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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 SEPTEMBER 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 November 6, 2002:
Class Number of Shares Outstanding
----- ----------------------------
Common 305,692,000
1
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GUIDANT CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -----------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net sales .......................... $ 827.4 $ 661.6 $ 2,344.1 $ 1,988.9
Cost of products sold .............. 205.7 165.0 585.8 490.1
--------- --------- ----------- -----------
Gross profit ................ 621.7 496.6 1,758.3 1,498.8
Research and development ........... 109.0 95.1 315.7 278.5
Purchased in-process research and
development ....................... -- -- 6.8 --
Sales, marketing, and administrative 252.6 200.0 723.0 616.0
Interest, net ...................... 0.1 7.1 5.9 25.5
Royalties, net ..................... 13.9 10.2 39.0 30.6
Amortization ....................... 3.4 10.8 9.8 32.6
Other, net ......................... 6.1 3.4 13.5 9.2
Foundation contribution ............ -- 10.0 40.0 10.0
Litigation, net .................... -- (10.0) (137.1) (10.0)
Restructuring charge ............... -- -- 31.0 --
Special charges .................... -- -- -- 25.0
--------- --------- ----------- -----------
Income before income taxes ......... 236.6 170.0 710.7 481.4
Income taxes ....................... 61.5 47.6 191.3 132.5
--------- --------- ----------- -----------
Net income .................. $ 175.1 $ 122.4 $ 519.4 $ 348.9
========= ========= =========== ===========
Earnings per share-basic ........... $ 0.58 $ 0.41 $ 1.72 $ 1.16
========= ========= =========== ===========
Earnings per share-diluted ......... $ 0.57 $ 0.40 $ 1.69 $ 1.14
========= ========= =========== ===========
See notes to consolidated financial statements
2
GUIDANT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
SEPTEMBER 30, DECEMBER 31,
2002 2001
---------- ----------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents .................................... $ 907.3 $ 437.8
Short-term investments ....................................... 8.9 8.9
Accounts receivable, net of allowances
of $31.0 (2002) and $26.6 (2001) ...................... 634.8 631.9
Inventories .................................................. 305.6 267.6
Deferred income taxes ........................................ 188.0 153.6
Prepaid expenses and other current assets .................... 75.9 48.5
---------- ----------
Total Current Assets .................................. 2,120.5 1,548.3
OTHER ASSETS
Goodwill, net of allowances of $159.4 (2002) and $143.3 (2001) 516.6 426.6
Other intangible assets, net of allowances of $58.5 (2002) and
$64.4 (2001) .......................................... 95.3 189.8
Deferred income taxes ........................................ 41.3 43.8
Investments .................................................. 48.3 38.6
Sundry ....................................................... 56.9 49.1
Property and equipment, net of accumulated depreciation of
$539.4 (2002) and $464.7 (2001) ....................... 640.6 620.6
---------- ----------
$ 3,519.5 $ 2,916.8
========== ==========
See notes to consolidated financial statements
3
GUIDANT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -----------
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable....................................................... $ 83.0 $ 60.1
Employee compensation.................................................. 150.6 116.9
Other liabilities...................................................... 238.2 164.6
Income taxes payable................................................... 226.7 147.5
Short-term debt........................................................ 127.1 300.0
-------- --------
Total Current Liabilities....................................... 825.6 789.1
NONCURRENT LIABILITIES
Long-term debt......................................................... 348.1 460.0
Other ................................................................ 152.9 121.9
-------- --------
501.0 581.9
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............................................. 194.4 182.5
Retained earnings...................................................... 1,910.0 1,390.5
Deferred cost, ESOP.................................................... (26.1) (30.5)
Treasury stock, at cost:
Shares: 2,428,000 (2002)
3,866,000 (2001)...................................... (93.6) (149.0)
Accumulated other comprehensive income ................................ (17.9) (73.8)
-------- --------
2,192.9 1,545.8
-------- --------
$3,519.5 $2,916.8
======== ========
See notes to consolidated financial statements
4
GUIDANT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
(In millions)
(unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
2002 2001
---- ----
CASH PROVIDED BY OPERATING ACTIVITIES
Net income .................................. $ 519.4 $ 348.9
ADJUSTMENTS TO RECONCILE NET INCOME TO CASH
PROVIDED BY OPERATING ACTIVITIES
Depreciation ................................ 86.0 71.9
Amortization of goodwill and other
intangible assets ....................... 9.8 32.6
Provision for inventory and other losses .... 65.9 61.6
Purchased in-process research and development 6.8 --
Other noncash expenses, net ................. (11.1) 45.2
-------- --------
676.8 560.2
CHANGES IN OPERATING ASSETS AND LIABILITIES
Receivables, increase ....................... (22.9) (69.5)
Inventories, increase ....................... (78.8) (76.7)
Prepaid expenses and other current assets,
increase ................................. (22.0) (15.8)
Accounts payable and accrued liabilities,
increase (decrease) ...................... 68.5 (32.1)
Income taxes payable, increase .............. 80.3 31.8
Other liabilities, increase ................. 85.8 50.6
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ... 787.7 448.5
INVESTING ACTIVITIES
Additions of property and equipment, net .... (102.0) (105.4)
Purchases of available-for-sale investments . (12.1) (4.0)
Sale/maturity of investments ................ 0.1 1.2
Additions of other assets, net .............. (6.4) (10.7)
Purchase of in-process research and
development .............................. (6.8) --
-------- --------
NET CASH USED FOR INVESTING ACTIVITIES ...... (127.2) (118.9)
FINANCING ACTIVITIES
(Decrease) increase in borrowings, net ...... (285.9) 42.1
Issuance of common stock and other capital
transactions ............................. 39.6 17.2
Purchase of common stock .................... -- (200.0)
-------- --------
NET CASH USED FOR FINANCING ACTIVITIES ...... (246.3) (140.7)
Effect of Exchange Rate Changes on Cash .......... 55.3 2.6
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS ........ 469.5 191.5
Cash and Cash Equivalents at Beginning of Period . 437.8 163.0
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ....... $ 907.3 $ 354.5
======== ========
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:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------ ------------
Finished products..................... $150.2 $138.5
Work in process....................... 51.4 66.5
Raw materials and supplies............ 104.0 62.6
------ ------
$305.6 $267.6
====== ======
The $41.4 million increase in raw materials and supplies was primarily due to
cardiac rhythm management product components. This increase was driven by the
market growth of implantable cardioverter defibrillator systems due to the
increased acceptance of the Multicenter Automatic Defibrillator Implantation
Trial (MADIT) II results and a management decision post-September 11th to carry
increased levels of certain key components.
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 follows:
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPT. 30, 2002 SEPT. 30, 2001 SEPT. 30, 2002 SEPT. 30, 2001
-------------- -------------- -------------- --------------
Reported net income..................... $ 175.1 $ 122.4 $ 519.4 $ 348.9
Goodwill and workforce
amortization.......................... -- 7.7 -- 22.8
----------- ----------- ---------- ----------
Adjusted net income..................... $ 175.1 $ 130.1 $ 519.4 $ 371.7
=========== =========== ========== ==========
Earnings per share-basic:
Reported net income..................... $ 0.58 $ 0.41 $ 1.72 $ 1.16
Goodwill and workforce
amortization.......................... -- 0.02 -- 0.07
----------- ---------- ---------- ----------
Adjusted earnings per
share-basic........................... $ 0.58 $ 0.43 $ 1.72 $ 1.23
=========== =========== ========== ==========
Earnings per share-diluted:
Reported net income..................... $ 0.57 $0.40 $ 1.69 $ 1.14
Goodwill and workforce
amortization.......................... -- 0.03 -- 0.07
----------- ----------- ---------- ----------
Adjusted earnings
per share-diluted..................... $ 0.57 $ 0.43 $ 1.69 $ 1.21
=========== =========== ========== ==========
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 nine months
of 2002.
Balances of acquired intangible assets, excluding goodwill, were as follows (in
millions):
ACCUMULATED CARRYING
ORIGINAL COST AMORTIZATION VALUE
------------- ------------ -----
SEPTEMBER 30, 2002
Licensed technologies
and distribution agreements.................... $ 124.8 $ 47.8 $ 77.0
Intermedics, Inc................................. 29.0 10.7 18.3
------------- ------------- -------------
$ 153.8 $ 58.5 $ 95.3
============= ============= =============
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 nine months of 2002, Guidant purchased intangibles totaling
$4.4 million. Excluding goodwill and intangible assets reclassified to goodwill,
amortization expense of intangible assets was $3.4 million and $2.7 million for
the three months ended and $9.8 million and $8.3 million for the nine months
ended September 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income ............................... $ 175.1 $ 122.4 $ 519.4 $ 348.9
========= ========= ========= =========
Weighted average common shares outstanding 302.09 299.25 301.44 301.19
Effect of employee stock options ......... 3.31 3.60 4.88 4.77
--------- --------- --------- ---------
Weighted average common shares outstanding
and assumed conversions ............... 305.40 302.85 306.32 305.96
========== ========== ========== ==========
Earnings per share-basic ................. $ 0.58 $ 0.41 $ 1.72 $ 1.16
========== ========== ========== ==========
Earnings per share-diluted ............... $ 0.57 $ 0.40 $ 1.69 $ 1.14
========== ========== ========== ==========
Earnings per share-diluted excludes 30.0 million and 31.1 million shares related
to options for the quarters ended September 30, 2002 and 2001, respectively, as
the exercise price per share of these options was greater than the average
market value, resulting in an anti-dilutive effect on earnings per
share-diluted. The shares related to options excluded from the earnings per
share-diluted calculations for the nine months ended September 30, 2002 and
2001, were 23.5 million and 22.3 million shares, respectively.
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) market value changes in available-for-sale securities. For the third
quarter of 2002 and 2001, comprehensive income was $172.4 million and $148.4
million, respectively. Comprehensive income for the nine months ended September
30, 2002 and 2001 was $575.3 million and $357.0 million. The increase in
comprehensive income for the three- and nine-month periods ended September 30,
2002, compared to the same periods in 2001, was primarily due to increased net
income and the strengthening of the Euro compared to the U.S. dollar.
8
GUIDANT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - SEGMENT INFORMATION
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
GEOGRAPHIC INFORMATION:
NET SALES(1):
U.S..................................... $586.5 $457.8 $1,663.5 $1,389.9
International........................... 240.9 203.8 680.6 599.0
------ ------ -------- --------
$827.4 $661.6 $2,344.1 $1,988.9
====== ====== ======== ========
(1) Revenues are attributed to countries based on location of the customer.
SEPTEMBER 30, DECEMBER 31,
LONG-LIVED ASSETS: 2002 2001
---- ----
U.S..................................... $563.0 $559.9
International........................... 77.6 60.7
------ ------
$640.6 $620.6
====== ======
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
NET SALES OF CLASSES
OF SIMILAR PRODUCTS:
Cardiac rhythm management............... $430.9 $328.0 $1,176.8 $ 972.7
Vascular intervention................... 340.5 290.4 998.1 893.9
Endovascular solutions.................. 32.7 25.2 102.9 68.8
Cardiac surgery......................... 23.3 18.0 66.3 53.5
------ ------ -------- --------
$827.4 $661.6 $2,344.1 $1,988.9
====== ====== ======== ========
NOTE 7 - PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
In March 2002, Guidant entered into an agreement with Novartis Pharma AG and
Novartis AG (Novartis) that provided Guidant a co-exclusive worldwide license to
use everolimus in drug eluting stents. 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. In September 2002, the parties expanded the license to
make Guidant's rights exclusive and to provide Guidant the right to sublicense.
The agreement remains subject to clearance under the Hart-Scott-Rodino Antitrust
Improvements Act. Under the agreement, Novartis will receive milestone payments
and a royalty on sales of Guidant products utilizing the drug.
NOTE 8 - SPECIAL ITEMS
In addition to the Novartis purchased 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 a $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 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 product clinical
trials, workforce reductions, facility reductions, and certain other related
costs. In connection with these activities, the Company
9
GUIDANT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - SPECIAL ITEMS (CONTINUED)
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 $17.8
million remain on September 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 Part II, Item 1,
("Legal Proceedings") to this filing is incorporated herein by reference.
NOTE 11 - PENDING ACQUISITION
On July 30, 2002, Guidant entered into an agreement to acquire Cook Group
Incorporated (Cook Group), the corporate parent of Cook Incorporated (Cook), in
a stock-for-stock transaction, subject to satisfaction of the conditions
described below. Cook Group owns a number of companies that produce and market
medical devices for interventional cardiology, vascular medicine, critical care
and other disciplines. Cook is a party to a License Agreement with Angiotech
Pharmaceuticals, Inc. relating to the use of paclitaxel on stents, along with
the related litigation described in Part II, Item 1, to this filing. Under the
agreement, Guidant would acquire all of Cook Group in exchange for a maximum of
65.79 million Guidant shares, priced in two phases. The first phase has been
priced at $40 per Guidant share, which will result in the maximum share issuance
for the phase, or 41.25 million shares. 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 that 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. As further described
in Part II, Item 1, to this filing, a federal court adjudicating Boston
Scientific Corporation's (Boston Scientific) challenge to existing agreements
between Cook and the Company granted summary judgment in favor of Boston
Scientific and entered a permanent injunction barring, among other things,
access to the clinical data mentioned above. Cook and the Company have filed
motions in the 7th Circuit Court of Appeals requesting a stay of the injunction
pending Cook's appeal. The transaction is also subject to shareholder approval,
government clearances and other conditions. If the transaction were not
consummated, Guidant would pay $50.0 million to Cook Group and amend an existing
stent delivery system distribution agreement.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
(Dollars in millions except per share data)
(unaudited)
Guidant Corporation pioneers lifesaving technology for millions of cardiac and
vascular patients worldwide. The Company 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 or biliary strictures; ii) implantable
cardioverter defibrillator (ICD) 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 ICD and pacemaker systems used to treat heart failure
and provide backup therapy for tachycardia and bradycardia; 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 U.S., Western Europe, and
Japan. The Company markets its products in nearly 100 countries through a direct
sales force in the U.S. 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.
SIGNIFICANT ACCOUNTING POLICIES
It is important to understand Guidant's accounting policies in order to
understand its financial statements. The 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 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
11
product development and frequent new product introductions. Uncertain timing of
product approvals, variability in product launch strategies, product recalls,
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 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
12
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.
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net sales............................................ $827.4 $661.6 $2,344.1 $1,988.9
Cost of products sold................................ 205.7 165.0 585.8 490.1
------ ------ -------- --------
Gross profit ................................... 621.7 496.6 1,758.3 1,498.8
Research and development............................. 109.0 95.1 315.7 278.5
Sales, marketing, and administrative 252.6 200.0 723.0 616.0
------ ------ -------- --------
Operating expense............................... 361.6 295.1 1,038.7 894.5
Operating income..................................... $260.1 $201.5 $ 719.6 $ 604.3
====== ====== ======== ========
AS A PERCENT OF NET SALES
---------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2002 2001 2002 2001
---- ---- ---- ----
Net sales............................................ 100.0% 100.0% 100.0% 100.0%
Cost of products sold................................ 24.9 24.9 25.0 24.6
----- ----- ----- -----
Gross profit ................................... 75.1 75.1 75.0 75.4
Research and development............................. 13.2 14.4 13.5 14.0
Sales, marketing, and administrative 30.5 30.2 30.8 31.0
----- ----- ----- -----
Operating expense............................... 43.7 44.6 44.3 45.0
Operating income..................................... 31.4% 30.5% 30.7% 30.4%
===== ===== ===== =====
13
OPERATING RESULTS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002
SALES
The Company had worldwide net sales of $827.4 million for the quarter ended
September 30, 2002, reflecting an increase of $165.8 million or 25% over the
same period in 2001. Growth in unit volume, price increases and fluctuations in
foreign currency exchange rates increased net sales by 21%, 2% and 2%,
respectively. The impact of fluctuations in foreign currency exchange rates on
net sales was $10.4 million, resulting in 23% sales revenue growth on a constant
currency basis. Guidant experienced double-digit growth across all product
groups and major geographies driven by new product launches and enhanced
distribution capability. U.S. sales of $586.5 million grew 28% over the prior
year, while international sales of $240.9 million increased 18%, 13% in constant
currency. Sales for the nine months ended September 30, 2002, of $2,344.1
million, increased $355.2 million or 18% over the same period in 2001. Unit
volume growth of 18% increased net sales and fluctuations in foreign currency
exchange rates increased net sales by 1% offset by price declines of 1%.
ICD Systems
Worldwide sales of ICD systems in the third quarter of 2002 were $259.7 million,
an increase of 47% over the prior year period or 45% in constant currency. U.S.
ICD system sales climbed 51% to $211.2 million, while international sales of
$48.5 million were up 31% over the same period in the prior year, 22% in
constant currency. U.S. and international ICD unit volume grew sales by 40% and
24%, respectively. For the nine months ended September 30, 2002, ICD system
sales were $704.3 million, representing growth of $172.0 million or 32% over the
first nine months of 2001. Sales growth was driven by the accelerating market
growth of ICD systems due to acceptance of the Multicenter Automatic
Defibrillator Implantation Trial (MADIT) II results and the U.S. launch of the
CONTAK CD(R)/EASYTRAK(R) System for the treatment of heart failure.
In July 2002, the Company announced that the U.S. Food and Drug Administration
(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 the measurement of how
effectively the heart is pumping blood. People with healthy hearts have an
ejection fraction of 50% or greater. 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 FDA approved labeling that includes the patient
population defined by MADIT II. Also during the third quarter of 2002, a joint
committee from the American College of Cardiology (ACC), the North American
Society of Pacing and Electrophysiology (NASPE) and the American Heart
Association (AHA) issued guidelines supporting the expanded use of ICDs based on
the results of the MADIT II trial.
In October 2002, Guidant announced that the FDA approved the CONTAK CD 2
Cardiac Resynchronization Therapy Defibrillator (CRT-D) for the treatment of
heart failure. The new CONTAK CD 2 system is smaller and lighter than any other
CRT-D product currently available in the U.S. It is physiologically shaped and,
at 41 cc, is approximately 38% smaller than any competing CRT-D system in the
U.S. The product will be available in the U.S. for the majority of the fourth
quarter of 2002.
14
Guidant's CRT-D devices combine cardiac resynchronization therapy with
defibrillation therapy, addressing the two primary concerns of physicians who
treat heart failure patients - improving their quality of life and protecting
them from sudden cardiac death. Approximately 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. The CRT function of the device helps the chambers of
the heart beat in a coordinated manner, improving a heart failure patient's
functional capabilities. The defibrillator function corrects potentially
life-threatening rapid heart rhythms, helping prevent sudden cardiac death.
Guidant's CRT-P devices combine cardiac resynchronization therapy with therapy
to address slow or irregular heart rhythms. CRT-P devices are available outside
the U.S. Sales of CRT devices are included in reported ICD and pacemaker sales,
as appropriate.
Also in October 2002, Guidant announced the European market launch of its
next-generation ICD family, the VITALITY(TM) ICD System. This new family of
devices offers reduced size and excellent longevity along with new advanced
rhythm management solutions. VITALITY ICD's elliptical shape and smaller size
are intended to facilitate insertion and provide greater patient comfort.
Pacemakers
Worldwide pacemaker sales were $171.2 million for the third quarter of 2002, an
increase of 13% over the prior year or 12% in constant currency. U.S. pacemaker
sales grew 16% to $112.3 million. International sales of pacemaker products were
$58.9 million for the three months ended September 30, 2002, an increase of 10%
over the prior year or 5% in constant currency. Sales of these products for the
first nine months of 2002 were $472.5 million compared to $440.5 million in the
first nine months of 2001, representing growth of 7%.
The worldwide launch of the INSIGNIA(TM) family of pacemakers in early June was
a significant contributor to pacemaker sales results. As with the VITALITY ICD,
the INSIGNIA pacemaker system's physiologic shape and smaller size are intended
to provide patient comfort and facilitate its insertion. This new platform
offers improved longevity over its predecessors and includes ease-of-use
features that facilitate patient follow-up.
Coronary Stent Systems
Worldwide coronary stent system revenues grew 21%, 20% in constant currency, to
$232.6 million for the three months ended September 30, 2002, compared to $192.7
million for the same period in 2001. U.S. sales were $156.8 million for the
third quarter of 2002 compared to $135.1 million for the third quarter of 2001.
Third-quarter average selling prices for stent systems in the U.S. decreased by
7% compared to the same period in the prior year and by 1% compared to the
second quarter of 2002, which is less than recent sequential declines.
International sales of these products during the third quarter of 2002 were
$75.8 million compared to $57.6 million in the third quarter of 2001, showing
31% growth, or 27% on a constant currency basis. Europe experienced 15% sales
growth, 7% in constant currency, from the third quarter of 2002 compared to the
third quarter of 2001 despite the April launch of a competitor's drug eluting
stent. Japan reported 80% sales growth, 78% in constant currency, from the third
quarter of 2002 versus the same period in the prior year. Worldwide coronary
stent system revenues were $681.5 million for the nine months ended September
30, 2002, representing growth of 15% compared to revenues of $593.1 million for
the same period in 2001. Competitive introductions of drug eluting stents in the
U.S. are expected to significantly
15
increase the value of the worldwide stent market through higher prices and
expanded stent utilization and negatively impact sales of non-drug eluting
stents.
Continued coronary stent system growth was driven by 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 broad use coronary stent
system. The MULTI-LINK PIXEL System is specifically designed to treat small
diameter vessels. International coronary stent system growth was fueled by sales
growth in Japan where Guidant's MULTI-LINK TRISTAR(TM) Coronary Stent System was
launched in the fourth quarter of 2001. The strength of European sales was
driven by the introduction of Guidant's sixth generation MULTI-LINK ZETA(TM)
Coronary Stent System in May 2002, despite recent competitors' introductions of
a drug eluting stent therapy and a new bare metal stent in the European market.
In September 2002, Guidant announced FDA approval and launch of the MULTI-LINK
ZETA System. The MULTI-LINK ZETA utilizes the same proven implant from the
MULTI-LINK PENTA and has a new delivery system designed to offer clinicians
improved deliverability in challenging clinical settings.
In October 2002, Guidant announced that a Pre-Market Approval (PMA) application
was submitted to the FDA for the investigational MULTI-LINK VISION(TM) Coronary
Stent System, the Company's seventh-generation MULTI-LINK Stent platform for the
treatment of coronary artery disease. The MULTI-LINK VISION Coronary Stent
System is the first in a new class of stents constructed of a cobalt chromium
alloy, enabling the stent to have thinner stent struts and enhanced
deliverability while maintaining radial strength and visibility.
In August 2001, Guidant and Cook Incorporated (Cook) announced that they had
entered into a series of development and distribution agreements involving
Cook'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
System, developed and manufactured by Cook. Enrollment in clinical trials
relating to the ACHIEVE has been completed. Clinical evaluation of the results
is continuing. As further described in Part II, Item 1, the court adjudicating
Boston Scientific's challenge to the agreements granted Boston Scientific
summary judgment in June 2002, and in October 2002 entered a permanent
injunction prohibiting, among other things, performance under the agreements and
commercial use of the data generated under them. Also in October 2002, Cook and
the Company filed motions in the 7th Circuit Court of Appeals requesting a stay
of the injunction pending Cook's appeal. The resolution of the litigation and
related matters may materially affect the timing of the Company's bringing a
competitive drug eluting stent to market.
On July 30, 2002, Guidant entered into an agreement to acquire Cook Group
Incorporated (Cook Group), the corporate parent of Cook, in a stock-for-stock
transaction, pursuant to which Guidant would issue up to 65.79 million Guidant
common shares. The terms of the agreement are more fully described in Note 11 to
the consolidated financial statements. Consummation of the agreement is subject
to a number of conditions, including the availability of the data described
above.
In pursuit of multiple product platforms for development of drug eluting stent
technology, Guidant announced an agreement with Novartis to expand an existing
license agreement to grant Guidant exclusive worldwide rights to utilize
everolimus in drug
16
eluting stents for the prevention and treatment of coronary and peripheral
vascular diseases. Terms are further described in Note 7. Pending regulatory
approvals, Guidant expects to initiate human clinical trials of everolimus
eluting coronary stents early next year.
Intravascular Radiotherapy Systems
Worldwide sales of the GALILEO(TM) Intravascular Radiotherapy System increased
to $10.2 million during the third quarter of 2002 compared to $0.9 million
during the same period in 2001. Sales for the first nine months of 2002 were
$25.6 million compared to $2.0 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. Introductions of drug eluting stents may negatively impact
the intravascular radiotherapy systems market.
In September 2002, Guidant announced FDA approval and launch of its
next-generation GALILEO III Intravascular Radiotherapy System. The system is
currently available in Europe. GALILEO III's enhanced automaticity is designed
to make the system easier to use for clinicians. Guidant's GALILEO INHIBIT trial
of the GALILEO III System showed a 71% reduction in binary restenosis and a 47%
reduction in the incidence of Major Adverse Cardiac Events (MACE), a composite
of death, myocardial infarction and repeat vascularization of the target site,
in patients treated with radiotherapy at nine months.
Angioplasty
Angioplasty system and accessory sales, including sales of atherectomy products,
totaled $97.7 million in the third quarter of 2002 compared to $96.8 million
during the third quarter of 2001. The increase in sales was driven by unit
volume increases of 2% and a 2% positive foreign currency exchange impact,
offset by price declines of 3%. Sales of these products for the nine months
ended September 30, 2002, were $291.0 million compared to $298.8 million for the
same period in 2001.
Peripheral Vascular and Biliary Products
Worldwide sales of peripheral vascular and biliary products totaled $18.4
million in the third quarter of 2002, representing 34% growth over the same
period in the prior year. Sales of these products for the nine months ended
September 30, 2002, were $53.8 million compared to $38.5 million for the same
period in 2001. Growth was driven by acceptance of the RX HERCULINK PLUS(TM)
Biliary 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 in Europe.
In October 2002, Guidant announced FDA clearance to market its new AGILTRAC(TM)
..035 Peripheral Dilatation Catheter. The AGILTRAC .035 Peripheral Dilatation
Catheter is Guidant's first dilatation catheter on a .035 platform. FDA
clearance follows recent CE Marking of the AGILTRAC .035 Peripheral Dilatation
Catheter, which will launch worldwide in the fourth quarter of 2002.
17
Systems for Treatment of AAA
Sales of Guidant's ANCURE(R) ENDOGRAFT(R) System and accessories for the
treatment of AAA were $14.3 million for the three months ended September 30,
2002, compared to $11.5 million for the three months ended September 30, 2001.
Sales of these products for the first nine months of 2002 were $49.1 million
compared to $30.3 million for the same period in 2001. Total sales were impacted
in 2001 by a voluntary product recall in March 2001 and subsequent relaunch in
August 2001.
Cardiac Surgery Products
Sales of cardiac surgery products were $23.3 million for the quarter ended
September 30, 2002, compared to $18.0 million for the quarter ended September
30, 2001, representing 29% growth. Sales of these products for the nine months
ended September 30, 2002, were $66.3 million compared to $53.5 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. 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 September 2002, Guidant announced that it received CE Mark and FDA 510k
clearance for its HEARTSTRING(TM) Proximal Seal System. During November 2002,
the Company initiated a voluntary recall that involved approximately 100
devices and will not have a material impact on the Company's results of
operations.
COST OF PRODUCTS SOLD AND EXPENSES
For the three months ended September 30, 2002, cost of products sold represented
24.9% of net sales, which was consistent with the same period in 2001. Improved
manufacturing efficiencies, particularly in the cardiac rhythm management
product lines, were offset by a shift in product sales mix. Cost of products
sold as a percentage of net sales was 25.0% for the first nine months of 2002
compared to 24.6% for the first nine months of 2001. The small increase was
driven by reduced manufacturing throughput and a shift in product mix in the
first half of 2002 versus 2001.
Guidant continued to invest aggressively in research and development in the
third quarter of 2002, evidenced by a 15% increase over the third quarter of
2001. Research and development expense was $109.0 million for the quarter ended
September 30, 2002, or 13.2% of net sales, compared to $95.1 million in 2001, or
14.4% of net sales. The $13.9 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 nine months of 2002 totaled $315.7 million compared to
$278.5 million for the same period in 2001.
Sales, marketing, and administrative expenses were $252.6 million for the three
months ended September 30, 2002, an increase of $52.6 million or 26%, compared
to the same period in 2001. These expenses for the nine months ended September
30, 2002, totaled $723.0 million, an increase of $107.0 million or 17% over the
same period in the prior year. The increase was the result of sales growth and
continued expansion of the U.S. sales organization.
18
Decreases in interest expense were driven by lower average debt outstanding and
lower interest rates in 2002, in addition to increased interest income in 2002.
Net interest expense totaled $0.1 million for the third quarter of 2002, a
decrease of $7.0 million compared to the third quarter of 2001. Net interest
expense totaled $5.9 million for the first nine months of 2002 compared to $25.5
million for the same period in 2001.
Amortization expense for the third quarter of 2002 was $3.4 million, a decrease
of $7.4 million compared to the third quarter of 2001. Amortization expense for
the first nine months of 2002 was $9.8 million, a decrease of $22.8 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 Novartis purchased in-process research and development
expense (described in Note 7), 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 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 the Company's endovascular
solutions product lines. The charge includes the termination of Guidant's
involvement in certain 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 $17.8 million remain at September 30, 2002.
In the first quarter of 2001, the Company recorded special charges of $25.0
million related to a VENTAK(R) PRIZM(TM) Implantable Defibrillator field action
and an ANCURE voluntary recall. The field action concerned a specific memory
component in the first-generation VENTAK PRIZM device. Field inventory that
contained the memory component was returned to the Company and a software
solution was designed to non-invasively return 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 approvals allowing the return to a full market
release of the ANCURE system.
The effective income tax rates for the quarters ended September 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 nine months ended
September 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.
19
Net income and earnings per share-diluted were $175.1 million and $0.57,
respectively, for the quarter ended September 30, 2002. Net income and earnings
per share-diluted for the quarter ended September 30, 2001, were $122.4 million
and $0.40 per share, respectively. This represents an increase in net income of
$52.7 million or 43%.
Reported net income and earnings per share-diluted were $519.4 million and $1.69
per share, respectively, for the first nine months of 2002 compared to $348.9
million and $1.14 per share, respectively, for the same period in 2001. Net
income and earnings per share-diluted were $482.1 million and $1.57 per share,
respectively for the nine months ended September 30, 2002, excluding the special
items previously described. Net income and earnings per share-diluted for the
nine months ended September 30, 2001, were $364.6 million and $1.19 per share,
respectively, excluding the special item.
LIQUIDITY AND FINANCIAL CONDITION
The Company generated cash flows that were more than sufficient to fund
operations during the nine months ended September 30, 2002. Cash and cash
equivalents were $907.3 million at September 30, 2002, an increase of $469.5
million over December 31, 2001. A substantial portion of the Company's cash and
cash equivalents are held as permanent investments by Guidant's non-U.S.
subsidiaries.
Working capital of $1,294.9 million at September 30, 2002, increased $535.7
million from the prior year-end level. The current ratio at September 30, 2002,
was 2.6:1 compared to 2.0:1 at December 31, 2001. Guidant's balance sheet
reflects a net cash position of $432.1 million at September 30, 2002, compared
to a net debt position of $322.2 million at December 31, 2001. Days receivables
outstanding (DSOs) decreased 9% to 73 days at September 30, 2002, compared to 80
days at December 31, 2001, due to increased credit and collection efforts.
Inventory turnover was consistent for the nine months ended September 30, 2002,
and September 30, 2001, at 2.0 and 2.1, respectively. 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 $787.7 million for the nine months
ended September 30, 2002, compared to $448.5 million for the same period in
2001. Net income for the nine months ended September 30, 2002, was $519.4
million, a $170.5 million increase compared to the same period in 2001. Changes
in other non-cash expenses were an $11.1 million use of cash for the nine-month
period ended September 30, 2002, compared to a $45.2 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 $68.5 million source
of cash in the first nine months of 2002 compared to a $32.1 million use of cash
in the first nine 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 third quarter of 2002, and accruals
for legal settlements in 2002. Increases in income taxes payable resulted in an
$80.3 million source of cash in the first nine months of 2002 compared to a
$31.8 million source of cash in the first nine months of 2001. Income taxes
payable increased primarily due to increased income before taxes in 2002
compared to 2001. Changes in other liabilities were an $85.8 million source of
cash in the first
20
nine months of 2002 compared to a $50.6 million source of cash in the first nine
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.
Net cash used for investing activities totaled $127.2 million for the nine
months ended September 30, 2002, compared to $118.9 million for the same period
in 2001. The primary investing activity was net additions of property and
equipment of $102.0 million and $105.4 million for the first nine months of 2002
and 2001, respectively.
Net cash used for financing activities totaled $246.3 million for the nine
months ended September 30, 2002, compared to $140.7 million for the same period
in 2001. This use of cash was driven by a net decrease in borrowings of $285.9
million for the first nine months of 2002 compared to a $42.1 million net
increase in borrowings for the same period in 2001. In addition, the Company
repurchased 5.2 million of its common shares for approximately $200.0 million in
the second quarter of 2001.
At September 30, 2002, the Company had outstanding borrowings of $475.2 million
through the issuance of commercial paper, bank borrowings, and a principal
amount of $350.0 million in long-term notes due in 2006. The Company entered
into an interest rate swap agreement related to the long-term notes in the
amount of $175.0 million. The total weighted average interest rate is 3.59%. The
commercial paper borrowings are supported by two credit facilities aggregating
$800.0 million. There are currently no outstanding borrowings under these
facilities. The Company has classified $127.1 million as short-term debt at
September 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 $165.0 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 $229.3 million at
September 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, capital expenditures, cash
flows and the timing of product developments. The statements are based on
assumptions about many important factors, including assumptions concerning:
o The development of the coronary stent market: Drug eluting stents present a
significant growth opportunity; however, the earlier introduction of drug
eluting stents by the Company's competitors are expected to substantially
affect the market for coronary stents generally and the Company's financial
results in coming quarters. Uncertainties concerning the litigation
relating to Cook Incorporated and the Cook Group transaction described in
this 10-Q may affect the timing of the Company's bringing a drug eluting
stent to market.
21
o The effects of operating in a highly regulated industry: Medical devices
are subject to extensive regulation by regulatory agencies, including the
FDA. Regulation substantially affects the timing and risks associated with
bringing new products to market. Further, the Company remains subject to
quality system reviews and reporting regulations with respect to marketed
products. If a regulatory agency believes that a company is not in
compliance with applicable regulations or that action is otherwise
warranted due to safety concerns or otherwise, the regulatory agency can
issue a warning letter or recall order, impose operating restrictions,
assess fines or impose other sanctions.
o The necessity for appropriate reimbursement for therapies: The major
third-party payors for hospital services in the U.S. and abroad can
significantly influence the products purchased and the amount purchasers
pay. The ability to obtain appropriate reimbursement is essential to the
success of medical devices. While the Company is actively engaged in the
policy dialogue concerning healthcare cost containment and reimbursement,
the outcomes of regulatory and other initiatives remain unpredictable.
Reimbursement decisions for the Company's products, such as ICDs, can
materially affect the Company's results.
o Other factors included on Exhibit 99.1: Exhibit 99.1 describes additional
factors, which are incorporated herein by reference, including: product
development and production factors (including the uncertainties associated
with clinical trials), litigation factors (including the importance of
intellectual property), competitive factors (including the rapid
introduction of new products and alternative therapies), and others.
Actual results may differ materially. The Company does not undertake to update
its forward-looking statements.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this report, an evaluation was carried out,
under the supervision of and with the participation of the Company's management,
including the Company's chief executive officer (CEO) and chief financial
officer (CFO), of the Company's disclosure controls and procedures. Based on the
evaluation, the CEO and CFO have concluded that the Company's disclosure
controls and procedures are effective.
Subsequent to the date of the evaluation, there were no significant changes in
the Company's internal controls or in other factors that could significantly
affect these controls, including any corrective actions with regard to
significant deficiencies and material weaknesses.
22
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 remaining
claims under U.S. patents 4,733,762 and 5,902,332. The arbitration hearing
currently is scheduled to take place early in 2003. In a separate arbitration,
Guidant has asserted claims against Cordis under Guidant's Lau/Lam patents. The
arbitration commenced in the first quarter of 2002, with Guidant asserting
claims under U.S. patents 5,514,154 and 6,066,167 relating to Cordis' BX
VELOCITY and OMNI BX stents. This arbitration is expected to be completed in
late 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 March 2003.
On August 20, 2001, the Company and Cook Incorporated (Cook) announced that they
had entered agreements pursuant to which the Company's ACS subsidiary would act
as worldwide exclusive distributor for a new paclitaxel coated coronary stent to
be developed and manufactured by Cook. On September 10, 2001, Boston Scientific
Corporation (Boston Scientific) sent a Notice of Dispute to Cook 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 Boston Scientific and Cook. Pursuant to an agreement among
the parties, Boston Scientific, Cook, the Company and ACS dismissed all
proceedings except for a complaint filed by Cook against Boston Scientific in
the Northern District of Illinois seeking a finding that Cook was not in breach
of the Angiotech license. Boston Scientific counterclaimed, alleging breach of
contract, seeking damages and injunctive relief preventing Cook from
implementing its agreements with ACS. On June 13, 2002, in ruling on
cross-motions for summary judgment, the court held in favor of Boston Scientific
on the breach of contract issue, concluding that the distribution arrangement
and processes for obtaining regulatory approvals were impermissible. On July 15,
2002, Boston Scientific filed a motion for permanent injunctive relief in
connection with the judgment. On October 1, 2002, the court entered a permanent
injunction prohibiting (a) any performance under or attempt to enforce the Cook
agreements with ACS, (b) sales by Cook of paclitaxel coated stents in a manner
inconsistent with the Angiotech agreement, and (c) any use for a commercial
purpose (including obtaining regulatory approval) of the information, data or
technology generated under the Cook agreements with ACS. On November 5, 2002,
the court clarified that the injunction does not enjoin the Company, as sponsor
of existing clinical trials relating to the stent, from fulfilling its reporting
obligations to the FDA. Cook and the Company have filed motions in the 7th
Circuit Court of Appeals requesting a stay of the injunction pending Cook's
appeal.
On July 30, following the Company's entry into an agreement to acquire Cook
Group Incorporated (corporate parent of Cook), 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 (now subject to the injunction noted above). Boston Scientific
subsequently filed a counterclaim alleging tortious interference with the
Angiotech license.
Except with respect to the matters described above, the outcomes of which could
be material to the Company, the ultimate liability associated with other matters
(including the previously disclosed matters described below) 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.
The Company is aware that the U.S. Department of Justice and the Office of
Criminal Investigations of the U.S. Food & Drug Administration (FDA) are
conducting an investigation into matters relating to the Company's ANCURE
23
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.
The Company has also has been served with a small number of individual suits and
is aware of the filing of additional suits alleging product liability related
causes of action relating to the ANCURE System.
On June 15, 2000, Medtronic, Inc. (Medtronic) filed a declaratory judgment
action against the Company and its subsidiary, Cardiac Pacemakers, Inc. (CPI),
in the District Court for Minnesota requesting that the court rule that
Medtronic does not infringe certain of CPI's patents for atrial fibrillation
technology or that the patents are not valid. Subsequently, Guidant asserted
additional patents related to atrial fibrillation technology against Medtronic
in the same court. Currently, nine patents are being asserted against Medtronic
in this consolidated litigation. Pretrial matters are scheduled through mid
2003.
On March 6, 2002, Pacesetter, Inc. (Pacesetter), a subsidiary of St. Jude
Medical, Inc. (St. Jude) filed a lawsuit against CPI and Guidant Sales
Corporation (GSC) in the Central District of California alleging that CPI and
GSC have infringed Pacesetter patents covering various features of pacemakers
and implantable defibrillators. Currently four patents are at issue. Pacesetter
is seeking injunctive relief, monetary damages and attorney fees. Pretrial
matters are scheduled through 2003.
Anna Mirowski, Eli Lilly and Company and two Company subsidiaries, GSC 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 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 each of the three jury findings above, along with the jury
award. The court awarded St. Jude certain post-trial fees and costs (in an
immaterial amount), along with contingent expenses and attorney fees upon any
retrial of the case if a retrial is required following any appeal of the court's
rulings. The plaintiffs have filed an appeal in the Federal Circuit Court of
Appeals.
24
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 two Current Reports on
Form 8-K: (i) filing dated July 30, 2002, relating to the Company's
entry into the Agreement and Plan of Merger with Cook Group
Incorporated described herein; (ii) filing dated August 13, 2002,
submitting sworn statements of the Company's CEO and CFO pursuant to
SEC order, File No. 4-460.
25
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 November 13, 2002 /S/ Keith E. Brauer
-----------------------------
Vice President, Finance and
Chief Financial Officer
Date November 13, 2002 /S/ Peter J. Mariani
-----------------------------
Corporate Controller and
Chief Accounting Officer
26
CERTIFICATIONS
I, Ronald W. Dollens, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Guidant
Corporation;
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 13, 2002 /S/ Ronald W. Dollens
-----------------------------
Chief Executive Officer
27
I, Keith E. Brauer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Guidant
Corporation;
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 13, 2002 /S/ Keith E. Brauer
-----------------------------
Chief Financial Officer
28
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
29