<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to __________________
Commission File Number: 0-21330
AVECOR CARDIOVASCULAR INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1695729
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7611 NORTHLAND DRIVE, MINNEAPOLIS, MINNESOTA 55428
(Address of principal executive offices) (Zip Code)
(612) 391-9000
(Registrant's telephone number, including area code)
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 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.
[ X ] Yes [ ] No
As of November 2, 1998, there were 8,067,180 shares of the registrant's
$.01 par value Common Stock outstanding.
<PAGE>
INDEX
<TABLE>
<CAPTION>
Part I. FINANCIAL INFORMATION Page(s)
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1998 (Unaudited)
and December 31, 1997 3
Consolidated Statements of Operations for the three and nine months
ended September 30, 1998 and 1997 (Unaudited) 4
Consolidated Statements of Cash Flows for nine months ended
September 30, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6 - 9
Item 2. Management s Discussion and Analysis of Financial Condition and
Results of Operations 10 - 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Part II. OTHER INFORMATION
Item 1. Legal Proceedings. 20
Item 2. Changes in Securities and Use of Proceeds. 20
Item 3. Defaults Upon Senior Securities. 20
Item 4. Submission of Matters to a Vote of Security Holders. 20
Item 5. Other Information. 20
Item 6. Exhibits and Reports on Form 8-K. 21
SIGNATURES 22
EXHIBIT INDEX 23
`</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVECOR CARDIOVASCULAR INC.
CONSOLIDATED BALANCE SHEETS
-------------------------
<TABLE>
<CAPTION>
ASSETS September 30, December 31,
1998 1997
------------- ------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $4,623,000 $1,215,000
Short-term investments -- 3,727,000
Accounts receivable, net 9,542,000 8,277,000
Inventories 12,547,000 10,634,000
Deferred taxes 1,339,000 1,315,000
Other current assets 751,000 330,000
----------- -----------
Total current assets 28,802,000 25,498,000
Property, plant and equipment, net 17,605,000 16,689,000
Other assets 690,000 572,000
----------- -----------
Total assets $47,097,000 $42,759,000
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $4,965,000 $1,978,000
Accrued expenses 3,772,000 3,058,000
Current portion of long-term debt 258,000 258,000
----------- -----------
Total current liabilities 8,995,000 5,294,000
Deferred grant 128,000 153,000
Deferred tax liability 147,000 --
Long-term debt 4,568,000 4,694,000
Shareholders' equity:
Serial preferred stock, par value $.01 per share;
authorized 2,000,000 shares; none issued
Common stock, par value $.01 per share;
authorized 20,000,000 shares; issued
and outstanding shares 8,067,000 and
8,021,000 shares at September 30,
1998 and December 31, 1997, respectively 81,000 80,000
Additional paid-in capital 30,787,000 30,482,000
Retained earnings 2,194,000 1,936,000
Cumulative translation adjustments 197,000 120,000
----------- -----------
Total shareholders' equity 33,259,000 32,618,000
----------- -----------
Total liabilities and shareholders' equity $47,097,000 $42,759,000
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
3
<PAGE>
AVECOR CARDIOVASCULAR INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $12,227,000 $11,273,000 $38,248,000 $35,277,000
Cost of sales 7,173,000 6,488,000 22,610,000 20,448,000
----------- ----------- ----------- -----------
Gross profit 5,054,000 4,785,000 15,638,000 14,829,000
Operating expenses:
Selling, general and
administrative 4,058,000 3,371,000 11,891,000 10,203,000
Acquistion Costs 601,000 - 651,000 -
Research and development 909,000 854,000 2,635,000 2,930,000
----------- ----------- ----------- -----------
Operating income (loss) (514,000) 560,000 461,000 1,696,000
Interest income 58,000 114,000 222,000 387,000
Interest expense (99,000) (104,000) (298,000) (280,000)
----------- ----------- ----------- -----------
Income (loss) before income taxes (555,000) 570,000 385,000 1,803,000
Income tax provision (benefit) (183,000) 205,000 127,000 648,000
----------- ----------- ----------- -----------
Net income (loss) ($372,000) $365,000 $258,000 $1,155,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Earnings (loss) per share:
Basic ($0.05) $0.05 $0.03 $0.15
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted ($0.05) $0.05 $0.03 $0.15
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Weighted average common shares
outstanding 8,052,000 7,944,000 8,035,000 7,901,000
Common equivalents:
Options - 60,000 29,000 68,000
----------- ----------- ----------- -----------
Weighted average common and
common equivalents 8,052,000 8,004,000 8,064,000 7,969,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
4
<PAGE>
AVECOR CARDIOVASCULAR INC.
CONSOLIDATED STATEMENTS OFCASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
For the nine months ended September 30,
---------------------------------------
1998 1997
---------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income $258,000 $1,155,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,886,000 1,210,000
Deferred taxes 147,000 471,000
Accretion of discount on investments (95,000) (233,000)
Changes in operating assets and liabilities:
Accounts receivable (1,156,000) (906,000)
Inventories (1,924,000) (2,122,000)
Other current assets (439,000) 383,000
Accounts payable 2,963,000 409,000
Accrued expenses 705,000 (186,000)
Accrued litigation settlement - (1,100,000)
---------- -----------
Net cash provided by (used in) operating activities 2,345,000 (919,000)
---------- -----------
Cash flows from investing activities:
Purchase of property, plant and equipment (2,720,000) (11,121,000)
Purchase of investments - (8,768,000)
Proceeds upon sale or maturity of short-term investments 3,822,000 7,760,000
Cash and investments restricted as to use - 3,450,000
Increase in other assets (158,000) (259,000)
---------- -----------
Net cash provided by (used in) investing activities 944,000 (8,938,000)
---------- -----------
Cash flows from financing activities:
Net proceeds from sales of common stock 209,000 224,000
Net proceeds from options exercised 76,000 718,000
Net proceeds from warrants exercised - 28,000
Borrowings on long-term debt - 5,167,000
Principal payments on long-term debt (194,000) (151,000)
---------- -----------
Net cash provided by financing activities 91,000 5,986,000
---------- -----------
Effect of exchange rates on cash 28,000 (56,000)
---------- -----------
Net increase (decrease) in cash and cash equivalents 3,408,000 (3,927,000)
Cash and cash equivalents at beginning of period 1,215,000 6,114,000
---------- -----------
Cash and cash equivalents at end of period $4,623,000 $2,187,000
---------- -----------
---------- -----------
Significant non-cash investing and financing transactions:
Acquistion of equipment through capital leases $67,000 -
---------- -----------
---------- -----------
Use of restricted funds for purchase of the U.S. facility - $1,000,000
---------- -----------
---------- -----------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
<PAGE>
AVECOR CARDIOVASCULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
-------------------
1. BASIS OF PRESENTATION
The consolidated financial statements included in this Form 10-Q have been
prepared by AVECOR Cardiovascular Inc. (the Company), without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission (SEC).
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed, or omitted, pursuant to these rules and regulations. The
year-end balance sheet was derived from audited financial statements, but does
not include all disclosures required by generally accepted accounting
principles. These unaudited consolidated interim financial statements should be
read in conjunction with the financial statements and related notes included in
the Company's 1997 Annual Report on Form 10-K as filed with the SEC.
The consolidated interim financial statements presented herein as of
September 30, 1998 and for the three and nine month periods ended September 30,
1998 and 1997 reflect, in the opinion of management, all adjustments (which
include only normal, recurring adjustments) necessary for a fair presentation of
financial position and the results of operations and cash flows for the periods
presented. The results of operations for any interim period are not necessarily
indicative of results for the full year.
2. ORGANIZATION
The Company was incorporated on December 13, 1990. The Company designs,
develops, manufactures and markets specialty medical devices for heart/lung
bypass surgery and long-term respiratory support.
The consolidated financial statements include the accounts of AVECOR
Cardiovascular Inc. and its wholly-owned subsidiaries, AVECOR Cardiovascular
Ltd. and AVECOR Foreign Sales Corporation after elimination of all significant
intercompany transactions and accounts.
6
<PAGE>
3. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(Unaudited)
<S> <C> <C>
Raw materials $ 4,512,000 $ 3,758,000
Work-in-process 2,484,000 2,189,000
Finished goods 5,551,000 4,687,000
----------- -----------
$12,547,000 $10,634,000
----------- -----------
----------- -----------
</TABLE>
4. INDUSTRY SEGMENT INFORMATION
The Company distributes its products through its direct sales force and
independent sales representatives in the United States, Canada, the United
Kingdom and France. Additionally, the Company distributes its products through
foreign independent distributors who then market the products directly to
medical institutions. No one independent distributor or other customer
accounted for 10% or more of the Company's net sales for the three or nine
months ended September 30, 1998 or 1997.
Total export sales from the U.S. to unaffiliated entities (primarily to
Europe and payable in U.S. dollars) were $1,152,000 and $4,490,000 for the three
and nine month periods ended September 30, 1998, respectively, compared to
$969,000 and $3,531,000 for the three and nine month periods ended September 30,
1997, respectively. Sales to customers located outside of the United States
were approximately 38% and 40% of net sales for the three and nine month periods
ended September 30, 1998, respectively, compared to 40% and 41% for the three
and nine month periods ended September 30, 1997, respectively.
At September 30, 1998 and December 31, 1997, consolidated accounts
receivable included $5,246,000 and $4,366,000, respectively, due from customers
located outside of the U.S.
In June 1997, the Financial Accounting Standards Board issued Statement
131, "Disclosures About Segments of an Enterprise and Related Information," a
new standard of reporting information about operating or business segments in
financial statements. The new standard will be effective for the Company's
annual financial statements in 1998. Although the Company has not specifically
evaluated what impact, if any, this new standard will have on the Company's
current reporting of operating and business segments, the Company believes it
will continue reporting as one operating and business segment.
5. COMPREHENSIVE INCOME
In the first quarter of 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." The standard
requires the display and reporting of comprehensive income, which includes all
changes in shareholders' equity with the
7
<PAGE>
exception of additional investments by shareholders or distributions to
shareholders. Comprehensive income for the Company includes net income and
foreign currency translation which is charged or credited to the cumulative
translation account within shareholders' equity. Comprehensive income for the
three and nine months ended September 30, 1998 and 1997 and the year ended
December 31, 1997, was as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended, Year Ended
September 30, September 30, December 31,
1998 1997 1998 1997 1997
--------- -------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net income (loss) ($372,000) $365,000 $258,000 $1,155,000 $1,327,000
Changes in cumulative
translation 20,000 (75,000) 78,000 (165,000) (107,000)
--------- -------- -------- ---------- ----------
Comprehensive income
(loss) ($352,000) $290,000 $336,000 $ 990,000 $1,220,000
--------- -------- -------- ---------- ----------
--------- -------- -------- ---------- ----------
</TABLE>
6. PATENT MATTERS
In March 1997, the Company filed suit in U.S. District Court for the
District of Minnesota, seeking to invalidate a newly issued U.S. patent held by
a competing manufacturer of blood oxygenators and other medical devices, and
requesting a determination that the Company's Affinity oxygenator does not
infringe the competitor's patent. The Company filed suit in response to a
December 1996 letter from the competitor, alleging that the Affinity oxygenator
infringes certain claims under the competitor's patent, and requesting
discussion regarding a possible license agreement. The Company reviewed the
subject patent and concluded, based on an opinion from its patent counsel, that
none of the claims in the patent are infringed by the Affinity oxygenator, and
that the patent is, in any event, invalid. On October 6, 1997, the Magistrate
Judge of the U.S. District Court vacated a previous order and granted a stay in
the proceedings, including the suspension of discovery, pending the outcome of
the competitor's request for re-issuance of the aforementioned patent. The
expense and effort potentially required to bring this action, as well as the
outcome of any counterclaim successfully brought against the Company by the
competitor, could have a material adverse effect on the Company's business,
financial condition and results of operations. See Part II, Item 1, "Legal
Proceedings."
7. ACQUISITION OF THE COMPANY
On July 12, 1998, Medtronic, Inc. ("Medtronic") and the Company entered
into an agreement under which Medtronic will acquire the Company in a
transaction valued at approximately $91 million. The transaction calls for the
Company's shareholders to receive $11.125 in Medtronic stock for each share of
the Company's stock they hold at the transaction close date. The Company's
shareholders approved the transaction on October 28, 1998. It is anticipated
that completion of the transaction will occur following clearance from the
Federal Trade Commission, which is reviewing the transaction. For the three and
nine months ended September 30, 1998, the Company has recorded acquisition costs
of $601,000 and $651,000, respectively.
8
<PAGE>
8. COMMON STOCK EQUIVALENTS
At September 30, 1998, the Company had 819,250 options outstanding to
purchase common stock at exercise prices ranging from $6.38 to $14.75 per share.
These options, which expire from 1998 to 2008, were excluded from the
computation of diluted earnings per share for the three month period ended
September 30, 1998 because the Company incurred a net loss during that period,
and the inclusion of options would be anti-dilutive to earnings per share. Of
the 819,250 options outstanding at September 30, 1998, the Company had 362,000
and 506,000 options outstanding that had exercise prices greater than the
average market price of the Company's common shares for the three and nine month
periods ended September 30, 1998, respectively.
At September 30, 1997, the Company had 572,250 options outstanding to
purchase common stock at exercise prices ranging from $5.06 to $14.75 per share.
These options expire from 1997 to 2002. Of the 572,250 options outstanding at
September 30, 1997, the Company had 237,000 and 205,000 options outstanding that
had exercise prices greater than the average market price of the Company's
common shares for the three and nine month periods ended September 30, 1997,
respectively.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is a discussion of the results of operations and financial
condition for the three and nine month periods ended September 30, 1998 compared
with the three and nine month periods ended September 30, 1997 and should be
read in conjunction with the Company's Consolidated Financial Statements and
Notes thereto. The discussion set forth below includes management's discussion
of the historical results and trends in the business, financial condition, and
results of operations of the Company for periods both prior and subsequent to
the July 12, 1998 public announcement of the acquisition of the Company by
Medtronic, Inc. The results of operations and financial condition for the three
months ended September 30, 1998 discussed below indicate that the announcement
of the merger has had an adverse effect on the Company's ability to sell its
products through its international distributors. There can be no assurance that
the Company's business, financial condition, and results of operations for
future periods will not be further adversely impacted as a result of the
announcement, particularly regarding the effect of the announcement on the
Company's revenue levels and trends.
OVERVIEW
AVECOR Cardiovascular Inc. (the "Company") develops, manufactures and
markets specialty medical devices for heart/lung bypass surgery and long-term
respiratory support. The Company was incorporated on December 13, 1990, and in
June 1991, acquired the business and assets and assumed certain liabilities of
the surgical division of SCIMED Life Systems, Inc. (the "Predecessor Business").
On December 1, 1992, the Company acquired AVECOR Cardiovascular Ltd. (formerly
Cardio Med Ltd.), which previously had been a distributor for the Company in the
United Kingdom. In October 1995, the Company opened a sales office in France
which is organized as a wholly-owned subsidiary of AVECOR Cardiovascular Ltd.
The assets acquired by the Company from the Predecessor Business included
the Company's line of solid silicone membrane oxygenators. Since that time, the
Company has engaged in extensive product development, resulting in the
introduction and receipt of regulatory approval from the U.S. Food and Drug
Administration (the "FDA") for the following proprietary products:
<TABLE>
<CAPTION>
PRODUCT APPROVAL DATE
-----------------------------------------------------------------------
<S> <C>
MYOtherm cardioplegia delivery system ............... October 1991
Signature custom tubing packs ....................... July 1993
Affinity oxygenator ................................. November 1993
Affinity blood reservoirs ........................... July 1994
Affinity arterial filter ............................ October 1995
MYOtherm XP (improved cardioplegia delivery system) . July 1997
Affinity blood pump ................................. August 1997
Affinity oxygenator with Trillium bio-passive surface February 1998
</TABLE>
10
<PAGE>
ACQUISITION OF THE COMPANY
On July 12, 1998, Medtronic, Inc. and the Company entered into an
agreement under which Medtronic will acquire the Company in a transaction valued
at approximately $91 million. The transaction calls for the Company's
shareholders to receive $11.125 in Medtronic stock for each share of the
Company's stock they hold at the transaction close date. The Company's
shareholders approved the transaction on October 28, 1998. It is anticipated
that completion of the transaction will occur following clearance from the
Federal Trade Commission, which is reviewing the transaction.
RESULTS OF OPERATIONS
NET SALES
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1997
Net sales increased 8.5% to $12,227,000 for the three months ended
September 30, 1998 from $11,273,000 for the three months ended September 30,
1997. This increase was primarily the result of a higher volume of product
shipments in three of the Company's product lines. Sales from the Affinity,
Signature custom tubing pack and Myotherm cardioplegia lines increased
approximately $407,000 (6.5%), $329,000 (13.8%) and $247,000 (27.9%),
respectively, during the three months ended September 30, 1998 as compared to
the three months ended September 30, 1997.
Overall, average prices of product shipments declined slightly when
compared to the corresponding period in 1997, principally due to competitive
pressures.
During the third quarter of 1997, the Company terminated agreements with
its last remaining United States distributor and its only Canadian distributor.
These markets are now being served by the Company's direct sales force. Sales
in the territories formerly represented by these distributors were approximately
$900,000 more in the three month period ended September 30, 1998 as compared to
the corresponding period in 1997.
Although sales increased $954,000 for the three months ended September 30,
1998 when compared to the corresponding period in 1997, international sales
represented only $235,000 of that increase. Also, a sales decrease of
$1,338,000 was experienced when comparing the three months ended September 30,
1998 to the prior three months ended June 30, 1998. Sales declines in the
international markets represented about $858,000 or 64% of that decrease. This
slowing of international sales during the quarter ended September 30, 1998 was
primarily caused by distributor uncertainty due to concerns regarding the
Medtronic acquisition combined with economic conditions in certain international
markets.
Sales to customers located outside of the United States were approximately
38% and 40% of net sales for the three month periods ended September 30, 1998
and 1997, respectively.
11
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 1997
Net sales increased 8.4% to $38,248,000 for the nine months ended September
30, 1998 from $35,277,000 for the nine months ended September 30, 1997. This
increase was primarily the result of a higher volume of product shipments of the
Company's Signature custom tubing pack line, Affinity line and the Myotherm
cardioplegia line. The Company received FDA marketing approval for a new
Affinity blood pump in August 1997 and the Myotherm XP cardioplegia delivery
system in July 1997. These products positively influenced the comparative sales
growth. Overall, average prices of product shipments declined slightly when
compared to the corresponding period in 1997, principally due to competitive
pressures.
Sales from the Affinity, Signature custom tubing pack and Myotherm
cardioplegia lines increased approximately $1,191,000 (6.0%), $1,118,000 (15.6%)
and $516,000 (18.2%), respectively, during the nine months ended September 30,
1998 as compared to the corresponding period in 1997.
As noted above, the Company terminated agreements with its last remaining
United States distributor and its only Canadian distributor during the third
quarter of 1997 and these markets are now being served by the Company's direct
sales force. Sales in the territories formerly represented by these
distributors increased approximately $2,100,000 in the nine months ended
September 30, 1998 as compared to the nine months ended September 30, 1997.
Although sales increased $2,971,000 for the nine months ended September 30,
1998 when compared to the corresponding period in 1997, international sales
represented only $708,000 of that increase. Sales for the nine months ended
September 30, 1998 were affected by the previously mentioned slowing of
international sales during the quarter ended September 30, 1998 which was
primarily caused by distributor uncertainty due to concerns regarding the
Medtronic acquisition, combined with economic conditions in certain
international markets.
Sales to customers located outside of the United States were approximately
40% and 41% of net sales for the nine month periods ended September 30, 1998 and
1997, respectively.
COST OF SALES / GROSS PROFIT
Gross profit as a percentage of net sales decreased 1.1% to 41.3% for the
three months ended September 30, 1998 from 42.4% for the three months ended
September 30, 1997. Similarly, gross profit as a percentage of net sales
decreased 1.1% to 40.9% for the nine months ended September 30, 1998 from 42.0%
for the nine months ended September 30, 1997. The gross profit percentage for
the three and nine month periods ended September 30, 1998 was unfavorably
impacted by significant increases in sales of the Company's lower-margin
Signature custom tubing pack line as well as competitive pricing pressures in
the marketplace. The mix of products sold in any period will influence the cost
of sales and gross profit for the period.
Affinity oxygenator product costs continued to decline due to efficiency
and material cost improvements, although these improvements were largely offset
by an ongoing decrease in average selling prices.
12
<PAGE>
The Company's future gross profit margin percentages will be influenced by
the ongoing pressures of the competitive pricing environment, changes in the
sales mix, the required levels of production, new product introductions and the
extent of further product cost improvements through increased manufacturing
efficiencies and reduced material costs, if any. Given the uncertainty
associated with new product introductions, the ultimate realization of any such
product cost improvements and the continuing price pressures characteristic of
the Company's markets, the Company cannot be certain if its gross profit margin
will be maintained, improve or decline.
SELLING, GENERAL AND ADMINISTRATIVE AND ACQUISITION COSTS
Selling, general and administrative expenses increased 20% to $4,058,000
for the three months ended September 30, 1998 from $3,371,000 for the three
months ended September 30, 1997. Selling, general and administrative expenses
increased 17% to $11,891,000 for the nine months ended September 30, 1998 from
$10,203,000 for the nine months ended September 30, 1997. These increases are
primarily attributed to costs associated with the continuing development of a
direct sales force in certain of the Company's territories formerly served by
distributors and independent sales representatives, marketing costs incurred for
the introduction of new products, including the Affinity blood pump, and
increased seasonal trade show costs. As a percentage of sales, selling, general
and administrative expenses increased to 33.2% and 31.1% for the three and nine
month periods ended September 30, 1998, respectively, from 29.9% and 28.9% for
the three and nine month periods ended September 30, 1997, respectively.
Without considering the impact of the acquisition of the Company,
management anticipates that selling, general and administrative expenses for
1998 will continue to be higher than 1997 and will also be higher than 1997
levels as a percentage of sales primarily due to lower-than-anticipated sales
levels. These forward-looking statements will be influenced by the revenue
levels achieved by the Company, its ability to attract and retain qualified
sales personnel as the Company continues to develop its direct sales force, and
the timing and extent of promotional activities associated with the Affinity
oxygenator with Trillium bio-passive surface, the new oxygen
saturation/hematocrit monitor and other new product introductions, if any.
On July 12, 1998, Medtronic and the Company entered into an agreement under
which Medtronic will acquire the Company. The Company has identified expenses
due to this acquisition of $601,000 and $651,000 for three and nine months ended
September 30, 1998, respectively.
RESEARCH AND DEVELOPMENT
Research and development expenses increased 6% to $909,000 from $854,000
from the three month period ended September 30, 1997 and decreased 10% to
$2,635,000 from $2,930,000 for the nine month period ended September 30, 1997.
This increased spending for the three month comparison was driven by expenses
associated with a new generation of products including the new oxygen
saturation/hematocrit monitor and several research studies being performed to
prove the clinical efficacy and, thus, market advantage of the Trillium coating.
The decreased spending for the nine month comparison was a result of the
transition from the completion or near completion of major projects including
the Affinity blood pump,
13
<PAGE>
Myotherm XP and the Affinity oxygenator with Trillium bio-passive surface to the
aforementioned current activities.
Without considering the impact of the acquisition of the Company,
management anticipates that research and development expenses for 1998 will
continue to be slightly lower than 1997 levels. This forward-looking statement
is dependent upon the extent and timing of new product development and the
impact of the regulatory process in obtaining marketing clearance for new
products, including the new oxygen saturation/hematocrit device which was
submitted for approval to the FDA near the end of the second quarter of 1998,
and the extent of expenses related to the research studies involving the
Trillium coating. The need or desire to modify the Company's existing products
could also influence the level of research and development expenses. There can
be no assurance, however, that the Company's research and development efforts
will result in any additional regulatory submissions to the FDA or will result
in any commercially successful products. The forward-looking statements
regarding anticipated regulatory submissions contained in this paragraph will be
impacted by the results of the Company's development efforts, the availability
of any required clinical data, any changes in the regulatory scheme for such
products, and the Company's assessment of the cost and anticipated benefit of
such submissions.
INTEREST INCOME AND EXPENSE
Interest income decreased to $58,000 for the three months ended September
30, 1998 from $114,000 for the three months ended September 30, 1997.
Similarly, interest income decreased to $222,000 for the nine months ended
September 30, 1998 from $387,000 for the nine months ended September 30, 1997.
This decrease in interest income is primarily due to the use of cash and cash
equivalents and investments for the purchase of manufacturing molds and
equipment and additional inventories needed to support the Company's new
products and revenue growth. At September 30, 1998, the majority of the
Company's cash and cash equivalents were invested with one investment portfolio
manager who primarily invested in money market funds.
Interest expense for the three and nine month periods ended September 30,
1998 was $99,000 and $298,000, respectively, compared to $104,000 and $280,000
for the three and nine month periods ended September 30, 1997, respectively.
The interest expense was exclusively due to the mortgage on the Company's U.S.
facility. The closing on the facility purchase occurred in late January 1997.
INCOME TAX PROVISION
For the three and nine month periods ended September 30, 1998 a tax benefit
of $183,000 and a tax provision of $127,000 were recorded, respectively,
compared to tax provisions of $205,000 and $648,000 for three and nine month
periods ended September 30, 1997. The tax benefit and provision recorded
correspond to the pretax loss and income for those respective periods. These
provisions vary from the statutory U.S. federal corporate rate primarily due to
losses incurred by the Company's French subsidiary for which no tax benefit has
been recognized because of uncertainty of realization and the potential
non-deductibility of certain acquisition-related costs, partially offset by the
generation of research and experimentation credits.
14
<PAGE>
NET INCOME (Loss)
Net loss was $372,000 or $.05 per share, on a diluted basis, and net income
was $258,000 or $.03 per share, on a diluted basis, for the three and nine month
periods ended September 30, 1998, respectively, compared to net income of
$365,000 or $.05 per share, on a diluted basis, and $1,155,000 or $.15 per
share, on a diluted basis, for the three and nine month periods ended September
30, 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 1998, the Company's operating
activities provided net cash of $2,345,000 compared to $919,000 used in
operating activities for the corresponding period in 1997. The improvement is
primarily the result of increased accounts payable balances and increased
accrued expenses when compared to the nine months ended September 30, 1997,
combined with the $1,100,000 which was expended during the nine months ended
September 30, 1997 for the settlement of the COBE litigation. Certain
merger-related expenses were unpaid at September 30, 1998 and account for a
portion of the increased accounts payable. These net sources of cash were
partially offset by the use of cash for increased accounts receivable and other
current assets during the nine months ended September 30, 1998. Net income
after adjustments for depreciation and amortization was $221,000 less in the
nine months ended September 30, 1998 as compared to the corresponding period in
1997.
Cash expenditures for capital additions totaled $2,720,000 for the nine
months ended September 30, 1998 compared to $3,121,000 for nine months ended
September 30, 1997 (excluding the 1997 cash expenditures for the Company's U.S.
facility and related furniture, fixtures and equipment). Capital expenditures
for the nine months ended September 30, 1998 were primarily related to
equipment, molds and tooling necessary to further production, increase
production efficiencies, improve quality and reduce raw material costs of the
Affinity blood pump, Myotherm XP and the Affinity oxygenator and related blood
reservoirs. These expenditures include approximately $400,000 in equipment
related to the Affinity blood pump. This pump equipment is placed with
customers in exchange for a long-term commitment to purchase disposable products
from the Company.
Without considering the impact of the acquisition of the Company,
management anticipates capital expenditures for 1998 will be approximately
$3,500,000. This estimate includes additional equipment, molds and tooling for
the new oxygen saturation/hematocrit device, Affinity blood pump, Myotherm XP,
and for furthering production and related efficiencies of the Affinity
oxygenator line.
The Company believes that its existing cash and cash equivalents as well as
anticipated cash generated from operations will be sufficient to satisfy the
Company's cash requirements for the foreseeable future.
The foregoing forward-looking statements relating to the amount of capital
expenditures and ultimate cash usage are dependent on the progress of the
Company's product development efforts, the outcome of certain patent matters
(see Note 6), the timing of the receipt of FDA marketing clearances for any
future products and the investment made in opportunities to further production
efficiencies and quality and reduce costs for the Company's existing products.
15
<PAGE>
FOREIGN CURRENCY TRANSACTIONS AND EURO CONVERSION
Transactions by the Company's international subsidiaries are negotiated,
invoiced and paid in various foreign currencies, primarily pounds sterling, and
U.S. dollars. Accordingly, the Company is currently subject to risks associated
with fluctuations in exchange rates between the various currencies.
Substantially all of the Company's other international transactions are
denominated in U.S. dollars. Fluctuations in currency exchange rates in other
countries may therefore reduce the demand for the Company's products by
increasing the price of the Company's products in the currency of the countries
in which the products are sold.
On January 1, 1999, eleven of the fifteen member countries of the European
Union are scheduled to establish fixed conversion rates between their existing
sovereign currencies and the euro, and to adopt the euro as their common legal
currency on that date. Following introduction of the euro, the legacy
currencies are scheduled to remain legal tender in the participating countries
as denominations of the euro during a transition period ending on January 1,
2002. During the transition period, conversion rates will no longer be computed
directly from one currency to another. Instead, conversion will be subject to a
"triangulation" method, requiring conversion of a legacy currency into a euro
amount prior to conversion into another legacy currency.
The Company is in the process of evaluating the information systems and
policies of its foreign subsidiaries to determine steps that must be taken in
order to permit transactions in both the euro and legacy currencies during the
transition period. The Company is also assessing its anticipated currency
exchange costs and rate exposure during and following the transition period.
Because the Company and its subsidiaries are currently undergoing this
evaluation, the Company is uncertain as to whether it will face material costs
in modifying its practices or systems to accommodate euro conversion.
Additionally, euro conversion is generally expected to increase
cross-border price transparency among the participating countries and result
in a more competitive European market. The Company is uncertain as to the
effect, if any, that euro conversion will have on its ability to sell its
products in the European market. Euro conversion could potentially impact
pricing strategies and demand for the Company's products in the European
market, lead to increased competition within the European market for the
specific types of products manufactured and sold by the Company, or impact
the Company's international distributor relationships. As a result of
competitive pressures, the Company could also potentially be required to
denominate all of its future European transactions in the euro and incur
additional currency risk and conversion costs as a result.
Until the Company is able to completely assess the impact of euro
conversion on its business, there can be no assurance that euro conversion will
not have a material, adverse effect on the Company's business, financial
condition and results of operation.
16
<PAGE>
YEAR 2000 ISSUES
OVERVIEW
Computer programs have historically been written to abbreviate dates by
using two digits instead of four digits to identify a particular year. The
so-called "Year 2000" problem is the inability of computer software or hardware
to recognize or properly process dates ending in or after "00." As the year
2000 approaches, significant attention is being focused on updating or replacing
such software and hardware in order to avoid system failures, miscalculations or
business interruptions that might otherwise result.
STATE OF READINESS
Potential areas of Year 2000 exposure for the Company include its internal
information technology systems (IT systems), other systems having embedded
technology or software such as manufacturing equipment and mechanical and
telephone systems (non-IT systems), the software products that the Company
distributes, and technology embedded in certain of the Company's other products.
Year 2000 issues may also significantly impact the Company by affecting the
business and operations of the Company's vendors, customers and other business
partners. The Company has undertaken a four-phased approach to addressing its
potential Year 2000 risks.
In the first phase, the Company instituted policies and procedures designed
to ensure that no new Year 2000 risks are created for the Company through the
purchase or development of IT systems, non-IT systems or Company products which
have not been certified as Year 2000 compliant. This phase has been completed,
although the Company continues to monitor the policies and procedures that were
implemented.
The second phase of the Company's Year 2000 remediation efforts has also
been completed. This phase involved a review of the Company's IT and non-IT
systems (including building security, environmental control, telephone systems
and other equipment) to identify Year 2000 exposure and the steps needed to
cause these systems to become Year 2000 compliant. With respect to its IT
systems, the Company believes that the Year 2000 issues that have been
identified can be resolved through replacements and upgrades to computer
software that the Company licenses from third parties. The only remaining
software replacement or upgrade to essential Company systems is in the Company's
United Kingdom subsidiary where the financial and manufacturing software must be
replaced. The final evaluation and selection of this replacement is expected to
be completed prior to January 1, 1999. All other essential non-compliant
hardware or software throughout the Company (IT and non-IT) has been replaced or
upgraded.
In the second phase, the Company also reviewed the current versions of its
OnCourse software product, the software embedded in its Affinity blood pump
console and the software for its saturation/hematocrit monitor under
development. The Company believes that the current version of each of their
products is Year 2000 compliant. The Company did identify potential Year 2000
issues regarding previous versions of its OnCourse software and the software
embedded in the Affinity blood pump console. Users of these previous versions
have been
17
<PAGE>
notified. The Company has also initiated replacement of the Affinity blood pump
console software, and expects to complete the replacement by the end of the
third quarter of 1999.
Phases three and four of the Company's remediation efforts are currently
underway. In phase three the Company began formal communication with its
vendors, customers and other business partners in order to assess the state of
their Year 2000 readiness and to identify the Company's risks with respect to
such parties. The Company is in the process of receiving and analyzing the
business partners' initial responses. In certain cases, analysis of these
responses is expected to prompt the Company to request further information. The
Company expects to complete phase three by the second quarter of 1999.
Phase four is the completion and individual testing of any outstanding Year
2000 compliance issues identified within the Company's or business partners'
systems during phases one, two and three. This includes final responses to
specific customers and suppliers who we have determined may place the Company at
risk. Phase four is expected to be completed by the second quarter of 1999.
COSTS TO ADDRESS YEAR 2000 ISSUES
The costs of remediation have not been and are not expected to be material.
With the exception of replacing the manufacturing and distribution hardware and
software for the Company's United Kingdom subsidiary, which is expected to cost
approximately $100,000, no other hardware or software replacements are
anticipated beyond those needed during the normal course of business. All Year
2000-related work is expected to be accomplished by current Company employees
and is not expected to cause a significant diversion of the efforts of such
employees away from other duties or information technology initiatives. The
Company does not separately track the internal costs incurred for Year 2000
remediation, which to date have principally consisted of the related payroll
costs for its information systems group.
RISKS PRESENTED BY YEAR 2000 ISSUES
Based on the current status of the Company's internal identification and
remediation efforts, the Company believes that the most reasonably likely, worst
case Year 2000 failure scenario would involve a disruption in the business and
operations of one or more of the Company's significant vendors or customers.
While the Company is undertaking efforts to identify its Year 2000 risk exposure
relative to parties with which it transacts business, the issues facing these
parties are beyond the Company's control. There can be no assurance that such
issues will be addressed on a timely basis or that the Company's inquiries will
identify all areas of Year 2000 exposure relative to its business partners. Any
interruption in the business and operations of a significant business partner
could result in a material, adverse impact upon the Company's business,
financial condition and results of operations.
CONTINGENCY PLANS
Because the Company is still in the process of implementing internal
upgrades and gathering data from third parties regarding its Year 2000 risks, a
detailed contingency plan has not yet been developed. As the Company identifies
areas of exposure to Year 2000 risk, it will develop its plans and procedures
for responding in the event that failures occur in such areas.
18
<PAGE>
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement
131, "Disclosures About Segments of an Enterprise and Related Information," a
new standard of reporting information about operating or business segments in
financial statements. The new standard will be effective for the Company's
annual financial statements in 1998. Although the Company has not specifically
evaluated what impact, if any, this new standard will have on the Company's
current reporting of operating and business segments, the Company believes it
will continue reporting as one operating and business segment.
CERTAIN IMPORTANT FACTORS
Except for the historical financial information contained herein, this Form
10-Q contains certain forward-looking statements. For this purpose, any
statements contained in this Form 10-Q that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, words such as "may," "will," "expect," "believe," "anticipate,"
"estimate" or "continue," the negative or other variations thereof, or
comparable terminology, are intended to identify forward-looking statements.
These statements by their nature involve substantial risks and uncertainties,
and actual results may differ materially depending on a variety of factors,
including the progress of product development and clinical studies, the timing
of and ability to obtain regulatory approvals, the extent to which the Company's
products gain market acceptance, the introduction of competitive products by
others, the pricing related to competitive products, litigation regarding patent
and other intellectual property rights, the availability of third-party
reimbursement and other factors. Additional information regarding these factors
is contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 under the heading "Important Factors".
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
19
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
During the quarter ended September 30, 1998, there were no material
developments in the Company's suit seeking to invalidate a newly
issued U.S. patent held by a competing manufacturer of blood
oxygenators and other medical devices, and requesting a determination
that the Company's Affinity oxygenator does not infringe the
competitor's patent. Information regarding the suit was previously
reported in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
A special meeting of the Company's shareholders was held on October
28, 1998 to consider and act upon a proposal to approve the Company's
merger with a subsidiary of Medtronic pursuant to the Plan of Merger
and Agreement and Plan of Merger among the Company, Medtronic and such
subsidiary. The Company's shareholders approved the merger, the Plan
of Merger and Agreement and Plan of Merger by the following vote taken
at the special meeting:
<TABLE>
<CAPTION>
Affirmative Votes Negative Votes Abstaining
----------------- -------------- ----------
<S> <C> <C>
5,034,359 58,077 8,496
</TABLE>
There were no broker non-votes on the proposal to approve the merger.
ITEM 5. OTHER INFORMATION.
None
20
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
The exhibits to this Quarterly Report on Form 10-Q are listed in
the Exhibit Index beginning on page 23 of this Report.
(b) Reports on Form 8-K:
None
21
<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.
AVECOR CARDIOVASCULAR INC.
November 11, 1998 By /s/ Anthony Badolato
- ------------------------- --------------------------------
Date Anthony Badolato
Chief Executive Officer
November 11, 1998 By /s/ Gregory J. Melsen
- ------------------------- --------------------------------
Date Gregory J. Melsen
Vice President-Finance, Treasurer and Chief
Financial Officer
(Principal Financial and Accounting Officer)
22
<PAGE>
AVECOR CARDIOVASCULAR INC.
EXHIBIT INDEX TO QUARTERLY REPORT
ON FORM 10-Q
For the Quarter Ended September 30, 1998
<TABLE>
<CAPTION>
Item No. Description Method of Filing
- -------- ----------- ----------------
<C> <S> <C>
27.1 Financial Data Schedule Filed herewith electronically
</TABLE>
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 4,623,000
<SECURITIES> 0
<RECEIVABLES> 10,123,000
<ALLOWANCES> (581,000)
<INVENTORY> 12,547,000
<CURRENT-ASSETS> 28,802,000
<PP&E> 25,648,000
<DEPRECIATION> (8,043,000)
<TOTAL-ASSETS> 47,097,000
<CURRENT-LIABILITIES> 8,995,000
<BONDS> 4,568,000
81,000
0
<COMMON> 0
<OTHER-SE> 33,178,000
<TOTAL-LIABILITY-AND-EQUITY> 47,097,000
<SALES> 38,248,000
<TOTAL-REVENUES> 38,248,000
<CGS> 22,610,000
<TOTAL-COSTS> 22,610,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 298,000
<INCOME-PRETAX> 385,000
<INCOME-TAX> 127,000
<INCOME-CONTINUING> 258,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 258,000
<EPS-PRIMARY> (.05)
<EPS-DILUTED> (.05)
</TABLE>
