UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
_X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO
________.
Commission File Number 0-8672
ST. JUDE MEDICAL, INC.
----------------------
(Exact name of Registrant as specified in its charter)
MINNESOTA 41-1276891
--------- ----------
(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
--------------
(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
November 1, 2002 was 177,559,849.
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
====================================================================================================
Net sales $ 404,857 $ 337,029 $1,180,398 $ 999,156
Cost of sales:
Cost of sales before special charges 128,381 108,322 376,131 325,622
Special charges -- 21,667 -- 21,667
----------------------------------------------------------------------------------------------------
Total cost of sales 128,381 129,989 376,131 347,289
----------------------------------------------------------------------------------------------------
Gross profit 276,476 207,040 804,267 651,867
Selling, general and administrative expense 129,162 116,684 383,059 347,385
Research and development expense 51,838 41,141 147,594 121,772
Purchased in-process research and
development charge -- -- -- 5,000
Special charges -- 11,167 -- 11,167
----------------------------------------------------------------------------------------------------
Operating profit 95,476 38,048 273,614 166,543
Other income (expense) 1,388 (1,614) 1,130 (7,251)
----------------------------------------------------------------------------------------------------
Earnings before income taxes 96,864 36,434 274,744 159,292
Income tax expense 25,184 5,000 71,433 36,965
----------------------------------------------------------------------------------------------------
Net earnings $ 71,680 $ 31,434 $ 203,311 $ 122,327
====================================================================================================
====================================================================================================
Net earnings per share:
Basic $ 0.40 $ 0.18 $ 1.15 $ 0.71
Diluted $ 0.39 $ 0.18 $ 1.11 $ 0.69
Weighted average shares outstanding:
Basic 177,064 173,020 176,228 171,890
Diluted 182,983 179,664 182,947 178,025
====================================================================================================
See notes to condensed consolidated financial statements.
1
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, 2002 DECEMBER 31,
(UNAUDITED) 2001 (SEE NOTE)
============================================================================================
ASSETS
Current assets
Cash and equivalents $ 276,121 $ 148,335
Accounts receivable, less allowances of $22,915 in 2002
and $17,210 in 2001 379,356 320,683
Inventories 231,263 240,390
Deferred income taxes 39,791 36,563
Other 59,721 51,575
-------------------------------------------------------------------------------------------
Total current assets 986,252 797,546
Property, plant and equipment - at cost 684,477 631,134
Less accumulated depreciation (381,191) (335,491)
-------------------------------------------------------------------------------------------
Net property, plant and equipment 303,286 295,643
Other assets
Goodwill, net 323,381 321,562
Other intangible assets, net 85,666 68,367
Deferred income taxes 67,238 67,238
Other 102,613 78,371
-------------------------------------------------------------------------------------------
Total other assets 578,898 535,538
-------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,868,436 $ 1,628,727
===========================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 99,666 $ 88,925
Income taxes payable 93,026 63,475
Accrued expenses
Employee compensation and related benefits 113,686 102,191
Other 84,748 67,263
-------------------------------------------------------------------------------------------
Total current liabilities 391,126 321,854
Long-term debt -- 123,128
Commitments and contingencies -- --
Shareholders' equity
Preferred stock -- --
Common stock 17,730 17,442
Additional paid-in capital 200,533 126,005
Retained earnings 1,338,220 1,134,909
Accumulated other comprehensive income
Cumulative translation adjustment (83,058) (103,781)
Unrealized gain on available-for-sale securities 3,885 9,170
-------------------------------------------------------------------------------------------
Total shareholders' equity 1,477,310 1,183,745
-------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,868,436 $ 1,628,727
===========================================================================================
NOTE: The balance sheet at December 31, 2001 has been derived from the Company's
audited financial statements. See notes to condensed consolidated financial
statements.
2
ST. JUDE MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2002 2001
=============================================================================================================
Operating Activities
Net earnings $ 203,311 $ 122,327
Depreciation 46,395 42,680
Amortization 4,419 23,716
Purchased in-process research and development charge -- 5,000
Special charges -- 32,834
Deferred income taxes 11 13
Changes in operating assets and liabilities, net of business acquisitions:
Accounts receivable (48,388) (31,441)
Inventories 13,208 (29,783)
Other current assets (14,684) 4,118
Accounts payable and accrued expenses 32,861 14,691
Income taxes 49,781 18,619
-------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 286,914 202,774
Investing Activities
Purchase of property, plant and equipment (48,105) (51,682)
Business acquisition payments (21,834) (10,919)
Other (24,545) (19,705)
-------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (94,484) (82,306)
Financing Activities
Proceeds from exercise of stock options and stock issued 53,812 44,377
Borrowings under debt facilities 352,000 1,691,700
Payments under debt facilities (475,128) (1,823,800)
-------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (69,316) (87,723)
Effect of currency exchange rate changes on cash 4,672 (994)
-------------------------------------------------------------------------------------------------------------
Net increase in cash and equivalents 127,786 31,751
Cash and equivalents at beginning of period 148,335 50,439
-------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 276,121 $ 82,190
=============================================================================================================
See notes to condensed consolidated financial statements.
3
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 - NEW ACCOUNTING PRONOUNCEMENT
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" (Statement 146). Statement 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred. Prior
to the adoption of this Standard, a liability for an exit cost, as defined by
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)," was recognized at the date of an
entity's commitment to an exit plan. Statement 146 is effective for exit plans
or disposal activities initiated after December 31, 2002. The adoption of
Statement 146 is not expected to have a material impact on the Company's
consolidated net earnings or financial position.
NOTE 3 - ACQUISITIONS
During 2002 and 2001, the Company acquired various businesses involved in the
distribution of the Company's products. Aggregate consideration paid in cash
during the nine months ended September 30, 2002 and 2001 was $21,834 and $5,919.
4
On September 17, 2002, the Company signed a Stock Purchase Agreement to acquire
Getz Bros. Co., Ltd., a Japanese distributor of medical technology products and
the largest Japanese distributor of the Company's products. The Company has
agreed to pay 26.9 billion Japanese yen in cash, or approximately $220,000 U.S.
dollars, to acquire 100% of the outstanding common stock of Getz Bros. Co., Ltd.
This transaction is expected to close during the second quarter of 2003.
NOTE 4 - INVENTORIES
Inventories consist of the following:
SEPTEMBER 30, DECEMBER 31,
2002 2001
================================================================================
Finished goods $ 138,867 $ 135,543
Work in process 30,384 35,984
Raw materials 62,012 68,863
-------------------------------------------------------------------------------
$ 231,263 $ 240,390
===============================================================================
NOTE 5 - 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:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
================================================================================
NET EARNINGS:
As reported $ 31,434 $ 122,327
Goodwill amortization, net of taxes 5,353 15,858
--------------------------------------------------------------------------------
Adjusted net earnings $ 36,787 $ 138,185
================================================================================
BASIC NET EARNINGS PER SHARE:
As reported $ 0.18 $ 0.71
Goodwill amortization, net of taxes 0.03 0.09
--------------------------------------------------------------------------------
Adjusted basic net earnings per share $ 0.21 $ 0.80
================================================================================
DILUTED NET EARNINGS PER SHARE:
As reported $ 0.18 $ 0.69
Goodwill amortization, net of taxes 0.03 0.09
--------------------------------------------------------------------------------
Adjusted diluted net earnings per share $ 0.21 $ 0.78
================================================================================
The net carrying amount of goodwill for the nine months ended September 30, 2002
increased $1,819 to $323,381 due to translation fluctuations of non-U.S.
goodwill balances.
5
The Company completed its initial required goodwill impairment test under
Statement 142 in the second quarter of 2002, which indicated that goodwill was
not impaired.
Other intangible assets consist of the following:
SEPTEMBER 30, DECEMBER 31,
2002 2001
===========================================================================================
Original Accumulated Original Accumulated
AMORTIZED INTANGIBLE ASSETS: Cost Amortization Cost Amortization
-------------------------------------------------------------------------------------------
Purchased technology & patents $ 71,278 $ (15,048) $ 72,050 $ (12,440)
Other 31,483 (2,047) 9,046 (289)
-------------------------------------------------------------------------------------------
$ 102,761 $ (17,095) $ 81,096 $ (12,729)
===========================================================================================
Total other intangible assets, net $ 85,666 $ 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.
NOTE 6 - LONG-TERM DEBT
The Company issues, from time to time, 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 no outstanding commercial paper borrowings at September
30, 2002 and $123,128 of commercial paper borrowings at 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. During 2002, the Company repaid all of its
commercial paper borrowings.
The Company's committed 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 September 30, 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
ratings.
6
NOTE 7 - 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 9
regarding the special charges associated with this matter.
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 in federal court involving products with Silzone(R) coating have been
and will likely continue to be transferred to Judge Tunheim for coordinated or
consolidated pretrial proceedings. The hearing concerning requests by certain
plaintiffs to have matters proceed as class actions occurred on October 2, 2002.
Judge Tunheim is presently considering plaintiffs' motion for class
certification, and a decision by Judge Tunheim in this regard is expected by
early 2003.
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 the various cases involving
Silzone(R) products, 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 a 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 appealed the ruling of invalidity
concerning the '191 patent, but in a ruling issued July 11, 2002, the U.S. Court
of Appeals for the Federal Circuit ultimately rejected Guidant's appeal and
affirmed the District Court's ruling of invalidity.
7
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 '288 and '472 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.
In rulings dated February 13, 2002 and July 5, 2002, the judge overseeing the
jury trial in the United States District Court for the Southern District of
Indiana issued his decisions 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 claims 1 and
18 were not infringed as a matter of law.
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 primary effect of the court's post-trial rulings was to eliminate the
$140,000 verdict against St. Jude Medical. On August 13, 2002, Guidant commenced
an appeal of the trial judge's decision. While it is not possible to predict the
outcome of the appeal process, the Company believes that it has meritorious
defenses against the claims asserted by Guidant and Guidant's continued pursuit
of this case.
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.
NOTE 8 - SHAREHOLDERS' EQUITY
CAPITAL STOCK: On May 16, 2002, the Company's Board of Directors declared a
two-for-one stock split in the form of a 100% stock dividend to shareholders of
record on June 10, 2002. Net earnings per share, shares outstanding and weighted
average shares outstanding have been restated to reflect the stock dividend. 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 2002. There were 177,298 and 174,419 shares of common stock outstanding at
September 30, 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. Since the inception of this authorization, the
Company has repurchased 1,955 shares of
8
its common stock for $29,826, all of which occurred during 1999. This
authorization expired in September 2002.
NOTE 9 - 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 $16,337of these special charge accruals
through September 30, 2002, consisting of $3,709 of employee severance costs,
$7,540 of inventory write-offs and scrap, $3,379 of capital equipment
write-offs, and $1,709 of other costs. The Company estimates that the remaining
accruals will be utilized primarily during the remainder of 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.
The charges relating to employee severance costs, capital equipment write-offs
and other costs were recorded in operating expenses as special charges. The
inventory and diagnostic equipment write-offs were included in cost of sales as
special charges.
SILZONE(R) SPECIAL CHARGES: 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 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 has approximately $200 million remaining in product liability insurance
currently available for the Silzone(R)-related matters. In the second quarter of
2002, the Company determined that the Silzone(R) reserves for other costs should
be increased by $11,000 due primarily to difficulties in getting the Company's
insurance carriers to pay various costs as required by the product liability
insurance policies. This additional accrual was included in selling, general and
administrative expenses for the second quarter ended June 30, 2002. The Company
has utilized $22,867 of these special charge accruals through September 30,
2002, consisting of $9,465 for asset write-downs and $13,402 for other costs.
The Company estimates that the remaining accruals will be utilized during the
remainder of 2002 through 2004. 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 10 - NET EARNINGS PER SHARE
The table below sets forth the computation of basic and diluted net earnings per
share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
================================================================================================================
Numerator:
Net earnings $ 71,680 $ 31,434 $ 203,311 $ 122,327
Denominator:
Basic-weighted average shares outstanding 177,064 173,020 176,228 171,890
Effect of dilutive securities:
Employee stock options 5,896 6,559 6,696 6,054
Restricted shares 23 85 23 81
----------------------------------------------------------------------------------------------------------------
Diluted-weighted average shares outstanding 182,983 179,664 182,947 178,025
================================================================================================================
Basic net earnings per share $ 0.40 $ 0.18 $ 1.15 $ 0.71
================================================================================================================
Diluted net earnings per share $ 0.39 $ 0.18 $ 1.11 $ 0.69
================================================================================================================
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 11 - 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 income (loss) was $(3,723) and
$7,077 for the three months ended September 30, 2002 and 2001, and $15,438 and
$(22,527) for the nine months ended September 30, 2002 and 2001. Total
comprehensive income (loss) combines reported net earnings and other
comprehensive income (loss). Total comprehensive income was $67,957 and $38,511
for the three months ended September 30, 2002 and 2001, and $218,749 and $99,800
for the nine months ended September 30, 2002 and 2001.
NOTE 12 - OTHER INCOME (EXPENSE)
Other income (expense) consists primarily of interest income and interest
expense, net.
NOTE 13 - 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
10
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.
Net sales by class of similar products were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
NET SALES 2002 2001 2002 2001
===========================================================================================
Cardiac rhythm management $ 294,562 $ 246,287 $ 853,040 $ 713,604
Cardiac surgery 60,343 57,955 189,512 187,449
Cardiology and vascular access 49,952 32,787 137,846 98,103
-------------------------------------------------------------------------------------------
$ 404,857 $ 337,029 $ 1,180,398 $ 999,156
============================================================================================
GEOGRAPHICAL INFORMATION: The following tables present certain geographical
financial information:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
NET SALES 2002 2001 2002 2001
===========================================================================================
United States $ 267,859 $ 226,938 $ 781,414 $ 654,546
International 136,998 110,091 398,984 344,610
-------------------------------------------------------------------------------------------
$ 404,857 $ 337,029 $ 1,180,398 $ 999,156
===========================================================================================
SEPTEMBER 30, DECEMBER 31,
LONG-LIVED ASSETS* 2002 2001
=============================================================
United States $ 663,884 $ 626,140
International 151,062 137,803
-------------------------------------------------------------
$ 814,946 $ 763,943
=============================================================
* LONG-LIVED ASSETS EXCLUDE DEFERRED INCOME TAXES.
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 third quarter of 2002 totaled $404,857, a 20.1%
increase over the $337,029 reported in the third quarter of 2001. For the first
nine months of 2002, net sales totaled $1,180,398, an 18.1% increase over the
$999,156 reported in 2001. Foreign exchange translation had a favorable impact
on 2002 net sales as compared with 2001 of approximately $7,000 for the third
quarter and $3,000 for the first nine months due primarily to the strengthening
of the Euro against the U.S. dollar.
Cardiac rhythm management (CRM) net sales for the third quarter of 2002 were
$294,562, a 19.6% increase over the $246,287 reported in the third quarter of
2001. CRM net sales for the first nine months of 2002 were $853,040, a 19.5%
increase over the $713,604 reported in 2001. The increase in CRM net sales for
the third quarter and first nine months of 2002 was primarily due to increased
bradycardia, implantable cardioverter defibrillator (ICD) and electrophysiology
catheter unit sales. The increase in bradycardia net sales was attributable to
the on-going success of the Company's Integrity(TM) AF, Integrity(TM) Micro and
Identity(TM) family of pacemakers, all with atrial fibrillation suppression
technology. The Company's ICD net sales benefited from the on-going success of
the Company's Atlas(TM) family of ICDs and the new Riata(TM) defibrillation
leads that were introduced to the U.S. market during the second quarter of 2002.
Cardiac surgery (CS) net sales for the third quarter of 2002 were $60,343, a
4.1% increase from the $57,955 reported in the third quarter of 2001. CS net
sales for the first nine months of 2002 were $189,512, a 1.1% increase from the
$187,449 reported in 2001. The increase in CS net sales for the third quarter
and first nine months of 2002 was due to an increase in aortic connector sales
as a result of the on-going rollout of this product in the U.S. market. Heart
valve net sales for the third quarter of 2002 were constant with 2001, and down
slightly for the first nine months of 2002 due to 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.
Cardiology and vascular access (C/VA) net sales for the third quarter of 2002
were $49,952, a 52.4% increase over the $32,787 reported in the third quarter of
2001. C/VA net sales for the first nine months of 2002 were $137,846, a 40.5%
increase over the $98,103 reported in 2001. The increase in C/VA net sales is
primarily due to increased Angio-Seal(TM) vascular closure unit sales,
benefiting from the on-going success of the Company's Angio-Seal(TM) STS
Platform that was launched in the first quarter of 2002.
GROSS PROFIT: Gross profit for the third quarter of 2002 totaled $276,476, or
68.3% of net sales, as compared with $207,040, or 61.4% of net sales, during the
third quarter of 2001. For the first nine months of 2002 and 2001, gross profit
was $804,267, or 68.1% of net sales, and $651,867, or 65.2% of net sales. In the
third quarter of 2001, the Company recorded $21,667 of special charges relating
to inventory and diagnostic equipment write-offs (see further details under the
discussion of Special charges). Excluding these special charges, the gross
profit percentage
12
was 67.9% for the third quarter of 2001 and 67.4% for the first nine months of
2001. The improvement in the gross profit percentage in 2002, excluding special
charges, 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 third
quarter of 2002 totaled $129,162, or 31.9% of net sales, compared with $116,684,
or 34.6% of net sales, for the third quarter of 2001. For the first nine months
of 2002, SG&A expense totaled $383,059, or 32.5% of net sales, compared with
$347,385, or 34.8% of net sales. The decrease in SG&A expense as a percentage of
net sales was primarily attributable to the elimination of goodwill amortization
expense in 2002 due to the Company's adoption of Financial Accounting Standards
Statement No. 142, "Goodwill and Other Intangible Assets," effective January 1,
2002. Goodwill amortization expense, on a pre-tax basis, was $7,137 in the third
quarter of 2001 and $21,144 in the first nine months of 2001. Higher sales
volume and increased productivity of the Company's sales organizations also
improved SG&A expense as a percentage of net sales during the third quarter and
first nine months of 2002.
During the second quarter of 2002, the Company received a cash payment of
$18,500 relating to the settlement of certain patent litigation, which was
recorded in the SG&A expense line item. Also during the second quarter of 2002,
the Company recorded an $11,000 SG&A charge to increase the reserve for expenses
related to the Silzone(R) recall (see Special charges) and a $7,500
discretionary contribution to its charitable foundation.
RESEARCH AND DEVELOPMENT (R&D) EXPENSE: R&D expenses in the third quarter of
2002 totaled $51,838, or 12.8% of net sales, compared with $41,141, or 12.2% of
net sales, for the third quarter of 2001. For the first nine months of 2002, R&D
expense totaled $147,594, or 12.5% of net sales, compared with $121,772, or
12.2% of net sales, for the same period in 2001. The increase in R&D expenses is
primarily attributable to increased CRM activities relating primarily to ICDs
and products treating emerging indications in atrial fibrillation and congestive
heart failure.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE: The Company recorded a
purchased in-process research and development charge of $5,000 during the second
quarter of 2001 relating to a performance-based milestone payment associated
with the 1999 acquisition of Vascular Science, Inc. (VSI). The Company
anticipates additional in-process research and development charges related to
the VSI acquisition as additional milestones are achieved. See "Purchased
in-process research and development charges" in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001 for additional discussion
on the VSI acquisition and related accounting.
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 $16,337 of these special charge accruals through September 30, 2002,
consisting of $3,709 of employee severance costs, $7,540 of inventory write-offs
and scrap, $3,379 of capital equipment write-offs, and $1,709 of other costs.
The Company estimates that the remaining accruals will be utilized primarily
during the remainder of 2002.
13
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.
The charges relating to employee severance costs, capital equipment write-offs
and other costs were recorded in operating expenses as special charges. The
inventory and diagnostic equipment write-offs were included in cost of sales as
special charges.
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 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 has
approximately $200 million remaining in product liability insurance currently
available for the Silzone(R)-related matters. In the second quarter of 2002, the
Company determined that the Silzone(R) reserves for other costs should be
increased by $11,000 due primarily to difficulties in getting the Company's
insurance carriers to pay various costs as required by the product liability
insurance policies. This additional accrual was included in selling, general and
administrative expenses for the second quarter ended June 30, 2002. The Company
has utilized $22,867 of these special charge accruals through September 30,
2002, consisting of $9,465 for asset write-downs and $13,402 for other costs.
The Company estimates that the remaining accruals will be utilized during the
remainder of 2002 through 2004. 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): Other income (expense) consists primarily of interest
income and interest expense, net. The change in other income (expense) during
2002 as compared with 2001 is due primarily to reduced interest expense as a
result of lower debt levels, lower interest rates on Company borrowings in 2002,
and higher levels of interest income as a result of the increase in cash and
equivalents in 2002.
INCOME TAXES: The Company's reported effective income tax rates were 26.0% and
13.7% for the third quarters of 2002 and 2001, and 26.0% and 23.2% for the first
nine months of 2002 and 2001. Excluding the purchased in-process research and
development and special charges in 2001, the Company's effective income tax rate
was 25% for each of these periods in 2001. The increase in the Company's
effective income tax rate in 2002 is due to a larger percentage of the Company's
taxable income being generated in higher taxing jurisdictions. The Company
anticipates that its effective income tax rate before purchased in-process
research and development and special charges will continue to increase 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 in the future and decide to
repatriate a portion of these earnings to one of the Company's U.S.
subsidiaries, additional U.S. tax liabilities would be incurred.
14
At September 30, 2002, the Company has approximately $52,000 of deferred tax
assets related 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. However, 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 in each of those
years, 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.
STOCK SPLIT: On May 16, 2002, the Company's Board of Directors declared a
two-for-one stock split in the form of a 100% stock dividend to shareholders of
record on June 10, 2002. Net earnings per share, shares outstanding and weighted
average shares outstanding have been restated to reflect the stock dividend.
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 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.
15
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 policies upon which the
Company's financial status depends. Management determined the critical
accounting policies 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.
FINANCIAL CONDITION
The Company's liquidity and cash flows remained strong during the first nine
months of 2002. Cash provided by operating activities was $286,914 for the nine
months ended September 30, 2002, an $84,140 increase over the same period one
year ago reflecting increased earnings and improved working capital management.
The Company's current assets to current liabilities ratio was 2.5 to 1 at
September 30, 2002 and December 31, 2001. At September 30, 2002 and December 31,
2002, a substantial portion of the Company's cash and equivalents were held by
the Company's non-U.S. subsidiaries. These funds are available for
16
use in the Company's U.S. operations; however, they would be subject to
additional U.S. tax upon repatriation (see Income taxes).
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. Management
believes that the Company can obtain a new credit facility or renegotiate and
extend its current credit facility prior to March 2003.
The Company's committed 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 September 30, 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
ratings.
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. During 2002, the Company repaid all of its
interest-bearing debt utilizing cash generated from operations and the proceeds
from employee stock option exercises.
On September 17, 2002, the Company signed a Stock Purchase Agreement to acquire
Getz Bros. Co., Ltd., a Japanese distributor of medical technology products and
the largest Japanese distributor of the Company's products. The Company has
agreed to pay 26.9 billion Japanese yen in cash, or approximately $220,000 U.S.
dollars, to acquire 100% of the outstanding common stock of Getz Bros. Co., Ltd.
This transaction is expected to close during the second quarter of 2003. The
Company anticipates utilizing cash on hand at its non-U.S. subsidiaries and
yen-denominated bank debt, which will be secured prior to the closing of the
transaction, to fund the purchase price.
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. Since the inception of this authorization, the Company has repurchased
1,955 shares of its common stock for $29,826, all of which occurred during 1999.
This authorization expired in September 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.
17
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 beliefs 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 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 international 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.
18
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.
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, except for the Stock Purchase Agreement that the Company
signed on September 17, 2002, to acquire Getz Bros. Co., Ltd. The Company has
agreed to pay 26.9 billion Japanese yen, or approximately $220,000 U.S. dollars,
to acquire 100% of the outstanding common stock of Getz Bros. Co., Ltd. The
Company is exposed to foreign currency exchange risk on this agreement until the
closing of the transaction, which is expected to be during the second quarter of
2003.
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.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
------------------------------------------------
Disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) of the Securities Exchange Act of
1934) refer to the controls and other procedures of a company
that are designed to ensure that information required to be
disclosed by a company in the reports that it files under the
Exchange Act is recorded, processed, summarized and reported
within required time periods. The Company's Chief Executive
Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and
procedures within 90 days prior to the filing of this
quarterly report, and they have concluded that such controls
and procedures are effective at ensuring that required
information will be disclosed on a timely basis in the
Company's reports filed under the Exchange Act.
(b) Changes in Internal Controls
----------------------------
There have been no significant changes to the Company's
internal controls or other factors that could significantly
affect these controls subsequent to the date of their most
recent evaluation.
19
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 9 regarding the special charges associated with this
matter.
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 in federal court involving products with Silzone(R) coating
have been and will likely continue to be transferred to Judge Tunheim for
coordinated or consolidated pretrial proceedings. The hearing concerning
requests by certain plaintiffs to have matters proceed as class actions occurred
on October 2, 2002. Judge Tunheim is presently considering plaintiffs' motion
for class certification, and a decision by Judge Tunheim in this regard is
expected by early 2003.
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 the various cases
involving Silzone(R) products, 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 a 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 appealed the ruling of
invalidity concerning the '191 patent, but in a ruling issued July 11, 2002, the
U.S. Court of Appeals for the Federal Circuit ultimately rejected Guidant's
appeal and affirmed the District Court's ruling of invalidity.
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
20
both the '288 and '472 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.
In rulings dated February 13, 2002 and July 5, 2002, the judge
overseeing the jury trial in the United States District Court for the Southern
District of Indiana issued his decisions 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 claims 1 and 18 were not infringed as a matter of law.
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 primary effect of the court's post-trial rulings was to eliminate
the $140,000 verdict against St. Jude Medical. On August 13, 2002, Guidant
commenced an appeal of the trial judge's decision. While it is not possible to
predict the outcome of the appeal process, the Company believes that it has
meritorious defenses against the claims asserted by Guidant and Guidant's
continued pursuit of this case.
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
Exhibit 99.1 Certification by Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
Exhibit 99.2 Certification by Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
A Form 8-K was filed on August 14, 2002, to report under Item 9 that
the Company's Chief Executive Officer and Chief Financial Officer
signed and submitted the sworn statements required by the SEC's Order
of June 27, 2002.
21
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.
November 8, 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)
22
CERTIFICATION
I, Terry L. Shepherd, certify that:
1. I have reviewed this quarterly report on Form 10-Q of St. Jude Medical,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 8, 2002
----------------
/s/ TERRY L. SHEPHERD
---------------------
Terry L. Shepherd
Chief Executive Officer
23
CERTIFICATION
I, John C. Heinmiller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of St. Jude Medical,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 8, 2002
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/s/ JOHN C. HEINMILLER
----------------------
John C. Heinmiller
Chief Financial Officer
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