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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2002
Commission File Number 1-13388
GUIDANT CORPORATION
(Exact name of Registrant as specified in its charter)
INDIANA 35-1931722
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
111 MONUMENT CIRCLE, 29TH FLOOR
INDIANAPOLIS, INDIANA 46204-5129
(Address of principal executive offices)
Registrant's telephone number, including area code: (317) 971-2000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The number of shares of common stock outstanding as of August 9, 2002:
Class Number of Shares Outstanding
----- ----------------------------
Common 305,716,000
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GUIDANT CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
(unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Net sales..................................................... $807.0 $656.3 $1,516.7 $1,327.3
Cost of products sold.......................................... 208.0 155.6 380.1 325.1
------ ------ ------ ------
Gross profit............................................ 599.0 500.7 1,136.6 1,002.2
Research and development....................................... 106.0 92.7 206.7 183.4
Purchased in-process research and
development................................................... -- -- 6.8 --
Sales, marketing, and administrative........................... 248.7 212.9 470.4 416.0
Interest, net.................................................. 1.7 9.0 5.8 18.4
Royalties, net................................................. 13.8 10.6 25.1 20.4
Amortization................................................... 3.2 11.0 6.4 21.8
Other, net..................................................... 5.1 4.4 7.4 5.8
Foundation contribution........................................ 40.0 -- 40.0 --
Litigation, net................................................ (137.1) -- (137.1) --
Restructuring charge........................................... 31.0 -- 31.0 --
Special charges.............................................. -- -- -- 25.0
------ ------ ------ ------
Income before income taxes..................................... 286.6 160.1 474.1 311.4
Income taxes................................................... 81.8 44.8 129.8 84.9
------ ------ ------ ------
Net income.............................................. $204.8 $115.3 $344.3 $226.5
====== ====== ====== ======
Earnings per share-basic....................................... $0.68 $0.38 $1.14 $0.75
====== ====== ====== ======
Earnings per share-diluted..................................... $0.67 $0.38 $1.12 $0.74
====== ====== ====== ======
See notes to consolidated financial statements
2
GUIDANT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
JUNE 30, DECEMBER 31,
2002 2001
------------------- ------------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents.............................................. $688.1 $437.8
Short-term investments................................................. 8.9 8.9
Accounts receivable, net of allowances
of $28.0(2002) and $26.6(2001).................................. 692.2 631.9
Inventories............................................................ 277.8 267.6
Deferred income taxes.................................................. 178.8 153.6
Prepaid expenses and other current assets.............................. 56.4 48.5
---- ----
Total Current Assets............................................ 1,902.2 1,548.3
OTHER ASSETS
Goodwill, net of allowances
of $159.4(2002) and $143.3(2001)................................ 516.5 426.6
Other intangible assets, net of allowances
of $55.1(2002) and $64.4(2001).................................. 98.8 189.8
Deferred income taxes ................................................. 53.1 43.8
Investments............................................................ 50.6 38.6
Sundry ................................................................ 52.9 49.1
Property and equipment, net of accumulated
depreciation of $514.0 (2002) and
$464.7 (2001)................................................... 639.6 620.6
----- -----
$3,313.7 $2,916.8
======== ========
See notes to consolidated financial statements
3
GUIDANT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
JUNE 30, DECEMBER 31,
2002 2001
------------------- ------------------
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable....................................................... $85.2 $60.1
Employee compensation.................................................. 119.2 116.9
Other liabilities...................................................... 246.6 164.6
Income taxes payable................................................... 238.5 147.5
Short-term debt........................................................ 126.2 300.0
----- -----
Total Current Liabilities....................................... 815.7 789.1
NONCURRENT LIABILITIES
Long-term debt......................................................... 347.8 460.0
Other ................................................................ 151.9 121.9
----- -----
499.7 581.9
Commitments and contingencies.......................................... -- --
SHAREHOLDERS' EQUITY
Common stock, no par value:
Authorized shares: 1,000,000,000
Issued shares: 309,019,000............................... 226.1 226.1
Additional paid-in capital............................................. 190.9 182.5
Retained earnings...................................................... 1,734.9 1,390.5
Deferred cost, ESOP.................................................... (27.7) (30.5)
Treasury stock, at cost:
Shares: 2,871,000 (2002)
3,866,000 (2001)....................................... (110.7) (149.0)
Accumulated other comprehensive income ................................ (15.2) (73.8)
------ ------
1,998.3 1,545.8
------- -------
$3,313.7 $2,916.8
======== ========
See notes to consolidated financial statements
4
GUIDANT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
(In millions)
(unaudited)
SIX MONTHS ENDED
JUNE 30,
--------
2002 2001
---- ----
CASH PROVIDED BY OPERATING ACTIVITIES
Net income........................................................ $344.3 $226.5
ADJUSTMENTS TO RECONCILE NET INCOME TO CASH
PROVIDED BY OPERATING ACTIVITIES
Depreciation...................................................... 55.1 46.3
Amortization of goodwill and other
intangible assets............................................. 6.4 21.8
Provision for inventory and other losses.......................... 42.8 44.8
Purchased in-process research and development..................... 6.8 --
Other noncash expenses, net....................................... (28.4) 34.2
------ ------
427.0 373.6
CHANGES IN OPERATING ASSETS AND LIABILITIES
Receivables, increase............................................. (54.8) (41.2)
Inventories, increase ............................................ (31.5) (36.2)
Prepaid expenses and other current assets,
increase....................................................... -- (19.0)
Accounts payable and accrued liabilities,
increase (decrease)............................................ 43.3 (34.6)
Income taxes payable, increase ................................... 91.8 3.4
Other liabilities, increase....................................... 69.1 30.4
------ ------
NET CASH PROVIDED BY OPERATING ACTIVITIES.............................. 544.9 276.4
INVESTING ACTIVITIES
Additions of property and equipment, net.......................... (68.3) (70.2)
Purchases of available-for-sale investments....................... (12.1) (2.9)
Sale/maturity of investments...................................... 0.1 1.2
Additions of other assets, net.................................... (6.4) --
Purchase of in-process research and
development.................................................... (6.8) --
------ ------
NET CASH USED FOR INVESTING ACTIVITIES................................. (93.5) (71.9)
FINANCING ACTIVITIES
(Decrease) increase in borrowings, net............................ (287.3) 91.2
Issuance of common stock under stock plans
and other capital transactions................................. 26.6 15.4
Repurchase of common stock........................................ -- (200.0)
------ ------
NET CASH USED FOR FINANCING ACTIVITIES................................. (260.7) (93.4)
Effect of Exchange Rate Changes on Cash................................ 59.6 (17.9)
------ ------
NET INCREASE IN CASH AND CASH EQUIVALENTS.............................. 250.3 93.2
Cash and Cash Equivalents at Beginning of Period....................... 437.8 163.0
------ ------
CASH AND CASH EQUIVALENTS AT END OF PERIOD............................. $688.1 $256.2
====== ======
See notes to consolidated financial statements
5
GUIDANT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions, except per share data)
(unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information
necessary for a fair presentation of results of operations, financial position,
and cash flows in conformity with generally accepted accounting principles.
Operating results from interim periods are not necessarily indicative of results
that may be expected for the fiscal year as a whole. In the opinion of
management, the consolidated financial statements reflect all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation of the Company's results for the periods presented. The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues, expenses, and related
disclosures at the date of the financial statements and during the reporting
period. Actual results could differ from these estimates. A discussion of the
Company's significant accounting policies is described in the "Significant
Accounting Policies" section of "Management's Discussion and Analysis of Results
of Operations and Financial Condition".
For further information, refer to the consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001.
NOTE 2 - INVENTORIES
Inventories consisted of the following:
JUNE 30, DECEMBER 31,
2002 2001
------------------ -------------------
Finished products................................ $142.0 $138.5
Work in process.................................. 54.0 66.5
Raw materials and supplies....................... 81.8 62.6
---- ----
$277.8 $267.6
====== ======
6
GUIDANT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets.
Under SFAS 142, goodwill is no longer amortized, but is subject to annual
impairment tests, or more frequently if impairment indicators arise. Guidant
adopted SFAS 142 on January 1, 2002. In accordance with SFAS 142, the Company
reclassified $105.0 million from other intangibles to goodwill on January 1,
2002. The net book value of these assets on January 1, 2002, was $89.1 million.
This reclassification is primarily related to the assembled workforce obtained
in conjunction with the Intermedics acquisition in February 1999. Had SFAS 142
been effective January 1, 2001, net income and earnings per share would have
been reported as:
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2002 JUNE 30, 2001 JUNE 30, 2002 JUNE 30, 2001
------------- ------------- ------------- -------------
Reported net income..................... $ 204.8 $ 115.3 $ 344.3 $ 226.5
Goodwill and workforce
amortization.......................... -- 7.6 -- 15.1
---------- ----------- ---------- ----------
Adjusted net income..................... $ 204.8 $ 122.9 $ 344.3 $ 241.6
========== =========== ========== ==========
Earnings per share-basic:
Reported net income..................... $ 0.68 $ 0.38 $ 1.14 $ 0.75
Goodwill and workforce
amortization.......................... -- 0.03 -- 0.05
---------- ----------- ---------- ----------
Adjusted earnings per
share-basic........................... $ 0.68 $ 0.41 $ 1.14 $ 0.80
========== =========== ========== ==========
Earnings per share-diluted:
Reported net income..................... $ 0.67 $ 0.38 $ 1.12 $ 0.74
Goodwill and workforce
amortization.......................... -- 0.02 -- 0.05
---------- ----------- ---------- ----------
Adjusted earnings
per share-diluted..................... $ 0.67 $ 0.40 $ 1.12 $ 0.79
========== =========== ========== ==========
The Company completed its initial impairment test of goodwill in February 2002,
indicating that goodwill was not impaired. This test involved the use of
estimates related to the fair market value of the Company's reporting units
associated with the goodwill. There were no material changes to goodwill as a
result of acquisitions, dispositions or translation during the first six months
of 2002.
Balances of acquired intangible assets, excluding goodwill, were as follows (in
millions):
ACCUMULATED CARRYING
ORIGINAL COST AMORTIZATION VALUE
------------- ------------ --------
JUNE 30, 2002
Licensed technologies
and distribution agreements.................... $ 124.9 $ 45.1 $ 79.8
Intermedics, Inc................................. 29.0 10.0 19.0
----------- ----------- -----------
$ 153.9 $ 55.1 $ 98.8
=========== =========== ===========
DECEMBER 31, 2001
Licensed technologies
and distribution agreements.................... $ 120.2 $ 39.9 $ 80.3
Intermedics, Inc................................. 134.0 24.5 109.5
----------- ----------- -----------
$ 254.2 $ 64.4 $ 189.8
=========== =========== ===========
7
GUIDANT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
During the first six months of 2002, Guidant purchased intangibles totaling $4.4
million. Excluding goodwill and intangible assets reclassified to goodwill,
amortization expense of intangible assets was $3.2 million and $2.8 million for
the three months ended and $6.4 million and $5.6 million for the six months
ended June 30, 2002 and 2001, respectively. The annual estimated amortization
expense for intangible assets for the five-year period ending December 31, 2006,
ranges from $12.0 million to $13.3 million.
NOTE 4 - EARNINGS PER SHARE
The following table sets forth the computation of earnings per share:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- ----------------
2002 2001 2002 2001
---- ---- ---- ----
Net income..................................................... $204.8 $115.3 $344.3 $226.5
====== ====== ====== ======
Weighted average common shares outstanding..................... 301.48 301.22 301.12 302.16
Effect of employee stock options............................... 4.74 4.34 5.65 5.35
---- ---- ---- ----
Weighted average common shares outstanding
and assumed conversions..................................... 306.22 305.56 306.77 307.51
====== ====== ====== ======
Earnings per share-basic....................................... $0.68 $0.38 1.14 $0.75
===== ===== ==== =====
Earnings per share-diluted..................................... $0.67 $0.38 1.12 $0.74
===== ===== ==== =====
For the quarter ended June 30, 2002, there were approximately 31 million common
shares that were not included in the computation of earnings per share-diluted
since they were anti-dilutive.
NOTE 5 - COMPREHENSIVE INCOME
Comprehensive income comprises net income adjusted for the changes in i) foreign
currency translation adjustments; ii) unrealized gains or losses on foreign
currency derivative contracts designated and qualifying as cash flow hedges; and
iii) available-for-sale securities. For the second quarter of 2002 and 2001,
comprehensive income was $270.1 million and $99.5 million, respectively.
Comprehensive income for the six months ended June 30, 2002 and 2001 was $402.9
million and $208.6 million. The increase in comprehensive income for the three
and six-month periods ended June 30, 2002, compared to the same periods in 2001,
was primarily due to increased net income and the improvement in the value of
the Euro compared to the U.S. dollar.
8
GUIDANT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - SEGMENT INFORMATION
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -----------------
GEOGRAPHIC INFORMATION: 2002 2001 2002 2001
---- ---- ---- ----
NET SALES(1):
United States........................... $571.8 $456.0 $1,077.0 $932.1
International........................... 235.2 200.3 439.7 395.2
----- ----- ----- -----
$807.0 $656.3 $1,516.7 $1,327.3
====== ====== ======== ========
(1) Revenues are attributed to countries based on location of the customer.
JUNE 30, DECEMBER 31,
2002 2001
---- ----
LONG-LIVED ASSETS:
United States........................... $562.6 $559.9
International........................... 77.0 60.7
---- ----
$639.6 $620.6
====== ======
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
NET SALES OF CLASSES
OF SIMILAR PRODUCTS:
Cardiac rhythm management............... $410.8 $334.4 $ 745.9 $ 644.7
Vascular intervention................... 335.5 289.2 657.6 603.5
Endovascular solutions.................. 38.0 14.3 70.2 43.6
Cardiac surgery......................... 22.7 18.4 43.0 35.5
---- ---- ---- ----
$807.0 $656.3 $1,516.7 $1,327.3
====== ====== ======== ========
NOTE 7 - PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
In March 2002, Guidant entered into a worldwide co-exclusive license agreement
with Novartis Pharma AG (Novartis) granting Guidant rights to utilize the drug
everolimus in drug eluting stents for the treatment of coronary and peripheral
vascular diseases. As a result, the Company recorded a pre-tax charge of $6.8
million related to the value of the purchased in-process research and
development. Values for the purchased in-process research and development were
computed based upon guidelines provided by the staff of the Securities and
Exchange Commission. Novartis will provide everolimus to Guidant, supply data to
support Guidant filings with regulatory agencies, and receive milestone payments
and a royalty on sales of Guidant products utilizing the drug. Pending
regulatory approvals, Guidant expects to initiate clinical trials of
everolimus-eluting coronary stents early next year.
NOTE 8 - SPECIAL ITEMS
In addition to the aforementioned purchased in-process research and development
expense, three special items were recorded in the second quarter of 2002: i) a
$137.1 million net legal benefit, primarily due to the $158.2 million judgment
plus interest and costs against Medtronic in April 2002; ii) a $40.0 million
contribution to the Guidant Foundation; and iii) a $31.0 million restructuring
charge for endovascular solutions operations. The total tax impact of all
special items, including the aforementioned purchased in-process research and
development charge was $22.0 million. The restructuring charge relates to
restructuring activities approved by Guidant's Board of Directors in May 2002
aimed at streamlining operations involving its endovascular solutions product
lines. The charge includes the termination of Guidant's involvement in certain
peripheral product clinical trials, workforce reductions, facility reductions,
and certain other related costs. In connection with these activities, the
Company terminated approximately 150 employees, primarily in manufacturing and
research and
9
GUIDANT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - SPECIAL ITEMS (CONTINUED)
development positions. Liabilities and provisions for inventory and other losses
totaling $31.0 million were recorded for this activity, of which $25.2 million
remain at June 30, 2002.
NOTE 9 - NEW ACCOUNTING PRONOUNCEMENT
On July 30, 2002, the Financial Accounting Standards Board issued SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities. This
pronouncement requires companies to recognize costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. It is to be applied prospectively to
exit or disposal activities initiated after December 31, 2002. SFAS 146 will be
adopted by Guidant on January 1, 2003. This pronouncement will not impact the
restructuring plan for the endovascular solutions product lines approved in May
2002, but will have an impact on any future exit or disposal activities approved
on or after January 1, 2003.
NOTE 10 - CONTINGENCIES
A discussion of the Company's policies with respect to legal proceedings and
other loss contingencies is described in the "Significant Accounting Policies"
section of "Management's Discussion and Analysis of Results of Operations and
Financial Condition". The description of legal proceedings in Item 1 ("Legal
Proceedings") included in Part II of this filing is incorporated herein by
reference.
NOTE 11 - SUBSEQUENT EVENT
On July 30, 2002, Guidant entered into an agreement to acquire Cook Group
Incorporated (Cook Group), the corporate parent of Cook Inc., in a
stock-for-stock transaction. Under the agreement, Guidant will acquire all of
Cook Group for up to $3.0 billion in Guidant stock, subject to a maximum
issuance of 65.79 million Guidant shares, priced in two phases. The first phase
will be priced at a minimum of $40 per Guidant share, with a maximum number of
shares issued of 41.25 million. The second phase will be priced at a minimum of
$55 per Guidant share, with a maximum number of shares issued of 24.54 million.
The terms of the transaction include an additional $150.0 million cash payment
which relates to cash expected to remain in Cook Group at closing. Guidant's
obligation to complete the acquisition is subject to certain clinical and legal
conditions relating to the ACHIEVE(TM) Drug Eluting Coronary Stent System. The
conditions include positive clinical results and Guidant's rights to use certain
clinical data and to sell the ACHIEVE product. The transaction is also subject
to shareholder approval, government clearances and other conditions. The parties
anticipate closing in early 2003, subject to the satisfaction or waiver of
conditions. If the transaction is not consummated, Guidant would pay $50.0
million to Cook Group and amend an existing stent delivery system distribution
agreement. Assuming a closing in the first quarter of 2003, the Company expects
to take one-time charges for merger-related costs and in-process research and
development expense in that quarter. Approximately 50 percent of the total
transaction value, as determined on the closing date, is expected to be recorded
as in-process research and development expense in accordance with generally
accepted accounting principles. See the description of litigation included in
Item 1, Part II of this filing.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Guidant Corporation pioneers lifesaving technology, giving an opportunity for
better life today to millions of cardiac and vascular patients worldwide. The
Company, driven by a strong entrepreneurial culture of more than 10,000
employees, develops, manufactures, and markets a broad array of products and
services that enable less-invasive care for some of life's most threatening
medical conditions. Guidant offers: i) coronary, biliary, and peripheral stent
systems, balloon dilatation catheters, and related accessories used to open
blocked arteries; ii) implantable defibrillator systems used to detect and treat
abnormally fast heart rhythms (tachycardia); iii) implantable pacemaker systems
used to manage slow or irregular heart rhythms (bradycardia); iv) implantable
cardiac resynchronization therapy used to treat heart failure; v) products for
use in less-invasive endovascular procedures, including the treatment of
abdominal aortic aneurysms (AAA); vi) products to perform leading edge cardiac
surgery procedures such as Off-Pump Coronary Revascularization with EndoScopic
vessel harvesting (OPCRES); and vii) intravascular radiotherapy systems for
artery disease. Guidant has principal operations in the United States, Western
Europe, and Japan. The Company markets its products in nearly 100 countries
through a direct sales force in the United States and a combination of direct
sales representatives and independent distributors in international markets. As
used herein, the terms "the Company" and "Guidant" mean Guidant Corporation and
its consolidated subsidiaries.
On July 30, 2002, the Company announced that it had agreed to acquire Cook Group
as further described in Note 11. Cook Group owns a number of companies that
produce and market medical devices for interventional cardiology, vascular
medicine, critical care, and other disciplines.
SIGNIFICANT ACCOUNTING POLICIES
It is important to understand Guidant's accounting policies in order to
understand its financial statements. Our most significant policies are described
in Note 2 and elsewhere in the Notes to the Consolidated Financial Statements in
our latest Annual Report on Form 10-K.
In preparing the financial statements in accordance with generally accepted
accounting principles, management must often make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues, expenses, and
related disclosures at the date of the financial statements and during the
reporting period. Some of those judgments can be subjective and complex.
Consequently, actual results
11
could differ from those estimates. The accounting policies that are most subject
to important estimates or assumptions include those described below. The Notes
to the Consolidated Financial Statements in our latest Annual Report on Form
10-K described above and this 10-Q provide additional information about our
evaluation of these items.
Guidant continually evaluates the accounting policies and estimates it uses to
prepare the consolidated financial statements. In cases where management
estimates are used, they are based on historical experience, information from
third-party professionals, and various other assumptions believed to be
reasonable.
Inventory Reserves - The Company values its inventory at the lower of cost,
determined on a first-in, first-out method, or market. Reserves are estimated
for excess, slow-moving, and obsolete inventory as well as inventory with a
carrying value in excess of its net realizable value. The Company reviews
inventory on hand at least quarterly and records provisions for excess and
obsolete inventory based on several factors including current assessment of
future product demand, anticipated release of new products into the market,
historical experience, and product expiration. The Company's industry is
characterized by rapid product development and frequent new product
introductions. Uncertain timing of product approvals, variability in product
launch strategies, and variation in product utilization all impact the estimates
related to excess and obsolete inventory.
Product Warranties - Provisions for estimated expenses related to product
warranties are recorded at the time the products are sold. Estimates for
warranty costs are calculated based primarily upon historical warranty
experience, but may include assumptions related to anticipated changes in
warranty costs, failure rates, etc. Assumptions and historical warranty
experience are evaluated on at least a quarterly basis to determine the
continued appropriateness of such assumptions. Warranty cost accruals are
adjusted from time to time when warranty claim experience differs from
estimates.
Valuation of Purchased In-Process Research and Development, Goodwill, and Other
Intangible Assets - When a business combination occurs, the purchase price is
allocated based upon the fair value of tangible assets, intangible assets,
in-process research and development, and goodwill, as required by SFAS 141,
Business Combinations. The Company recognizes purchased in-process research and
development expense in business combinations for
12
the portion of the purchase price allocated to the appraised value of in-process
technologies, defined as those technologies relating to products that have not
received regulatory approval and have no alternative future use. The portion
assigned to in-process technologies excludes the value of core and developed
technologies, which are recognized as intangible assets when purchased.
Valuations require the use of significant estimates. The amount of the purchase
price allocated to purchased in-process research and development is determined
by estimating the future cash flows of the technology and discounting the net
cash flows back to their present values. Goodwill represents the excess of cost
over the fair value of identifiable net assets of the business acquired and the
amount allocated to purchased in-process research and development expense. The
methodologies used in arriving at these estimates are in accordance with
accepted valuation methods.
Income Taxes - Guidant operates in multiple tax jurisdictions with different tax
rates and must determine the allocation of income to each of these jurisdictions
based on estimates and assumptions. In the normal course of business, the
Company will undergo scheduled reviews by taxing authorities regarding the
amount of taxes due. These reviews include questions regarding the timing and
amount of deductions and the allocation of income among various tax
jurisdictions. Tax reviews oftentimes require an extended period of time to
resolve and may result in income tax adjustments if changes to the allocation
are required between jurisdictions with different tax rates.
Legal Proceedings and Other Loss Contingencies - The Company is subject to
various legal proceedings, many involving routine litigation incidental to the
business. Other matters contain allegations that are not routine and involve
compensatory, punitive, or treble damage claims, or claims for injunctive relief
related to alleged infringement of a third party's patents, or seek declarations
affecting the validity of the Company's patents. Litigation outcomes are not
within the Company's complete control, are often very difficult to predict, and
often are resolved over long periods of time. Estimating probable losses
requires the analysis of multiple possible outcomes that often depend on
judgments about potential actions by third parties. Loss contingencies are
recorded as liabilities in the consolidated financial statements when it is both
i)probable or known that a liability has been incurred, and ii) the amount of
the loss is reasonably estimable, in accordance with SFAS 5, Accounting for
Contingencies. If the reasonable estimate of the loss is a range and no amount
within the range is a better estimate, the minimum amount of the range is
recorded as a liability. If a loss contingency is not probable or not reasonably
estimable, a liability is not recorded in the consolidated financial statements.
13
SUMMARY RESULTS
The following tables are summaries of the Company's net sales and major
expenses. For purposes of analysis and discussion herein, the Company employs
the concepts of operating expenses and operating income. Operating expenses are
defined as research and development and sales, marketing, and administrative
expenses, excluding special items. Operating income is defined as gross profit
less operating expenses.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2002 2001 2002 2001
---- ---- ---- ----
(Dollars in millions)
(unaudited)
Net sales............................................ $807.0 $656.3 $1,516.7 $1,327.3
Cost of products sold................................ 208.0 155.6 380.1 325.1
----- ----- ----- -------
Gross profit ................................... 599.0 500.7 1,136.6 1,002.2
Research and development............................. 106.0 92.7 206.7 183.4
Sales, marketing, and administrative 248.7 212.9 470.4 416.0
----- ----- ----- -----
Operating expense............................... 354.7 305.6 677.1 599.4
Operating income..................................... $244.3 $195.1 $459.5 $402.8
====== ====== ====== ======
AS A PERCENT OF NET SALES
------------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Net sales............................................ 100.0% 100.0% 100.0% 100.0%
Cost of products sold................................ 25.8 23.7 25.1 24.5
---- ---- ---- ----
Gross profit ................................... 74.2 76.3 74.9 75.5
Research and development............................. 13.1 14.1 13.6 13.8
Sales, marketing, and administrative 30.8 32.5 31.0 31.4
---- ---- ---- ----
Operating expense............................... 43.9 46.6 44.6 45.2
Operating income..................................... 30.3% 29.7% 30.3% 30.3%
===== ===== ===== =====
14
OPERATING RESULTS - THREE AND SIX MONTHS ENDED JUNE 30, 2002
SALES
The Company had worldwide net sales of $807.0 million for the quarter ended June
30, 2002, reflecting an increase of $150.7 million or 23% over the same period
in 2001. Growth in unit volume, price increases and fluctuations in foreign
currency exchange rates increased net sales by 20%, 1% and 2%, respectively. All
of Guidant's geographic regions reported growth year over year. U.S. sales of
$571.8 million grew 25% over the prior year, while international sales of $235.2
million increased 17%, 12% in constant currency. Balanced sales growth was
generated by a broad base of products resulting from internal development
efforts, including i) implantable cardioverter defibrillators (ICDs), ii)
coronary stents, iii) pacemakers, and iv) devices addressing emerging therapies
such as heart failure, abdominal aortic aneurysms, peripheral vascular disease,
intravascular radiation, and endoscopic vein harvesting. Sales for the six
months ended June 30, 2002, of $1,516.7 million, increased $189.4 million or 14%
over the same period in 2001. Unit volume growth of 16% increased net sales,
while price declines of 2% decreased net sales.
Worldwide sales of ICD systems in the second quarter of 2002 were $251.2
million, an increase of 37% over the prior year period or 35% in constant
currency. U.S. ICD system sales climbed 40% to $205.2 million, while
international sales of $46.0 million were up 15% in constant currency over the
same period in the prior year. U.S. and international ICD unit volume grew 30%
and 19%, respectively. For the six months ended June 30, 2002, ICD system sales
were $444.6 million, representing growth of $89.5 million or 25% over the first
six months of 2001. Sales growth was driven by the U.S. launch of the CONTAK
CD(R)/EASYTRAK(R) System for the treatment of heart failure and accelerating
market growth of ICD systems due to acceptance of the Multicenter Automatic
Defibrillator Implantation Trial (MADIT) II results.
In May 2002, Guidant announced U.S. Food and Drug Administration (FDA) approval
of the CONTAK CD/EASYTRAK System for the treatment of heart failure. The CONTAK
CD/EASYTRAK System has been indicated for use in patients who are at high risk
of sudden cardiac death due to ventricular arrhythmias and who have moderate to
severe heart failure. It was the first U.S. approved system to combine an ICD
with cardiac resynchronization therapy (CRT-D). The CONTAK CD CRT-D device
addresses the two primary concerns of physicians who treat heart failure
patients: improving their quality of life and protecting them from sudden
cardiac death. The CRT function of the device helps the chambers of the heart
beat in a coordinated manner, improving a
15
heart failure patient's functional capabilities. The ICD function corrects
potentially life-threatening rapid heart rhythms, preventing sudden cardiac
death. It is estimated that half of all heart failure deaths are a result of
end-stage, progressive pump failure, and the other half are due to sudden
cardiac death. Heart failure affects well over 5 million people in the U.S., an
estimated 6.5 million in Europe, and 2.4 million in Japan. Sales of these
devices are included in reported ICD and pacemaker sales, as appropriate.
In July 2002, the Company announced that the FDA expanded the product labeling
for its family of ICDs. The expanded indication now includes the prophylactic
use of Guidant ICDs for cardiac patients who have had a previous heart attack
and have an ejection fraction that is less than or equal to 30%. Ejection
fraction is a measure of how efficiently the heart pumps blood. A level of 30%
or less is an indication of impaired function that puts heart attack survivors
at increased risk for sudden cardiac death. The expanded indication is based on
results from the landmark MADIT II trial that showed that use of Guidant ICDs
reduced total mortality by 31% for heart attack survivors with compromised heart
function - those whose ejection fractions are at or below 30%. Guidant is the
only ICD manufacturer to have approved labeling that includes the patient
population defined by MADIT II.
Also in July 2002, Guidant announced CE Mark approval and first implant of the
world's smallest dual-chamber ICD, the VITALITY(TM) DS ICD System. This new
family of devices offers both improved size and longevity along with new
advanced rhythm management features. VITALITY ICDs are designed with a unique
elliptical shape and smaller size to facilitate insertion during implantation
and provide greater patient comfort. In addition, this new platform offers
advanced rhythm management, including Guidant's proprietary RHYTHM ID(TM)
feature, which uses new, highly sophisticated algorithms intended to pinpoint
the origin of dangerously fast or erratic heartbeats in order to allow the
physician to program the most appropriate therapy for the heart.
Worldwide pacemaker sales were $159.6 million for the second quarter of 2002, an
increase of 6% over the prior year or 4% in constant currency. U.S. pacemaker
sales grew 2% to $102.4 million. International sales of pacemaker products were
$57.2 million for the three months ended June 30, 2002, an increase of 13% over
the prior year or 8% in constant currency. Sales of these products for the first
half of 2002 were $301.3 million compared to $289.6 million in the first half of
2001, representing growth of 4%. The worldwide launch of the INSIGNIA(TM) family
of
16
pacemakers in early June was a significant contributor to pacemaker sales
results. The INSIGNIA pacemaker system's unique teardrop shape and smaller size
give the device a more physiologic dimension intended to provide patient comfort
and to facilitate its insertion during implantation. In addition to being
smaller than previous Guidant pacemakers, this new platform offers improved
longevity over its predecessors. The pacemaker also includes ease-of-use
features that allow the clinician to easily and quickly perform a comprehensive
set of patient follow-up tests.
Worldwide coronary stent system revenues grew 22%, 20% in constant currency, to
$228.0 million for the three months ended June 30, 2002, compared to $187.6
million for the same period in 2001. U.S. sales were $153.9 million for the
second quarter of 2002 compared to $130.2 million for the second quarter of
2001. Second quarter average selling prices for stent systems in the U.S.
decreased by 11% compared to the same period in the prior year and by 2%
compared to the first quarter of 2002, consistent with recent sequential
declines. International sales of these products during the second quarter of
2002 were $74.1 million compared to $57.5 million in the second quarter of 2001,
showing 24% growth on a constant currency basis. Europe experienced 13% sales
growth, 4% in constant currency, from the second quarter of 2002 compared to the
second quarter of 2001 despite the April launch of a competitor's drug eluting
stent. The introduction of drug eluting stents is expected to affect the market
for stents generally in future quarters. Worldwide stent revenues were $448.9
million for the six months ended June 30, 2002, compared to $400.4 million for
the same period in 2001.
Continued coronary stent system growth was driven by the acceptance of the
MULTI-LINK PENTA(TM) Coronary Stent System launched in the U.S. in June 2001,
and the MULTI-LINK PIXEL(TM) Coronary Stent System launched in the U.S. in the
fourth quarter of 2001. The MULTI-LINK PENTA System is Guidant's fifth and most
advanced broad use coronary stent system, while the MULTI-LINK PIXEL System is
designed to treat small diameter vessels. In May 2002, the FDA approved the
release of six-month follow-up clinical trial results for the MULTI-LINK PENTA
System. The clinical trial, involving 200 patients with previously untreated
native coronary artery lesions, demonstrated a 17.5% binary restenosis rate.
Restenosis is the recurrence of a blockage in a coronary artery that has
previously been propped open with a coronary stent. Restenosis typically occurs
in approximately 20-25% of patients within about six months of the initial
procedure. International coronary stent system growth was fueled by an 81%
growth rate in Japan where Guidant's MULTI-LINK TRISTAR(TM) Coronary
17
Stent System was launched in the fourth quarter of 2001. Additionally,
international growth was driven by the success of the European launch of the
MULTI-LINK ZETA(TM) Coronary Stent System. The MULTI-LINK ZETA System provides
enhanced ease of use and improved deliverability.
In August 2001, Guidant announced initial implants of the MULTI-LINK VISION(TM)
Coronary Stent System. The MULTI-LINK VISION System incorporates a cobalt
chromium alloy, enabling a lower profile and enhanced deliverability while
maintaining radial strength and radiopacity (visibility during the implant
procedure). The Company expects to file for FDA approval for the MULTI-LINK
VISION in 2002.
In August 2001, Guidant and Cook Inc. announced that they had entered into a
series of development and distribution agreements involving Cook Inc.'s drug
eluting stent program and Guidant's stent and balloon dilatation technology.
Guidant agreed to act as worldwide exclusive distributor for a new
paclitaxel-coated coronary stent, the ACHIEVE Drug Eluting Coronary Stent,
developed and manufactured by Cook Inc. The agreements, as well as the status of
Boston Scientific Corporation's (BSC) legal challenge to them, including the
court's entry of summary judgment for BSC and BSC's motion for injunctive
relief, are further described in Part II, Item I. On July 30, 2002, Guidant
announced its agreement to acquire Cook Group Incorporated, the corporate parent
of Cook Inc. (see Note 11), and filed a declaratory judgment action described in
Part II, Item I.
In January 2002, Guidant filed for CE Mark approval to market the ACHIEVE System
in Europe. In May 2002, 30-day data were presented from the 1,043-patient U.S.
clinical trial, named DELIVER, using the ACHIEVE paclitaxel eluting stent via
Guidant's collaboration with Cook Inc. The DELIVER clinical trial is designed to
evaluate the safety and efficacy of the ACHIEVE System for purposes of seeking
U.S. regulatory approval. Enrollment was completed in early March and clinical
investigators continue to follow patients in order to collect clinical data
necessary for regulatory submissions. Thirty-day safety data from the DELIVER
trial demonstrated an excellent safety profile.
In May 2002, Guidant announced the enrollment of the first patient in a new
clinical study designed to evaluate the benefit of the ACHIEVE System in a broad
population of patients, including high-risk patients and patients with complex
lesions including in-stent restenosis. Data from this trial, DELIVER II, which
is being conducted on behalf of Cook Inc., may be used to expand indications for
the ACHIEVE System beyond those
18
outlined in Cook Inc.'s ASPECT and ELUTES trial protocols. DELIVER II will be
the largest drug eluting stent trial to date, with a target enrollment of 1,500
patients in approximately 100 centers outside the U.S.
In pursuit of multiple alternatives for development of drug eluting stent
technology, Guidant entered into a worldwide co-exclusive license agreement with
Novartis in March 2002 granting Guidant rights to utilize the drug everolimus in
drug eluting stents for the treatment of coronary and peripheral vascular
diseases. As a result, the Company recorded a pre-tax charge of $6.8 million in
the first quarter of 2002 related to the value of the in-process research and
development. Novartis will provide everolimus to Guidant, supply data to support
Guidant filings with regulatory agencies, and receive milestone payments and a
royalty on sales of Guidant products utilizing the drug. Pending regulatory
approval, Guidant expects to initiate clinical trials of everolimus-eluting
coronary stents early next year.
Worldwide sales of the GALILEO(TM) Intravascular Radiotherapy System increased
to $9.3 million during the second quarter of 2002 compared to $0.7 million
during the same period in 2001. Sales for the first six months of 2002 were
$15.4 million compared to $1.1 million for the same period in 2001. Approved in
the U.S. in November 2001, the GALILEO System is used for the treatment of
in-stent restenosis. Radiation therapy is currently the only FDA approved method
to treat in-stent restenosis. In December 2001 the Company announced that it had
submitted a pre-market approval (PMA) supplement to the FDA for its
next-generation radiotherapy system, the GALILEO III Intravascular Radiotherapy
System.
Angioplasty system and accessory sales totaled $93.9 million in the second
quarter of 2002 compared to $97.6 million during the second quarter of 2001. The
decline in sales was driven by price declines of 5% and unit volume decreases of
1%, offset by a 2% positive foreign currency exchange impact. Sales of these
products for the six months ended June 30, 2002, were $184.8 million compared to
$196.1 million for the same period in 2001.
Worldwide sales of peripheral vascular and biliary products totaled $18.8
million in the second quarter of 2002, representing 53% growth over the same
period in the prior year. Sales of these products for the six months ended June
30, 2002, were $35.4 million compared to $23.0 million for the same period in
2001. Growth was driven by acceptance of such non-coronary stent products as the
RX HERCULINK PLUS(TM) Biliary
19
Stent System, the OMNILINK(TM) Biliary Stent System, the DYNALINK(TM) Biliary
Self-Expanding Stent System, as well as the DYNALINK Peripheral Self-Expanding
Stent System.
Sales of Guidant's ANCURE(R) ENDOGRAFT(R) System and accessories for the
treatment of AAA were $19.2 million for the three months ended June 30, 2002,
compared to $1.1 million for the three months ended June 30, 2001. Sales of
these products for the first six months of 2002 were $34.8 million compared to
$18.7 million for the same period in 2001. Following a voluntary recall in March
2001 and subsequent relaunch in August 2001, Guidant has experienced a ramp-up
in sales over the past three quarters. Four-year follow-up data was recently
presented showing that 97% of abdominal aortic aneurysms treated with an ANCURE
System were either smaller in diameter or controlled. In April 2002, Guidant
announced that its ANCURE Aortoiliac ENDOGRAFT System received FDA approval and
is now available in the U.S. The graft provides a less-invasive option for
patients previously ineligible for treatment with endovascular graft systems due
to advanced vascular disease in the iliac arteries. The ANCURE Aortoiliac
System, also available in Europe, is the first of its kind to be launched in the
U.S.
Sales of cardiac surgery products were $22.7 million for the quarter ended June
30, 2002, compared to $18.4 million for the quarter ended June 30, 2001,
representing 23% growth. Sales of these products for the six months ended June
30, 2002, were $43.0 million compared to $35.5 million during the same period in
2001. Cardiac surgery sales include the VASOVIEW(R) Endoscopic Vessel Harvesting
System and the AXIUS(TM) Off-Pump System. When combined these two systems allow
for a complete, less-invasive coronary artery bypass graft (CABG) procedure
called OPCRES - Off-Pump Coronary Revascularization with EndoScopic vessel
harvesting. Cardiac surgeons are increasingly adopting the OPCRES approach in
place of the traditional CABG approach. Guidant estimates that approximately 25%
of all CABG procedures in the U.S. utilize the off-pump approach and
approximately 35% use less-invasive vein harvesting.
In May 2002, the Company announced FDA clearance for the SYNCRUS(TM) Internal
Cardioversion System to treat postoperative atrial fibrillation following
cardiac surgery. The SYNCRUS System is now available in the U.S., Europe and
Canada. Postoperative atrial fibrillation is one of the most common
complications in cardiac surgery, occurring in 20-50% of all patients within two
to four days after heart surgery. The upper chambers of the patient's heart beat
in a rapid and disorganized way, compromising the heart's pumping function.
Postoperative atrial fibrillation
20
requires treatment before the patient is discharged from the hospital. If left
untreated, atrial fibrillation may lead to a variety of medical conditions,
including increased risk of hemodynamic instability, stroke, neurocognitive
dysfunction, congestive heart failure, and increased need for a permanent
pacemaker. The SYNCRUS System is designed to deliver a low energy shock to the
atria, the heart's upper chambers, to restore normal heart rhythm immediately.
Also in May 2002, Guidant announced the launch of its fifth generation VASOVIEW
5 Endoscopic Vessel Harvesting System for extracting vessels used by surgeons
during CABG procedures. The newest generation of VASOVIEW has an integrated
design that potentially makes it easier for the user to perform endoscopic vein
harvesting on patients with thinner legs or more difficult anatomy.
COST OF PRODUCTS SOLD AND EXPENSES
For the three months ended June 30, 2002, cost of products sold represented
25.8% of net sales compared to 23.7% for the three months ended June 30, 2001.
This increase was mainly due to reduced manufacturing throughput, despite record
sales levels in 2002. Throughput levels of pacemaker and defibrillator products
in the quarter ended June 30, 2001, outpaced those experienced in the second
quarter of 2002. Cost of products sold as a percentage of net sales was 25.1%
for the first six months of 2002 compared to 24.5% for the first six months of
2001. The increase was driven by reduced manufacturing throughput, a shift in
product mix, and sales price declines in coronary stents systems compared to the
prior year.
Guidant continued to invest aggressively in research and development in the
second quarter of 2002, evidenced by a 14% increase over the second quarter of
2001. Research and development expense was $106.0 million for the quarter ended
June 30, 2002, or 13.1% of net sales, compared to $92.7 million in 2001, or
14.1% of net sales. The $13.3 million increase was driven by significant
investments in the research and development of drug eluting stents for the
treatment of artery disease and implantable resynchronization therapy for the
treatment of heart failure, as previously described. Research and development
expense for the first six months of 2002 totaled $206.7 million compared to
$183.4 million for the same period in 2001.
Sales, marketing, and administrative expenses were $248.7 million for the three
months ended June 30, 2002, an increase of $35.8 million or 17%, compared to the
same period in 2001. These expenses for the six months ended June 30, 2002,
totaled $470.4 million, an increase of $54.4 million or 13% over the same period
in the prior
21
year. The increase was driven by the sales growth and continued expansion of the
U.S. sales organization. On a percentage of sales basis, these expenses
decreased for the quarter and six-month periods ended June 30, 2002, compared to
the prior year periods.
Net interest expense totaled $1.7 million for the second quarter of 2002, a
decrease of $7.3 million compared to the second quarter of 2001. Net interest
expense totaled $5.8 million for the first six months of 2002 compared to $18.4
million for the same period in 2001. These decreases in interest expense were
driven by lower average debt outstanding and lower interest rates in 2002.
Amortization expense for the second quarter of 2002 was $3.2 million, a decrease
of $7.8 million compared to the second quarter of 2001. Amortization expense for
the first six months of 2002 was $6.4 million, a decrease of $15.4 million
compared to the same period in 2001. These decreases in amortization expense are
primarily due to the elimination of goodwill amortization as directed by SFAS
142.
In addition to the aforementioned Novartis purchased in-process research and
development expense, three special items were recorded in the second quarter of
2002: i) a $137.1 million net legal benefit, primarily due to the $158.2 million
judgment plus interest and costs against Medtronic in April 2002; ii) a $40.0
million contribution to the Guidant Foundation; and iii) a $31.0 million
restructuring charge for endovascular solutions operations. The total tax impact
of all special items, including the afore-mentioned Novartis purchased
in-process research and development charge was $22.0 million. The restructuring
charge relates to restructuring activities approved by Guidant's Board of
Directors in May 2002 aimed at streamlining operations involving its
endovascular solutions product lines. The charge includes the termination of
Guidant's involvement in certain peripheral product clinical trials, workforce
reductions, facility reductions, and certain other related costs. In connection
with these activities, the Company terminated approximately 150 employees,
primarily in manufacturing and research and development positions. Liabilities
and provisions for inventory and other losses totaling $31.0 million were
recorded for this activity, of which $25.2 million remain at June 30, 2002.
In the first quarter of 2001, the Company recorded special charges of $25.0
million related to the VENTAK(R) PRIZM(TM) Implantable Defibrillator field
action and the ANCURE voluntary recall. The field action concerned a specific
memory component in the first-generation VENTAK PRIZM device. Field inventory
that contained the memory
22
component was returned to the Company and a software solution was designed to
non-invasively return full functionality to any affected implanted device. Sales
of the ANCURE system were voluntarily halted in March 2001 as a result of
Guidant's identification of certain deficiencies in the ANCURE-related
regulatory processes and communications with the FDA. In August 2001, the
Company received FDA approval allowing the return to a full market release of
the ANCURE system.
Excluding the effect of the special items in 2002, the effective income tax
rates for the quarters ended June 30, 2002 and 2001, were 26.0% and 28.0%,
respectively. Excluding the effect of the special items in 2002 and 2001, the
effective income tax rates for the six months ended June 30, 2002 and 2001, were
26.0% and 28.0%, respectively. The improvement in the adjusted tax rate reflects
benefits from increased overseas manufacturing, strategic investments in
research and development, and the elimination of primarily non-tax-deductible
goodwill amortization.
Net income and earnings per share-diluted were $163.2 million and $0.53,
respectively, for the quarter ended June 30, 2002, excluding the special items
previously described. Net income and earnings per share-diluted for the quarter
ended June 30, 2001, were $115.3 million and $0.38 per share, respectively. This
represents an increase in adjusted net income of $47.9 million or 42%. Reported
net income and earnings per share-diluted for the quarter ended June 30, 2002,
were $204.8 million and $0.67 per share, respectively.
Net income and earnings per share-diluted were $307.0 million and $1.00 per
share, respectively, for the six months ended June 30, 2002, excluding the
special items previously described. Net income and earnings per share-diluted
for the six months ended June 30, 2001, were $242.2 million and $0.79 per share,
respectively, excluding the special item. Reported net income and earnings per
share-diluted were $344.3 million and $1.12 per share, respectively, for the
first six months of 2002 compared to $226.5 million and $0.74 per share,
respectively, for the same period in 2001.
LIQUIDITY AND FINANCIAL CONDITION
The Company generated cash flows that were more than sufficient to fund
operations during the six months ended June 30, 2002. Cash and cash equivalents
were $688.1 million at June 30, 2002, an increase of $250.3 million over
December 31, 2001.
Working capital of $1,086.5 million at June 30, 2002, increased $327.3 million
from the prior year-end level. The current ratio at June 31, 2002, was 2.3:1
compared to
23
2.0:1 at December 31, 2001. Guidant's balance sheet reflects a net cash position
of $214.1 million at June 30, 2002, compared to a net debt position of $322.2
million at December 31, 2001. The Company believes its cash from operations is
sufficient to fund anticipated working capital needs and discretionary operating
spending requirements for 2002.
Net cash provided by operating activities was $544.9 million for the six months
ended June 30, 2002, compared to $276.4 million for the same period in 2001. Net
income for the six months ended June 30, 2002, was $344.3 million, a $117.8
million increase compared to the same period in 2001. Changes in other non-cash
expenses were a $28.4 million use of cash for the six-month period ended June
30, 2002, compared to a $34.2 million source of cash for the same period in
2001. This fluctuation is primarily due to the change in fair value of foreign
exchange contracts and an increase in deferred tax assets. Changes in accounts
payable and accrued liabilities were a $43.3 million source of cash in the first
six months of 2002 compared to a $34.6 million use of cash in the first six
months of 2001. This fluctuation is due to a lower bonus payout in 2002 compared
to 2001, a second quarter 2002 restructuring charge for the endovascular
solutions operations, increased liabilities for rebates and royalties related to
increased sales in the second quarter of 2002, and accruals for legal
settlements in 2002. Changes in other liabilities were a $69.1 million inflow of
cash in the first six months of 2002 compared to a $30.4 million inflow of cash
in the first six months of 2001. The increase in other liabilities is primarily
due to the $40.0 million announced contribution to the Guidant Foundation in the
second quarter of 2002. Increases in income taxes payable resulted in a $91.8
million source of cash in the first six months of 2002 compared to a $3.4
million source of cash in the first six months of 2001. Income taxes payable
increased primarily due to a favorable patent infringement ruling for which the
Company will be required to pay income tax in 2002.
Net cash used for investing activities totaled $93.5 million for the six months
ended June 30, 2002, compared to $71.9 million for the same period in 2001. This
was driven by net additions of property and equipment of $68.3 million and $70.2
million for the first six months of 2002 and 2001, respectively.
Net cash used for financing activities totaled $260.7 million for the six months
ended June 30, 2002, compared to $93.4 million for the same period in 2001. This
use of cash was driven by a net decrease in borrowings of $287.3 million for the
first six months of 2002 compared to a $91.2 million net increase in borrowings
for the same period in 2001. In addition, the Company
24
repurchased 5.2 million of its common shares for approximately $200.0 million in
the second quarter of 2001.
At June 30, 2002, the Company had outstanding borrowings of $474.0 million at a
weighted average interest rate of 3.88% through the issuance of commercial
paper, bank borrowings, and long-term notes due in 2006. Bank borrowings
represent short-term uncommitted credit facilities with various commercial
banks. The commercial paper borrowings are supported by two credit facilities
aggregating $950.0 million. There are currently no outstanding borrowings under
these facilities. The Company has classified $126.2 million as short-term debt
at June 30, 2002.
The Company believes that amounts available through existing commercial paper
programs should be adequate to fund maturities of short-term borrowings. The
Company also expects its cash from operations to be adequate to meet its
obligations to make interest payments on its debt and other anticipated
operating cash needs, including planned capital expenditures. Capital
expenditures are expected to be approximately $180.0 million in 2002, primarily
due to continued investment in the Company's manufacturing and research
facilities.
The Company has recognized net deferred tax assets aggregating $231.9 million at
June 30, 2002, compared to $197.4 million at December 31, 2001. In view of the
consistent profitability of its past operations, the Company believes that these
assets will be substantially recovered and that no significant additional
valuation allowances are necessary.
CAUTIONARY STATEMENT
This report includes forward-looking statements, including accounting estimates,
expectations with respect to announced transactions, statements concerning
pricing and sales trends, recovery of tax assets, and the timing of product
developments. The statements are based on assumptions about many important
factors, including the results of clinical trials, regulatory approvals,
competitive offerings, market developments, and the factors listed on Exhibit
99.1 to this report, which is incorporated herein by reference. As such, they
involve risks that could cause actual results to differ materially. The Company
does not undertake to update its forward-looking statements.
25
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
The Company's policies with respect to legal proceedings and other loss
contingencies are described in the "Significant Accounting Policies" section of
"Management's Discussion and Analysis of Results of Operations and Financial
Condition."
On October 3, 1997, Cordis Corporation (Cordis), a subsidiary of Johnson &
Johnson, filed suit against the Company alleging that the sale of the Company's
stent products infringes the Palmaz/Schatz patents owned by Cordis. On April 3,
2000, the parties agreed to dismiss all patent litigation between them and
resolve remaining disputes in arbitration proceedings. As part of the agreement,
each party received licenses to the other's patents involved in the disputes.
The arbitration proceeding regarding the Palmaz/Schatz patents will resolve
whether Cordis is entitled to damages based on a limited number of claims under
United States patents 4,733,762 and 5,902,332. The arbitration hearing currently
is scheduled to take place early in 2003.
On February 18, 1998, Arterial Vascular Engineering, Inc. (now known as
Medtronic AVE, Inc.), filed suit against the Company's subsidiary, Advanced
Cardiovascular Systems, Inc. (ACS), in the District Court of Delaware alleging
that the sale of the ACS MULTI-LINK Coronary Stent System infringes certain
patents owned by Medtronic AVE. The suit is consolidated with a suit by ACS
alleging infringement by Medtronic AVE of certain ACS stent patents. The
Medtronic AVE complaint also alleges misappropriation of trade secrets and
breach of a confidentiality agreement by ACS. In the lawsuit, Medtronic AVE is
seeking injunctive relief and monetary damages and to invalidate ACS stent
patents asserted against Medtronic AVE. The court has approved a joint motion to
stay the litigation until September 2002.
On August 20, 2001, the Company and Cook Inc. announced that they had entered
agreements pursuant to which the Company would act as worldwide exclusive
distributor for a new paclitaxel-coated coronary stent to be developed and
manufactured by Cook Inc. On September 10, 2001, Boston Scientific Corporation
(BSC) sent a Notice of Dispute to Cook Inc. alleging that its agreements with
the Company appear to constitute actual and anticipatory breaches of a License
Agreement with Angiotech Pharmaceuticals, Inc. (Angiotech) granting licenses to
BSC and Cook Inc. Pursuant to an agreement among the parties, BSC, Cook Inc.,
and the Company dismissed all proceedings except for a complaint filed by Cook
Inc. against BSC in the Northern District of Illinois seeking a finding that
Cook Inc. is not in breach of the Angiotech license. BSC counterclaimed,
alleging breach of contract and the covenant of good faith and fair dealing,
seeking damages and injunctive relief preventing Cook Inc. from implementing its
agreement with Guidant. On June 13, 2002, in ruling on cross-motions for summary
judgment, the court held in favor of BSC on the breach of contract issue,
concluding that the distribution arrangement and processes for obtaining
regulatory approvals were impermissible. The Company believes that Cook Inc.
intends to appeal the ruling. On July 15, 2002, BSC filed a motion for permanent
injunctive relief, seeking to prevent any performance under the Cook Inc.
agreements with the Company, any use of the data generated in connection with
them, and any sales of paclitaxel-coated stents through the Company. Briefing on
this issue is expected to be completed in August. On July 30, following the
Company's entry into an agreement to acquire Cook Group Incorporated (corporate
parent of Cook Inc.), the Company filed a complaint in the Northern District of
Illinois seeking declaratory judgment relating to rights available under the
Angiotech license and the availability of clinical trial data.
Except with respect to the three previously disclosed matters described above,
the outcomes of which could be material to the Company, ultimate liability is
not expected to have a material effect on consolidated financial position or
liquidity, but could possibly be material to the consolidated results of
operations of any one period. An additional new matter and updates to certain of
the matters described in the Company's 10-K are provided below.
26
The Company is aware that the U.S. Department of Justice and the Office of
Criminal Investigations of the U.S. Food & Drug Administration are conducting an
investigation into matters relating to the Company's ANCURE ENDOGRAFT System for
the treatment of abdominal aortic aneurysms. In March 2001, the Company
voluntarily halted production and sale of the product and performed a voluntary
recall following the discovery of certain regulatory compliance deficiencies in
the business unit responsible for the sales of the product. The product was
returned to full market release in August 2001 with FDA approval. The Company is
cooperating fully in the investigation.
On December 23, 1999, the Company's subsidiary, ACS, brought suit against
Medtronic, Inc. and Medtronic AVE (together, Medtronic) in the Northern District
of California alleging that certain Medtronic rapid exchange products infringe
an ACS patent. In March 2000, the parties agreed to stay the litigation and
enter arbitration. On April 25, 2002, the arbitration panel found that the
Medtronic products infringe the ACS patent and were not licensed. The panel
awarded ACS $158.2 million in damages, plus interest and costs. The panel also
enjoined Medtronic from selling or manufacturing the products, which Medtronic
had already removed from the market under an injunction obtained by BSC. The
damage award has been satisfied.
On February 7, 2000, Medtronic, Inc. filed suit against the Company and its
subsidiary, Cardio Thoracic Systems, Inc. (CTS), in the Northern District of
California alleging false advertising, unfair competition and patent
infringement by the Company and CTS for making, using and selling the VORTEX
Stabilization System and seeking injunctive relief, damages, attorney fees and
costs. On March 30, 2000, the Company and CTS filed an answer asserting
invalidity and non-infringement of the patents and filed a counterclaim alleging
infringement of a CTS patent involving similar technology. The parties have
settled the case. The settlement was not material to the Company.
On May 3, 1996, Pacesetter, Inc. (Pacesetter), a subsidiary of St. Jude Medical,
Inc. (St. Jude), filed suit against the Company's subsidiary, Cardiac
Pacemakers, Inc. (CPI) alleging infringement of certain Pacesetter patents by
certain CPI pacemaker models and programmers for pacemakers and defibrillators.
The suit sought injunctive relief, unspecified monetary damages, and an award of
attorney fees. On December 16, 1998, following a trial on the merits in the
District Court in Minnesota, the jury returned a verdict finding no liability by
CPI on two of the three patents asserted by Pacesetter, and infringement by
software in CPI programmers for certain pacemakers and defibrillators of the
third patent. The jury awarded Pacesetter damages in the amount of $9.7 million,
which the Company accrued, plus royalties and interest. The parties have settled
the case. The settlement was not material to the Company.
Anna Mirowski, Eli Lilly and Company and two Company subsidiaries, Guidant Sales
Corporation and CPI, are plaintiffs in a patent infringement suit originally
filed against St. Jude and its affiliates in November 1996 in the District Court
in Indianapolis. The suit alleges that St. Jude's defibrillator products
infringe patents licensed to CPI. In July 2001, a jury found that two of the
licensed patents were valid and that St. Jude had infringed one, which patent
expired in March 2001. The jury awarded damages of $140.0 million against St.
Jude. The Company did not record a gain. On February 13, 2002, the court, in
ruling on a number of post-trial motions, reversed the jury's findings and
award. The court awarded St. Jude certain post-trial fees and costs, including
contingent expenses and attorney fees upon any retrial of the case if a retrial
is required following any appeal of the court's rulings. On August 1, 2002,
plaintiffs filed a notice of appeal.
27
Item 4. Submission of Matters to a Vote of Security-Holders
The Company's Annual Meeting of Shareholders was held on May 20, 2002. The
following matters were voted on at the meeting:
Election of Directors:
NAME FOR WITHHELD
J.B. King 258,741,160 7,585,663
Susan B. King 263,555,335 2,771,448
J. Kevin Moore 262,106,309 4,220,514
Ruedi E. Wager 263,649,559 2,677,264
August M. Watanabe 263,615,489 2,711,334
Ratification of the appointment by the Board of Directors of Ernst & Young LLP
as independent auditors for the year 2002:
For 256,504,096
Against 8,836,470
Abstain 986,257
Thus, each listed director was elected to a three-year term, and the appointment
of auditors was ratified.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. The Exhibit Index is incorporated herein by reference.
(b) Reports on Form 8-K. During the quarter for which this Report on Form
10-Q is filed, the registrant filed a Form 8-K, dated June 13, 2002,
pertaining to the litigation between BSC and Cook Inc. described
herein.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GUIDANT CORPORATION
-------------------
(Registrant)
Date August 13, 2002 /s/Keith E. Brauer
-------------------
Keith E. Brauer
Vice President, Finance and
Chief Financial Officer
Date August 13, 2002 /s/Peter J. Mariani
-------------------
Peter J. Mariani
Corporate Controller and
Chief Accounting Officer
29
EXHIBIT INDEX
2 Agreement and Plan of Merger between Guidant Corporation, Diane
Acquisition Corporation and Cook Group Incorporated dated as of July
30, 2002 (incorporated by reference to the Company's 8-K dated July 30,
2002)
3.1 Amended Articles of Incorporation (incorporated by reference to the
Company's 10-Q for the quarter ended September 30, 1999)
3.2 By-laws of the Registrant (incorporated by reference to the Company's
10-K for the year ended December 31, 2000)
4.1 Specimen of Certificate for Common Stock (incorporated by reference to
the Company's S-1, File No. 33-83934)
4.2 Form of Indenture between the Company and Citibank, N.A., as Trustee
(incorporated by reference to the Company's S-1, File No. 333-00014)
4.3 Form of Supplemental Indenture between the Company and Citibank, N.A.,
as Trustee (incorporated by reference to the Company's S-1, File No.
333-00014)
99.1 Factors Possibly Affecting Future Operating Results
99.2 CEO/CFO Certifications
30