UNITED STATES
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 March 31, 2002 Commission File Number 0-8672
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ST. JUDE MEDICAL, INC.
----------------------
(Exact name of Registrant as specified in its charter)
MINNESOTA 41-1276891
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
One Lillehei Plaza, St. Paul, Minnesota 55117
---------------------------------------------
(Address of principal executive offices)
(651) 483-2000
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(Registrant's telephone number, including area code)
Not Applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
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; and (2) has been subject to such filing
requirements for the past 90 days.
YES _X_ NO ___
The number of shares of common stock, par value $.10 per share, outstanding on
April 26, 2002 was 88,111,873.
1
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002 2001
================================================================================
Net sales $ 371,193 $ 326,065
Cost of sales 118,788 107,077
--------------------------------------------------------------------------------
Gross profit 252,405 218,988
Selling, general and administrative expense 122,687 113,621
Research and development expense 46,465 39,505
--------------------------------------------------------------------------------
Operating profit 83,253 65,862
Other income (expense) (485) (3,097)
--------------------------------------------------------------------------------
Earnings before income taxes 82,768 62,765
Income tax expense 20,692 15,691
--------------------------------------------------------------------------------
Net earnings $ 62,076 $ 47,074
================================================================================
================================================================================
Net earnings per share:
Basic $ 0.71 $ 0.55
Diluted $ 0.68 $ 0.53
Weighted average shares outstanding:
Basic 87,612 85,537
Diluted 91,193 88,401
================================================================================
See notes to condensed consolidated financial statements.
2
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
MARCH 31, 2002 DECEMBER 31,
(UNAUDITED) 2001 (SEE NOTE)
==================================================================================================
ASSETS
Current assets
Cash and equivalents $ 138,882 $ 148,335
Accounts receivable, less allowances of $19,539 in 2002
and $17,210 in 2001 352,441 320,683
Inventories 238,665 240,390
Deferred income taxes 39,626 36,563
Other 65,599 51,575
--------------------------------------------------------------------------------------------------
Total current assets 835,213 797,546
Property, plant and equipment - at cost 643,696 631,134
Less accumulated depreciation (348,226) (335,491)
--------------------------------------------------------------------------------------------------
Net property, plant and equipment 295,470 295,643
Other assets
Goodwill, net 321,999 321,562
Other intangible assets, net 76,434 68,367
Deferred income taxes 67,238 67,238
Other 88,747 78,371
--------------------------------------------------------------------------------------------------
Total other assets 554,418 535,538
--------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,685,101 $ 1,628,727
==================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current maturities of long-term debt $ 87,750 $ --
Accounts payable 95,441 88,925
Income taxes payable 69,841 63,475
Accrued expenses 155,103 169,454
--------------------------------------------------------------------------------------------------
Total current liabilities 408,135 321,854
Long-term debt, less current maturities -- 123,128
Commitments and contingencies -- --
Shareholders' equity
Preferred stock -- --
Common stock 8,791 8,721
Additional paid-in capital 170,360 134,726
Retained earnings 1,196,985 1,134,909
Accumulated other comprehensive income
Cumulative translation adjustment (103,364) (103,781)
Unrealized gain on available-for-sale securities 4,194 9,170
--------------------------------------------------------------------------------------------------
Total shareholders' equity 1,276,966 1,183,745
--------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,685,101 $ 1,628,727
==================================================================================================
NOTE: THE BALANCE SHEET AT DECEMBER 31, 2001 HAS BEEN DERIVED FROM THE COMPANY'S
AUDITED FINANCIAL STATEMENTS AT THAT DATE. SEE NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
3
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002 2001
=============================================================================================================
Operating Activities
Net earnings $ 62,076 $ 47,074
Depreciation 14,875 14,059
Amortization 1,499 8,295
Deferred income taxes (24) 12
Changes in operating assets and liabilities, net of business acquisitions:
Accounts receivable (32,181) (15,051)
Inventories 2,161 (6,509)
Other current assets (21,952) 11,882
Accounts payable and accrued expenses (8,709) (23,008)
Income taxes 18,257 13,336
-------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 36,002 50,090
Investing Activities
Purchase of property, plant and equipment (13,105) (17,433)
Business acquisition payments (9,427) (1,075)
Other (10,420) (6,998)
-------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (32,952) (25,506)
Financing Activities
Proceeds from exercise of stock options 23,649 11,175
Borrowings under debt facilities 296,900 468,050
Payments under debt facilities (332,278) (511,400)
-------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (11,729) (32,175)
Effect of currency exchange rate changes on cash (774) (2,698)
-------------------------------------------------------------------------------------------------------------
Net decrease in cash and equivalents (9,453) (10,289)
Cash and equivalents at beginning of period 148,335 50,439
-------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 138,882 $ 40,150
=============================================================================================================
See notes to condensed consolidated financial statements.
4
ST. JUDE MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States (U.S.) for interim financial information, and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the U.S. for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the interim periods are not necessarily indicative of the
results that may be expected for the full year. Preparation of the Company's
financial statements in conformity with accounting principles generally accepted
in the U.S. requires management to make estimates and assumptions that affect
the reported amounts in the financial statements and accompanying notes. Actual
results could differ from those estimates. For further information, refer to the
consolidated financial statements and footnotes included in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2001.
Certain 2001 amounts have been reclassified to conform to the 2002 presentation.
NOTE 2 - INVENTORIES
Inventories consist of the following:
MARCH 31, DECEMBER 31,
2002 2001
================================================================================
Finished goods $ 140,526 $ 135,543
Work in process 37,545 35,984
Raw materials 60,594 68,863
--------------------------------------------------------------------------------
$ 238,665 $ 240,390
================================================================================
NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted all provisions of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" (Statement 142), on
January 1, 2002. Under Statement 142, goodwill is no longer amortized, but is
subject to annual impairment tests. The following table reconciles reported 2001
net earnings and basic and diluted net earnings per share had this statement
been effective January 1, 2001:
5
THREE MONTHS ENDED
March 31, 2002
================================================================================
Net earnings:
Reported net earnings $ 47,074
Goodwill amortization, net of taxes 5,171
--------------------------------------------------------------------------------
Adjusted net earnings $ 52,245
================================================================================
BASIC NET EARNINGS PER SHARE:
Reported net earnings $ 0.55
Goodwill amortization, net of taxes 0.06
--------------------------------------------------------------------------------
Adjusted basic net earnings per share $ 0.61
================================================================================
DILUTED NET EARNINGS PER SHARE:
Reported net earnings $ 0.53
Goodwill amortization, net of taxes 0.06
--------------------------------------------------------------------------------
Adjusted diluted net earnings per share $ 0.59
================================================================================
The net carrying amount of goodwill for the first quarter ended March 31, 2002
increased $437 to $321,999 due to the translation of non-U.S. goodwill balances
from local currencies to U.S. dollars.
The Company is in the process of performing its initial required goodwill
impairment test under Statement 142, however, management does not expect the
outcome of this test to have a material impact on the Company's consolidated
results of operations or financial position.
Balances of other intangible assets as of March 31, 2002 and December 31, 2001
were as follows:
MARCH 31, DECEMBER 31,
2002 2001
========================================================================================================
Original Accumulated Original Accumulated
AMORTIZED INTANGIBLE ASSETS: Cost Amortization Cost Amortization
--------------------------------------------------------------------------------------------------------
Purchased technology & patents $ 72,194 $(13,339) $ 72,050 $(12,440)
Other 18,475 (896) 9,046 (289)
--------------------------------------------------------------------------------------------------------
$ 90,669 $(14,235) $ 81,096 $(12,729)
========================================================================================================
Total other intangible assets, net $ 76,434 -- 68,367 --
--------------------------------------------------------------------------------------------------------
During the first quarter of 2002, the Company reclassified $24,599 of certain
intangible assets to goodwill based upon the guidance provided in Statement 142
and Statement of Financial Accounting Standards No. 141, "Business
Combinations." This reclassification has been reflected in the goodwill and
other intangible asset balances as of December 31, 2001 for comparative
purposes.
6
NOTE 4 - LONG-TERM DEBT
The Company issues short-term, unsecured commercial paper with maturities up to
270 days. These commercial paper borrowings are backed by the Company's
committed credit facility and bear interest at varying market rates. The Company
had outstanding commercial paper borrowings of $87,750 and $123,128 at March 31,
2002 and December 31, 2001.
The Company has a $350,000 unsecured, revolving credit facility that expires in
March 2003. The Company's commercial paper borrowings are backed by this
committed credit facility. The Company also borrows from time to time under
uncommitted, due-on-demand credit facilities with various banks.
At December 31, 2001, the Company classified all of its commercial paper
borrowings as long-term on its balance sheet as the Company had the ability to
repay these short-term obligations with available cash from its existing
long-term, committed credit facility. At March 31, 2002, the Company classified
all of its commercial paper borrowings as current maturities of long-term debt
as its $350,000 committed credit facility expires in less than one year.
Management continually reviews the Company's cash flow projections and may from
time to time repay a portion of the Company's borrowings.
The Company's credit facility agreement contains various restrictive covenants
such as minimum financial ratios, limitations on additional liens or
indebtedness, and limitations on certain acquisitions and investments, all of
which the Company was in compliance with at March 31, 2002. The Company's credit
facility agreement does not include a provision for termination of the facility
or acceleration of repayment due to changes in the Company's credit rating.
NOTE 5 - COMMITMENTS AND CONTINGENCIES
SILZONE(R) LITIGATION: The Company has been sued by patients alleging defects in
the Company's mechanical heart valves and valve repair products with Silzone(R)
coating. Some of these cases are seeking monitoring of patients implanted with
Silzone(R)-coated valves and repair products who allege no injury to date. Some
of these cases are seeking class action status. The Company voluntarily recalled
products with Silzone(R) coating on January 21, 2000, and sent a Recall Notice
and Advisory concerning the recall to physicians and others. See also Note 7
regarding the 2000 special charge for the voluntary recall of products
incorporating Silzone(R) coating.
In 2001, the U.S. Judicial Panel on Multi-District Litigation ruled that certain
lawsuits filed in U.S. federal district court involving products with Silzone(R)
coating should be part of Multi-District Litigation proceedings under the
supervision of U.S. District Court Judge John Tunheim in Minnesota. As a result,
actions involving products with Silzone(R) coating have been and will likely
continue to be transferred to Judge Tunheim for coordinated or consolidated
pretrial proceedings. There are other actions involving products with Silzone(R)
coating in various state courts that may or may not be coordinated with the
matters presently before Judge Tunheim.
While it is not possible to predict the outcome of these cases, the Company
believes that it has adequate product liability insurance to cover the costs
associated with them. The Company further believes that any costs not covered by
product liability insurance will not have a material
7
adverse impact on the Company's financial position or liquidity, but may be
material to the consolidated results of operations of a future period.
GUIDANT LITIGATION: In November 1996 Guidant Corporation ("Guidant") sued St.
Jude Medical alleging that St. Jude Medical did not have a license to certain
patents controlled by Guidant covering ICD products and alleging that St. Jude
Medical was infringing those patents.
St. Jude Medical's contention that it had obtained its patent license from
Guidant to the patents in issue when it acquired certain assets of Telectronics
in November 1996 was rejected by an arbitrator in July 2000. In May 2001, a
federal district court judge also ruled that the Guidant patent license with
Telectronics had not transferred to St. Jude Medical.
Guidant's suit in the United States District Court for the Southern District of
Indiana originally alleged infringement by St. Jude Medical of four patents.
Guidant later dismissed its claim on one patent (the '678 patent). In addition,
in response to a stipulation by the parties, the court ruled that a second
patent (the '191 patent) was invalid. Guidant has appealed the ruling of
invalidity concerning the '191 patent and the Court of Appeals for the Federal
Circuit held oral arguments on the '191 appeal on February 5, 2002.
A jury trial involving the two remaining patents asserted by Guidant (the '288
and '472 patents) commenced in June 2001. The jury issued its verdict on July 3,
2001, finding that both the '472 and '288 patents were valid and that St. Jude
Medical did not infringe the '288 patent. The jury also found that St. Jude did
infringe the '472 patent, which expired on March 4, 2001, but that the
infringement was not willful. The jury awarded damages of $140,000 to Guidant.
On February 13, 2002, the judge overseeing the jury trial issued his rulings on
the various post-trial motions. In particular, the judge ruled that the '472
patent was invalid on two grounds: lack of proper written description and double
patenting. The judge also ruled that claim 18 was not infringed and that claim 1
was infringed in only a limited manner.
The judge further ruled that the '288 patent was invalid for both obviousness
and failure to disclose the best mode.
The judge also found that St. Jude Medical was entitled to a new trial on the
issue of damages in the event the court's rulings on the other matters were
reversed on appeal. Finally, the judge held that in the event his other rulings
were reversed, St. Jude Medical would be entitled to a new trial because of
misconduct by Guidant and its attorneys during the first trial and that, in such
an event, Guidant would have to pay certain attorney's fees of St. Jude Medical.
The court also ruled on several other motions, not summarized here.
The effect of the court's post-trial rulings was to eliminate the $140,000
verdict against St. Jude Medical. The Company expects that Guidant will appeal
the judge's decision. While it is not possible to predict the outcome of an
appeal process, the Company believes that it has meritorious defenses against
the claims asserted by Guidant.
OTHER LITIGATION MATTERS: The Company is involved in various other product
liability lawsuits, claims and proceedings that arise in the ordinary course of
business. Subject to self-insured
8
retentions, the Company believes it has product liability insurance sufficient
to cover such claims and suits.
NOTE 6 - SHAREHOLDERS' EQUITY
CAPITAL STOCK: The Company's authorized capital consists of 25,000 shares of
$1.00 per share par value preferred stock and 250,000 shares of $0.10 per share
par value common stock. There were no shares of preferred stock issued or
outstanding during 2001 or the first quarter of 2002. There were 87,902 and
87,209 shares of common stock outstanding at March 31, 2002 and December 31,
2001.
SHARE REPURCHASES: In September 1999, the Company's Board of Directors
authorized the repurchase of up to $250,000 of the Company's outstanding common
stock over a three-year period. There were no share repurchases during 2001 or
the first quarter of 2002.
NOTE 7 - SPECIAL CHARGES
2001 SPECIAL CHARGE: In July 2001, the Company initiated efforts to streamline
its heart valve operations, consolidate its U.S. sales activities and
restructure its international sales organization. As a result of these
activities, the Company recorded pre-tax special charges of $20,657 in the third
quarter of 2001, consisting of employee severance costs resulting from the
elimination of approximately 90 production and administrative positions
($5,293), inventory write-offs and scrap ($9,490), capital equipment write-offs
($3,379) and other costs related primarily to lease terminations and other
facility exit costs due to the closing and consolidation of sales offices
($2,495). The Company has utilized $14,302 of these special charge accruals
through March 31, 2002, consisting of $3,045 of employee severance costs, $7,365
of inventory write-offs and scrap, $3,379 of capital equipment write-offs, and
$513 of other costs. The Company estimates that the remaining accruals will be
utilized primarily during 2002.
During the third quarter of 2001, the Company also wrote off $12,177 of certain
diagnostic equipment deemed obsolete due to the overwhelming acceptance of newer
technology equipment which received U.S. regulatory approvals in late 2000 and
early 2001, and was launched earlier in 2001.
2000 SPECIAL CHARGE: On January 21, 2000, the Company initiated a worldwide
voluntary recall of all field inventory of heart valve replacement and repair
products incorporating Silzone(R) coating on the sewing cuff fabric. The Company
concluded that it will no longer utilize a Silzone(R) coating. The Company
recorded a special charge accrual totaling $26,101 during the first quarter of
2000 relating to asset write-downs ($9,465) and other costs ($16,636), including
monitoring expenses, associated with this recall and product discontinuance. The
Company also maintains product liability coverage for litigation-related costs
in excess of its self-insured retention. The Company has utilized $20,980 of
this special charge accrual through March 31, 2002, consisting of $9,465 of
asset write-downs and $11,515 of other costs. The Company estimates that the
remaining accrual will be utilized primarily during 2002. There can be no
assurance that the final costs associated with this recall that are not covered
by insurance, including litigation-related costs, will not exceed management's
estimates.
9
NOTE 8 - NET EARNINGS PER SHARE
The table below sets forth the computation of basic and diluted net earnings per
share:
THREE MONTHS ENDED MARCH 31, 2002 2001
================================================================================
Numerator:
Net earnings $62,076 $47,074
Denominator:
Basic-weighted average shares outstanding 87,612 85,537
Effect of dilutive securities:
Employee stock options 3,570 2,826
Restricted shares 11 38
--------------------------------------------------------------------------------
Diluted-weighted average shares outstanding 91,193 88,401
================================================================================
Basic net earnings per share $ .71 $ .55
================================================================================
Diluted net earnings per share $ .68 $ .53
--------------------------------------------------------------------------------
Net earnings and diluted-weighted average shares outstanding have not been
adjusted for certain employee stock options and awards where the effect of those
securities would have been anti-dilutive.
NOTE 9 - COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) consists of unrealized gains or losses on
available-for-sale marketable securities and foreign currency translation
adjustments, net of taxes. Other comprehensive loss was $(4,559) and $(13,577)
for the three months ended March 31, 2002 and 2001. Total comprehensive income
(loss) combines reported net earnings (loss) and other comprehensive income
(loss). Total comprehensive income was $57,517 and $33,497 for the three months
ended March 31, 2002 and 2001.
NOTE 10 - OTHER INCOME (EXPENSE)
Other income (expense) consists primarily of interest income and interest
expense, net.
NOTE 11 - SEGMENT AND GEOGRAPHICAL INFORMATION
SEGMENT INFORMATION: The Company manages its business on the basis of one
reportable segment - the development, manufacture and distribution of
cardiovascular medical devices for the global cardiac rhythm management (CRM),
cardiac surgery (CS) and cardiology and vascular access (C/VA) markets. The
Company's principal products in each of these markets are: bradycardia pacemaker
systems, tachycardia implantable cardioverter defibrillator (ICD) systems, and
electrophysiology catheters in CRM; mechanical and tissue heart valves, valve
repair products, and suture-free devices to facilitate coronary artery bypass
graft anastomoses in CS; and vascular closure devices, catheters, guidewires and
introducers in C/VA.
10
GEOGRAPHICAL INFORMATION: The following tables present certain geographical
financial information:
THREE MONTHS ENDED MARCH 31,
NET SALES 2002 2001
================================================================================
United States $ 245,830 $ 210,650
International 125,363 115,415
--------------------------------------------------------------------------------
$ 371,193 $ 326,065
================================================================================
MARCH 31, DECEMBER 31,
LONG-LIVED ASSETS* 2002 2001
================================================================================
United States $ 642,085 $ 626,140
International 140,565 137,803
--------------------------------------------------------------------------------
$ 782,650 $ 763,943
================================================================================
*LONG-LIVED ASSETS EXCLUDE DEFERRED INCOME TAXES.
Net sales by class of similar products were as follows:
THREE MONTHS ENDED MARCH 31,
NET SALES 2002 2001
================================================================================
Cardiac rhythm management $ 267,798 $ 229,033
Cardiac surgery 62,882 65,645
Cardiology and vascular access 40,513 31,387
--------------------------------------------------------------------------------
$ 371,193 $ 326,065
--------------------------------------------------------------------------------
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
RESULTS OF OPERATIONS
NET SALES: Net sales for the first quarter of 2002 totaled $371,193, a 13.8%
increase over the $326,065 reported in the first quarter of 2001. Unfavorable
foreign currency effects due to a stronger U.S. dollar, primarily against the
major Western European currencies, reduced first quarter 2002 net sales as
compared with 2001 by approximately $5,000.
Cardiac rhythm management (CRM) net sales for the first quarter of 2002 were
$267,798, a 16.9% increase over the $229,033 reported in the first quarter of
2001. The increase in CRM net sales for the first quarter of 2002 was primarily
due to increased bradycardia, implantable cardioverter defibrillator (ICD) and
electrophysiology catheter unit sales. The increase in bradycardia net sales in
the first quarter of 2002 was attributable to the on-going success of the
Company's Integrity AFx(R) pacemakers with atrial fibrillation suppression
technology and to the global introduction of the Identity(TM) family of
pacemakers during the quarter. The Company's ICD net sales during the first
quarter of 2002 benefited from the introduction of the Atlas(TM) family of ICDs
to the U.S. market during the quarter.
Cardiac surgery (CS) net sales for the first quarter of 2002 were $62,882, a
4.2% decrease from the $65,645 reported in the first quarter of 2001. The
decrease in CS net sales was due to the effects of the stronger U.S. dollar and
a clinical preference shift from mechanical valves to tissue valves in the U.S.
market where the Company holds significant mechanical valve market share and a
smaller share of the tissue valve market. This decrease was offset in part by an
increase in aortic connector sales as the Company continues its rollout of this
product into the U.S. market.
Cardiology and vascular access net sales for the first quarter of 2002 were
$40,513, a 29.1% increase over the $31,387 reported in the first quarter of
2001, primarily due to increased Angio-Seal(TM) vascular closure unit sales,
benefiting from the global introduction of the Angio-Seal(TM) STS Platform in
January 2002.
GROSS PROFIT: Gross profit for the first quarter of 2002 totaled $252,405, or
68.0% of net sales, as compared with $218,988, or 67.2% of net sales, during the
first quarter of 2001. The improvement in the gross profit percentage is due
primarily to higher ICD and pacemaker unit volumes and improved CRM
manufacturing efficiencies.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSE: SG&A expense for the first
quarter of 2002 totaled $122,687, or 33.1% of net sales, compared with $113,621,
or 34.8% of net sales, for the first quarter of 2001. The decrease in SG&A
expense as a percentage of net sales was primarily attributable to the
elimination of goodwill amortization expense in the first quarter of 2002 due to
the Company's adoption of FASB Statement 142, "Goodwill and Other Intangible
Assets," effective January 1, 2002. Goodwill amortization expense in the first
quarter of 2001 was $6,895.
12
RESEARCH AND DEVELOPMENT (R&D) EXPENSE: R&D expenses in the first quarter of
2002 totaled $46,465, or 12.5% of net sales, compared with $39,505, or 12.1% of
net sales, for the first quarter of 2001. The increase in R&D expenses as a
percentage of net sales is primarily attributable to increased CRM activities
relating primarily to ICDs and products treating emerging indications in atrial
fibrillation and congestive heart failure.
SPECIAL CHARGES: In July 2001, the Company initiated efforts to streamline its
heart valve operations, consolidate its U.S. sales activities and restructure
its international sales organization. As a result of these activities, the
Company recorded pre-tax special charges of $20,657 in the third quarter of
2001, consisting of employee severance costs resulting from the elimination of
approximately 90 production and administrative positions ($5,293), inventory
write-offs and scrap ($9,490), capital equipment write-offs ($3,379) and other
costs related primarily to lease terminations and other facility exit costs due
to the closing and consolidation of sales offices ($2,495). The Company has
utilized $14,302 of these special charge accruals through March 31, 2002,
consisting of $3,045 of employee severance costs, $7,365 of inventory write-offs
and scrap, $3,379 of capital equipment write-offs, and $513 of other costs. The
Company estimates that the remaining accruals will be utilized primarily during
2002.
During the third quarter of 2001, the Company also wrote off $12,177 of certain
diagnostic equipment deemed obsolete due to the overwhelming acceptance of newer
technology equipment which received U.S. regulatory approvals in late 2000 and
early 2001, and was launched earlier in 2001.
On January 21, 2000, the Company initiated a worldwide voluntary recall of all
field inventory of heart valve replacement and repair products incorporating
Silzone(R) coating on the sewing cuff fabric. The Company concluded that it
would no longer utilize Silzone(R) coating. The Company recorded a special
charge accrual totaling $26,101 during the first quarter of 2000 relating to
asset write-downs ($9,465) and other costs ($16,636), including monitoring
expenses, associated with this recall and product discontinuance. The Company
also maintains product liability coverage for litigation-related costs in excess
of its self-insured retention. The Company has utilized $20,980 of this special
charge accrual through March 31, 2002, consisting of $9,465 of asset write-downs
and $11,515 of other costs. The Company estimates that the remaining accrual
will be utilized primarily during 2002. There can be no assurance that the final
costs associated with this recall that are not covered by insurance, including
litigation-related costs, will not exceed management's estimates.
OTHER INCOME (EXPENSE): Net other expense decreased in the first quarter of 2002
as compared with 2001 due primarily to reduced interest expense as a result of
lower debt levels and lower interest rates in 2002.
INCOME TAXES: The Company's effective income tax rate was 25% for the first
quarters of 2002 and 2001. The Company anticipates that its effective income tax
rate will increase beginning in 2003 due to a larger percentage of the Company's
forecasted taxable income being generated in higher taxing jurisdictions.
The Company has not recorded U.S. deferred income taxes on certain of its
non-U.S. subsidiaries' undistributed earnings as such amounts are intended to be
reinvested outside the United States indefinitely. However, should the Company
change its business and tax strategies
13
in the future and decide to repatriate a portion of these earnings to one of the
Company's U.S. subsidiaries, including cash maintained by these non-U.S.
subsidiaries, additional U.S. tax liabilities would be incurred.
At March 31, 2002, the Company has approximately $52,000 of deferred tax assets
related principally to U.S. tax loss carryforwards, arising primarily from
acquisitions, which expire from 2003 to 2021, for which no valuation allowance
has been recorded. The Company believes that these loss carryforwards will be
fully utilized based upon its estimates of future taxable income. If these
estimates of future taxable income are not met, a valuation allowance for some
of these deferred tax assets would be required.
The Company from time to time faces challenges from tax authorities regarding
the amount of taxes due. These challenges include questions regarding the timing
and amount of deductions and the allocation of income among various tax
jurisdictions. The Company's U.S. federal tax filings prior to 1998 have been
examined by the Internal Revenue Service (IRS) and the Company has settled all
differences arising out of those examinations. Consistent with the Company's
status with the U.S. federal tax authorities as a "coordinated industry case,"
the IRS is currently in the process of examining the Company's U.S. federal tax
returns for the calendar years 1998, 1999 and 2000. Although the Company
believes it has recorded an appropriate income tax provision, there can be no
assurance that the IRS will not take positions contrary to those taken by the
Company. The Company further believes that any costs not covered by the
Company's income tax provision will not have a material adverse impact on the
Company's consolidated financial position or liquidity, but may be material to
the consolidated results of operations of a future period.
OUTLOOK: The Company expects that market demand, government regulation and
reimbursement policies, and societal pressures will continue to change the
worldwide health care industry resulting in further business consolidations and
alliances. The Company participates with industry groups to promote the use of
advanced medical device technology in a cost-conscious environment. Customer
service in the form of cost-effective clinical outcomes will continue to be a
primary focus for the Company.
The global medical technology industry is highly competitive. Competitors have
historically employed litigation to gain a competitive advantage. In addition,
the Company's products must continually improve technologically and provide
improved clinical outcomes due to the competitive nature of the industry.
The heart valve and repair portion of the cardiac surgery market is highly
competitive, and consists of mechanical heart valves, tissue heart valves, and
repair products. Since 1999, the market has shifted to tissue heart valves and
repair products from mechanical heart valves, resulting in an overall market
share loss for the Company. Competition is anticipated to continue to place
pressure on pricing and terms, including a trend toward vendor-owned
(consignment) inventory at the hospitals, and health care reform is expected to
result in further hospital consolidations over time.
The cardiac rhythm management market is also a highly competitive industry and
has undergone consolidation. There are currently three principal suppliers,
including the Company, and the Company's two principal competitors both have
substantially greater assets and sales than the
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Company. Rapid technological change in the CRM market is expected to continue,
requiring the Company to invest heavily in R&D and to effectively market its
products.
The Company operates in an industry that is susceptible to significant product
liability claims. These claims may be brought by individuals seeking relief for
themselves or, increasingly, by groups seeking to represent a class. In
addition, product liability claims may be asserted against the Company in the
future relative to events that are not known to management at the present time.
While it is not possible to predict the outcome of every claim, the Company
believes that it has adequate product liability insurance to cover the costs
associated with them. The Company further believes that any costs not covered by
product liability insurance, including the Company's self-insured deductible,
will not have a material adverse impact on the Company's consolidated financial
position or liquidity, but may be material to the consolidated results of
operations of a future period.
Subsequent to the tragic events of September 2001, the product liability
insurance market has dramatically changed. The Company has secured product
liability coverage for 2002; however, the self-insured retention and insurance
premiums are significantly higher than in prior years. There can be no assurance
that this trend will reverse in the near future. As a result of the increased
self-insured retention for 2002, the Company has increased financial exposure in
the event of significant product liability matters. However, management believes
that any payment under the Company's 2002 policy self-insured retention would
not have a material adverse impact on the Company's consolidated financial
position or liquidity, but may be material to the consolidated results of
operations of a future period.
Group purchasing organizations (GPOs) in the United States continue to
consolidate the purchasing for some of the Company's customers. Several GPOs
have executed contracts with the Company's CRM market competitors, which exclude
the Company. These contracts, if enforced, may adversely affect the Company's
sales of these products to members of these GPOs.
CRITICAL ACCOUNTING POLICIES
Management has identified the most critical accounting principles upon which the
Company's financial status depends. Management determined the critical
accounting principles by considering accounting policies that involve the most
complex or subjective decisions or assessments. Management identified the
Company's most critical accounting policies to be those related to income taxes,
product liability accruals, special charges, accounts receivable allowance for
doubtful accounts, and estimated useful lives of property, plant and equipment.
These accounting policies are discussed in the notes to the consolidated
financial statements included in the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2001, and in relevant sections in this
Management's Discussion and Analysis.
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FINANCIAL CONDITION
The Company's liquidity and cash flows remained strong during the first quarter
of 2002. The Company's current assets to current liabilities ratio, excluding
current maturities of long-term debt, was 2.6 to 1 at March 31, 2002, as
compared with 2.5 to 1 at December 31, 2001.
At March 31, 2002, substantially all of the Company's cash and equivalents were
maintained by the Company's non-U.S. subsidiaries and would be subject to
additional U.S. tax if repatriated to one of the Company's U.S. subsidiaries
(see Income Taxes).
Total interest-bearing debt at March 31, 2002 decreased $35,378 from December
31, 2001 utilizing excess cash generated from operations and the proceeds from
employee stock option exercises.
At December 31, 2001, the Company classified all of its commercial paper
borrowings as long-term on its balance sheet as the Company had the ability to
repay these short-term obligations with available cash from its existing
long-term, committed credit facility. At March 31, 2002, the Company classified
all of its commercial paper borrowings as current maturities of long-term debt
as its $350,000 committed credit facility expires in less than one year.
Management believes that the Company can obtain a new credit facility or
renegotiate and extend its current credit facility prior to March 2003, which
will meet its working capital and capital investment needs. Management
continually reviews the Company's cash flow projections and may from time to
time repay a portion of the Company's borrowings.
In September 1999, the Company's Board of Directors authorized the repurchase of
up to $250,000 of the Company's outstanding common stock over a three-year
period. There were no share repurchases during 2001 or the first quarter of
2002.
Management believes that cash generated from operations and cash available under
the Company's credit facilities will be sufficient to meet the Company's working
capital and capital investment needs in the near term. Should suitable
investment opportunities arise, management believes that the Company's earnings,
cash flows and balance sheet will permit the Company to obtain additional debt
financing or equity capital, if necessary.
The Company has no off-balance sheet financing arrangements other than certain
operating leases previously disclosed in its Annual Report on Form 10-K for the
fiscal year ended December 31, 2001. There have been no significant changes in
the Company's operating lease obligations since December 31, 2001.
CAUTIONARY STATEMENTS
In this discussion and in other written or oral statements made from time to
time, we have included and may include statements that may constitute
"forward-looking statements" within the meaning of the safe harbor provisions of
the Private Litigation Securities Reform Act of 1995. These forward-looking
statements are not historical facts but instead represent our belief regarding
future events, many of which, by their nature, are inherently uncertain and
beyond our control. These statements relate to our future plans and objectives,
among other things. By identifying these statements for you in this manner, we
are alerting you to the possibility that our
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actual results may differ, possibly materially, from the results indicated by
these forward-looking statements. We undertake no obligation to update any
forward-looking statements.
Various factors contained in the previous discussion and those described below
may affect the Company's operations and results. Since it is not possible to
foresee all such factors, you should not consider these factors to be a complete
list of all risks or uncertainties. Risk factors include the following:
1. Legislative or administrative reforms to the U.S. Medicare and Medicaid
systems or similar reforms of foreign reimbursement systems in a manner
that significantly reduces reimbursement for procedures using the
Company's medical devices or denies coverage for such procedures.
2. Acquisition of key patents by others that have the affect of excluding
the Company from market segments or require the Company to pay
royalties.
3. Economic factors, including inflation, changes in interest rates and
changes in foreign currency exchange rates.
4. Product introductions by competitors which have advanced technology,
better features or lower pricing.
5. Price increases by suppliers of key components, some of which are
sole-sourced.
6. A reduction in the number of procedures using the Company's devices
caused by cost containment pressures or preferences for alternate
therapies.
7. Safety, performance or efficacy concerns about the Company's marketed
products, many of which are expected to be implanted for many years,
leading to recalls and advisories with the attendant expenses and
declining sales.
8. Changes in laws, regulations or administrative practices affecting
government regulation of the Company's products, such as FDA laws and
regulations, that increase pre-approval testing requirements for
products or impose additional burdens on the manufacture and sale of
medical devices.
9. Difficulties obtaining, or the inability to obtain, appropriate levels
of product liability insurance.
10. A serious earthquake affecting the Company's facilities in Sunnyvale or
Sylmar, California.
11. Health care industry consolidation leading to demands for price
concessions or the exclusion of some suppliers from significant market
segments.
12. Adverse developments in litigation including product liability
litigation and patent litigation or other intellectual property
litigation including that arising from the Telectronics and Ventritex
acquisitions.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
There have been no material changes from December 31, 2001 in the
Company's market risk. For further information on market risk, refer to Item 7A
in the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 2001.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
SILZONE(R) LITIGATION: The Company has been sued by patients alleging
defects in the Company's mechanical heart valves and valve repair products with
Silzone(R) coating. Some of these cases are seeking monitoring of patients
implanted with Silzone(R)-coated valves and repair products who allege no injury
to date. Some of these cases are seeking class action status. The Company
voluntarily recalled products with Silzone(R) coating on January 21, 2000, and
sent a Recall Notice and Advisory concerning the recall to physicians and
others. See also Note 7 regarding the 2000 special charge for the voluntary
recall of products incorporating Silzone(R) coating.
In 2001, the U.S. Judicial Panel on Multi-District Litigation ruled
that certain lawsuits filed in U.S. federal district court involving products
with Silzone(R) coating should be part of Multi-District Litigation proceedings
under the supervision of U.S. District Court Judge John Tunheim in Minnesota. As
a result, actions involving products with Silzone(R) coating have been and will
likely continue to be transferred to Judge Tunheim for coordinated or
consolidated pretrial proceedings. There are other actions involving products
with Silzone(R) coating in various state courts that may or may not be
coordinated with the matters presently before Judge Tunheim.
While it is not possible to predict the outcome of these cases, the
Company believes that it has adequate product liability insurance to cover the
costs associated with them. The Company further believes that any costs not
covered by product liability insurance will not have a material adverse impact
on the Company's financial position or liquidity, but may be material to the
consolidated results of operations of a future period.
GUIDANT LITIGATION: In November 1996 Guidant Corporation ("Guidant")
sued St. Jude Medical alleging that St. Jude Medical did not have a license to
certain patents controlled by Guidant covering ICD products and alleging that
St. Jude Medical was infringing those patents.
St. Jude Medical's contention that it had obtained its patent license
from Guidant to the patents in issue when it acquired certain assets of
Telectronics in November 1996 was rejected by an arbitrator in July 2000. In May
2001, a federal district court judge also ruled that the Guidant patent license
with Telectronics had not transferred to St. Jude Medical.
Guidant's suit in the United States District Court for the Southern
District of Indiana originally alleged infringement by St. Jude Medical of four
patents. Guidant later dismissed its claim on one patent (the '678 patent). In
addition, in response to a stipulation by the parties, the court ruled that a
second patent (the '191 patent) was invalid. Guidant has appealed the ruling of
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invalidity concerning the '191 patent and the Court of Appeals for the Federal
Circuit held oral arguments on the '191 appeal on February 5, 2002.
A jury trial involving the two remaining patents asserted by Guidant
(the '288 and '472 patents) commenced in June 2001. The jury issued its verdict
on July 3, 2001, finding that both the '472 and '288 patents were valid and that
St. Jude Medical did not infringe the '288 patent. The jury also found that St.
Jude did infringe the '472 patent, which expired on March 4, 2001, but that the
infringement was not willful. The jury awarded damages of $140,000 to Guidant.
On February 13, 2002, the judge overseeing the jury trial issued his
rulings on the various post-trial motions. In particular, the judge ruled that
the '472 patent was invalid on two grounds: lack of proper written description
and double patenting. The judge also ruled that claim 18 was not infringed and
that claim 1 was infringed in only a limited manner.
The judge further ruled that the '288 patent was invalid for both
obviousness and failure to disclose the best mode.
The judge also found that St. Jude Medical was entitled to a new trial
on the issue of damages in the event the court's rulings on the other matters
were reversed on appeal. Finally, the judge held that in the event his other
rulings were reversed, St. Jude Medical would be entitled to a new trial because
of misconduct by Guidant and its attorneys during the first trial and that, in
such an event, Guidant would have to pay certain attorney's fees of St. Jude
Medical. The court ruled on several other motions, not summarized here.
The effect of the court's post-trial rulings was to eliminate the
$140,000 verdict against St. Jude Medical. The Company expects that Guidant will
appeal the judge's decision. While it is not possible to predict the outcome of
an appeal process, the Company believes that it has meritorious defenses against
the claims asserted by Guidant.
OTHER LITIGATION MATTERS: The Company is involved in various other
product liability lawsuits, claims and proceedings that arise in the ordinary
course of business. Subject to self-insured retentions, the Company believes it
has product liability insurance sufficient to cover such claims and suits.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
A Form 8-K was filed on February 14, 2002, announcing a ruling on
post-trial motions filed by the parties in a patent lawsuit between
Guidant Corporation and St. Jude Medical, Inc.
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SIGNATURE
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.
ST. JUDE MEDICAL, INC.
May 6, 2002 /s/ JOHN C. HEINMILLER
----------- ----------------------
DATE JOHN C. HEINMILLER
Vice President - Finance
and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
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