<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
Commission File Number 1-13388
GUIDANT CORPORATION
(Exact name of Registrant as specified in its charter)
INDIANA 35-1931722
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
111 MONUMENT CIRCLE, 29TH FLOOR
INDIANAPOLIS, INDIANA 46204-5129
(Address of principal executive offices)
Registrant's telephone number, including area code: (317) 971-2000
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 _____
-----
The number of shares of common stock outstanding as of July 30, 1999:
Class Number of Shares Outstanding
----- ----------------------------
Common 302,135,851
1
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
GUIDANT CORPORATION and Subsidiaries
Consolidated Statements of Income
(In millions, except per-share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1999 1998 1999 1998
-------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Net sales.................................. $603.5 $ 487.8 $1,193.6 $ 958.1
Cost of products sold...................... 157.5 110.0 303.9 217.4
------ ------- -------- -------
Gross profit............................ 446.0 377.8 889.7 740.7
Research and development................... 79.2 65.8 161.5 127.8
Purchased research and development......... -- 28.7 49.0 28.7
Sales, marketing, and administrative....... 170.0 141.1 341.0 276.2
------ ------- -------- -------
249.2 235.6 551.5 432.7
Other income (expenses):
Interest, net........................... (15.4) (3.5) (28.0) (6.9)
Royalties, net.......................... (12.0) (11.2) (26.0) (20.4)
Amortization............................ (10.7) (4.6) (19.4) (8.3)
Litigation settlement charge............ -- -- -- (60.0)
Other, net.............................. (6.3) (1.2) 6.6 (5.2)
------ ------- -------- -------
(44.4) (20.5) (66.8) (100.8)
------ ------- -------- -------
Income before income taxes and cumulative
effect of change in accounting principle.. 152.4 121.7 271.4 207.2
Income taxes............................... 58.6 43.0 122.2 73.2
------ ------- -------- -------
Income before cumulative effect of change
in accounting principle................... 93.8 78.7 149.2 134.0
Cumulative effect of change in accounting
principle, net............................ -- -- (3.3) --
------ ------- -------- -------
Net income.............................. $ 93.8 $ 78.7 $ 145.9 $ 134.0
====== ======= ======== =======
Earnings per share......................... $ 0.32 $ 0.27 $ 0.49 $ 0.45
====== ======= ======== =======
Earnings per share-assuming dilution....... $ 0.31 $ 0.26 $ 0.48 $ 0.44
====== ======= ======== =======
Dividends paid per share................... $ -- $.00625 $ -- $0.0125
====== ======= ======== =======
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Consolidated Balance Sheets
(Dollars in millions)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------- ------------
(unaudited)
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents................... $ 20.6 $ 15.6
Accounts receivable, net of allowances
of $19.4(1999) and $19.5(1998)........... 468.5 435.4
Other receivables........................... 8.3 8.3
Inventories................................. 261.0 193.4
Deferred income taxes....................... 101.4 83.3
Prepaid expenses............................ 56.5 27.5
------ ------
Total Current Assets..................... 916.3 763.5
Other Assets
Goodwill, net of allowances
of $93.5(1999) and $78.9(1998)........... 586.7 202.6
Other intangible assets, net of allowances
of $21.2(1999) and $16.6(1998)........... 111.2 44.3
Deferred income taxes....................... 66.1 73.8
Investments................................. 60.7 62.5
Sundry...................................... 31.1 33.6
Property and equipment, net of accumulated
depreciation of $298.2 (1999) and
$262.3 (1998)............................ 467.3 389.2
------ ------
$2,239.4 $1,569.5
======== ========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Consolidated Balance Sheets
(Dollars in millions)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------------- -------------
(unaudited)
<S> <C> <C>
Liabilities and Shareholders' Equity
Current Liabilities
Accounts payable........................ $ 77.8 $ 65.3
Employee compensation................... 87.0 129.5
Other liabilities....................... 216.2 137.9
Current portion of long-term debt....... 310.0 54.5
Payable to Sulzer Medica................ -- 200.0
--------- --------
Total Current Liabilities............ 691.0 587.2
Noncurrent Liabilities
Long-term debt.......................... 808.9 390.0
Other................................... 116.3 38.4
--------- --------
925.2 428.4
Commitments and contingencies........... -- --
Shareholders' Equity
Common stock-no par value:
Authorized shares: 1,000,000,000
Issued shares: 302,138,000 (1999)
301,848,000 (1998)...... 192.9 192.5
Additional paid-in capital.............. 151.7 197.0
Retained earnings....................... 398.9 253.0
Deferred cost, ESOP..................... (39.9) (41.3)
Treasury stock, at cost:
Shares: 684,673 (1999).............
671,618 (1998).............. (36.5) (27.0)
Accumulated other comprehensive income.. (43.9) (20.3)
--------- --------
623.2 553.9
--------- --------
$ 2,239.4 $1,569.5
========= ========
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Consolidated Statements of Cash Flow
(In millions)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------
1999 1998
---- ----
(unaudited)
<S> <C> <C>
Cash Provided by Operating Activities:
Net income.......................................... $ 145.9 $134.0
Adjustments to Reconcile Net Income to Cash
Provided by Operating Activities:
Depreciation........................................ 38.7 24.6
Amortization of intangible assets................... 19.4 8.3
Purchased research and development.................. 49.0 --
Change in deferred income taxes..................... 3.4 (13.5)
Other noncash expenses, net......................... 19.7 34.3
------- ------
276.1 187.7
Changes in Operating Assets and Liabilities:
Receivables, increase............................... (10.3) (11.0)
Inventories, increase............................... (19.9) (18.0)
Prepaid expenses and other assets, decrease......... 3.6 6.4
Accounts payable and accrued expenses, decrease..... (36.9) (9.7)
Income taxes payable, increase (decrease)........... 117.1 (13.7)
Other liabilities, decrease......................... (208.6) (3.1)
------- ------
Net Cash Provided by Operating Activities............. 121.1 138.6
Investing Activities:
Additions of property and equipment, net............ (88.8) (49.5)
Purchases of available-for-sale securities.......... -- (0.7)
Sale/maturity of available-for-sale securities...... -- 13.1
Additions of other assets, net...................... (36.4) (47.5)
Acquisition, net of cash acquired................... (568.0) --
------- ------
Net Cash Used for Investing Activities................ (693.2) (84.6)
Financing Activities:
Proceeds from long-term borrowings.................. 346.4 --
Increase/(decrease) in borrowings, net.............. 330.5 (7.4)
Dividends........................................... -- (3.7)
Purchases of common stock and other capital
transactions....................................... (97.6) (25.1)
------- ------
Net Cash Provided by (Used for) Financing Activities.. 579.3 (36.2)
Effect of Exchange Rate Changes on Cash............... (2.2) (0.2)
------- ------
Net Increase in Cash and Cash Equivalents............. 5.0 17.6
Cash and Cash Equivalents at Beginning of Period...... 15.6 17.7
------- ------
Cash and Cash Equivalents at End of Period............ $ 20.6 $ 35.3
======= ======
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
(In millions)
(unaudited)
Note 1 - General Information
Guidant Corporation (Guidant or the Company) operates in one segment: the
development, manufacture, and marketing of a broad range of innovative, high-
quality therapeutic medical devices for the treatment of cardiovascular and
vascular diseases. Guidant is a leader in minimally invasive procedures used for
opening blocked coronary arteries using coronary stents, coronary balloon
dilatation catheters, and related accessories. The Company is also a leader in
automatic implantable cardioverter defibrillator systems, which are used to
detect and treat abnormally fast heart rhythms (tachycardia). The Company
designs, manufactures, and markets a full line of implantable pacemaker systems
used to manage slow or irregular heart rhythms (bradycardia). In addition,
Guidant develops, manufactures, and markets products for use in minimally
invasive cardiac and vascular surgeries. Guidant is a global company with
principal operations in the United States, Western Europe, and Japan. The
Company markets its products in over 100 countries through a direct sales force
in the United States and a combination of direct sales representatives and
independent distributors in international markets.
Note 2 - Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information
necessary for a fair presentation of results of operations, financial position,
and cash flows in conformity with generally accepted accounting principles. In
the opinion of management, the consolidated financial statements reflect all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation of the Company's results for the periods presented. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues, expenses, and
related disclosures at the date of the financial statements and during the
reporting period. Actual results could differ from these estimates.
For further information, refer to the consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
Note 3 - Inventories
Inventories consisted of the following:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------- ------------
<S> <C> <C>
Finished products $130.8 $ 89.9
Work in process 66.4 51.9
Raw materials and supplies 63.8 51.6
------ ------
$261.0 $193.4
====== ======
</TABLE>
6
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 4 - Acquisition
On February 1, 1999, the Company completed its acquisition of the
electrophysiology business of Sulzer Medica, Ltd. (Sulzer), which includes
Intermedics, Inc. (Intermedics), a leader in the manufacture and distribution of
bradycardia pacemakers, for an aggregate cost of $810 million in cash. The
purchase price was based on the aggregate sales volume produced by independent
U.S. representatives of Sulzer who agreed to become Guidant employees. In the
second quarter, Guidant received a $30 million purchase price adjustment from
Sulzer based on the net worth of the electrophysiology business as reported on
the closing balance sheet received in May 1999. This has currently reduced the
aggregate purchase price to approximately $780 million. The acquisition was
accounted for using the purchase method. The consolidated financial statements
include the Intermedics operating results from the date of acquisition.
The aggregate purchase price includes $200 million required to settle the
Company's intellectual property litigation with Intermedics, which was payable
regardless of the consummation of the acquisition. This litigation settlement
charge was recorded in the third quarter of 1998. The remaining purchase price
has been allocated on a preliminary basis to the assets acquired and liabilities
assumed based on their estimated fair values at the date of acquisition. The
final aggregate purchase cost and allocation are subject to final closing
balance sheet adjustments, based on net worth, and final valuation of certain
assets acquired as well as other conditions. Final adjustments will be made over
the next few quarters, and will adjust goodwill recorded in connection with this
transaction.
The Company continued to finalize the purchase price allocation in the second
qurter as additional information became available. The Company recorded $75
million of liabilities relative to the announced closing of the acquired
facilities and termination of various Intermedics' contractual commitments. The
facilities will be closed after a transition period of approximately one year.
Intangible assets related to developed technology, the sales network, assembled
work force, and the excess of cost over net assets acquired (goodwill) will be
amortized over their estimated useful lives. Developed technology will be
amortized over ten years, and all other intangible assets will be amortized over
twenty years. The preliminary aggregate purchase price allocation is as follows:
<TABLE>
<CAPTION>
<S> <C>
Litigation settlement $200
Developed technology 28
Purchased research and development 49
Sales network and assembled workforce 101
Net tangible assets 101
Excess of cost over net assets acquired 301
----
$780
====
Liabilities recorded are included in net assets as follows:
Workforce reductions $ 45
Contractual commitments 30
----
$ 75
====
</TABLE>
The majority of these costs will be paid by the end of the first quarter of
2000. Approximately $45 million of the liabilities assumed remain outstanding at
June 30, 1999.
The Company recorded a $49 million charge in the first quarter of 1999 related
to the ascribed value of Intermedics' in-process technology. The valuation of
this
7
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 4 - Acquisition - (Continued)
technology was based upon guidelines provided by the Securities and Exchange
Commission and involved an analysis of those projects which had not reached
technological feasibility and had no alternative future use. This charge
reflects the unproven status of these technologies.
The following unaudited pro forma information presents a summary of consolidated
results of operations of the Company and Intermedics as if the acquisition had
occurred at the beginning of each period presented, with pro forma adjustments
to give effect to amortization of intangibles, purchased research and
development, and an increase in interest expense related to acquisition
financing. The pro forma amounts do not reflect any benefits from synergies and
are not necessarily indicative of the results that would have occurred had the
acquisition taken place at the beginning of the specified periods, or the
expected results of future operations.
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
---- ----
<S> <C> <C>
Net sales $1,209.7 $1,106.7
Net income 129.2 47.1
Net income per share - assuming dilution $ 0.42 $ 0.16
</TABLE>
Note 5 - Borrowings
As of June 30, 1999, the Company's outstanding borrowings consisted of:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------- ------------
<S> <C> <C>
Commercial paper $ 512.0 $230.5
Bank borrowings 260.5 214.0
Long-term notes 346.4 --
-------- ------
$1,118.9 $444.5
======== ======
</TABLE>
The acquisition of Intermedics was initially financed with commercial paper. On
February 11, 1999, the Company issued seven-year 6.15% notes with a $350 million
principal amount to replace a portion of the commercial paper. In order to
support the additional commercial paper, the Company increased its credit
facilities with certain banks. At June 30, 1999, the Company had a $400 million
facility that permits borrowings through August 2003 and a $450 million facility
that permits borrowings through August 1999 that would be due and payable one
year from that date. The Company anticipates that the credit facility that
expires in August 1999 will be extended. There are currently no outstanding
borrowings under these arrangements which carry a variable market rate of
interest. Restrictive covenants in the borrowing agreements are unchanged from
year-end.
Bank borrowings represent short-term uncommitted credit facilities with various
commercial banks. The Company expects that approximately $463 million in
commercial paper borrowings will remain outstanding throughout the next twelve
months and, accordingly, has classified that portion of commercial paper as
long-term at June 30, 1999. The weighted average interest rate on borrowings
outstanding at June 30, 1999, was 5.32% compared to 5.39% at December 31, 1998.
8
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 6 - Earnings Per Share
The following table sets forth the computation of earnings per share:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income before cumulative effect of
accounting change............................ $ 93.8 $ 78.7 $ 149.2 $ 134.0
Cumulative effect of accounting change, net.. -- -- (3.3) --
------- ------- ------- -------
Net income................................... $ 93.8 $ 78.7 $ 145.9 $ 134.0
======= ======= ======= =======
Weighted-average common shares outstanding... 295.27 294.60 295.21 294.56
Effect of employee stock options............. 9.89 7.30 10.46 7.16
------- ------- ------- -------
Weighted-average common shares outstanding
and assumed conversions...................... 305.16 301.90 305.67 301.72
======= ======= ======= =======
Earnings per share:
Income before cumulative effect of
accounting change............................ $ 0.32 $ 0.27 $ 0.50 $ 0.45
Cumulative effect of accounting change, net.. -- -- (0.01) --
------- ------- ------- -------
Earnings per share........................... $ 0.32 $ 0.27 $ 0.49 $ 0.45
======= ======= ======= =======
Earnings per share - assuming dilution:
Income before cumulative effect of
accounting change............................ $ 0.31 $ 0.26 $ 0.49 $ 0.44
Cumulative effect of accounting change, net.. -- -- (0.01) --
------- ------- ------- -------
Earnings per share - assuming dilution....... $ 0.31 $ 0.26 $ 0.48 $ 0.44
======= ======= ======= =======
</TABLE>
9
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 7 - Comprehensive Income
Comprehensive income comprises net income adjusted for the changes in unrealized
gains or losses on available-for-sale securities and foreign currency
translation adjustments. For the second quarter of 1999 and 1998, comprehensive
income was $88.6 million and $78.0 million, respectively. Total comprehensive
income for the six months ended June 30, 1999 and 1998 was $122.3 million and
$131.0 million, respectively.
Note 8 - New Accounting Pronouncements
Effective January 1, 1999, the Company adopted the American Institute of
Certified Public Accountants' Statement of Position (SOP) 98-5, Reporting on the
Costs of Start-Up Activities, which requires that all start-up costs, as defined
by the statement, are expensed as incurred. This change in accounting principle
resulted in a pretax cumulative effect adjustment (charge) of $5.3 million ($3.3
million after tax; $0.01 per share). Prior to January 1, 1999, these costs were
capitalized and depreciated over periods of up to five years.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities, which establishes accounting and reporting
standards for derivative financial instruments and hedging activities. This
pronouncement has been delayed by the FASB and is now required to be adopted in
fiscal years beginning after June 15, 2000. SFAS No. 133 will require, among
other things, the Company to recognize all derivatives as either assets or
liabilities on the balance sheet at fair value. Derivatives not qualifying as
hedges must be adjusted to fair value through income. If the derivative is a
hedge, depending on the nature of the hedge, changes in its fair value will
either be offset against the change in fair value of the hedged assets,
liabilities, or firm commitments through income or recognized in other
comprehensive income. Hedge ineffectiveness, the amount by which the change in
the value of a hedge does not exactly offset the change in the value of the
hedged item, will be immediately recognized in earnings. Management has not yet
determined the effect SFAS No. 133 will have on the Company or when the
statement will be adopted.
10
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 9 - Segment Information
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
Geographic Information: 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Sales(1):
United States $425.9 $370.0 $ 851.3 $728.0
International 177.6 117.8 342.3 230.1
------ ------ -------- ------
$603.5 $487.8 $1,193.6 $958.1
====== ====== ======== ======
</TABLE>
(1) Revenues are attributed to countries based on location of the customer.
<TABLE>
<CAPTION>
June 30, December 31,
Long-lived Assets: 1999 1998
---- ----
<S> <C> <C>
United States $1,178.6 $678.4
International 78.4 53.8
-------- ------
$1,257.0 $732.2
======== ======
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
Net Sales of Classes June 30, June 30,
of Similar Products: 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Vascular intervention $317.5 $256.4 $ 641.9 $523.4
Cardiac rhythm management 269.8 215.1 515.4 400.5
Cardiac & vascular surgery 16.2 16.3 36.3 34.2
------ ------ -------- ------
$603.5 $487.8 $1,193.6 $958.1
====== ====== ======== ======
</TABLE>
Note 10 - Contingencies
The Company is a party to various legal actions which have arisen in the normal
course of business.
In a lawsuit originally filed against Advanced Cardiovascular Systems, Inc.
("ACS"), a wholly owned subsidiary of the Company, on May 31, 1994, in the
Northern District of California, SciMed Life Systems, Inc., ("SciMed") a
subsidiary of Boston Scientific Corporation, ("BSC") alleged that the ACS RX
ELIPSE Coronary Dilatation Catheter infringes certain patents owned by SciMed.
Subsequently, the complaint was amended to further allege infringement by the
ACS RX MULTI-LINK Coronary Stent System. On June 15, 1999, the court entered an
order granting a motion for summary judgment of non-infringement in favor of
ACS. By granting ACS' motion, the court found that neither of the accused
products infringes the patents asserted by SciMed. As a result, the court
entered judgment in favor of ACS and closed the case. SciMed has filed a Notice
of Appeal.
11
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 10 - Contingencies - (Continued)
On March 12, 1996, ACS filed suit against SciMed in the Northern District of
California alleging that SciMed's Trio/Bandit line of coronary dilatation
catheters infringes a patent of ACS'. On June 22, 1999, the court granted ACS'
motions for summary judgment of validity and infringement of its patent, and
denied the parties' other summary judgment motions, including SciMed's motions
for summary judgment of invalidity and no willful infringement of the ACS patent
and ACS motion for summary judgment of enforceability. In the lawsuit, ACS is
seeking injunctive relief and monetary damages. Trial of the remaining issues
is currently scheduled to commence on February 7, 2000.
On May 3, 1996, Pacesetter, Inc., filed suit against Cardiac Pacemakers, Inc.,
("CPI") a wholly owned subsidiary of the Company, in the District Court for
Minnesota. The complaint, as subsequently amended, alleges infringement of
certain Pacesetter patents by certain CPI pacemaker models and programmers for
pacemakers and defibrillators. The lawsuit sought injunctive relief,
unspecified monetary damages, and an award of attorneys' fees. On December 16,
1998, following a trial on the merits, the jury of the District Court of
Minnesota returned a verdict finding no liability by CPI on two of the three
patents asserted by Pacesetter, and infringement by software in CPI programmers
adapted for use with certain pacemakers and defibrillators of the third patent.
The jury awarded Pacesetter damages in the amount of $9.7 million, which the
Company has accrued. The court is currently considering (1) Pacesetter's
request for an injunction, (2) Pacesetter's request to overturn the jury's
verdict of no liability on one patent, and (3) the Company's request that the
court overturn the jury's verdict of liability and declare Pacesetter's patent
not infringed and invalid.
On May 28, 1996, Origin Medsystems, Inc. ("Origin"), a wholly-owned subsidiary
of the Company, filed suit against General Surgical Innovations, Inc. ("GSI")
in the Northern District of California alleging that GSI's Spacemaker balloon
products infringe a patent of Origin. In the lawsuit, Origin is seeking
injunctive relief and monetary damages. On April 20, 1998 GSI's motion for
summary judgment that the Origin patent was obtained by inequitable conduct was
granted. On November 2, 1998 the Court awarded GSI its attorney fees. Origin
appealed both decisions. On July 16, 1999 the Court of Appeals for the Federal
Circuit vacated the summary judgment of inequitable conduct and remanded the
case to the district court for further proceedings. The Company expects that,
as a result of the Federal Circuit's decision, the award of attorney fees will
be vacated as well.
On June 4, 1996, GSI filed suit against Origin in the Northern District of
California alleging that Origin's VASOVIEW Balloon Dissection System,
Preperitoneal Distention Balloon (PDB) Systems and Extraview Balloon Systems
infringe a patent owned by GSI. GSI's motion for summary judgement of
infringement was granted on October 29, 1998, and a trial was held on the
validity of the GSI patent, willful infringement and damages. On February 8,
1999, the jury determined the patent to be valid and infringement to be willful,
and awarded GSI approximately $12.9 million in damages, which the Company has
accrued. GSI filed post-trial motions seeking injunctive relief, enhancement of
damages and a declaration that the case was exceptional so as to provide a basis
for an award of attorneys fees. By an order and judgment entered on April 16,
1999, the court declined GSI's requests to increase damages and to declare the
case exceptional. An injunction was issued
12
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 10 - Contingencies - (Continued)
enjoining sales of the accused Origin products for use in the United States, but
the implementation was stayed until November 15, 1999, as to customers who were
users of the products as of February 8, 1999, subject to Origin paying to GSI a
30% royalty. Origin has appealed, and this appeal relates to the injunctive
relief as well as to liability.
On September 24, 1997, GSI filed a second suit against Origin in the Northern
District of California alleging that Origin's VASOVIEW Balloon Dissection System
infringes another patent owned by GSI. GSI is seeking injunctive relief and
monetary damages. On July 6, 1999, GSI amended its complaint to add an
additional patent and Origin's PDB and ExtraView Systems to the suit, but did
not oppose Origin's currently pending motion to stay all proceedings pending the
outcome of the appeal in the first GSI case.
On October 3, 1997, Cordis Corporation ("Cordis"), a subsidiary of Johnson and
Johnson, filed suit against the Company and ACS in the District Court of
Delaware, alleging that the sale of the ACS MULTI-LINK Coronary Stent infringes
certain patents licensed to Cordis. In addition, on October 8, 1997, Cordis
filed a motion for a preliminary injunction in this lawsuit seeking to prevent
the Company from selling the ACS MULTI-LINK Coronary Stent other than in certain
limited circumstances and subject to certain conditions. On October 22, 1997,
Cordis amended its complaint to include Arterial Vascular Engineering, Inc.
("AVE") and BSC as co-defendants. A hearing on the motion for a preliminary
injunction was held in February 1998 and in July 1998, Cordis' motion for a
preliminary injunction was denied by the court. On October 27, 1998, one of the
patents asserted against the Company and ACS emerged from reexamination filed by
Cordis. On April 1, 1999, Cordis filed a motion to again amend its complaint to
add allegations of infringement of the reexamined patent and a new patent that
was issued on May 11, 1999, and to add the ACS MULTI-LINK DUET Coronary and
MEGALINK Peripheral Stents as well. The motion was granted by the court on May
13, 1999. In the lawsuit, Cordis is seeking injunctive relief and monetary
damages.
On November 6, 1997, Medtronic, Inc., filed suit against ACS in the District
Court for Minnesota, alleging that the ACS RX MULTI-LINK Coronary Stent
infringes a patent owned by Medtronic. A trial date has been set for October
18, 1999. Medtronic has filed a new complaint to add allegations of
infringement by the ACS MULTI-LINK DUET and SOLO Coronary and MEGALINK
Peripheral stents of the same patent. In these lawsuits, Medtronic is seeking
injunctive relief and monetary damages.
On December 2, 1997, Cordis filed suit against Guidant and ACS in the District
Court of Delaware, alleging that the ACS RX ROCKET Coronary Dilatation Catheter
infringes patents owned by Cordis. Cordis has also filed a motion for a
preliminary injunction, which was heard by the court on April 9, 1998. A
decision has not yet been rendered. In the lawsuit, Cordis is seeking
injunctive relief, monetary damages, and attorney fees. A separate lawsuit was
also filed against the Company in December 1997 in the Netherlands alleging
infringement of the European equivalents of these patents. In this separate
lawsuit, Cordis is seeking injunctive relief and monetary damages.
On February 18, 1998, AVE filed suit against ACS in the District Court of
Delaware alleging that the sale of the ACS MULTI-LINK Coronary Stent infringes
certain patents owned by AVE. The lawsuit also alleges misappropriation of
trade secrets and breach of a confidentiality agreement by ACS. In the
13
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Note 10 - Contingencies - (Continued)
lawsuit, AVE is seeking injunctive relief, monetary damages, and to invalidate
certain ACS stent patents.
On December 29, 1998, SciMed filed suit against the Company in the Hague, the
Netherlands, alleging infringement of a European Patent owned by SciMed by the
ACS RX ELIPSE Coronary Dilatation Catheter and the ACS RX MULTI-LINK, ACS RX
MULTI-LINK HP, and ACS MULTI-LINK RX DUET Coronary Stent Systems. SciMed is
seeking injunctive relief and monetary damages.
On January 13, 1999, SciMed filed suit against the Company, ACS, and Guidant
Sales Corporation in the Northern District of California alleging that ACS's RX
MULTI-LINK, RX MULTI-LINK HP, and MULTI-LINK RX DUET Coronary Stent Systems
infringe certain SciMed patents. In the lawsuit, SciMed is seeking injunctive
relief and monetary damages.
On February 1, 1999, Deborah Charms filed suit against the Company and CPI in
the United States District Court for the Western District of Texas alleging that
unspecified defibrillation products of CPI infringe a patent owned by Charms.
In the lawsuit, Charms is seeking injunctive relief and unspecified monetary
damages.
On March 31, 1999, Pacesetter, Inc. filed suit against Guidant Sales
Corporation, Inc. and CPI in the Central District of California, alleging that
rate responsive pacemakers or defibrillators having rate responsive pacing
(including, by name the VIGOR SR and VIGOR DR pacemakers) infringe two patents
owned by Pacesetter. In the lawsuit, Pacesetter is seeking injunctive relief
and monetary damages.
The Company believes that it has substantial and meritorious defenses against
the above infringement claims and intends to vigorously contest them. The
Company has filed suit and has lawsuits and other legal actions currently
outstanding against most of the companies discussed above. While it is not
possible to predict or determine the outcomes of the legal actions brought
against it, or to provide an estimate of any additional losses, if any, that may
arise, the Company believes the costs associated with all of these actions will
not have a material adverse effect on its consolidated financial position or
liquidity, but could possibly be material to the consolidated results of
operations of any one period.
Further, product liability claims may be asserted in the future relative to
events currently unknown to management. Management believes that the Company's
risk-management practices, including insurance coverage, are reasonably adequate
to protect against potential product liability losses.
Note 11 - Subsequent Event
On July 7, 1999, the Company reached a definitive agreement to sell the assets
related to its general surgery business. The financial impact of the disposal
is immaterial to the consolidated financial statements. Under the terms of the
agreement, the Company has retained the ability to apply certain of the
technologies that are being transferred as part of the transaction to Cardiac
and Vascular surgery products that are either currently in development or will
be developed in the future.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Guidant Corporation (Guidant or the Company), is a global company that designs,
develops, manufactures, and markets a broad range of innovative, high-quality
therapeutic devices for use in: (i) vascular intervention (VI), (ii) cardiac
rhythm management (CRM), and (iii) cardiac and vascular surgery (C&VS). Guidant
is a worldwide leader in minimally invasive devices used for opening blocked
coronary arteries, such as coronary stents and coronary balloon dilatation
catheters. The Company is also a worldwide leader in automatic implantable
cardioverter defibrillator (AICD) systems, used to detect and treat abnormally
fast heart rhythms (tachycardia). The Company designs, manufactures, and
markets a full line of implantable pacemaker systems used to manage slow or
irregular heart rhythms (bradycardia). In addition, the Company develops,
manufactures, and markets devices principally for use in minimally invasive
cardiac and vascular surgeries.
Cardiovascular disease continues to be the leading cause of death in the United
States. Guidant's business strategy is to design, develop, manufacture, and
market innovative, high-quality therapeutic products principally for use in
treating cardiovascular and vascular diseases which result in improved quality
of patient care and reduced treatment costs. In implementing this strategy, the
Company focuses on the following three areas, which it believes are critical to
its future success: (i) global product innovation, (ii) economic partnerships
with customers worldwide, and (iii) organizational excellence.
15
<PAGE>
The following tables are summaries of the Company's net sales and major costs
and expenses excluding the impact of special items. For purposes of analysis
and discussion herein, the Company employs a concept of operating income, which
is defined as income before special items, and excludes the items under the
category, "other income (expenses)", as set forth on the consolidated statements
of income on page 2, and accounting changes.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ----------------
1999 1998 1999 1998
---- ---- ---- ----
(Dollars in millions)
(unaudited)
<S> <C> <C> <C> <C>
Vascular intervention $317.5 $256.4 $ 641.9 $523.4
Cardiac rhythm management 269.8 215.1 515.4 400.5
Cardiac & vascular surgery 16.2 16.3 36.3 34.2
------ ------ -------- ------
Total net sales $603.5 $487.8 $1,193.6 $958.1
Cost of products sold 146.5 110.0 286.0 217.4
------ ------ -------- ------
Gross profit 457.0 377.8 907.6 740.7
Research and development 78.7 65.8 160.5 127.8
Sales, marketing, and administrative 168.5 141.1 338.6 276.2
------ ------ -------- ------
247.2 206.9 499.1 404.0
Operating income $209.8(1) $170.9(2) $ 408.5(1) $336.7(2)
====== ====== ======== ======
</TABLE>
<TABLE>
<CAPTION>
As a Percent of Net Sales
----------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Vascular intervention 52.6% 52.6% 53.8% 54.6%
Cardiac rhythm management 44.7 44.1 43.2 41.8
Cardiac & vascular surgery 2.7 3.3 3.0 3.6
----- ----- ----- -----
Total net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 24.3 22.6 24.0 22.7
----- ----- ----- -----
Gross profit 75.7 77.4 76.0 77.3
Research and development 13.0 13.5 13.5 13.3
Sales, marketing, and administrative 27.9 28.9 28.3 28.8
----- ----- ----- -----
40.9 42.4 41.8 42.1
Operating income 34.8%(1) 35.0%(2) 34.2%(1) 35.2%(2)
===== ===== ===== =====
</TABLE>
(1) Excludes purchased research and development charges of $49.0 million for the
six months ended June 30, 1999. Also excludes the impact of stay-pay and the
purchase accounting write-up of acquired Intermedics inventory sold for a total
of $13 million in the second quarter of 1999 and $21.3 million for the six
months ended June 30, 1999. Therefore, the cost of products sold, gross profit,
research and development, and sales, marketing, and administrative lines
displayed above do not agree to the reported consolidated statement of income
presentation.
(2) Excludes a purchased research and development charge of $28.7 million in the
second quarter of 1998 which represents the appraised value of in-process
research and development recognized in conjunction with the asset acquisition of
NeoCardia, LLC.
16
<PAGE>
Operating Results - Three and Six Months Ended June 30, 1999
The Company had all-time record worldwide net sales of $603.5 million for the
three months ended June 30, 1999, reflecting an increase of $115.7 million or
24% over the same period in 1998. Significant growth in unit volume of 29% was
partially offset by net sales price declines of 5%, which includes the effect of
changes in product mix.
The Company had worldwide net sales of $1,193.6 million for the six months ended
June 30, 1999, reflecting an increase of $235.5 million or 25% over the six
months ended June 30, 1998. Growth in unit volume of 30% was also partially
offset by net sales price declines of 5%, including changes in worldwide product
mix. The impact of foreign currency exchange rate fluctuations was not
significant on the three and six month periods ended June 30, 1999, as compared
to the same periods ended June 30, 1998.
Net sales of VI products for the three months ended June 30, 1999, were $317.5
million, an increase of $61.1 million or 23.8%, from the same period in 1998.
Net sales of VI products for the six months ended June 30, 1999 were $641.9
million, an increase of $118.5 million or 22.6% over the comparable period in
1998. This sales growth was due to the continued enthusiastic customer
acceptance of the ACS MULTI-LINK in Japan and the ACS MULTI-LINK DUET Coronary
Stent System in the U.S., Europe, and the rest of the world.
Coronary stent sales experienced growth in all major markets. Worldwide coronary
stent sales during the second quarter of 1999 were $232.3 million, compared to
$176.4 million in the second quarter of 1998. Sales of these products during the
first half of 1999 were $474.0 million compared to $360.1 million during the
first half of 1998. Sales of coronary stents in the United States of $174.5
million increased 20.0% in the second quarter of 1999 compared to the second
quarter of last year. Sales of these products in the United States during the
first half of 1999 were $361.2 million compared to $304.4 million during the
first half of 1998. International sales of coronary stents also contributed to
the Company's sales growth, due to continued strong sales of the ACS MULTI-LINK
RX DUET Coronary Stent System in Europe, and the February 1998 receipt of
approval from Japan's Ministry of Health and Welfare for reimbursement of the
ACS RX MULTI-LINK Coronary Stent System. Sales of coronary stents in
international markets increased 86.5% in the second quarter to $57.8 million,
while sales of these products during the first half of 1999 were $112.8 million
compared to $55.7 million during the first half of 1998.
17
<PAGE>
On July 6, 1999, Guidant announced CE Mark Approval to market the ACS MULTI-LINK
TRISTAR Coronary Stent System in Europe. This is Guidant's next generation stent
system which features improvements designed to increase ease of stent placement
and reduce vessel injury, which is thought to be a contributor to eventual
vessel reclosure. Although management believes stent sales will grow in the
third quarter of 1999 relative to the third quarter of 1998, they may decline
relative to the second quarter of 1999 due to increased market competition.
Total angioplasty sales, which include coronary balloon dilatation catheters,
increased 4% during the second quarter of 1999 to $80.6 million compared to the
second quarter of 1998. Sales of such products during the first half of 1999 of
$159.0 were essentially flat compared to the first half of 1998. Management
believes utilization of balloons in coronary stent procedures is decreasing due
to the current prevalence of high pressure - capable delivery systems for these
devices. As a result, post-stent dilatation balloon units have declined.
Comparing the second quarter and first half of 1999 to the second quarter and
first half of 1998, the Company experienced pricing pressure on VI products,
such as coronary balloon dilatation catheters and, to a lesser extent, coronary
stents. The average sales price decline on the stent from the first quarter of
1999 to the second quarter was 2% in the United States. The Company believes
that pricing pressures on VI products may continue. Some of the price decline
on stents is influenced by usage mix shifts toward lower priced, shorter length
stents.
Sales of CRM products of $269.8 million during the second quarter of 1999
increased $54.7 million or 25.4% from the same period in 1998. Net sales of CRM
products for the six months ended June 30, 1999 were $515.4 million, an increase
of $114.9 million or 28.7% for the same period in 1998. Pacemaker products
experienced substantial sales growth during 1999, particularly in the United
States and Europe where sales of these products increased 93.4% and 70.7%,
respectively, for the second quarter of 1999 compared to the second quarter of
1998. For the six months ended June 30, 1999, compared to the six months ended
June 30, 1998, these products increased 95.4% and 73.2% in the United States and
Europe, respectively. This sales growth was driven by the increasing popularity
of the DISCOVERY and MERIDIAN pacing devices launched in the U.S. and Europe in
the first half of 1998, in addition to the acquisition of Intermedics. Guidant
launched the PULSAR and PULSAR MAX Dual-Sensor Pacemaker Systems in the U.S. in
June 1999. These new systems provide
18
<PAGE>
sophisticated adaptive-rate therapy designed to match the pacing rate provided
by the pacemaker to individual patient needs. Due to the progressing integration
of the Intermedics sales representatives and operations, reporting the separate
sales of the former Intermedics' product lines is no longer meaningful.
AICD systems sales declined 8.1% and 1.4%, for the three and six month periods
ended June 30, 1999, as compared to the same periods in 1998 due to the
introduction of competitor devices. The second quarter of 1998 represented
all-time record sales of these devices related to the March 1998 U.S. market
release of the VENTAK AV II DR. The VENTAK AV II DR was the world's first
implantable defibrillator system to incorporate dual-chamber adaptive-rate
pacing capability. AICD systems sales were $140.2 million in the second quarter
and $279.1 for the six months ended June 30, 1999. The VENTAK VR was released in
the United States in May 1999. This device offers single-chamber, adaptive-rate
pacing capability combined with cardioversion and defibrillation therapies. Also
in May 1999, the results of the Multicenter Unsustained Tachycardia Trial
(MUSTT) were presented. This trial showed a 74% reduction in sudden cardiac
death for certain patients with coronary heart disease who received an
implantable cardioverter defibrillator. Although management believes sales of
AICD systems in the third quarter of 1999 may grow over the second quarter of
1999, they could decline relative to the third quarter of 1998.
Net sales of C&VS products in the second quarter of 1999 were $16.2 million,
which are level with the same period in 1998. Net sales of C&VS products for
the six months ended June 30, 1999 were $36.3 million, an increase of $2.1
million or 6.1% over the comparable period in 1998. On July 7, 1999, the Company
reached a definitive agreement to sell its general surgery business. The
financial impact of the disposal of this business will be recorded in the third
quarter of 1999 and is not material to Guidant's consolidated financial results.
Sales of general surgery products were approximately $12 million and $28 million
for the three and six months ended June 30, 1999. The C&VS group is now
primarily focused on the ANCURE product family for the treatment of abdominal
aortic aneurysm (AAA). An advisory panel of the FDA unanimously recommended
approval of the ANCURE System in June 1999.
The Company experienced sales growth both in the United States and international
markets during the second quarter of 1999. Net sales in the United States of
$425.9 million increased 15.1%, while international net sales of $177.6 million
increased 50.8% compared to the second quarter of 1998. For
19
<PAGE>
the six months ended June 30, 1999, U.S. net sales increased 16.9% to $851.3
million and international net sales increased 48.8% to $342.3 million, as
compared to the same period in 1998. U.S. net sales growth was primarily due to
sales of the ACS MULTI-LINK DUET Coronary Stent System, sales of pacemaker
systems such as DISCOVERY and MERIDIAN, and the incremental sales due to the
Intermedics acquisition. International net sales growth was primarily driven by
the ACS MULTI-LINK RX DUET in Europe, ACS RX MULTI-LINK in Japan, ACS RX GEMINI
coronary dilatation catheter, and the Intermedics acquisition.
Cost of products sold was $157.5 million for the quarter ended June 30, 1999,
and represented 26.1% of net sales versus 22.6% for the same period in 1998.
For the six months ended June 30, 1999, cost of products sold was $303.9 million
or 25.5% of net sales versus $217.4 million or 22.7% of net sales for the
comparable period in 1998. For both periods in 1999, cost of products sold
includes the impact of purchase accounting adjustments related to the write-up
of acquired Intermedics inventory sold in the first half of 1999. It also
includes the impact of stay-pay for Intermedics manufacturing personnel in the
first half of 1999. The impact of these two items was $11.0 million and $17.9
million for the three and six month periods ended June 30, 1999, respectively.
Excluding these charges, costs of products sold represented 24.3% and 24.0%,
respectively of net sales for the three and six months ended June 30, 1999. The
increase in cost of products sold as a percent of sales over 1998 primarily
reflects the impact of the sale of Intermedics products, which have lower gross
profit.
The Company continued its commitment to achieving long-term growth by investing
significant resources in research and development. Excluding stay-pay, research
and development spending as a percentage of net sales was 13.0% and 13.5% in the
second quarters of 1999 and 1998, respectively, and 13.5% and 13.3% for the six
months ended June 30, 1999 and 1998, respectively. Adjusted research and
development expenses of $78.7 million increased $12.9 million or 19.6% during
the second quarter of 1999 compared to the same period in 1998. For the six
months ended June 30, 1999, adjusted research and development expenses increased
$32.7 million or 25.6% over the comparable period in 1998. These spending
increases resulted primarily from: (i) new product development costs related to
future generations of AICDs, pacemakers, coronary stents, and dilatation
catheters; (ii) the acquisition of Intermedics and its related incremental
spending; (iii) development of radiation therapy devices for coronary
restenosis; (iv) development of stent technology for other parts of the vascular
anatomy, such as peripheral and carotid arteries; (v) development
20
<PAGE>
of treatment for atrial arrhythmias; and (vi) clinical evaluation of implantable
device systems for treatment of heart failure. The Company intends to maintain
its commitment to bring new technologies to the market and provide cost-
effective therapies to people who suffer from cardiovascular diseases. As a
result, the Company believes research and development spending will be 14% - 15%
of net sales in 1999.
On February 1, 1999, the Company completed the acquisition of Intermedics, a
leading designer, manufacturer, and marketer of cardiac rhythm management
products. Intermedics' products include bradycardia pacemakers, leads, and
programmers. The aggregate purchase price of the Intermedics acquisition of
$780 million has been allocated on a preliminary basis to the assets acquired
and liabilities assumed based on their estimated fair values at the date of
acquisition. Intangible assets acquired will be amortized over their estimated
useful lives. Developed technology will be amortized over ten years, while the
sales network, assembled work force, and the excess of cost over net assets
acquired will be amortized over twenty years.
The valuation of purchased research and development represents the estimated
fair value related to incomplete projects. The in-process technology acquired
in the Intermedics acquisition consists of bradycardia research and development
projects which will be integrated into existing Guidant products. This
technology relates to increased longevity, expanded diagnostics, connector
technology, and pacing technology. Management anticipates that these
technologies will be on the market in late 2000 and will cost approximately $20
- - $30 million to complete. In addition, Guidant acquired the THINLINE pacing
lead family from Intermedics. This product, which will be available in silicone
or polyurethane, is presently in clinical trials and will have lower profile and
improved radiopacity. Management anticipates that this product will also be on
the market in late 2000 and will cost approximately $8 - $10 million to
complete. At the acquisition date, the technological feasibility of the new
THINLINE products and the new bradycardia technologies had not been established,
and the in-process technology had no alternative uses. A 20% discount rate was
used in calculating the net present value of the cash flows. As a result of
this analysis, the Company recognized a pre-tax charge of $49 million in the
first quarter of 1999 relating to the appraised value of in-process research and
developed technology.
Adjusted sales, marketing, and administrative expenses in the second quarter of
1999 increased $27.4 million or 19.4%, compared to the second quarter of 1998,
21
<PAGE>
and $62.4 million or 22.6% for the six months ended June 30, 1999, versus the
comparable period in 1998. For both periods, these expenses increased at a rate
less than sales growth. This increase in spending was due to: (i) incremental
expenses associated with the inclusion of Intermedics results; (ii) increased
legal costs associated with various litigation; (iii) costs related to the
implementation of direct operations in certain international markets, such as
Japan; and (iv) increased investment in the United States field-sales force.
Total adjusted operating expenses for the second quarter were 40.9% of sales
compared to 42.4% of sales for the second quarter of 1998.
Operating income, as previously defined, was $209.8 million in the second
quarter of 1999, or 34.8% of net sales, compared to $170.9 million or 35.0% of
net sales for the three months ended June 30, 1998. This growth of 22.8% in
operating income was less than the growth in net sales due to the aforementioned
increased cost of products sold, offset somewhat by controlled growth in
adjusted operating expenses. Operating income for the six months ended June 30,
1999 and 1998 was $408.5 million and $336.7 million, respectively, representing
growth of 21.3%, which is less than the growth rate in sales due to the same
factors described above.
For the three months ended June 30, 1999, the Company had net other expenses of
$44.4 million compared to $20.5 million for the same period in the prior year.
This increase is primarily due to increased interest and amortization expense
related to the Intermedics acquisition. Net other expenses for the six months
ended June 30, 1999, were $66.8 million, including a one-time gain of $14.4
million. This one-time gain was recorded in connection with the merger of
CardioGenesis Corporation, in which Guidant had an equity interest, and Eclipse
Surgical Technologies, Inc. Excluding this gain, net other expenses were $81.2
million for the six months ended June 30, 1999. Net other expenses for the six
months ended June 30, 1998, excluding a $60 million charge related to an
agreement with C.R. Bard, Inc., that settled two patent infringement lawsuits
and granted the Company paid-up licenses to certain patents, were $40.8 million.
The increase in adjusted other expenses of $40.4 million in the first six months
of 1999 is due to the same factors mentioned above.
Excluding the impact of special items, the effective income tax rate for the
three and six months ended June 30, 1999, was 36.9%. The Company's effective
income tax rate for the three and six month periods ended June 30, 1998 was
35.3%. This increase in the adjusted effective tax rate relates to the non-
22
<PAGE>
deductible goodwill amortization expense related to the acquisition of
Intermedics.
Earnings before interest, taxes, depreciation, and amortization (EBITDA),
exclusive of special items in both years, was $211.2 million for the three
months ended June 30, 1999, and $413.4 million for the six months ended June 30,
1999. EBITDA was $171.1 million for the three months ended June 30, 1998, and
$335.7 million for the six months ended June 30, 1998. These 23.4% and 23.1%
improvements in EBITDA, respectively, are primarily driven by sales growth.
Guidant had reported net income for the three months ended June 30, 1999, of
$93.8 million and diluted earnings per share of $0.31. Net income for the three
months ended June 30, 1998 was $78.7 million and diluted earnings per share was
$0.26. Excluding the aforementioned special items in the second quarters of
1999 and 1998, net income would have been $104.4 million and $97.3 million,
respectively. This 7.3% growth in adjusted net income is less than operating
income growth due to the aforementioned increase in other expenses and the
effective income tax rate in 1999. Earnings per share-assuming dilution,
exclusive of the above special items, were $0.34 for the three months ended June
30, 1999, and $0.32 for the three months ended June 30, 1998.
For the six months ended June 30, 1999, net income would have been $206.5
million and earnings per share-assuming dilution would have been $0.68 without
the aforementioned special charges. Reported net income for the six months
ended June 30, 1999, also includes the net impact of $3.3 million for the
cumulative effect of a change in accounting principle, net of income taxes, in
the first quarter of 1999. Net income for the six months ended June 30, 1998,
excluding the impact of the special charges, would have been $191.4 million and
$0.63 per share-assuming dilution.
23
<PAGE>
Liquidity and Financial Condition
The Company continued to generate cash flows which were more than sufficient to
fund operations during the first half of 1999. Cash and cash equivalents
increased to $20.6 million at June 30, 1999, from $15.6 million at December 31,
1998. For the six months ended June 30, 1999, cash provided by operating
activities was $121.1 million compared to $138.6 million for the same period in
1998.
Working capital of $225.3 million at June 30, 1999, increased by $49.0 million
from the prior year-end level. Acquired Intermedics' assets increased working
capital approximately $69 million. This increase is offset by increases in trade
payables and the current portion of long-term debt. The current ratio at June
30, 1999 and December 31, 1998 was 1.3:1. The Company believes its cash from
operations is sufficient to fund essentially all future working capital needs
and discretionary operating spending requirements.
Net cash used for investing activities totaled $693.2 million for the six months
ended June 30, 1999, compared to $84.6 million for the same period in 1998. The
acquisition of Intermedics, net of cash acquired, was a $568.0 million use of
cash in the first quarter of 1999. The payment of the Intermedics settlement of
$200 million is included in operating activities. Net additions of property and
equipment of $88.8 million for the six months ended June 30, 1999, compared to
$49.5 million for the same period in 1998, were also a significant use of cash
for investing activities during both periods. This increase is due in part to
the Company's announced investment in a manufacturing facility in Ireland and
expansion of certain facilities, including equipment purchases, in both
California and Minnesota.
Net cash provided by financing activities totaled $579.3 million for the six
months ended June 30, 1999. Net proceeds of $346.4 million were received from
the issuance of seven year, 6.15% long-term notes. In addition, commercial paper
was issued to finance the acquisition of Intermedics on February 1, 1999. In the
first six months of 1998, financing activities decreased cash by $36.2 million.
At June 30, 1999, the Company had outstanding borrowings of $1,118.9 million
through the issuance of commercial paper, bank borrowings, and long-term notes
due in 2006. Bank borrowings represent short-term uncommitted credit
24
<PAGE>
facilities with various commercial banks. The commercial paper borrowings are
supported by two credit facilities aggregating $850 million. This includes a
$400 million facility that permits borrowings through August 2003 and a $450
million facility that permits borrowings through August 1999 which would not be
required to be repaid until August 2000. The Company anticipates that the credit
facility that expires in August 1999 will be extended. There are currently no
outstanding borrowings under these facilities. The Company expects that
approximately $463 million of commercial paper borrowings will remain
outstanding for the next twelve months and, as a result, this amount of
commercial paper has been classified as long-term at June 30, 1999. The
weighted-average interest rate of all debt outstanding at June 30, 1999, was
5.32%.
The Company expects its cash from operations to be adequate to meet its
obligations to make interest payments on its debt and other anticipated
operating cash needs including planned capital expenditures. Capital
expenditures are expected to be over $200 million in 1999, primarily due to
continued investment in the Company's new manufacturing facility in Ireland and
expansion of U.S. development, manufacturing and support facilities. In
addition, Guidant has recorded liabilities for the discharge of certain
obligations related to the Intermedics acquisition. These liabilities include
severance, distributor terminations, and miscellaneous cancellation fees. The
liabilities outstanding at June 30, 1999, related to the Intermedics acquisition
are $45 million, most of which will be paid in 1999. The Company believes that
amounts available through existing commercial paper programs should be adequate
to fund maturities of short-term borrowings.
The Company has recognized net deferred tax assets aggregating $167.5 million at
June 30, 1999, compared to $157.1 million at December 31, 1998. This increase is
due primarily to the establishment of deferred tax assets as part of the
purchase accounting adjustments on the Intermedics acquisition. In view of the
consistent profitability of its past operations, the Company believes that all
these assets will be substantially recovered and that no significant additional
valuation allowances are necessary.
Year 2000
Guidant is taking reasonable steps necessary to confirm that its business
systems, software, and equipment that consider and process date-related
information will continue to function properly after December 31, 1999. In
25
<PAGE>
doing so, Guidant is paying particular attention to assuring compliance with all
regulatory guidelines regarding Year 2000 issues. Guidant's implantable devices
do not contain real-time clocks. As a result, these devices present no Year 2000
issues. The Company's other products have been assessed and found to be Year
2000 ready with the exception of a few minor adjustments to the implantable
device control units (Programmers). These adjustments relate to minor date
limitations that present no adverse health impact to the patient.
Guidant, as a corporation formed in 1994, has many relatively new systems,
including an enterprise-wide operational support system, which has been
certified Year 2000 ready by its developer and extensively tested by Guidant. As
such, management's focus has been on assessing and readying manufacturing
equipment, facilities infrastructure, other computer systems, and business
partners. Guidant believes it has substantially completed any necessary
remediation of business critical equipment, other computer systems, and
infrastructure. This allows for development of contingency arrangements,
internal auditing and testing, as well as any further remediation, if necessary,
of these systems to take place in the second half of 1999. Efforts to confirm
the readiness of various business partners will continue up to and through,
January 1, 2000.
The Company has also performed an assessment of two recent acquisitions,
Intermedics, Inc., and InControl, Inc. Like Guidant, the implantable devices
produced by these companies do not contain real-time clocks, and therefore are
not susceptible to Year 2000 issues. Assessments of other business operations
from these acquisitions did not reveal any major deficiencies. Guidant believes,
therefore, that the integration of these enterprises will not adversely impact
Guidant's Year 2000 project schedule.
The Company is devoting the necessary resources to resolve all significant
issues in a timely manner. The costs associated with the Year 2000 assessment
and remediation of problems noted are expensed as incurred or capitalized if the
expenditures relate to hardware or software that will benefit future periods.
Based upon current assessments, management believes that the cost of such
actions will not have a material effect on Guidant's operating results or
financial condition. The Company currently expects that its total out-of-pocket
costs related to addressing its Year 2000 issues will be less than $20 million,
$10.6 million of which has been incurred to date. Approximately $5 million of
the total will be capital expenditures, which will be depreciated over the
assets' estimated useful lives.
26
<PAGE>
Recognizing that there are external forces beyond its control, Guidant is
developing contingency plans to address any situations that might occur. The
Guidant Year 2000 Contingency Plan Process is an extension of Guidant's business
continuation planning process. These plans lay out what each reporting unit will
do if, despite best efforts, elements crucial to business are not available or
cease to function properly due to Year 2000 processing problems. Considerations
include: adjusting inventory levels, identifying alternative sources of supply
and services, understanding and anticipating supply and demand chain readiness,
establishing crisis response processes to address unexpected problems, and
defining alternative ways to stabilize business operations quickly and get the
business critical jobs done if a Year 2000 problem arises.
The Year 2000 issue is expected to affect the systems of other external entities
with which the Company interacts. However, the Company cannot reasonably
estimate the potential impact on its financial condition and operations if
critical third parties do not become Year 2000-ready on a timely basis. The
Company is working through various trade associations as well as communicating
directly with its significant suppliers and customers to determine their Year
2000 readiness. In addition, the Company has also begun contingency planning to
handle disruptions with utility providers including electrical and
telecommunications suppliers.
Guidant expects to have contingency plans in place early in the fourth quarter.
There can be no guarantee, however, that these efforts will prevent an event
that will have a materially adverse effect on the Company's financial condition
or operations due to the failure of third parties to become Year 2000-ready.
Private Securities Litigation Reform Act of 1995
Under the safe harbor provisions of the Private Securities Litigation Reform Act
of 1995, the Company cautions investors that any forward-looking statements or
projections made by the Company, including those made in this document, are
subject to risks and uncertainties which may cause actual results to differ
materially from those projected. Economic, competitive, governmental,
technological, and other factors which may affect the Company's operations are
discussed Exhibit 99.1 filed herewith.
27
<PAGE>
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
In a lawsuit originally filed against ACS, a wholly owned subsidiary of the
Company, on May 31, 1994, in the Northern District of California, SciMed Life
Systems, Inc., ("SciMed") a subsidiary of Boston Scientific Corporation, ("BSC")
alleged that the ACS RX ELIPSE Coronary Dilatation Catheter infringes certain
patents owned by SciMed. Subsequently, the complaint was amended to further
allege infringement by the ACS RX MULTI-LINK Coronary Stent System. On June 15,
1999, the court entered an order granting a motion for summary judgment of non-
infringement in favor of ACS. By granting ACS's motion, the court found that
neither of the accused products infringes the patents asserted by SciMed. As a
result, the court entered judgment in favor of ACS and closed the case. SciMed
has filed a Notice of Appeal.
On March 12, 1996, ACS filed suit against SciMed in the Northern District of
California alleging that SciMed's Trio/Bandit line of coronary dilatation
catheters infringes a patent of ACS. On June 22, 1999 the court granted ACS's
motions for summary judgment of validity and infringement of its patent, and
denied the parties' other summary judgment motions, including SciMed's motions
for summary judgment of invalidity and no willful infringement of the ACS patent
and ACS's motion for summary judgment of enforceability. In the lawsuit, ACS is
seeking injunctive relief and monetary damages. Trial of the remaining issues is
currently scheduled to commence on February 7, 2000.
On November 6, 1997, Medtronic, Inc., filed suit against ACS in the District
Court for Minnesota, alleging that the ACS RX MULTI-LINK Coronary Stent
infringes a patent owned by Medtronic. A trial date has been set for October 18,
1999. Medtronic has filed a new complaint to add allegations of infringement by
the ACS MULTI-LINK DUET and SOLO Coronary and MEGALINK Peripheral stents of the
same patent. In these lawsuits, Medtronic is seeking injunctive relief and
monetary damages.
On May 28, 1996, Origin Medsystems, Inc. ("Origin"), a wholly-owned subsidiary
of the Company, filed suit against General Surgical Innovations, Inc. ("GSI") in
the Northern District of California alleging that GSI's Spacemaker balloon
products infringe a patent of Origin. In the lawsuit, Origin is seeking
injunctive relief and monetary damages. On April 20, 1998 GSI's motion for
28
<PAGE>
summary judgment that the Origin patent was obtained by inequitable conduct was
granted. On November 2, 1998 the Court awarded GSI its attorney fees. Origin
appealed both decisions. On July 16, 1999 the Court of Appeals for the Federal
Circuit vacated the summary judgment of inequitable conduct and remanded the
case to the district court for further proceedings. The Company expects that,
as a result of the Federal Circuit's decision, the award of attorney fees will
be vacated as well.
Item 4. Submission of Matters to a Vote of Security-Holders.
(a) The Company's Annual Meeting of Shareholders was held on May 17,
1999.
(b) At the meeting, the following directors were re-elected to three
year terms:
J.B. King
S.B. King
J.K. Moore
R.E. Wager
In addition, the following directors continue in office for terms ending in the
year indicated:
J.M. Cornelius - 2000
K.B. Clark - 2001
M.A. Cox, Jr. - 2001
R.W. Dollens - 2001
E.C. Falla - 2001
M. Grobstein - 2000
M. Novitch - 2000
E.L. Step - 2000
(c) The following matters were voted on at the meeting: Election of
Directors:
Name For Withheld
---- --- --------
J.B. King 259,132,935 1,805,743
S.B. King 259,149,417 1,789,261
J.K. Moore 259,151,893 1,786,785
R.E. Wager 259,177,897 1,760,781
29
<PAGE>
Approval of Amendment to the Company's Amended and Restated Articles
of Incorporation:
For Against Abstain
--- ------- -------
247,669,944 12,558,842 709,892
Ratification of appointment of Ernst & Young LLP as Independent Auditors:
For Against Abstain
--- ------- -------
260,144,222 200,642 593,814
30
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. The following documents are filed as exhibits to this report:
27.1 Financial Data Schedule
99.1 Factors Possibly Affecting
Future Operating Results.
(b) Reports on Form 8-K. During the quarter for which this Report on Form 10-Q
is filed, the registrant filed no Report on Form 8-K.
31
<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.
GUIDANT CORPORATION
-------------------
(Registrant)
Date August 4, 1999 /s/ Keith E. Brauer
-------------------------
Keith E. Brauer
Vice President, Finance and
Chief Financial Officer
Date August 4, 1999 /s/ Roger Marchetti
-------------------------
Roger Marchetti
Corporate Controller and
Chief Accounting Officer
32
<PAGE>
Exhibit List
27.1 Financial Data Schedule
99.1 Factors Possibly Affecting
Future Operating Results.
33
<PAGE>
GUIDANT CORPORATION and Subsidiaries
Financial Data Schedule
Six Months Ended June 30, 1999
(In millions, except per-share data)
(unaudited)
<TABLE>
<CAPTION>
Reference
Regulation S-X Item Description Amount
- -------------- ---------------- -------
<S> <C> <C>
5-02 (1) Cash and cash equivalents $ 20.6
5-02 (3) (a) (1) Accounts receivable 487.9
5-02 (4) Allowances for accounts receivable 19.4
5-02 (6) Inventories 261.0
5-02 (9) Total current assets 916.3
5-02 (13) Property and equipment 765.5
5-02 (14) Accumulated depreciation 298.2
5-02 (18) Total assets 2,239.4
5-02 (21) Total current liabilities 691.0
5-02 (22) Long-term debt 808.9
5-02 (30) Common stock 192.9
5-02 (31) Other shareholders' equity 430.3
5-02 (32) Total liabilities and shareholders' equity 2,239.4
5-03 (b) 1 (a) Net sales 1,193.6
5-03 (b) 1 Total revenues 1,193.6
5-03 (b) 2 (a) Cost of products sold 303.9
5-03 (b) 2 Total costs and expenses applicable to sales 303.9
5-03 (b) 3 Other costs and expenses 210.5
5-03 (b) (8) Interest expense, net 28.0
5-03 (b) (10) Income before income taxes 271.4
5-03 (b) (11) Income taxes 122.2
5-03 (b) (14) Net income before cumulative effect of 149.2
accounting change
5-03 (b) (18) Cumulative effect of accounting change, net 3.3
5-03 (b) (19) Net income 145.9
5-03 (b) (20) Income per share 0.49
5-03 (b) (20) Income per share - assuming dilution 0.48
</TABLE>
34
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 21
<SECURITIES> 0
<RECEIVABLES> 488
<ALLOWANCES> 19
<INVENTORY> 261
<CURRENT-ASSETS> 916
<PP&E> 766
<DEPRECIATION> 298
<TOTAL-ASSETS> 2,239
<CURRENT-LIABILITIES> 691
<BONDS> 809
0
0
<COMMON> 193
<OTHER-SE> 430
<TOTAL-LIABILITY-AND-EQUITY> 2,239
<SALES> 1,194
<TOTAL-REVENUES> 1,194
<CGS> 304
<TOTAL-COSTS> 304
<OTHER-EXPENSES> 211
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 28
<INCOME-PRETAX> 271
<INCOME-TAX> 122
<INCOME-CONTINUING> 149
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 3
<NET-INCOME> 146
<EPS-BASIC> 0.49
<EPS-DILUTED> 0.48
</TABLE>
<PAGE>
GUIDANT CORPORATION
Exhibit 99.1
Factors Possibly Affecting Future Operating Results
From time to time, the Company may publish forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, research and development
activities and similar matters. The Private Securities Litigation Reform Act of
1995 provides a safe harbor for forward-looking statements. In order to comply
with the terms of the safe harbor, the Company notes that a variety of factors
could cause the Company's actual results and experience to differ materially
from the anticipated results or other expectations expressed in the Company's
forward-looking statements. The risks and uncertainties that may affect the
operations, performance, development and results of the Company's business
include the following:
1. Economic factors over which the Company has no control, including
changes in inflation, interest rates and foreign currency exchange
rates.
2. Delays and uncertainties in the regulatory approval process in the
United States and other countries, resulting in lost market
opportunities.
3. Unexpected safety, performance or efficacy concerns arising with
respect to marketed products, whether or not scientifically
justified, leading to product recalls, withdrawals or declining
sales.
4. Unexpected interruptions of manufacturing operations as a result of
regulatory enforcement actions by the FDA or other regulatory
authorities.
5. The difficulties and uncertainties inherent in new product
development, including new products that appear promising during
development but fail to reach the market as a result of safety,
performance or efficacy concerns, inability to obtain necessary
regulatory approvals, unanticipated restrictions imposed on approved
indications, excessive costs to manufacture, infringement of patents
or other intellectual property rights of others, or technological
advances by a competitor of the Company.
6. Litigation and other legal factors which could preclude
commercialization of products or negatively affect the level of sales
or profitability of existing products, including litigation of
product liability claims, antitrust litigation, environmental
matters and patent disputes.
7. Future difficulties obtaining necessary components or materials used
in manufacturing the Company's products.
8. Future difficulties obtaining or the inability to obtain appropriate
levels of product liability insurance.
9. Competitive factors including the ability of the Company to obtain
patent rights or other intellectual property rights sufficient to
keep competitors from marketing competing products, the introduction
of new products or therapies by competitors or scientific or medical
developments that render the Company's products obsolete,
uneconomical or otherwise noncompetitive or the acquisition of
patents by competitors that prevent the Company from selling a
product or including key features in the Company's products.
<PAGE>
10. Governmental factors including laws and regulations, policies and
judicial decisions that affect the regulation and reimbursement of
medical devices, product liability, health care reform or tax laws.
11. Health care industry factors, including increased customer demands
for price concessions, reductions in third-party (Medicare, Medicaid
and other governmental programs, private health care insurance and
managed care plans) reimbursement levels for procedures using the
Company's products and limits imposed by customers on the number of
manufacturers or vendors which the customer will purchase products
from.
12. Accounting requirements to write off obsolete inventory or goodwill
which reduces reported earnings or changes in accounting standards
applicable to the Company.
13. Internal factors such as retention of key employees, change in
business strategies and the impact of restructuring and business
combinations.
14. The ability of the Company to implement its strategy that includes
the potential acquisition of one or more businesses and difficulties
in achieving the integration of the operations of acquired businesses
in a cost-effective manner and in implementing strategies necessary
for the realization of anticipated synergies.
15. The inability of certain of the Company's, or its Suppliers' or
Customers', computer systems to handle dates beyond the year 1999.
16. The Euro Conversions impact on the competitive environment in which
the Company operates or its impact on the Company's fundamental risk
management philosophy.
17. Factors beyond the control of the Company, including earthquakes
(particularly in light of the fact that the Company has significant
facilities located near major earthquake fault lines), floods, fires
or explosions.
