 par value, which is the registrant's only class of Common Stock.
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ENDOSONICS CORPORATION
FORM 10-Q
THIRD QUARTER
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
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Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
Condensed consolidated balance sheets at September 30, 1999 and
December 31, 1998................................................... 3
Condensed consolidated statements of operations for the three months
and nine months ended September 30, 1999 and 1998................... 4
Condensed consolidated statements of cash flows for the nine months
ended September 30, 1999 and 1998................................... 5
Notes to condensed consolidated financial statements...................... 6
Item 2. Management's discussion and analysis of financial condition
and results of operations........................................... 8
Part II. Other Information
Item 1 through 4. Not Applicable.
Item 5. Other Items..................................................................... 18
Item 6. Exhibits and Reports on Form 8-K................................................ 18
Signatures............................................................................... 19
</TABLE>
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ENDOSONICS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,266 $ 8,749
Short-term investments 13,772 16,269
Investment in Radiance Medical Systems, Inc. 9,116 4,137
Trade accounts receivable, net 14,356 13,725
Inventories 13,271 6,834
Accrued interest receivable and other current assets 930 560
--------- ---------
Total current assets 55,711 50,274
Property and equipment, net 6,184 4,064
Intangible assets, net 11,009 12,392
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$ 72,904 $ 66,730
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 10,723 $ 8,200
Accrued restructuring and integration expenses 1,938 3,674
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Total current liabilities 12,661 11,874
Other liabilities 547 604
--------- ---------
Total liabilities 13,208 12,478
STOCKHOLDERS' EQUITY
Convertible preferred stock, $.001 par value
5,000,000 shares authorized, no shares issued
and outstanding -- --
Common stock, $.001 par value; 25,000,000 shares
authorized, and 17,667,088 and 17,590,120 shares
issued and outstanding as of September 30, 1999
and December 31, 1998 respectively 19 18
Additional paid-in capital 179,243 76,433
Common stock in treasury, at cost, 1,212,692 and
860,000 shares at September 30, 1999 and
December 31, 1998 respectively (6,926) (4,839)
Accumulated other comprehensive gain (loss) 3,614 (1,305)
Accumulated deficit (116,254) (116,055)
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Total stockholders' equity 59,696 54,252
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$ 72,904 $ 66,730
========= =========
</TABLE>
See accompanying notes.
3
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ENDOSONICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Total revenue $ 10,499 $ 11,702 $ 36,525 $ 30,818
Cost of sales 5,301 4,940 17,680 14,473
----------- ----------- ----------- -----------
Gross profit 5,198 6,762 18,845 16,345
Operating expenses:
Acquired in process research and development -- 11,107 -- 11,107
Other research, development and clinical 2,136 1,710 5,786 5,306
Marketing and sales 3,107 2,674 8,192 6,781
General and administrative 2,977 1,088 5,158 3,678
Restructuring -- 223 (738) 223
Amortization of intangibles 462 396 1,385 930
----------- ----------- ----------- -----------
Total operating expenses 8,682 17,198 19,783 28,025
----------- ----------- ----------- -----------
Loss from operations (3,484) (10,436) (938) (11,680)
Equity in net loss of Radiance Medical Systems, Inc -- -- -- (158)
Other income :
Interest income 193 310 767 900
Gain realized on sale of common shares of
Radiance Medical Systems, Inc. -- -- -- 739
----------- ----------- ----------- -----------
Total other income 193 310 767 1,639
----------- ----------- ----------- -----------
Net loss before tax (3,291) (10,126) (171) (10,199)
Tax provision (benefit) (125) 150 -- 150
----------- ----------- ----------- -----------
Net loss $ (3,166) $ (10,276) $ (171) $ (10,349)
=========== =========== =========== ===========
Basic net loss per share $ (0.18) $ (0.63) $ (0.01) $ (0.62)
=========== =========== =========== ===========
Shares used in computing basic net loss per share: 17,594,102 16,367,639 17,821,058 16,616,069
=========== =========== =========== ===========
</TABLE>
See accompanying notes.
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ENDOSONICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------
1999 1998
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<S> <C> <C>
Cash flows from operating activities
Net loss $ (171) $(10,349)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Acquired in process research and development -- 11,107
Depreciation and amortization 2,267 1,563
Gain on sale of common shares of Radiance Medical
Systems, Inc. -- (739)
Equity in net loss of Radiance Medical Systems, Inc. -- 158
Net changes in :
Operating assets (7,765) 1,740
Operating liabilities 1,451 (1,639)
-------- --------
Net cash provided by (used in) operating activities (4,218) 1,841
-------- --------
Cash flows from investing activities:
Purchase of short-term investments (14,584) (3,272)
Proceeds from sale of Radiance Medical Systems, Inc.
common stock -- 3,942
Business acquisitions, net of cash acquired -- (6,511)
Maturities of short-term investments 17,082 1,943
Capital expenditures for property and equipment (3,008) (840)
-------- --------
Net cash provided by (used in) investing activities (510) (4,738)
-------- --------
Cash flows from financing activities:
Treasury shares acquired (2,482) (4,839)
Proceeds from exercise of stock options 2,810 328
-------- --------
Net cash used in financing activities 328 (4,511)
-------- --------
Effect of exchange rate changes on cash and cash equivalents (83) (56)
-------- --------
Net decrease in cash and equivalents (4,483) (7,464)
Cash and equivalents, beginning of period 8,749 13,889
======== ========
Cash and equivalents, end of period $ 4,266 $ 6,425
======== ========
</TABLE>
See accompanying notes.
5
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The interim financial information is unaudited. In the opinion of management of
EndoSonics Corporation ("EndoSonics" or the "Company"), the condensed
consolidated financial statements included in this report reflect all
adjustments necessary, consisting only of normal recurring adjustments, to
present fairly the Company's consolidated financial position at September 30,
1999 and the consolidated results of its operations and cash flows for the nine
month periods ended September 30, 1999 and 1998. Results for the interim periods
are not necessarily indicative of consolidated results to be expected for the
entire fiscal year. These financial statements should be read in conjunction
with the Company's audited financial statements for the year ended December 31,
1998, contained in the Company's Annual Report on Form 10-K.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of EndoSonics and its
subsidiaries. (EndoSonics and its subsidiaries are collectively referred to
hereinafter as "the Company"). All significant intercompany accounts and
transactions have been eliminated. Investments in unconsolidated subsidiaries,
and other investments in which the Company has a 20% to 50% interest or
otherwise has the ability to exercise significant influence, are accounted for
under the equity method.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period balances to conform
to current period presentations.
INVESTMENTS
In accordance with SFAS 115, the Company has classified its investment portfolio
as available-for-sale. Unrealized gains (losses) on available-for-sale
securities are recorded as a separate component of stockholders' equity.
2. INVENTORIES
Inventories are stated at the lower of cost, determined on a first in, first out
(FIFO) cost basis, or market value. Inventories consist of the following:
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
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<S> <C> <C>
Raw materials $ 5,052 $3,206
Work-in-process 3,681 1,354
Finished goods 4,538 2,274
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Total $13,271 $6,834
======= ======
</TABLE>
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3. COMPUTATION OF NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of shares of
common stock outstanding. Common equivalent shares from stock options and
warrants are excluded from the computation of net loss per share because their
effect is antidilutive.
At September 30, 1999 and December 31, 1998 the Company had outstanding options
to purchase 3,809,293 and 3,744,030 shares of common stock, respectively (with
exercise prices ranging from $0.32 to $16.50) and outstanding warrants to
purchase 12,304 shares of common stock (with exercise prices from $11.76 to
$12.55). If exercised, these options could potentially dilute basic earnings per
share in future periods.
4. COMPREHENSIVE INCOME
The following table sets forth the computation of comprehensive income:
<TABLE>
<CAPTION>
Three months ended
September 30,
-----------------------------
1999 1998
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<S> <C> <C>
Net income (loss) $(3,166) $(10,449)
Other comprehensive income:
Unrealized gain on available for sale securities (net tax
of $155 and $867 in 1999 and 1998, respectively) 3,711 (1,415)
Foreign currency translation (net tax of $(8) and $20 in
1999 and 1998, respectively) (160) 32
------- --------
Comprehensive income $ 385 $(11,832)
======= ========
</TABLE>
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------------
1999 1998
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<S> <C> <C>
Net income (loss) $ (171) $(10,522)
Other comprehensive income:
Unrealized gain on available for sale securities (net tax
of $97 and $44 in 1999 and 1998, respectively) 2,335 72
Foreign currency translation (net tax of $(5) and $21 in
1999 and 1998, respectively) (118) 35
------- --------
Comprehensive income $ 2,046 $(10,415)
======= ========
</TABLE>
7
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5. RESTRUCTURING AND OTHER CHARGES
During the nine months ended September 30, 1999, the Company determined that
certain accrued costs related to the cancellation of certain distribution
agreements would most likely not be incurred. Accordingly, $738 in accrued
restructuring reserves was reversed in June. The elements of the accrual for
restructuring and integration charges as of September 30, 1999 are as follows:
<TABLE>
<CAPTION>
Accrual as
of Accrual as of
December 31, Cost Restructuring September
1998 Incurred Decrease 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Corporate reorganization $3,674 $(998) $(738) $1,938
============= ============= ============== =============
</TABLE>
6. STOCK REPURCHASE
The Board of Directors has authorized a stock repurchase program whereby the
Company may repurchase up to 1.7 million shares of its common stock from
time-to-time in the open market or private transactions. As of December 31,
1998, the Company had repurchased 860,000 shares of its common stock on the open
market at an aggregate cost of approximately $4,839. During the nine months
ended September 30, 1999, the Company repurchased an additional 410,000 shares
of its common stock on the open market at an aggregate cost of approximately
$2,482. Also, during the nine months ended September 30, 1999, 57,308 shares of
common stock held in treasury were re-issued to participants of the Company's
Employee Stock Purchase Plan at prices ranging from $4.0375 to $7.3313 per
share. As a result, a total of 1,212,692 shares were held in treasury at
September 30, 1999 at an aggregate cost of approximately $6,926.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report of Form 10-Q contains forward-looking statements. These
statements are generally indicated by words or phrases such as "anticipates",
"estimates", "projects", "believes", "intends", "expects", and similar words and
phrases. The Company's business is subject to risks and uncertainties and the
Company's actual results may differ significantly from the results discussed in
the forward-looking statements. Factors that might cause such a difference
include, but are not limited to, the Company's ability to transition to new
distribution arrangements in Europe and North America, the introduction of new
products, FDA approval of new products and changes in regulatory requirements
and third-party reimbursement policies. For discussion of these and other
factors, please see "Risks Factors" on page 12 of this Form 10-Q and in the
Company's Annual Report on Form 10-K (starting on page 20) for the fiscal year
ended December 31, 1998.
RESULTS OF OPERATIONS
THIRD QUARTER OF 1999 COMPARED TO THE SAME PERIOD IN 1998
Total Revenue. Total revenue decreased 10% to $10.5 million for the third
quarter of 1999, from $11.7 million for the third quarter of 1998. The decrease
is primarily due to a decline in orders from Europe and Asia as compared to
1998. This decrease in export orders was not fully offset by the increase in
domestic revenues. Export sales comprised approximately 61% of total revenues in
third quarter of 1999 as compared to 74% in the third quarter of 1998. The
Company expects that export sales will continue to represent a substantial
portion of the Company's revenue in future periods. Third quarter revenues for
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the IVUS business decreased by $1.7 million or 23%, due primarily to a decline
in distributor orders in Europe and Asia. Revenues for the Cardiometrics
business increased by $0.1 million, or 4%, primarily due to increased Wavewire
shipments, which were partially offset by decreases in Cardiometrics instrument
shipments. Subsequent to the end of the third quarter, the Company terminated
its relationship with its principal European distributor. In the third quarter
of 1999 sales to this distributor amounted to approximately $1.2 million. Future
revenue growth in Europe will be dependent on the ability of the Company to
successfully transition to alternative distribution channels.
Cost of Sales. Cost of sales as a percentage of product sales increased to 50%
for the third quarter of 1999, as compared to 42% for the third quarter of 1998.
Cost of sales as a percentage of total revenues increased due primarily to
manufacturing inefficiencies related to the transition of certain product lines
to the Company's San Diego facility. Due to the uncertainty associated with
improvements in the efficiency of the Company's manufacturing process and the
impact of increasingly competitive pricing, there can be no assurance that the
Company's gross profit margin will be maintained or improve in future periods.
Acquired In-Process Research and Development. In the third quarter of 1998 the
Company incurred an $11.1 million charge related to the write-off of in-process
research and development acquired in the August 1998 purchase of Navius.
Other Research, Development, and Clinical. Research, development and clinical
expenses increased to $2.1 million for the third quarter of 1999 from $1.7
million for the third quarter of 1998. In addition to a general increase in
research and development programs, Navius research and development expenses were
included in the Company's operations for a full quarter in 1999. Acquired in
August 1998, Navius expenses were included in the Company's operations for only
two months in the third quarter of 1998.
Marketing and Sales. Marketing and sales expenses increased to $3.1 million in
the third quarter of 1999 compared to $2.7 million in the third quarter of 1998.
The 16% increase is due to increased staffing and marketing programs related to
staffing a direct sales force in the United States and Germany. As a percentage
of total revenues marketing and sales expenses increased to 30% in the third
quarter of 1999 from 23% in the third quarter of 1998. The increase is a result
of a ramp up of expenses coupled with the decrease in revenue. The Company
anticipates that it will continue to expand its direct sales force in the United
States and certain European territories.
General and Administrative. General and administrative expenses increased to
$3.0 million in the third quarter of 1999 from $1.1 million during the same
quarter in 1998. In the third quarter of 1999, the Company increased its bad
debt reserves of approximately $1.7 million, primarily related to past due
accounts receivables of one of the Company's distributors. Excluding the
adjustment to the Company's bad debt reserves, general and administrative
expenses increased to $1.4 million, which is attributable to an overall increase
in the Company's level of operations.
Amortization of Intangibles. Amortization of intangibles increased to $0.5
million in the third quarter of 1999 from $0.4 million in the third quarter of
1998. The amortization relates to goodwill and other intangible assets acquired
in the acquisition of Navius in August 1998 and Cardiometrics in July 1997.
Goodwill and other intangibles are being amortized over periods ranging from
three to nine years
Other Income. Other income decreased to $0.2 million in the third quarter of
1999 compared to $0.3 million in the third quarter of 1998. This is due to a
decrease in interest income, which is a result of lower cash balances.
Net Loss. Net loss was $3.2 million, or $0.18 per basic share, in the third
quarter of 1999 as compared to $10.3 million, or $0.63 per basic share, in the
third quarter of 1998.
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FIRST NINE MONTHS OF 1999 COMPARED TO SAME PERIOD OF 1998
Total Revenue. Total revenue increased 19% to $36.5 million for the nine months
ended September 30, 1999 as compared to $30.8 million for the nine months ended
September 30, 1998. Revenues for the IVUS business increased by $2.5 million or
12%, primarily due to an increase in direct and distributor sales in Europe over
1998. Revenues for the Cardiometrics business increased by $0.8 million or 10%,
primarily due to increased Wavewire shipments, which were partially offset by
decreases in Cardiometrics instrument shipments. Export sales comprised
approximately 67% of total revenues in the nine-month period ending September
1999 as compared to 73% in the same period of 1998. The Company expects that
export sales will continue to represent a substantial portion of the Company's
revenue in future periods. Subsequent to the end of the third quarter, the
Company terminated its relationship with its principal European distributor. In
the first months of 1999 sales to this distributor amounted to approximately
$6.7 million. Future revenue growth in Europe will be dependent on the ability
of the Company to successfully transition to alternative distribution channels.
Cost of Sales. Cost of sales as a percentage of product sales increased slightly
to 48% for the nine months ended September 30, 1999, from 47% for the nine
months ended September 30, 1998. Among other factors, the increase is due to
manufacturing inefficiencies related to the transition of certain product lines
to the Company's San Diego facility. Due to the uncertainty associated with
improvements in the efficiency of the Company's manufacturing process and the
impact of increasingly competitive pricing, there can be no assurance that the
Company's gross profit margin will be maintained or improve in future periods.
Acquired In-Process Research and Development. During the first nine months of
1998 the Company incurred an $11.1 million charge related to the write-off of
in-process research and development acquired in the August 1998 purchase of
Navius.
Other Research, Development, and Clinical. Research, development and clinical
expenses increased to $5.8 million for the first nine months of 1999 from $5.3
million for the same period in 1998. In addition to a general increase in
research and development programs, Navius research and development expenses were
included in the Company's operations for the full nine-month period ending
September 1999. Acquired in August 1998, Navius expenses were included in the
Company's operations for only two months in the nine-month period ending
September 1998.
Marketing and Sales. Marketing and sales increased to $8.2 million in the first
nine months of 1999 compared to $6.8 million in the same period of 1998. The 21%
increase is due to increased staffing and marketing programs related to staffing
a direct sales force in the United States and Germany. The increased marketing
and sales expense is largely offset by the 19% increase in revenues.
Consequently, marketing and sales expense as a percentage of revenues remained
flat at 22% for both periods. The Company anticipates that it will continue to
expand its direct sales force in the United States and certain European
territories.
General and Administrative. General and administrative expenses increased to
$5.2 million for the nine months ended September 30, 1999 as compared to $3.7
million dollars for the same period in 1998. In September 1999, the Company
increased its bad debt reserves by approximately $1.7 million, primarily related
to past due accounts receivables of one of the Company's distributors.
Restructuring. During the first nine months of 1999 the Company determined that
certain accrued costs related to the cancellation of certain distribution
agreements would most likely not be incurred. Accordingly, $0.7 million in
accrued restructuring reserves was reversed during the period.
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Amortization of Intangibles. Amortization of intangibles increased $0.5 million
for the nine months ended September 30, 1999 to $1.4 million as compared to $0.9
million for the same period in 1998. The amortization relates to goodwill and
other intangible assets acquired in the acquisition of Navius in August 1998 and
Cardiometrics in July 1997. Goodwill and other intangibles are being amortized
over periods ranging from three to nine years.
Equity in Net Loss of Radiance Medical Systems, Inc. There was no equity in net
loss of Radiance Medical Systems, Inc. (RADX) in the nine months ended September
30, 1999. Equity in the net loss of RADX for the nine months ended September 30,
1998 was $0.2 million. Since February 1998, the Company's ownership in RADX has
been less than 20%.
Other Income. Other income decreased to $0.8 million as compared to $1.6 million
for the nine months ended September 30, 1998. The Company recognized a gain of
$0.7 million in the nine months ended June 30, 1998, related to the sale of
Radiance Medical Systems, Inc. (RADX) common stock. The company did not sell any
RADX common stock during the first nine months of 1999. In addition, due to
lower cash balances, interest income decreased to about $0.7 million for the
first nine months of 1999 as compared to $0.9 million for the same period in
1998.
Net Loss. Net loss was $0.2 million, or $0.01 per basic share, for the nine
months ended September 30, 1999 as compared to a loss of $10.3 million, or $0.62
per basic share, for the nine months ended September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
On September 30, 1999, the Company had cash and cash equivalents of $4.3
million, short-term investments of $22.9 million and no borrowings or credit
facilities. Net cash provided by (used in) operations was $ (4.2) million in the
nine months ended September 30, 1999 as compared to $1.8 million in the same
period in 1998. The use of cash in operations relates to increases in inventory
to support future sales and increased account receivables, including some that
are past due, arising from sales to distributors.
Net cash used in investing activities decreased to $0.5 million in the nine
months ended September 30, 1999 as compared to $4.7 million in the same period
of 1998. There was no cash provided by sales of Radiance Medical Systems, Inc.,
common stock in the nine months ended September 30, 1999, as compared to $3.9
million provided in the same period of 1998. Also, capital expenditures in the
nine months ended September 30, 1999 increased to $3.0 million from $0.8 million
for the same period in 1998. These reductions in cash were offset by an increase
in maturities of short-term investments.
Net cash provided by (used in) financing activities was $0.3 million for the
nine months ended September 30, 1999 as compared to $(4.5) million in the same
period of 1998. In the nine months ended September 30, 1999 the Company used
$2.5 million to acquire treasury stock and received $2.8 million from the
exercise of stock options. In the nine months ended September 30, 1998 the
Company used $4.8 million to acquire treasury stock and received $0.3 million
from the exercise of stock options.
The Company anticipates using cash resources primarily for capital expenditures,
product development, sales and marketing efforts and working capital purposes.
The Company believes that its existing cash, cash equivalents, and short-term
investments as of September 30, 1999 will be sufficient to meet the Company's
operating expenses and capital requirements through 2000. In addition,
subsequent to the end of the third quarter the Company secured a $10 million
working capital line of credit. However, there can be no assurance that the
Company will not be required to seek other financing or that such financing, if
required, will be available on terms satisfactory to the Company.
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IMPACT OF YEAR 2000
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions to operations, including a
temporary inability to process transactions, send invoices, or engage in similar
normal business activities. Should any of these disruptions occur, the financial
impact on the Company is unknown.
The Company has completed an assessment and will have to modify or replace
certain portions of its existing software in order for its computer systems to
function properly with respect to dates in the year 2000 and thereafter.
However, independent of the Year 2000 Issue, the Company expects to replace the
majority of its existing separate manufacturing and financial software systems
with an integrated, enterprise-wide (ERP) software platform. The Company
believes that the new ERP software can be installed and tested with regards to
the Year 2000 Issue by December 1999. It is expected that the cost of the new
software, installation, and testing will be approximately $1.5 million, the
majority of which would be capitalized. In the event that the new software does
not function properly with regard to the Year 2000, and an adequate solution is
not readily available, the Company's believes that it can make the necessary
modifications (consisting primarily of software version upgrades) to its current
computer programs in order to make them Year 2000 compliant.
It is anticipated that the Year 2000 project will be completed not later than
December 1999, which is prior to any anticipated impact on the Company's
operating systems. The Company believes that with the planned software
conversion or with modifications to the existing software, the Year 2000 Issue
will not pose a significant operational problem. However, if such modifications
are not completed timely, the Year 2000 Issue could have a material impact on
the operations of the Company. Likewise, based on a survey of its major
suppliers, vendors and customers with regard to their Year 2000 readiness, the
Company does not anticipate any operational problems related its suppliers,
vendors, customers and the Year 2000 Issue. However, if any of the Company's key
suppliers, vendors or customers does experience a prolonged business
interruption as a result of the Year 2000 Issue, it could have a material impact
on the operations of the Company.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which assume certain future events, including the continued availability of
certain resources. However, there can be no guarantee that these estimates will
be achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
effectiveness of the new software and, if necessary, the upgrades received from
the Company's software vendors at addressing the Year 2000 Issue and similar
uncertainties.
RISK FACTORS
History of Operating Losses; Anticipated Future Losses. The Company was
founded in 1984 and has experienced annual operating losses since its inception.
The Company's accumulated deficit at September 30, 1999 was approximately $116
million. There can be no assurance that the Company will be able to achieve or
sustain profitability in the future. Although the Company believes that its
existing cash, cash equivalents and short-term investments will be sufficient to
meet its liquidity requirements
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through 2000, there can be no assurance that the Company will not require
additional financing or that such financing, if required, will be available on
satisfactory terms, if at all.
Uncertainty of Market Acceptance. Although external ultrasound imaging
and balloon angioplasty are widely used technologies, the use of IVUS imaging in
connection with interventional cardiology is relatively new. The commercial
success of the Company's products will depend upon their acceptance by the
medical community as a useful, cost-effective component of interventional
cardiovascular and peripheral vascular procedures. IVUS imaging is used in
conjunction with angioplasty and other intravascular procedures such as vascular
stenting. Accordingly, the medical community must determine that the information
obtained from the use of the Company's ultrasound products will increase the
safety or effectiveness or lower the overall cost of the care being provided and
that the value of such information justifies the incremental expense of
obtaining IVUS imaging. In addition, market acceptance of the Company's
combination balloon angioplasty/IVUS imaging catheters will depend, among other
things, on a determination by the medical community that the efficacy of the
therapeutic component of the Company's combination catheters is at least
comparable to that of competing non-imaging angioplasty catheters and other
types of therapy. Although IVUS imaging devices have been available for over ten
years, the market for such products has remained relatively small. Although the
Company believes the benefits of IVUS imaging can be demonstrated, there can be
no assurance that the benefits will be considered sufficient by the medical
community to enable the Company's products to achieve widespread market
acceptance. Failure of the Company's products to achieve market acceptance would
have a material adverse effect on the Company's business, financial condition
and results of operations.
Dependence on Strategic Relationships. In recent years there has been
significant consolidation among medical device suppliers as the major suppliers
have attempted to broaden their product lines in order to focus on product
configurations that address a given procedure or treatment and in order to
respond to cost pressures from health care providers. This consolidation has
made it increasingly difficult for smaller suppliers, such as the Company, to
effectively distribute their products without a major relationship with one of
the major suppliers. There can be no assurance that the Company will be able to
maintain its relationship with its key distributors or replace a key distributor
in the event the Company's relationship with that distributor would be
terminated. In the event of such a termination, the Company's ability to
distribute its IVUS imaging products would be materially adversely affected,
which would have a material adverse effect on the Company's business, financial
condition and results of operations. Subsequent to the end of the third quarter,
the Company terminated its relationship with its principal European distributor.
Further revenue growth in Europe will be dependent on the ability of the Company
to successfully transition to alternative distribution channels.
Dependence on New Products; Rapid Technological Change. The medical
device industry generally, and the IVUS imaging device market in particular, are
characterized by rapid technological change, changing customer needs, and
frequent new product introductions. The Company's future success will depend
upon its ability to develop and introduce new products that address the
increasingly sophisticated needs of its customers. There can be no assurance
that the Company will be successful in developing and marketing new products
that achieve market acceptance or that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of new products.
Dependence on International Sales. The Company derives, and expects to
continue to derive, a significant portion of its revenue from international
sales. In 1996, 1997, and 1998, the Company's international sales were $16.9
million, $21.9 million and $32.2 million respectively, or 69%, 64% and 73% of
total revenue. Therefore, a significant portion of the Company's revenues will
continue to be subject to the risks associated with international sales,
including economic or political instability, shipping delays, changes in
applicable regulatory policies, fluctuations in foreign currency exchange rates
and various trade restrictions, all of which could have a significant impact on
the Company's ability to deliver products on a competitive and timely basis.
Future imposition of, or significant increases in the
13
<PAGE> 14
level of, customs duties, import quotas or other trade restrictions, could have
an adverse effect on the Company's business, financial condition and results of
operation. The regulation of medical devices, particularly in the European
Community, continues to expand and there can be no assurance that new laws or
regulations will not have an adverse effect on the Company.
Suppliers. The Company purchases many standard and custom built
components from independent suppliers, and contracts with third parties for
certain specialized electronic component manufacturing processes. Most of these
purchased components and processes are available from more than one vendor.
However, the manufacturing of the connection points on the integrated circuit
microchips and the pressure microchip are currently performed by single vendors.
Although the Company is in the process of identifying alternative vendors, the
qualification of additional or replacement vendors for certain components or
services is a lengthy process. Any supply interruption from these single source
vendors would have a material adverse effect on the Company's ability to
manufacture its products until a new source of supply was qualified and, as a
result, could have an adverse effect on the Company's business, financial
condition and results of operations.
Limitations on Third-Party Reimbursement. In the United States, the
Company's products are purchased primarily by medical institutions that then
bill various third-party payors. Medical institutions are reimbursed for the
care of Medicare hospital patients based at a predetermined lump sum amount for
diagnostic related group or DRGs regardless of the costs involved. The amount of
money paid for a specific DRG is determined by the average resource consumption
needed to treat a specific disease, including the nursing time, operating room
time and supplies. The amount of reimbursement is fixed and thus the amount of
potential profit for the medical institution relating to the procedure may be
reduced to the extent the physician performs additional procedures such as IVUS
imaging, pressure measurement or uses a more expensive product that combines
ultrasound imaging with therapeutic capabilities.
Private insurers and other payors determine whether to provide coverage
for a particular procedure and reimburse hospitals for medical treatment also
usually at a fixed rate. The fixed rate of reimbursement is based on the
procedure performed, and is unrelated to the specific type or number of devices
used in a procedure. Some payors may deny reimbursement if they determine that
the device used in a treatment was unnecessary, inappropriate or not
cost-effective, experimental or used for a non-approved indication.
Physicians are reimbursed for performing medical procedures based on the
amount of resource costs needed to provide the services. Included in the cost of
providing each service is the physician work, practice expense and malpractice
insurance. Payments are adjusted for geographic differences. CPT codes are now
available for all EndoSonics technology. CPT codes have been available for
ultrasound procedures since 1997 and since January 1999 for Doppler flow and
pressure measurement. Physicians are responsible to determine that the clinical
benefits of intravascular ultrasound imaging and physiological assessment
justify the additional costs for the medical institutions.
Although the Company believes that less invasive procedures generally
provide less costly overall therapies as compared to alternative surgical
procedures, there can be no assurance that reimbursement for such less invasive
procedures will continue to be available, or that future reimbursement policies
of payors will not adversely affect the Company's ability to sell its products
on a profitable basis. Failure by hospitals and other users of the Company's
products to obtain reimbursement from third-party payors, or changes in
government and private third-party payors' policies toward reimbursement for
procedures employing the Company's products, would have a material adverse
effect on the Company's business, financial condition and results of operations.
14
<PAGE> 15
The market for the Company's products could be adversely affected by
changes in governmental and private third-party payors' policies. A portion of
capital costs for medical equipment purchased by hospitals is currently
reimbursed separately from DRG payments. Moreover, the Company is unable to
predict what additional legislation or regulation if any, relating to the health
care industry or third-party coverage and reimbursement may be enacted in the
future, or what effect such legislation or regulation would have on the Company.
Competition. Competition in the market for devices used in the diagnosis
and treatment of cardiovascular and peripheral vascular disease is intense, and
is expected to increase. The interventional cardiology market is characterized
by rapid technological innovation and change, and the Company's products could
be rendered obsolete as a result of future innovations. The Company's digital,
all-electronic IVUS imaging catheters compete with mechanical ultrasound devices
manufactured by CVIS, a subsidiary of Boston Scientific. CVIS is significantly
larger than the Company, and has significantly greater financial, sales and
marketing and technical resources available. CVIS has also developed IVUS
imaging products with high quality images and the Company believes that its
competitive position is dependent upon its ability to establish its reputation
as a producer of high quality IVUS imaging products. There can be no assurance
that CVIS is not currently developing, or will not attempt to develop,
combination balloon angioplasty/IVUS imaging catheters that would compete with
the Company's combination balloon angioplasty/IVUS imaging products. Moreover,
companies currently engaged in the manufacture and marketing of non-imaging
angioplasty catheters could attempt to expand their product lines to include
combination balloon angioplasty/IVUS imaging products.
The Company's combination balloon angioplasty/IVUS imaging catheters
compete or will compete with therapeutic catheters marketed by a number of
manufacturers, including CVIS, Cordis, Guidant and Medtronic, Inc. Such
companies have substantial resources, established market positions, and
significantly larger sales and marketing organizations. In addition, the Company
faces competition from manufacturers of atherectomy devices, vascular stents and
pharmaceutical products intended to treat cardiovascular disease.
Reliance on Patents and Proprietary Technology; Risk of Patent
Infringement. The Company holds six issued United States patents and has other
United States and several foreign patent applications pending covering various
aspects of its IVUS imaging technology. No assurance can be given, however, that
the Company's patent applications will issue as patents or that any issued
patents will provide competitive advantages for the Company's products or will
not be successfully challenged or circumvented by its competitors. Although the
Company attempts to ensure that its products do not infringe other parties'
patents and proprietary rights, there can be no assurance that its products do
not infringe such patents or rights. The interventional cardiovascular market
has been characterized by substantial litigation regarding patent and other
intellectual property rights. In the event that any relevant claims of
third-party patents are upheld as valid and enforceable, the Company could be
prevented from practicing the subject matter claimed in such patents, or would
be required to obtain licenses from the owners of any such patents or redesign
its products or processes to avoid infringement. There can be no assurance that
such licenses would be available or, if available, would be so on terms
acceptable to the Company or that the Company would be successful in any attempt
to redesign its products or processes to avoid infringement. The Company also
relies on trade secrets and proprietary technology and enters into
confidentiality and non-disclosure agreements with its employees and
consultants. There can be no assurance that the confidentiality of such trade
secrets or proprietary information will be maintained by employees, consultants,
advisors or others, or that the Company's trade secrets or proprietary
technology will not otherwise become known or be independently developed by
competitors in such a manner that the Company has no practical recourse.
Litigation may be necessary to defend against claims of
15
<PAGE> 16
infringement or invalidity, to enforce patents issued to the Company or to
protect trade secrets and could result in substantial cost to, and diversion of
effort by, the Company.
Government Regulation. The manufacturing and marketing of the Company's
products are subject to extensive and rigorous government regulation in the
United States and in other countries. The Company believes that its success will
be significantly dependent upon commercial sales of improved versions of its
imaging systems and catheter products. The Company will not be able to market
these new products in the United States unless and until the Company obtains
approval from the FDA.
If a medical device manufacturer can establish that a newly developed
device is "substantially equivalent" to a device that was legally marketed prior
to May 1976, or to a device that the FDA has found to be substantially
equivalent to a legally marketed pre-1976 device, the manufacturer may seek
clearance from the FDA to market the device by filing a pre-market notification
with the FDA under Section 510(k) of the Federal Food, Drug, and Cosmetic Act
("510(k)"). There can be no assurance that 510(k) clearance for any future
product or modification of an existing product will be granted or that the
process will not be unduly lengthy. All of the 510(k) clearances received for
the Company's catheters were based on substantial equivalence to legally
marketed pre-1976 devices. Review of the substantially equivalent pre- 1976
devices on which the 510(k) clearances for the Company's catheters were based
and any resulting restrictions on the Company or requirements imposed to present
additional data could have a material adverse effect on the Company's business,
financial condition and results of operations.
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 that the manufacturer submit a PMA
application that must be reviewed and approved by the FDA prior to sales and
marketing of the device in the United States. The PMA process is significantly
more complex, expensive and time consuming than the 510(k) clearance process and
frequently requires the submission of clinical data. It is expected that certain
of the Company's combination angioplasty/IVUS imaging products under development
will be subject to this PMA process. Failure to comply with applicable
regulatory requirements can, among other consequences, result in fines,
injunctions, civil penalties, suspensions or loss of regulatory approvals,
product recalls, seizure of products, operating restrictions and criminal
prosecution. In addition, governmental regulations may be established that could
prevent or delay regulatory approval of the Company's products. Delays in
receipt of approvals, failure to receive approvals or the loss of previously
received approvals would have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company is also required to register as a medical device
manufacturer with the FDA and certain state agencies, such as the Food and Drug
Branch of CDHS. As such, the Company is inspected on a routine basis by both the
FDA and the CDHS for compliance with the GMP regulations. These regulations
require that the Company manufacture its products and maintain related
documentation in a prescribed manner with respect to manufacturing, testing and
control activities. Further, the Company is required to comply with various FDA
requirements for labeling. The Medical Device Reporting regulation requires that
the Company provide information to the FDA on deaths or serious injuries alleged
to have been associated with the use of its devices, as well as product
malfunctions that would likely cause or contribute to death or serious injury if
the malfunction were to recur. In addition, the FDA prohibits an approved device
from being marketed for unapproved applications. If the FDA believes that a
company is not in compliance with applicable laws and regulations, it can
institute proceedings to detain or seize products, issue a recall, prohibit
marketing and sales of the company's products and assess civil and criminal
penalties against the company, its officers or its employees.
16
<PAGE> 17
The Company is also subject to other federal, state and local laws,
regulations and recommendations relating to safe working conditions, laboratory
and manufacturing practices. The extent of government regulation that might
result from any future legislation or administrative action cannot be accurately
predicted. Failure to comply with regulatory requirements could have a material
adverse effect on the Company's business, financial condition and results of
operations.
International sales of the Company's products are subject to the
regulatory agency product registration requirements of each country. The
regulatory review process varies from country to country and may in some cases
require the submission of clinical data. The Company typically relies on its
distributors in such foreign countries to obtain the requisite regulatory
approvals. There can be no assurance, however, that such approvals will be
obtained on a timely basis or at all.
The Company has received ISO 9001 certification of its Quality System as
well as CE Mark certifications for most of its products. The ISO 9000 series of
standards for quality operations has been developed to ensure that companies
know the standards of quality to which they must adhere to receive
certification. The European Union has promulgated rules which require that
medical products obtain the right to affix the CE Mark, an international symbol
of adherence to quality assurance standards and compliance with applicable
European medical device directives. All medical devices placed on the market
within the European Union are required to bear the CE Mark. ISO 9000
certification is one of the CE Mark certification requirements. Failure to
receive the right to affix the CE Mark for any product will prohibit the Company
from selling that product in member countries in the European Union. In Europe,
the Company has obtained ISO 9001 certification for operations at the EndoSonics
Europe, B.V. office. There can be no assurance that the Company will be
successful in meeting ongoing certification requirements.
Potential Product Liability; Limited Insurance. The Company faces the
risk of financial exposure to product liability claims. The Company's products
are often used in situations in which there is a high risk of serious injury or
death. Such risks will exist even with respect to those products that have
received, or in the future may receive, regulatory approval for commercial sale.
The Company maintains product liability insurance with coverage limits of $1.0
million per occurrence and $10.0 million per year in the aggregate. There can be
no assurance that the Company's product liability insurance is adequate or that
such insurance coverage will remain available at acceptable costs. There can be
no assurance that the Company will not incur significant product liability
claims in the future. A successful claim brought against the Company in excess
of its insurance coverage could have a material adverse effect on the Company's
business, financial condition and results of operations. Additionally, adverse
product liability actions could negatively affect the reputation and sales of
the Company's products as well as the Company's ability to obtain and maintain
regulatory approval for its products.
Volatility of Stock Price. The Company's Common Stock has experienced
and can be expected to continue to experience substantial price volatility in
response to actual or anticipated quarterly variations in operating results,
announcements of technological innovations or new products by the Company or its
competitors, developments related to patents or other intellectual property
rights, developments in the Company's relationships with its customers,
distributors or suppliers, acquisitions or divestitures of other companies in
the health care industry, and other events or factors. In addition, any
shortfall or changes in revenue, gross margins, earnings, or other financial
results from analysts' expectations could cause the price of the Company's
Common Stock to fluctuate significantly. In recent years, the stock market in
general has experienced extreme price and volume fluctuations, which have
particularly affected the market price of many technology and healthcare
companies and which have often been unrelated to the operating performance of
those companies. These broad market fluctuations may adversely affect the market
price of the Company's Common Stock.
17
<PAGE> 18
Part II.
OTHER INFORMATION
ITEMS 1 through 4. Not applicable.
ITEM 5. Other Information
Effective November 1, 1999 Mr. Roger Salquist, Chairman, resigned from
the Company's Board of Directors, to devote his full attention to the
portfolio companies and the investing activities of the North American
Nutrition and Agribusiness Fund (NANAF), of which he is Chief Investment
Officer.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27 Financial Data Schedule
(b) No reports on Form 8-K were filed during the period.
18
<PAGE> 19
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.
ENDOSONICS CORPORATION
/s/ REINHARD J. WARNKING
------------------------
Reinhard J. Warnking
President and
Chief Executive Officer
Date: November 15, 1999
/s/ RICHARD L. FISCHER
----------------------
Richard L. Fischer
Vice President, Finance and
Chief Financial Officer
Date: November 15, 1999
/s/ KATHLEEN E. REDD
--------------------
Kathleen E. Redd
Corporate Controller and
Principal Accounting Officer
Date: November 15, 1999
19
<PAGE> 20
EXHIBIT INDEX
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NO. DESCRIPTION
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<S> <C>
27 FINANCIAL DATA SCHEDULE
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<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 4,266
<SECURITIES> 22,888
<RECEIVABLES> 14,356
<ALLOWANCES> 0
<INVENTORY> 13,271
<CURRENT-ASSETS> 55,711
<PP&E> 6,184
<DEPRECIATION> 0
<TOTAL-ASSETS> 72,904
<CURRENT-LIABILITIES> 12,661
<BONDS> 0
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0
<COMMON> 19
<OTHER-SE> 59,677
<TOTAL-LIABILITY-AND-EQUITY> 72,904
<SALES> 36,525
<TOTAL-REVENUES> 36,525
<CGS> 17,680
<TOTAL-COSTS> 19,783
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (171)
<INCOME-TAX> 0
<INCOME-CONTINUING> (171)
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<NET-INCOME> (171)
<EPS-BASIC> (0.01)
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