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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

ý

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended September 30, 2004

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

 

 

 

 

 

For the transition period from                     to                    

 

 

 

Commission File Number 0-27558

 

CYTYC CORPORATION

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

02-0407755

(State or other jurisdiction of incorporation or
organization)

 

(I.R.S. Employer
Identification No.)

 

85 Swanson Road, Boxborough, MA  01719

(Address of principal executive offices, including Zip Code)

 

(978) 263-8000

(Registrant’s telephone number, including area code)

 

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 ý    No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý    No o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: The number of shares of the issuer’s Common Stock, $0.01 par value per share, outstanding as of October 26, 2004 was 111,731,766.

 

Total Number of Pages: 26

Exhibit index located on page 26

 

 



 

CYTYC CORPORATION

 

INDEX TO FORM 10-Q

 

 

 

Page

 

 

 

Part I

Financial Information

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements

 

 

 

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

3

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2004 and 2003 (unaudited)

 

5

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (unaudited)

 

6

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

7

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

16

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

22

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

22

 

 

 

 

 

 

 

 

 

 

Part II

 

Other Information

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

23

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

23

 

 

 

 

 

 

Item 6.

Exhibits

 

23

 

 

 

 

Signatures

 

 

25

 

 

 

 

Exhibit Index

 

 

26

 

2



 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the Board of Directors and Stockholders of

Cytyc Corporation

85 Swanson Road

Boxborough, Massachusetts

 

 

We have reviewed the accompanying condensed consolidated balance sheet of Cytyc Corporation and subsidiaries as of September 30, 2004, and the related condensed consolidated statements of income for the three-month and nine-month periods ended September 30, 2004 and 2003, and of cash flows for the nine-month periods ended September 30, 2004 and 2003.  These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Cytyc Corporation and subsidiaries as of December 31, 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated January 27, 2004, we expressed an unqualified opinion on those consolidated financial statements, and included an explanatory paragraph describing a change in accounting principle with respect to goodwill in the year ended December 31, 2002 and certain revisions, resulting from the change in accounting principle, to disclosures in the financial statements for the year ended December 31, 2001 which were audited by other auditors who have ceased operations, as disclosed in Note 2 to the consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

DELOITTE & TOUCHE LLP

 

Boston, Massachusetts

October 29, 2004

 

3



Part I                 FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

 

CYTYC CORPORATION

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

 

 

 

September 30,
2004

 

December 31,
2003

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

116,632

 

$

71,597

 

Investment securities

 

62,246

 

106,300

 

Accounts receivable, net of allowance of $1,168 and $1,744 at September 30, 2004 and December 31, 2003, respectively

 

61,466

 

42,070

 

Inventories

 

25,017

 

17,801

 

Deferred tax assets, net

 

2,830

 

2,730

 

Prepaid expenses and other current assets

 

7,430

 

2,129

 

Total current assets

 

275,621

 

242,627

 

Property and equipment, net

 

40,405

 

32,561

 

Intangible assets:

 

 

 

 

 

Patents and developed technology, net of accumulated amortization of $5,460 and $3,281 at September 30, 2004 and December 31, 2003, respectively

 

97,670

 

16,149

 

Goodwill

 

294,000

 

91,097

 

Total intangible assets

 

391,670

 

107,246

 

Equipment under customer usage agreements, net

 

26,630

 

8,072

 

Other assets, net

 

7,757

 

394

 

Total assets

 

$

742,083

 

$

390,900

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

9,693

 

$

8,364

 

Accrued expenses

 

44,729

 

23,141

 

Deferred revenue

 

3,195

 

1,415

 

Total current liabilities

 

57,617

 

32,920

 

 

 

 

 

 

 

Deferred tax liabilities, net

 

4,333

 

4,221

 

Long-term debt and other non-current liabilities

 

250,142

 

128

 

Commitments and contingencies (note 14)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $.01 par value—
Authorized-5,000,000 shares
No shares issued or outstanding

 

 

 

Common stock, $.01 par value—
Authorized-200,000,000 shares
Issued-126,977,436 and 124,725,579 shares in 2004 and 2003, respectively
Outstanding-111,698,397 and 109,581,540 shares in 2004 and 2003, respectively

 

1,270

 

1,247

 

Additional paid-in capital

 

435,847

 

405,828

 

Treasury stock, at cost: 15,279,039 and 15,144,039 shares in 2004 and 2003, respectively

 

(157,448

)

(155,767

)

Accumulated other comprehensive income

 

2,504

 

2,679

 

Retained earnings

 

147,818

 

99,644

 

 

 

 

 

 

 

Total stockholders’ equity

 

429,991

 

353,631

 

Total liabilities and stockholders’ equity

 

$

742,083

 

$

390,900

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4



 

CYTYC CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

(unaudited)

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Net sales

 

$

102,787

 

$

75,457

 

$

282,986

 

$

224,766

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

21,334

 

14,063

 

58,172

 

41,639

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

81,453

 

61,394

 

224,814

 

183,127

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

5,424

 

4,212

 

15,031

 

10,989

 

In-process research and development

 

 

 

19,100

 

 

Sales and marketing

 

26,349

 

20,201

 

73,913

 

60,201

 

General and administrative

 

8,402

 

6,805

 

24,667

 

19,711

 

Total operating expenses

 

40,175

 

31,218

 

132,711

 

90,901

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

41,278

 

30,176

 

92,103

 

92,226

 

Other (expense) income, net:

 

 

 

 

 

 

 

 

 

Interest income

 

492

 

477

 

1,597

 

1,884

 

Interest expense

 

(1,801

)

 

(3,590

)

 

Other

 

(30

)

(200

)

(703

)

(112

)

Total other (expense) income, net

 

(1,339

)

277

 

(2,696

)

1,772

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

39,939

 

30,453

 

89,407

 

93,998

 

Provision for income taxes

 

15,177

 

11,855

 

41,233

 

37,281

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

24,762

 

$

18,598

 

$

48,174

 

$

56,717

 

 

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.22

 

$

0.17

 

$

0.44

 

$

0.51

 

Diluted

 

$

0.21

 

$

0.17

 

$

0.42

 

$

0.50

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

111,412

 

109,728

 

110,707

 

111,410

 

Diluted

 

115,791

 

111,613

 

114,553

 

113,196

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5



 

CYTYC CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Nine Months
Ended
September 30,

 

 

 

2004

 

2003

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

48,174

 

$

56,717

 

Depreciation and amortization

 

11,818

 

6,448

 

Provision for doubtful accounts

 

(576

)

(280

)

Acquired in-process research and development

 

19,100

 

 

Amortization of deferred financing costs

 

777

 

 

Compensation expense related to issuance of stock to directors, executives and non-employee awards

 

309

 

562

 

Compensation expense related to stock options assumed in acquisition of Pro-Duct Health

 

 

21

 

Change in deferred income taxes

 

(455

)

3,644

 

Changes in assets and liabilities, excluding effects of acquisition—

 

 

 

 

 

Accounts receivable

 

(12,264

)

(6,376

)

Inventories

 

(3,332

)

(4,208

)

Prepaid expenses and other current assets

 

(4,903

)

(1,325

)

Accounts payable

 

(4,978

)

2,802

 

Accrued expenses

 

18,697

 

2,939

 

Deferred revenue

 

1,748

 

(198

)

Tax benefit from exercise of stock options

 

5,934

 

3,078

 

 

 

 

 

 

 

Net cash provided by operating activities

 

80,049

 

63,824

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Acquisition of Novacept, net of cash acquired

 

(309,330

)

 

(Increase) decrease in other assets

 

(247

)

2,935

 

Increase in equipment under customer usage agreements

 

(21,963

)

(1,310

)

Purchases of property and equipment

 

(11,537

)

(7,787

)

Purchases of investment securities

 

(36,522

)

(108,473

)

Proceeds from sale of investment securities

 

80,351

 

147,237

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

(299,248

)

32,602

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of convertible notes, net of issuance costs

 

242,226

 

 

Purchase of treasury shares

 

(1,680

)

(55,133

)

Proceeds from issuance of shares under Employee Stock Purchase Plan

 

769

 

633

 

Proceeds from exercise of stock options

 

23,029

 

4,147

 

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

264,344

 

(50,353

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(110

)

1,733

 

Net increase in cash and cash equivalents

 

45,035

 

47,806

 

Cash and cash equivalents, beginning of period

 

71,597

 

39,251

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

116,632

 

$

87,057

 

 

 

 

 

 

 

Supplemental disclosure of non-cash items:

 

 

 

 

 

Unrealized holding loss on investment securities

 

$

(138

)

$

(39

)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6



 

CYTYC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

(1)       Basis of Presentation

 

The accompanying condensed consolidated financial statements of Cytyc Corporation and subsidiaries (the “Company” or “Cytyc”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.   These financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

The notes and accompanying condensed consolidated financial statements are unaudited.  The information furnished reflects all adjustments, which, in the opinion of management, are necessary for a fair presentation of results for the interim periods.  Such adjustments consisted only of normal recurring items.  The interim periods are not necessarily indicative of the results expected for the full year or any future period.

 

The preparation of these condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

(2)       Acquisition of Novacept

 

On March 24, 2004, Cytyc acquired Novacept, a privately held California corporation, in a non-taxable transaction through the merger (the “Merger”) of Radio Acquisition Corporation, a newly formed, wholly-owned subsidiary of Cytyc, with and into Novacept. The Merger was effected pursuant to the Agreement and Plan of Merger, dated as of March 1, 2004, as amended by Amendment No. 1 to the Merger Agreement, dated as of March 22, 2004. As a result of the Merger, all of Novacept’s issued and outstanding capital stock immediately prior to the Merger was automatically converted into the right to receive an aggregate of approximately $321.4 million in cash. To satisfy certain claims as provided in the Merger Agreement, $27.5 million of the purchase price was placed in escrow.

 

Novacept, renamed Cytyc Surgical Products following the acquisition, manufactures and markets the NovaSure® System, an endometrial ablation device to treat menorrhagia, or excessive menstrual bleeding. The acquisition of Novacept is intended to build on Cytyc’s reputation and leadership position in providing innovative medical technologies for women’s health, significantly increase Cytyc’s sales and marketing resources to obstetrics and gynecology physicians and thereby increase the Company’s competitive position for both the ThinPrep® and NovaSure product lines, leverage the Company’s international infrastructure, and provide a strong and diversified financial growth trajectory. The purchase price was supported by estimates of future revenue and earnings of Novacept, as well as the value of sales force and other projected synergies.

 

The aggregate purchase price for Novacept was approximately $325.8 million, of which $321.4 million represented cash payable to Novacept shareholders and $4.4 million represented acquisition-related fees and expenses. The acquisition has been accounted for as a purchase in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, and accordingly, the results of operations of Novacept have been included in the accompanying condensed consolidated statement of operations from the date of the acquisition. In accordance with SFAS No. 141, the total purchase price has been preliminarily allocated to the tangible and intangible assets acquired and liabilities assumed based on management’s estimates of current fair values and may change as additional information becomes available. The goodwill and other intangible assets resulting from the acquisition will be accounted for under SFAS No. 142, Goodwill and Other Intangible Assets.

 

In-Process Research and Development and Developed Technology

 

As part of the purchase price allocation, all intangible assets were identified and valued. It was determined that certain developed and in-development technology had value. As a result of this identification and valuation process, the Company allocated approximately $19.1 million of the purchase price to in-process research and development projects. This allocation represents the estimated fair value based on risk-adjusted cash flows related to incomplete research and development activities primarily associated with an upgrade to the RF Controller, a controller that

 

7



 

delivers radio frequency and serves as a primary component of the NovaSure System. At the date of acquisition, the development of the next generation RF Controller had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, the acquired in-process research and development was charged to expense as of the date of the acquisition.

 

Of the total purchase price, the Company also allocated approximately $83.7 million to patents and developed technology, which is being amortized using the cash flow method over a period of 15 years and relates to the NovaSure System.  Under the cash flow method, amortization is calculated and recognized based upon the Company’s estimated net cash flows over the life of the intangible asset, reflecting the pattern in which the economic benefits of the intangible asset are consumed in accordance with SFAS No. 142.

 

Goodwill

 

The excess of the purchase price over the fair value of tangible and identifiable intangible net assets of approximately $202.9 million was allocated to goodwill, which is non-deductible for tax purposes. In accordance with SFAS No. 142, this amount will not be systematically amortized. Instead, the Company will perform an annual assessment for impairment by applying a fair-value-based test.

 

Purchase Price Allocation

 

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed, at the date of acquisition, for an aggregate purchase price of approximately $325.8 million including acquisition costs.

 

 

 

Amount

 

 

 

(in thousands)

 

 

 

 

 

Current assets

 

$

27,418

 

Property and equipment

 

2,556

 

Patents and developed technology

 

83,700

 

Goodwill

 

202,912

 

Other assets

 

121

 

Current liabilities

 

(9,189

)

Deferred tax liability—long-term

 

(793

)

In-process research and development

 

19,100

 

 

 

$

325,825

 

 

Pro Forma results

 

The following unaudited pro forma financial information presents the combined results of operations of Cytyc and Novacept as if the acquisition had occurred as of the beginning of the periods presented. Both periods include pro forma adjustments to reflect interest costs related to the convertible notes offering (see Note 7). The pro forma results for the three and nine months ended September 30, 2004 include $5.6 million of transaction fees and expenses incurred by Novacept related to the Merger, but exclude $19.1 million of in-process research and development costs.  The pro forma adjustments are based upon available information and certain assumptions that management believes are reasonable. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated results of operations or financial condition of the Company that would have been reported had the acquisition been completed as of the dates presented, and should not be taken as representative of the future consolidated results of operations or financial condition of the Company.

 

8



 

Pro forma results were as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands,
except per share data)

 

(in thousands,
except per share data)

 

Net sales

 

$

102,787

 

$

85,961

 

$

295,085

 

$

249,334

 

Net income

 

$

24,762

 

$

17,541

 

$

60,610

 

$

50,161

 

 

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.22

 

$

0.16

 

$

0.55

 

$

0.45

 

Diluted

 

$

0.21

 

$

0.16

 

$

0.53

 

$

0.44

 

 

(3)       Amortization of Other Intangible Assets

 

Amortization expense related to identifiable other intangible assets that will continue to be amortized in the future was approximately $924,000 and $368,000 for the three months ended September 30, 2004 and 2003, respectively, and approximately $2,179,000 and $1,104,000 for the nine months ended September 30, 2004 and 2003, respectively. Estimated amortization expense related to other identifiable intangible assets, including patents and developed technology from the Novacept acquisition, is as follows:

 

 

 

Amount

 

 

 

(in thousands)

 

Remaining three months ending December 31, 2004

 

$

963

 

Year ending December 31, 2005

 

6,584

 

Year ending December 31, 2006

 

8,506

 

Year ending December 31, 2007

 

10,816

 

Year ending December 31, 2008

 

12,671

 

Year ending December 31, 2009

 

12,630

 

Thereafter

 

45,500

 

 

 

 

 

Total

 

$

97,670

 

 

(4)       Investment Securities

 

Investment securities consist of U.S. government securities, municipal bonds, corporate bonds and commercial paper. At September 30, 2004, the Company’s available-for-sale securities had contractual maturities at various dates through July 2006.  The fair value of available-for-sale securities was determined based on quoted market prices at the reporting date for those securities.  Available-for-sale securities are shown in the consolidated financial statements at fair market value.  The Company has the ability and intent to hold securities when fair value is less than cost. At September 30, 2004 and December 31, 2003, the cost basis, aggregate fair value and gross unrealized holding gains (losses) by major security type were as follows:

 

9



 

 

 

Amortized
Cost

 

Gross
Unrealized
Holding
Gains /(Losses)

 

Fair
Value

 

 

 

(in thousands)

 

September 30, 2004

 

 

 

 

 

 

 

Available-for-sale securities

 

 

 

 

 

 

 

Municipal bonds (average maturity of 7.7 months)

 

$

45,661

 

$

(88

)

$

45,573

 

U.S. government and agency securities (average maturity of 5.2 months)

 

12,428

 

(19

)

12,409

 

Corporate bonds (average maturity of 3.2 months)

 

4,273

 

(9

)

4,264

 

 

 

$

62,362

 

$

(116

)

$

62,246

 

 

 

 

 

 

 

 

 

December 31, 2003

 

 

 

 

 

 

 

Available-for-sale securities

 

 

 

 

 

 

 

Municipal bonds (average maturity of 13.3 months)

 

$

38,754

 

$

21

 

$

38,775

 

U.S. government and agency securities (average maturity of 8.3 months)

 

37,265

 

20

 

37,285

 

Corporate bonds (average maturity of 6.8 months)

 

28,175

 

68

 

28,243

 

Commercial paper (average maturity of 1.7 months)

 

1,997

 

 

1,997

 

 

 

$

106,191

 

$

109

 

$

106,300

 

 

(5)       Inventories

 

Inventories are stated at the lower of cost (first-in, first-out) or market and consist of the following:

 

 

 

September 30,
2004

 

December 31,
2003

 

 

 

(in thousands)

 

Raw material and work-in-process

 

$

14,152

 

$

10,580

 

Finished goods

 

10,865

 

7,221

 

 

 

$

25,017

 

$

17,801

 

 

 

(6)       Product Warranty Obligation

 

The Company records a liability for product warranty obligations at the time of sale based upon historical warranty experience. The term of the warranty is generally twelve months. The Company also records an additional liability for specific warranty matters when they become known and are reasonably estimable. The Company’s product warranty obligations are included in accrued expenses. Changes in the product warranty obligations for the nine months ended September 30, 2004 and 2003 are as follows:

 

 

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

 

 

(in thousands)

 

 

 

 

 

 

 

Balance, beginning of year

 

$

925

 

$

1,923

 

New warranties

 

296

 

137

 

Payments

 

(848

)

(887

)

Adjustments

 

118

 

 

Balance, September 30

 

$

491

 

$

1,173

 

 

10



 

(7)       Long-Term Debt

 

On March 22, 2004, the Company completed the sale (the “Offering”) of $250 million aggregate principal amount of its 2.25% convertible notes due 2024. The convertible notes were sold to qualified institutional buyers pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended. The Company used the proceeds from the Offering along with existing cash to finance the acquisition of Novacept. Total proceeds from the private placement were $242.2 million, net of debt issuance costs of $7.8 million.

 

The notes bear interest at a rate of 2.25% per year on the principal amount, payable semi-annually in arrears in cash on March 15 and September 15 of each year, beginning September 15, 2004.  In addition, if the average trading price of a note for the five trading days immediately preceding the first day of the applicable six-month period equals 120% or more of the principal amount of such note, the Company will also pay contingent interest during any six-month period from March 15 to September 14, and from September 15 to March 14, with the initial six-month period commencing March 15, 2009. During any interest period when contingent interest shall be payable, the contingent interest payable per note will equal 0.25% of the average trading price of the notes during the five trading days immediately preceding the first day of the applicable six-month interest period.

 

The holders of the notes may convert the notes into shares of the Company’s common stock at a conversion rate of 33.7041 shares per $1,000 principal amount of notes, which represents a conversion price of $29.67 per share, subject to adjustment, prior to the close of business on March 15, 2024, subject to prior redemption or repurchase of the notes, under any of the following circumstances: (1) during any calendar quarter commencing after June 30, 2004 if the closing sale price of the Company’s common stock exceeds 120% of the conversion price for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding calendar quarter (if the specified threshold is met, the notes will thereafter be convertible at any time at the option of the holder prior to the close of business on March 15, 2024); (2) during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of notes for each day of such period was less than 98% of the product of the closing sale price of the Company’s common stock and the number of shares issuable upon conversion of $1,000 principal amount of the notes; (3) if the notes have been called for redemption; or (4) upon the occurrence of specified corporate events.

 

Holders may require the Company to repurchase the notes on March 15 of 2009, 2014 and 2019 at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, including contingent interest and liquidated damages, if any, to, but excluding, the repurchase date. The Company may redeem any of the notes beginning March 20, 2009, by giving holders at least 30 days’ notice. The Company may redeem the notes either in whole or in part at a redemption price equal to 100% of their principal amount, plus accrued and unpaid interest, including contingent interest and liquidated damages, if any, to, but excluding, the redemption date.

 

The notes will be the Company’s senior unsecured obligations and will rank equally with all of the Company’s existing and future senior unsecured debt and prior to all future subordinated debt. The notes will be effectively subordinated to any future secured indebtedness to the extent of the collateral securing such indebtedness, and to all indebtedness and other liabilities (including trade payables) of the Company’s subsidiaries.

 

(8)       Net Income Per Common Share

 

Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing net income by the weighted average number of common shares and potential common shares from outstanding stock options. Potential common shares are calculated using the treasury stock method and represent incremental shares issuable upon exercise of the Company’s outstanding stock options. The following table provides a reconciliation of the denominators used in calculating basic and diluted net income per share for the three and nine months ended September 30, 2004 and 2003.

 

11



 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands)

 

(in thousands)

 

Basic weighted average common shares outstanding

 

111,412

 

109,728

 

110,707

 

111,410

 

Dilutive effect of assumed exercise of stock options

 

4,379

 

1,885

 

3,846

 

1,786

 

Diluted weighted average common shares outstanding

 

115,791

 

111,613

 

114,553

 

113,196

 

 

Diluted weighted average common shares outstanding for the three months ended September 30, 2004 and 2003 excludes 3,859,244 and 11,390,425 potential common shares, respectively, from stock options outstanding because the exercise prices of such stock options were higher than the average closing price of the Company’s common stock as quoted on The Nasdaq National Market during the applicable periods and their effect would be anti-dilutive. Diluted weighted average common shares outstanding for the nine months ended September 30, 2004 and 2003 excludes 6,748,411 and 11,999,644 potential common shares, respectively, from stock options outstanding because the exercise prices of such stock options were higher than the average closing price of the Company’s common stock as quoted on The Nasdaq National Market during the applicable periods and their effect would be anti-dilutive. The effect of approximately 8.4 million shares related to the assumed conversion of the $250 million 2.25% convertible notes issued in March 2004 has been excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2004 because the conversion circumstances are substantive contingencies and none of the conditions that would permit conversion have been satisfied. However, as a result of a recent change in accounting rules that is effective for periods ending after December 15, 2004, the dilutive effect of the 2.25% convertible notes will be included in dilutive earnings per share regardless of whether any of the triggering contingencies have been satisfied (see Note 13).

 

(9)       Stock-Based Compensation

 

SFAS No. 123, Accounting for Stock-Based Compensation, as amended, addresses the financial accounting and reporting standards for stock or other equity-based compensation arrangements.  The Company has elected to continue to use the intrinsic value-based method to account for employee stock option awards under the provisions of Accounting Principles Board Opinion (“APB”) No. 25 and provides disclosures based on the fair value method in the notes to the financial statements as permitted by SFAS No. 123.

 

Prior to October 2003, pro forma compensation cost for the Company’s stock options had been calculated using the Black-Scholes model based on a single-option valuation approach using the straight-line method of amortization. In October 2003, the Company revised the assumptions utilized by the Black-Scholes model in determining pro forma compensation cost based on updated historical data of option exercise behavior, such that the cost is determined based on the multiple-option valuation approach. As a result, beginning in October 2003, the Company calculated pro forma compensation cost for all outstanding unvested stock options and any stock options granted since that time using the accelerated amortization method prescribed in FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. Utilizing these assumptions, pro forma net income and net income per share would have been the following if compensation cost for the Company’s stock option plans had been determined consistent with SFAS No. 123:

 

12



 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands,
except per share data)

 

(in thousands,
except per share data)

 

Net income as reported

 

$

24,762

 

$

18,598

 

$

48,174

 

$

56,717

 

Assumed stock compensation cost

 

7,778

 

12,684

 

30,971

 

39,212

 

Pro forma net income

 

$

16,984

 

$

5,914

 

$

17,203

 

$

17,505

 

 

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic — as reported

 

$

0.22

 

$

0.17

 

$

0.44

 

$

0.51

 

Basic — pro forma

 

$

0.15

 

$

0.05

 

$

0.16

 

$

0.16

 

Diluted — as reported

 

$

0.21

 

$

0.17

 

$

0.42

 

$

0.50

 

Diluted — pro forma

 

$

0.15

 

$

0.05

 

$

0.15

 

$

0.15

 

 

The underlying assumptions used in the Black-Scholes model are as follows:

 

 

 

September 30,

 

 

 

2004

 

2003

 

Risk-free interest rate.

 

3.05

%

3.14

%

Expected dividend yield

 

 

 

Expected lives (in years)

 

3.50

 

5.28

 

Expected volatility

 

65

%

92

%

 

(10)   Comprehensive Income

 

Comprehensive income for the three and nine months ended September 30, 2004 and 2003 was as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands)

 

(in thousands)

 

Net income

 

$

24,762

 

$

18,598

 

$

48,174

 

$

56,717

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) on investment securities

 

40

 

6

 

(138

)

(39

)

Foreign currency translation adjustments

 

133

 

176

 

(37

)

1,368

 

Comprehensive income

 

$

24,935

 

$

18,780

 

$

47,999

 

$

58,046

 

 

(11)   Stock Repurchase Program

 

The Company has established a stock repurchase program, with authority to spend up to $200,000,000, plus the cost of purchasing additional shares in an amount equal to the number of shares issued to the Company’s stock option holders upon exercise of their stock options.  As of September 30, 2004, the Company had repurchased 15,279,039 shares under the program, with an aggregate cost of approximately $157,448,000 of which 135,000 shares were repurchased during the nine months ended September 30, 2004 for cash of approximately $1,680,000. There have been no repurchases under the program since January 2004. As of September 30, 2004, all of the 15,279,039 repurchased common shares were held in treasury.

 

(12)   Segment Information

 

The Company operates its business in two operating segments, which are aggregated into one reportable segment – the manufacture and sale of device-based medical products. These two operating segments are described below:

 

13



 

Diagnostic Products—  This segment provides the ThinPrep System for use in diagnostic applications primarily focused on women’s health. The ThinPrep System is widely used for cervical cancer screening and is the platform from which the Company has launched its expansion into breast cancer risk assessment with the FirstCyte Breast Test. The ThinPrep System consists of the ThinPrep 2000 Processor, ThinPrep 3000 Processor, ThinPrep Imaging System, and related reagents, filters, and other supplies.

 

Surgical Products—  Following the acquisition of Novacept on March 24, 2004, this segment provides the NovaSure System, an innovative endometrial ablation device to treat menorrhagia, or excessive menstrual bleeding. The NovaSure System allows physicians to treat women with excessive menstrual bleeding in a minimally invasive manner to eliminate or reduce their bleeding to normal levels. The NovaSure System consists of a single-use device and a controller that delivers radio frequency energy to the uterus.

 

Each of the Company’s operating segments has similar economic characteristics, technology, manufacturing processes, customers, distribution and marketing strategies and regulatory environments. Net sales by operating segment are as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands)

 

(in thousands)

 

Diagnostic products

 

$

83,115

 

$

75,457

 

$

243,920

 

$

224,766

 

Surgical products

 

19,672

 

 

39,066

 

 

 

 

$

102,787

 

$

75,457

 

$

282,986

 

$

224,766

 

 

(13)   Recent Accounting Pronouncement

 

In September 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, requiring that the dilutive effect of contingent convertible debt instruments (“CoCo’s”) be included in dilutive earnings per share regardless of whether the triggering contingency has been satisfied. This change in accounting principle is effective for all periods after December 15, 2004 and would be applied on a retroactive basis, requiring restatement of prior period dilutive earnings per share. This change is expected to result in additional dilution to the Company’s diluted earnings per share as a result of its $250.0 million 2.25% senior convertible notes issued in March 2004, which are CoCo’s. At September 30, 2004, for purposes of determining dilutive earnings per share, the interest expense net of tax effect would be added back to net income and an additional 8.4 million and 5.9 million shares of common stock would be added to diluted shares outstanding for the three and nine months ended September 30, 2004, respectively. Inclusion of the CoCo’s in diluted shares outstanding would not have affected diluted earnings per share for the three and nine months ended September 30, 2004.

 

(14)   Commitments and Contingencies

 

On June 16, 2003, the Company filed a suit for Declaratory Judgment in United States District Court for the District of Massachusetts asking the court to determine and declare that certain of TriPath Imaging, Inc.’s patents are invalid and not infringed by Cytyc’s ThinPrep Imaging System.  On June 17, TriPath Imaging, Inc. announced that it had filed a lawsuit against Cytyc Corporation in the United States District Court for the Middle District of North Carolina alleging patent infringement, false advertising, defamation, intentional interference, unfair competition, and unfair and deceptive trade practices.  On October 30, 2003, an order was entered by the district court judge in North Carolina transferring the North Carolina action to Massachusetts, thereby consolidating the cases into a single action to be heard in United States District Court for the District of Massachusetts.  Additionally on October 30, 2003, the district court judge in Massachusetts denied a motion by TriPath to have Cytyc’s Massachusetts case dismissed.  The case is currently in the discovery phase and the Massachusetts court has not yet set a trial date.  On March 17, 2004, a motion was granted removing the non-patent claims from the suit with the condition that if they are re-filed, they must be filed in Massachusetts.  Based on the current case schedule, the Company anticipates that a trial will be scheduled to occur sometime in late 2005 or 2006. Given the early stage and current status of the litigation, management is unable to express an opinion as to their likely outcome or an estimate of the possible loss or range of

 

14



 

loss. Nevertheless, the Company believes that the claims against it are without merit and intends to vigorously defend this suit.

 

Cytyc Surgical Products, formerly Novacept, is a party to a number of legal proceedings involving alleged injuries to patients that occurred during endometrial ablation procedures using the NovaSure product. The Company plans to vigorously defend against these product liability claims related to the NovaSure System. The Company believes that it has sufficient product liability insurance and certain indemnification rights under the terms of the Merger Agreement with Novacept to cover these claims and that the resolution of the pending proceedings will not materially harm its business or operating results.

 

(15)   Reclassification of Equipment Under Customer Usage Agreements

 

Cytyc installs certain of its equipment (the ThinPrep Imaging System, for example) at customer sites under use-plan agreements.  Under these arrangements, the equipment remains the Company’s property and the cost of the equipment is amortized to cost of sales over the respective terms of the customer arrangements, which are generally between three and five years. Use-plan agreements commit the customer to purchase certain minimum quantities of disposable supplies (ThinPrep Pap Tests) from the Company at a stated price over a defined contract term.  As of September 30, 2004, this equipment is reflected in equipment under customer usage agreements on the Company’s consolidated balance sheets. Previously, this equipment was included in other assets on the Company’s consolidated balance sheets. For presentation purposes, the prior period’s amounts have been reclassified to conform to the current period’s presentation.

 

15



 

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with our consolidated financial statements and the related notes appearing in our annual report on Form 10-K for the year ended December 31, 2003. Our discussion contains forward-looking statements that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth below under the heading “Certain Factors Which May Affect Future Results”.

 

Overview

 

Cytyc Corporation is a leading medical device company that designs, develops, manufactures, and markets innovative and clinically effective products primarily focused on women’s health.  Our products cover a range of women’s health applications including cervical cancer screening, breast cancer risk assessment and treatment of excessive menstrual bleeding.

 

We operate our business in two operating segments — diagnostic products and surgical products. These two operating segments are aggregated into one reportable segment — the manufacture and sale of device-based medical products. Our diagnostics products business provides the ThinPrep® System, the most widely used method for cervical cancer screening in the United States. The ThinPrep System consists of the ThinPrep 2000 Processor, ThinPrep 3000 Processor, ThinPrep Imaging System, and related reagents, filters, and other supplies.  In addition to the automated preparation of cervical cell specimens on microscope slides for use in cervical cancer screening, our ThinPrep System also allows for the automated preparation of other cell specimens on microscope slides for use in general, non-gynecological diagnostic applications. The ThinPrep System provides the platform from which we have launched our expansion into breast cancer risk assessment with the FirstCyte® Breast Test.

 

Our surgical products business manufactures and markets the NovaSure® Impedance Controlled Endometrial Ablation System, or the NovaSure System, an innovative endometrial ablation device to treat menorrhagia, or excessive menstrual bleeding.  The NovaSure System allows physicians to treat women with excessive menstrual bleeding in a minimally invasive manner to eliminate or reduce their bleeding. This business was created following our acquisition of Novacept, a California corporation, in March 2004. The NovaSure System is marketed and sold primarily to hospitals and outpatient surgery centers in the United States.

 

Critical Accounting Estimates

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. A “critical accounting estimate” is one which is both important to the portrayal of our financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We continuously evaluate our critical accounting estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Valuation of Long-Lived Assets, Intangibles and Goodwill. Intangible assets acquired in a business combination, including acquired in-process research and development, are recorded under the purchase method of accounting at their estimated fair values at the date of acquisition. The fair values of acquired intangible assets are determined by management using relevant information and assumptions and assisted, in certain situations, by independent appraisers. Fair value is generally calculated as the present value of estimated future cash flows using a risk-adjusted discount rate, which requires significant management judgment with respect to revenue and expense growth rates, and the selection and use of an appropriate discount rate. We assess the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable and at least annually in the case of goodwill. If it is determined that the carrying value of intangible, long-lived assets and goodwill might not be recoverable based upon the existence of one or more indicators of impairment, we would measure any impairment based on a projected discounted cash flow method if the undiscounted cash flows did not exceed the carrying value of such assets. No such impairment charges have been recorded to date. We are required to perform an impairment review for goodwill on an annual basis, or earlier if indicators of potential impairment exist. Based on our impairment review during 2004, the carrying amount of

 

16



 

goodwill did not exceed its fair value and, accordingly, no impairment loss exists. At September 30, 2004, we had $391.7 million of intangible assets, of which $294.0 million represented goodwill. An impairment to our intangible assets could result in a material, non-cash expense in our condensed consolidated statement of income.

 

Income Taxes and Deferred Taxes. We file income tax returns in ten countries as well as many states and other localities. We must estimate our income tax expense after considering, among other factors, differing tax rates between jurisdictions, allocation factors, tax credits, non-deductible items and changes in enacted tax rates. Deferred taxes arise because of the different treatment between financial statement accounting and tax accounting, known as “temporary differences.” We record the tax effect of these temporary differences as “deferred tax assets” and “deferred tax liabilities” on our consolidated balance sheet. Deferred tax assets generally result in tax deductions or credits subsequent to the period in which the related item was recorded in the consolidated statement of income. Deferred tax liabilities typically reflect a current tax deduction for which the related item has not yet been recorded in the consolidated statement of income. The carrying value of our deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions, to fully recover the net carrying value of the assets. If these estimates and related assumptions change in the future, we may be required to record a valuation allowance against our deferred tax assets resulting in additional income tax expense in our consolidated statement of income. As a result of the acquisition of Novacept, we recorded approximately $31.4 million of deferred tax assets related to acquired net operating losses (“NOL’s”).  If we are unable to realize the benefits of these NOL’s in future years, we may be required to record additional tax expense in our condensed consolidated statement of income.

 

Legal Proceedings. We are involved in various legal actions, the outcomes of which are not within our complete control and may not be known for prolonged periods of time. In some actions, the claimants seek damages, as well as other relief, which, if granted, would require significant expenditures. We record a liability in our consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. We review these estimates each accounting period as additional information is known and adjust the loss provision when appropriate. If the loss is not probable or cannot be reasonably estimated, a liability is not recorded in the consolidated financial statements. Our significant legal proceedings, some of which are a result of our acquisition of Novacept in March 2004, are discussed in Note 14 to these consolidated financial statements, in our annual report on Form 10-K for the year ended December 31, 2003 and in our quarterly reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004.

 

The above list is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended December 31, 2003, which contain accounting policies and other disclosures required by generally accepted accounting principles in the United States.

 

Results of Operations

 

Net Sales

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

%
Change

 

2004

 

2003

 

%
Change

 

 

 

($ in millions)

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diagnostic Products

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic

 

$

73.2

 

$

67.7

 

8

%

$

213.6

 

$

202.2

 

6

%

International

 

9.9

 

7.8

 

27

%

30.3

 

22.6

 

34

%

Total Diagnostic Products

 

83.1

 

75.5

 

10

%

243.9

 

224.8

 

9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Surgical Products (1)

 

19.7

 

 

n/a

 

39.1

 

 

n/a

 

Total Company

 

$

102.8

 

$

75.5

 

36

%

$

283.0

 

$

224.8

 

26

%

 


(1)       The surgical products division was created following our acquisition of Novacept on March 24, 2004. Our fiscal year 2004 operating results include the results of Novacept from the date of acquisition.

 

17



 

Net sales for our diagnostic products increased primarily due to increased domestic sales of our ThinPrep Pap Test (the disposable supplies used in gynecological applications of the ThinPrep System), which increased 7% in both the three and nine months ended September 30, 2004 compared to the same periods of 2003. This increase reflects an increase in unit sales of our ThinPrep Pap Tests for use with the ThinPrep Imaging System, which generally include a fee for use of the ThinPrep Imaging System. Domestic sales of disposable supplies for use with our ThinPrep Imaging System, which include the usage fee, reached $11.5 million in the third quarter of 2004, for a total of $22.8 million in the nine months ended September 30, 2004.  There were no revenues from the sale of disposable supplies for use with our ThinPrep Imaging System for the same periods of 2003 due to the timing of market introduction in June 2003. ThinPrep Pap Test sales to our two largest customers, Quest Diagnostics, Inc. (“Quest”) and Laboratory Corporation of America (“LabCorp”), remained consistent in the third quarter of 2004 as compared to the same period of 2003, both in terms of volume and pricing. For the nine months ended September 30, 2004, sales to Quest and LabCorp remained consistent with those in the same period of 2003 as higher unit sales offset lower average selling prices to Quest following the signing of their multi-year agreement with us in May 2003. ThinPrep Pap Test sales to Quest and LabCorp together represented 23% and 25% of our consolidated net sales in the three and nine months ended September 30, 2004, respectively.

 

International net sales for our diagnostic products increased to $9.9 million and $30.3 million for the three and nine months ended September 30, 2004, respectively, an increase of 27% and 34% from the same periods of 2003, primarily reflecting increased unit sales of the ThinPrep Pap Test and, to a lesser degree, an increase in average pricing. International sales grew to 12% of diagnostics products worldwide net sales for the three and nine months ended September 30, 2004, as compared with 10% in the same periods of 2003.

 

Net sales for our surgical products division, which was created following our acquisition of Novacept on March 24, 2004, were $19.7 million and $39.1 million for the three and nine months ended September 30, 2004, respectively. Sales of NovaSure single-use devices represented 89% and 88% of the net sales in this division for the three and nine months ended September 30, 2004, respectively. Our fiscal year 2004 operating results include the results of Novacept, now renamed Cytyc Surgical Products, from the date of acquisition.

 

Gross Profit

 

Gross profit increased to $81.5 million and $224.8 million for the three and nine months ended September 30, 2004, respectively, an increase of 33% and 23% as compared with the same periods of 2003, primarily reflecting growth in net sales during the periods. The gross margin decreased to 79% for the three and nine months ended September 30, 2004, as compared to 81% for the same periods of 2003. These decreases resulted from expenses related to the introduction of the ThinPrep Imaging System, as well as the sales of the NovaSure System at our surgical products division and an increase in international sales of our diagnostic products, which both generally have lower margins as compared to domestic sales of the ThinPrep Pap Test.

 

Operating Expenses

 

Total operating expenses increased to $40.2 million and $132.7 million for the three and nine months ended September 30, 2004, respectively, an increase of 29% and 46% as compared to the same periods of 2003. Operating expenses in 2004 reflect the results of both our diagnostic products segment and our surgical products business acquired in March 2004, including a one-time charge of $19.1 million to write off acquired in-process research and development costs related to the acquisition of Novacept. The following is a summary of operating expenses for the three and nine months ended September 30, 2004 and 2003:

 

18



 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

$

 

% of
Sales

 

$

 

% of
Sales

 

$

 

% of
Sales

 

$

 

% of
Sales

 

 

 

($ in millions)

 

($ in millions)

 

($ in millions)

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

5.4

 

5.3

%

$

4.2

 

5.6

%

$

15.0

 

5.3

%

$

11.0

 

4.9

%

In-process research and development

 

 

 

 

 

19.1

 

6.7

%

 

 

Sales and marketing

 

26.3

 

25.6

%

20.2

 

26.8

%

73.9

 

26.1

%

60.2

 

26.8

%

General and administrative

 

8.4

 

8.2

%

6.8

 

9.0

%

24.7

 

8.7

%

19.7

 

8.8

%

 

Research and Development

 

Our investment in research and development reflects spending on product development programs as well as regulatory compliance and clinical research. Research and development costs increased to $5.4 million and $15.0 million for the three and nine months ended September 30, 2004, respectively, an increase of 29% and 37% as compared to the same periods of 2003, primarily due to efforts to continue to improve the ThinPrep Imaging System, development of the second generation RF Controller at our surgical products business, as well as amortization of the developed technology intangible asset that resulted from our acquisition of Novacept in March 2004.

 

In-Process Research and Development

 

As part of the allocation of the purchase price of Novacept, all intangible assets were identified and valued. It was determined that certain developed and in-development technology had value. As a result of this identification and valuation process, we allocated approximately $19.1 million of the purchase price to in-process research and development projects. This allocation represents the estimated fair value based on risk-adjusted cash flows related to incomplete research and development activities primarily associated with an upgrade to the RF Controller, a primary component of the NovaSure System. At the date of acquisition, the development of the next generation RF Controller had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, the acquired in-process research and development was charged to expense as of the date of the acquisition.

 

Sales and Marketing

 

Sales and marketing costs increased to $26.3 million and $73.9 million for the three and nine months ended September 30, 2004, respectively, an increase of 30% and 23% as compared to the same periods of 2003, primarily due to sales and marketing costs at our surgical products business acquired in March 2004, including costs associated with the integration and cross-training of our diagnostic products and surgical products sales forces. In addition, we incurred higher selling and customer training costs associated with supporting the continued market release of the ThinPrep Imaging System and increased marketing costs to support our international expansion efforts following the recommendation of liquid-based cytology as the primary means to process samples for cervical cancer screening programs by the United Kingdom’s National Institute for Clinical Excellence (“NICE”) in October 2003.

 

General and Administrative

 

General and administrative costs increased to $8.4 million and $24.7 million for the three and nine months ended September 30, 2004, respectively, an increase of 23% and 25% as compared to the same periods of 2003, largely due to legal costs associated with litigation, as well as administrative costs at our surgical products business acquired in March 2004. The impact of these administrative costs was offset in part by a reduction of our allowance for doubtful accounts based on favorable collections experience. As a percentage of revenues, general and administrative expenses represented 8% of revenue for the three months ended September 30, 2004 and 9% of revenues for the nine months ended September 30, 2004 as compared to 9% of revenue for the three and nine months ended September 30, 2003.

 

Other (Expense) Income, net

 

We recorded interest expense of $1.8 million and $3.6 million for the three and nine months ended September 30, 2004 related to our 2.25% convertible notes due 2024, which were issued on March 22, 2004, as well as the amortization of deferred financing costs associated with the issuance of these notes. Previously we did not

 

19



 

have any long-term debt obligations. Interest income remained consistent at $0.5 million for the three months ended September 30, 2004 and 2003, however interest income decreased by 15% to $1.6 million for the nine months ended September 30, 2004, as compared to $1.9 million in the same period of 2003, as cash balances were lower immediately following the use of our cash to acquire Novacept in March 2004.

 

Income Taxes

 

Our effective tax rate for the three and nine months ended September 30, 2004 was 38% and 46%. Exclusive of the effects of the non-deductible $19.1 million in-process research and development charge incurred in connection with the Novacept acquisition in March 2004, our effective tax rate for the three and nine months ended September 30, 2004 was 38%, as compared to 40% for the same periods of 2003. The decrease is primarily due to savings from tax planning initiatives which began in 2003. We estimate that our effective tax rate for fiscal 2004, exclusive of the effects of the in-process research and development charge, will be 38%.

 

Liquidity and Capital Resources

 

At September 30, 2004, we had cash, cash equivalents and investment securities totaling $178.9 million. Cash provided by operations was $80.0 million for the nine months ended September 30, 2004, an increase of 25% compared to $63.8 million during the same period of 2003, primarily as a result of increasing net sales. Our net accounts receivable increased 46% to $61.5 million at September 30, 2004, as compared to $42.1 million at December 31, 2003, reflecting growth in net sales as well the addition of receivables from our surgical products division, which was acquired in March 2004. Our Days Sales Outstanding increased from 46 days at December 31, 2003 to 52 days at September 30, 2004. We have had no significant issues of collectibility. The term “Days Sales Outstanding”, which we calculate by dividing gross trade accounts receivable at the end of the quarter by our average consolidated daily net sales for the quarter, refers to the estimated number of days’ worth of sales that are outstanding and unpaid at any given time. Our inventories increased 41% to $25.0 million at September 30, 2004, as compared to $17.8 million at December 31, 2003, primarily reflecting the addition of inventory from our surgical products division, as well as the purchase of materials to support current demand for the ThinPrep Imaging System.

 

Our investing activities used cash of $299.2 million in the first nine months of 2004, primarily related to the purchase of Novacept in March 2004. We paid $325.8 million to purchase Novacept, including acquisition-related costs, using a combination of debt financing and cash on hand to fund the purchase. During the first nine months of 2004, we invested $22.0 million in equipment for customer usage agreements, of which $20.6 million represented ThinPrep Imaging Systems placed at customer sites. We also made $11.5 million of capital expenditures during the first nine months of 2004, related primarily to the expansion of our manufacturing and administrative facilities to support the growth of our business.  Our investing activities during the first nine months of 2003 primarily related to the sale of investment securities, a portion of which was used to fund capital purchases including machinery and office equipment for our distribution center in Methuen, Massachusetts.

 

Our financing activities in the first nine months of 2004 generated cash of $264.3 million, primarily as a result of the private placement of $250 million of 2.25% convertible notes due 2024. Proceeds from this offering of $242.2 million are net of debt issuance costs. We also generated cash of $23.8 million as a result of proceeds from the exercise of stock options and our Employee Stock Purchase Plan. During the first nine months of 2003, our financing activities consisted primarily of the repurchase of our common stock. During the first nine months of 2004 and 2003, we spent $1.7 million and $55.1 million, respectively, under our stock repurchase program. There have been no repurchases under this program since January 2004.

 

Long-Term Debt and Contractual Obligations

 

On March 22, 2004, we completed the sale of $250 million aggregate principal amount of our 2.25% convertible notes due 2024. The convertible notes were sold to qualified institutional buyers pursuant to exemptions from the registration requirements of the Securities Act of 1933, as amended. We used the proceeds from the offering along with existing cash to finance the acquisition of Novacept. Total proceeds from the private placement were $242.2 million, net of debt issue costs of $7.8 million. The notes bear interest at a rate of 2.25% per year on the principal amount, payable semi-annually in arrears in cash on March 15 and September 15 of each year, beginning September 15, 2004.

 

Holders may require us to repurchase the notes on March 15 of 2009, 2014 and 2019 at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, including contingent interest and liquidated damages, if any, to, but excluding, the repurchase date. We may redeem any of the notes beginning March 20, 2009, by giving holders at least 30 days’ notice. We may redeem the notes either in whole or in part at a redemption price equal to 100% of their principal amount, plus accrued and unpaid interest, including contingent interest and liquidated damages, if any, to, but excluding, the redemption date.

 

As of September 30, 2004, we had no material additions to the contractual cash obligations described in our annual report on Form 10-K for the fiscal year ended December 31, 2003 and our quarterly report on Form 10-Q for the three months ended March 31, 2004.

 

20



 

We expect that our cash and cash equivalents, investment securities and cash flows from operating activities will be sufficient to meet our projected operating cash needs, including capital expenditures, lease and purchase commitments and tax payments.

 

Recent Accounting Pronouncement

 

In September 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, requiring that the dilutive effect of contingent convertible debt instruments (“CoCo’s”) be included in dilutive earnings per share regardless of whether the triggering contingency has been satisfied. This change in accounting principle is effective for all periods after December 15, 2004 and would be applied on a retroactive basis, requiring restatement of prior period dilutive earnings per share. This change is expected to result in additional dilution to our diluted earnings per share as a result of our $250.0 million 2.25% senior convertible notes issued in March 2004, which are CoCo’s. At September 30, 2004, for purposes of determining dilutive earnings per share, the interest expense net of tax effect would be added back to net income and an additional 8.4 million and 5.9 million shares of common stock would be added to diluted shares outstanding for the three and nine months ended September 30, 2004, respectively. Inclusion of the CoCo’s in diluted shares outstanding would not have affected diluted earnings per share for the three and nine months ended September 30, 2004.

 

Certain Factors Which May Affect Future Results

 

The forward-looking statements in this Form 10-Q are made under the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended. Our operating results and financial condition have varied and may in the future vary significantly depending on a number of factors. Statements in this Form 10-Q which are not strictly historical statements, including, without limitation, statements regarding management’s expectations for future growth and plans and objectives for future management and operations, domestic and international marketing and sales plans, product plans and performance, research and development plans, regulatory uncertainties, potential savings to the healthcare system, management’s assessment of market factors, costs and uncertainties related to current or future litigation, successful integration of acquired businesses and technologies, as well as statements regarding our strategy and plans, constitute forward-looking statements that involve risks and uncertainties. In some cases these forward-looking statements can be identified by the use of words such as “may,” “will,” “could,” “should,” “would,” “expect,” “project,” “predict,” “potential” or the negative of these words or comparable words.

 

The factors listed under “Certain Factors Which May Affect Future Results” in our annual report on Form 10-K for the fiscal year ended December 31, 2003 and under the same heading in our quarterly report on Form 10-Q for the quarter ended March 31, 2004 related to our acquisition of Novacept, among others, could cause actual results to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by management from time to time. Such factors, among others, may have a material adverse effect upon our business, financial condition, and results of operations. We undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, you are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made.

 

21



 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

 

Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments. We do not participate in derivative financial instruments, other financial instruments for which the fair value disclosure would be required under SFAS No. 107, Disclosures about Fair Value of Financial Instruments, or derivative commodity instruments. All of our investments are in investment-grade U.S. government securities, municipal bonds, corporate bonds and commercial paper, which are carried at fair value on our books.

 

Primary Market Risk Exposures. Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. Our investment portfolio of cash equivalents and investment securities is subject to interest rate fluctuations, but we believe this risk is immaterial due to the short-term nature of these investments. Our business outside the United States is conducted in local currency. We have no foreign exchange contracts, option contracts, or other foreign hedging arrangements. There can be no assurance that the costs associated with our foreign operations will not be affected by exchange fluctuations between the United States and the local currencies where we do business. We estimate that any market risk associated with our foreign operations is not significant and is unlikely to have a material adverse effect on our business, financial condition or results of operations.

 

Item 4. Controls and Procedures

 

(a)          Evaluation of Disclosure Controls and Procedures.  As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Acting Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based on this evaluation, our Chief Executive Officer and Acting Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely notification to them of information we are required to disclose in our periodic SEC filings and in ensuring that this information is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations.

 

(b)         Changes in Internal Control.  During the period covered by this report, there have been no significant changes in our internal control over financial reporting that have materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

 

22



 

PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

We are subject to legal claims and assertions in the ordinary course of business.  Except for the matters described in the annual report for the year ended December 31, 2003 and in the quarterly reports for the quarters ended March 31, 2004 and June 30, 2004, filed with the Securities and Exchange Commission, we are not aware of any such claims or assertions that could have a material effect on us.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

(c)          Our stock repurchase program was established in January 2002.  Under this program, we have the authority to spend up to $200 million, plus the cost of purchasing additional shares in an amount equal to the number of shares issued to our stock option holders upon exercise of their stock options.  The repurchase program may be suspended at any time and from time to time without prior notice.  The repurchase program was suspended in January 2004. No shares were purchased during the third quarter of 2004.  As of September 30, 2004, we have repurchased 15,279,039 shares under the program with an aggregate cost of $157.4 million.  As of September 30, 2004, $42.6 million of shares may be repurchased under the program.

 

Item 6.   Exhibits

 

Exhibit No.

 

Description

 

 

 

3.1(1)

 

Third Amended and Restated Certificate of Incorporation of Cytyc Corporation.

3.2(1)

 

Amended and Restated By-Laws of Cytyc Corporation.

3.3(2)

 

Certificate of Amendment of Third Amended and Restated Certificate of Incorporation.

4.1(3)

 

Specimen certificate representing the Common Stock.

4.2(4)

 

Rights Agreement, dated as of August 27, 1997, between Cytyc Corporation and BankBoston, N.A (the “Rights Agreement”) which includes as Exhibit A the Form of Certificate of Designations, as Exhibit B the Form of Rights Certificate, and as Exhibit C the Summary of Rights to Purchase Preferred Stock.

4.3(5)

 

Amendment No. 1 to Rights Agreement, dated as of June 22, 1998, between Cytyc Corporation and BankBoston, N.A., amending the Rights Agreement.

4.4(6)

 

Amendment to the Rights Agreement, dated as of January 3, 2003, among Cytyc Corporation, BankBoston, N.A. and EquiServe Trust Company, N.A.

4.5(7)

 

Amendment No. 2 to Rights Agreement, dated as of November 6, 2003, between Cytyc Corporation and EquiServe Trust Company, N.A., amending the Rights Agreement.

10.1 *

 

Form of Indemnification Agreement between Cytyc and Certain Directors and Executive Officers

10.2 *#

 

Form of Incentive Stock Option Agreement for Executive Officers

10.3 *#

 

Form of Nonqualified Stock Option Agreement for Executive Officers

10.4 *#

 

Form of Nonqualified Stock Option Agreement for Non-Employee Directors

10.5 *+

 

Master Agreement with Laboratory Corporation of America dated October 15, 2004

15 *

 

Letter on Unaudited Interim Financial Information

31.1 *

 

Certification of Patrick J. Sullivan, Chief Executive Officer and President, pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 *

 

Certification of Leslie Teso-Lichtman, Vice President, Controller and Acting Chief Financial Officer, pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 *

 

Certification of Patrick J. Sullivan, Chief Executive Officer and President, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 *

 

Certification of Leslie Teso-Lichtman, Vice President, Controller and Acting Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 


(1)          Incorporated by reference to the exhibits to our Registration Statement on Form S-1 (File No. 333-19367).

(2)          Incorporated herein by reference to the exhibits to our Quarterly Report on Form 10-Q, filed August 14, 2000.

(3)          Incorporated herein by reference to the exhibits to our Registration Statement on Form S-1 (File No. 333-00300).

(4)          Incorporated herein by reference to Exhibit 4.1 to our Current Report on Form 8-K, filed August 29, 1997.

 

23



 

(5)          Incorporated herein by reference to Exhibit 4.2 to our Quarterly Report on Form 10-Q, filed August 13, 1998.

(6)          Incorporated herein by reference to Exhibit 4.4 to our Annual Report on Form 10-K, filed January 30, 2004.

(7)          Incorporated herein by reference to Exhibit 4.4 to our Quarterly Report on Form 10-Q, filed November 12, 2003.

 

*  Filed herewith

#  Indicates a management contract or any compensatory plan, contract or arrangement

+  Confidential treatment requested as to certain portions

 

24



 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

 

CYTYC CORPORATION

 

 

 

 

Date: November 2, 2004

By:

/s/ Leslie Teso-Lichtman

 

 

 

Leslie Teso-Lichtman

 

 

Vice President, Controller, Acting Chief
Financial Officer and Treasurer (Principal
Financial Officer and Principal Accounting
Officer)

 

25



 

EXHIBIT INDEX

 

Exhibit No.

 

Description

 

 

 

3.1(1)

 

Third Amended and Restated Certificate of Incorporation of Cytyc Corporation.

3.2(1)

 

Amended and Restated By-Laws of Cytyc Corporation.

3.3(2)

 

Certificate of Amendment of Third Amended and Restated Certificate of Incorporation.

4.1(3)

 

Specimen certificate representing the Common Stock.

4.2(4)

 

Rights Agreement, dated as of August 27, 1997, between Cytyc Corporation and BankBoston, N.A (the “Rights Agreement”) which includes as Exhibit A the Form of Certificate of Designations, as Exhibit B the Form of Rights Certificate, and as Exhibit C the Summary of Rights to Purchase Preferred Stock.

4.3(5)

 

Amendment No. 1 to Rights Agreement, dated as of June 22, 1998, between Cytyc Corporation and BankBoston, N.A., amending the Rights Agreement.

4.4(6)

 

Amendment to the Rights Agreement, dated as of January 3, 2003, among Cytyc Corporation, BankBoston, N.A. and EquiServe Trust Company, N.A.

4.5(7)

 

Amendment No. 2 to Rights Agreement, dated as of November 6, 2003, between Cytyc Corporation and EquiServe Trust Company, N.A., amending the Rights Agreement.

10.1 *

 

Form of Indemnification Agreement between Cytyc and Certain Directors and Executive Officers

10.2 *#

 

Form of Incentive Stock Option Agreement for Executive Officers

10.3 *#

 

Form of Nonqualified Stock Option Agreement for Executive Officers

10.4 *#

 

Form of Nonqualified Stock Option Agreement for Non-Employee Directors

10.5 *+

 

Master Agreement with Laboratory Corporation of America dated October 15, 2004

15 *

 

Letter on Unaudited Interim Financial Information

31.1 *

 

Certification of Patrick J. Sullivan, Chief Executive Officer and President, pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 *

 

Certification of Leslie Teso-Lichtman, Vice President, Controller and Acting Chief Financial Officer, pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 *

 

Certification of Patrick J. Sullivan, Chief Executive Officer and President, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 *

 

Certification of Leslie Teso-Lichtman, Vice President, Controller and Acting Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 


(1)            Incorporated by reference to the exhibits to our Registration Statement on Form S-1 (File No. 333-19367).

(2)            Incorporated herein by reference to the exhibits to our Quarterly Report on Form 10-Q, filed August 14, 2000.

(3)            Incorporated herein by reference to the exhibits to our Registration Statement on Form S-1 (File No. 333-00300).

(4)            Incorporated herein by reference to Exhibit 4.1 to our Current Report on Form 8-K, filed August 29, 1997.

(5)            Incorporated herein by reference to Exhibit 4.2 to our Quarterly Report on Form 10-Q, filed August 13, 1998.

(6)            Incorporated herein by reference to Exhibit 4.4 to our Annual Report on Form 10-K, filed January 30, 2004.

(7)            Incorporated herein by reference to Exhibit 4.4 to our Quarterly Report on Form 10-Q, filed November 12, 2003.

 

*  Filed herewith

#  Indicates a management contract or any compensatory plan, contract or arrangement

+  Confidential treatment requested as to certain portions

 

26