1
EXHIBIT 13.1
CONSOLIDATED BALANCE SHEET
(In thousands, except share amounts)
July 2, 1995 July 3, 1994
- -----------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 75,642 $ 68,163
Marketable securities (Note 2) 65,039 53,470
Accounts receivable, net of allowance for doubtful
accounts of $1,274 ($1,128 at July 3, 1994) 44,304 34,308
Inventories (Note 1) 31,446 27,238
Deferred income taxes (Note 6) 4,898 3,581
Other current assets 2,038 1,650
--------- ---------
Total current assets 223,367 188,410
--------- ---------
Property and equipment, at cost:
Machinery and equipment 57,057 47,814
Demonstration equipment 12,155 13,093
Furniture and fixtures 7,737 7,304
Leasehold improvements 4,947 5,276
--------- ---------
81,896 73,487
Accumulated depreciation (46,083) (39,315)
--------- ---------
Net property and equipment 35,813 34,172
--------- ---------
Intangibles and other assets, net (Notes 3 and 4) 35,289 15,566
========= =========
$ 294,469 $ 238,148
========= =========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 20,697 $ 14,229
Accrued liabilities:
Payroll and payroll related 16,711 11,091
Warranty 4,195 1,882
Other 8,070 4,811
Income taxes payable (Note 6) 3,207 1,570
--------- ---------
Total current liabilities 52,880 33,583
Deferred income taxes (Note 6) 868 452
--------- ---------
Total liabilities 53,748 34,035
Commitments and contingencies (Notes 8 and 10)
Stockholders' equity (Note 7):
Preferred stock, $.001 par value; 5,000,000 shares authorized;
none outstanding
Common stock, $.001 par value; 50,000,000 shares authorized;
17,854,250 shares issued and outstanding (17,058,059 in 1994) 18 17
Additional paid-in-capital 111,012 90,302
Treasury stock, at cost (1,148,000 shares in 1995; 522,500 shares in (34,539) (13,630)
1994)
Retained earnings 164,494 127,329
Accumulated translation adjustment (259) 100
Notes receivable from stockholders (5) (5)
--------- ---------
Total stockholders' equity 240,721 204,113
========= =========
$ 294,469 $ 238,148
========= =========
See accompanying notes to consolidated financial statements
2
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
Years ended July 2, 1995 July 3, 1994 July 4, 1993
- --------------------------------------------------------------------------------------
Net revenue $ 264,040 $ 234,972 $ 218,186
Cost of goods sold 103,181 93,706 88,762
--------- --------- ---------
Gross profit 160,859 141,266 129,424
--------- --------- ---------
Operating expenses:
Research and development 27,225 23,980 22,696
Selling, general and
administrative 79,289 73,935 68,891
Restructuring charge (Note 5) --- 500 ---
--------- --------- ---------
106,514 98,415 91,587
--------- --------- ---------
Income from operations 54,345 42,851 37,837
Interest income 6,139 4,209 3,410
Litigation settlements, net (Note 10) --- (13,000) ---
Other income (expense), net (537) (1,062) (401)
--------- --------- ---------
Income before income taxes 59,947 32,998 40,846
Provision for income taxes (Note 6) 22,782 12,441 15,726
--------- --------- ---------
Net income $ 37,165 $ 20,557 $ 25,120
========= ========= =========
Income per common and
common equivalent share $ 2.20 $ 1.22 $ 1.50
========= ========= =========
Weighted average common
and common equivalent
shares used in the calculation
of income per share 16,923 16,843 16,745
========= ========= =========
See accompanying notes to consolidated financial statements
3
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
COMPENSATION
AND NOTES
COMMON STOCK ADDITIONAL ACCUMULATED RECEIVABLE
---------------------- PAID-IN RETAINED TRANSLATION FROM
SHARES PAR VALUE CAPITAL EARNINGS ADJUSTMENT STOCKHOLDERS
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT JULY 5, 1992 16,122,099 $16 $ 73,174 $ 81,652 $ 204 $(554)
Issuance of common stock
and related tax benefits of 591,163 1 12,521
$3,621 under employee stock plans
Compensation related to
acquisition of Radiant
Systems (Note 7) 549
Accumulated translation
adjustment (219)
Net income 25,120
---------- --- -------- -------- ----- -----
BALANCE AT JULY 4, 1993 16,713,262 17 85,695 106,772 (15) (5)
Issuance of common stock and
related tax benefits of
$2,394 under employee stock
plans 554,797 10,460
Acquisition of treasury
stock (Note 7)
Acquisition and retirement of
common stock (Note 7) (210,000) (5,853)
Accumulated translation
adjustment 115
Net income 20,557
---------- --- -------- -------- ----- -----
BALANCE AT JULY 3, 1994 17,058,059 17 90,302 127,329 100 (5)
Issuance of common stock and
related tax benefits of
$3,487 under employee stock
plans 796,191 1 20,710
Acquisition of treasury stock
(Note 7)
Accumulated translation
adjustment (359)
Net income 37,165
---------- --- -------- -------- ----- -----
BALANCE AT JULY 2, 1995 17,854,250 $18 $111,012 $164,494 $(259) $ (5)
========== === ======== ======== ===== =====
TREASURY STOCK
----------------------
SHARES PAR VALUE
- --------------------------------------------------------------
BALANCE AT JULY 5, 1992 0 $ 0
Issuance of common stock
and related tax benefits of
$3,621 under employee stock plans
Compensation related to
acquisition of Radiant
Systems (Note 7)
Accumulated translation
adjustment
Net income
--------- --------
BALANCE AT JULY 4, 1993 0 $ 0
Issuance of common stock and
related tax benefits of
$2,394 under employee stock
plans
Acquisition of treasury 522,500 (13,630)
stock (Note 7)
Acquisition and retirement of
common stock (Note 7)
Accumulated translation
adjustment
Net income
--------- --------
BALANCE AT JULY 3, 1994 522,500 (13,630)
Issuance of common stock and
related tax benefits of
$3,487 under employee stock
plans
Acquisition of treasury stock 625,500 (20,909)
(Note 7)
Accumulated translation
adjustment
Net income
--------- --------
BALANCE AT JULY 2, 1995 1,148,000 $(34,539)
========= ========
See accompanying notes to consolidated financial statements
4
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Years ended July 2, 1995 July 3, 1994 July 4, 1993
- ----------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 37,165 $ 20,557 $ 25,120
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization 16,089 16,281 13,153
Compensation to Radiant stockholders (Note 7) --- --- 549
Deferred income taxes (Note 6) 901 400 (493)
Increases (decreases) in cash flows, net of effects of purchases of
companies, as a result of changes in:
Accounts receivable (3,336) (1,218) (3,046)
Inventories (1,251) (4,676) 51
Other current assets (3,181) (1,319) 1,764
Other assets (5,007) (1,949) (588)
Accounts payable 3,340 1,809 685
Accrued liabilities 8,082 404 1,108
Income taxes payable 1,601 (1,845) (1,083)
-------- --------- ---------
Cash provided by operating activities 54,403 28,444 37,220
-------- --------- ---------
Cash flows from investing activities:
Capital expenditures (11,906) (14,133) (14,767)
Cash used to purchase securities held-to-maturity (47,245) (87,212) (156,078)
Proceeds from maturities of securities held-to-
maturity 35,676 104,643 144,860
Investment in non-marketable equity securities (2,100) --- ---
Payment for purchase of Pierre Medical, net of
cash acquired (Note 3) (21,415) --- ---
Other investing activities (305) (680) ---
-------- --------- ---------
Cash provided by (used for) investing activities (47,295) 2,618 (25,985)
-------- --------- ---------
Cash flows from financing activities:
Proceeds from the issuance of common stock under
the Company's stock plans and related tax
benefits, net of notes receivable from
stockholders 20,710 10,460 12,521
Purchase of treasury stock, including shares retired (20,909) (19,483) ---
-------- --------- ---------
Cash provided by (used for) financing activities (199) (9,023) 12,521
-------- --------- ---------
Effect of exchange rate changes on cash balances 570 218 (790)
-------- --------- ---------
Increase in cash and cash equivalents 7,479 22,257 22,966
Cash and cash equivalents at the beginning of the year 68,163 45,906 22,940
======== ========= =========
Cash and cash equivalents at the end of the year $ 75,642 $ 68,163 $ 45,906
======== ========= =========
See accompanying notes to consolidated financial statements
5
NOTE 1
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION.
The financial statements include the accounts of Nellcor Incorporated and its
wholly owned subsidiaries (the Company). All significant intercompany
transactions have been eliminated. The Company uses the equity method of
accounting for investments that represent greater than 20% of the net book value
of the investee at the date of investment. Investments which represent less than
20% of the net book value of the investee at the date of investment are recorded
at cost. All such investments were immaterial as of July 2, 1995.
FISCAL YEAR.
The Company's fiscal year ends on the first Sunday in July, which results in a
52 or 53-week fiscal year. Fiscal 1993, 1994 and 1995 were 52-week years.
FOREIGN CURRENCY TRANSLATION.
The financial statements of the Company's subsidiaries located in Europe use the
local currency as their functional currency. Assets and liabilities denominated
in foreign currencies are translated at the rates of exchange at the balance
sheet date. Income and expense items are translated at average monthly rates of
exchange. Any resulting translation adjustments are recorded as a separate
component of stockholders' equity. Realized and unrealized gains and losses on
foreign currency transactions and hedge contracts are included in non-operating
income and expense. Foreign currency transaction gains or losses have not been
material in any year or period presented.
REVENUE RECOGNITION AND PRODUCT WARRANTY.
The Company recognizes revenue at the time of shipment of product and provides
currently for the estimated cost to repair or replace products under the
warranty provisions in effect at the time of sale.
CASH EQUIVALENTS.
The Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents. These investments are stated at
cost which approximates fair value due to their short maturity.
INVENTORIES.
Inventories are stated at the lower of cost (first-in, first-out) or market (net
realizable value). Allowances are made for slow-moving, obsolete, unsalable, or
unusable inventories. Inventories were as follows (in thousands):
July 2, 1995 July 3, 1994
- ----------------------------------------------------------------------------------
Raw materials $14,437 $10,040
Work-in-process 4,843 5,180
Finished goods 12,166 12,018
======= =======
$31,446 $27,238
======= =======
PROPERTY AND EQUIPMENT.
Depreciation is provided using the straight-line method and estimated useful
lives of three to seven years. Leasehold improvements are amortized over the
life of the lease, or the estimated useful life of the asset, whichever is
shorter. Depreciation expense was approximately $10.2 million in fiscal 1995,
$10.6 million in fiscal 1994, and $9.0 million in fiscal 1993.
INTANGIBLE AND OTHER ASSETS.
Intangible and other assets, including excess of cost over net assets acquired,
are amortized on a straight-line basis over useful lives ranging from two to
fifteen years. An impairment of intangible assets is recognized when it is
deemed probable that the carrying amount of an asset cannot be fully recovered,
based on estimated future cash flows of the related business.
6
INCOME TAXES.
Deferred income taxes are computed using the liability method. Under the
liability method, taxes are recorded based on the future tax effect of the
difference between the tax and financial reporting bases of the Company's assets
and liabilities. In estimating future tax consequences, all expected future
events are considered, except for potential income tax law or rate changes. The
Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109)
"Accounting for Income Taxes" in fiscal 1994. Adoption of SFAS 109 did not have
a material effect on the Company's financial position or result of operations.
INCOME PER SHARE.
Income per share is based upon weighted average common shares and includes the
dilutive effect of stock options outstanding (using the treasury stock method).
RECLASSIFICATIONS.
Certain reclassifications have been made to the consolidated financial
statements in the prior years to conform to the 1995 presentation.
NOTE 2
FINANCIAL INSTRUMENTS AND OFF BALANCE SHEET RISK
FOREIGN CURRENCY INSTRUMENTS.
The Company enters into foreign currency exchange contracts, primarily forward
currency contracts, to reduce exposure to currency exchange risk. The effect of
this practice is to minimize the impact of foreign exchange rate movements on
the Company's operating results as gains and losses on these contracts offset
losses and gains on the assets, liabilities and transactions being hedged. The
Company does not engage in foreign currency speculation. The counterparties to
foreign currency exchange contracts are major domestic and international
financial institutions. To decrease the risk of non-performance which may result
in currency losses, the Company diversifies its selection of counterparties. At
July 2, 1995, the Company had foreign currency forward exchange contracts with a
notional amount of $35.4 million ($9.8 million at July 3, 1994), and a fair
market value of approximately $35.9 million ($10.0 million at July 3, 1994), all
of which were denominated in European currencies. The fair market value was
determined based upon foreign currency exchange rates in effect at the end of
each fiscal period. The Company records both the amortized premium and any
unrealized gain or loss on outstanding foreign currency forward exchange
contracts as non-operating income or expense. For both fiscal 1995 and fiscal
1994, all outstanding foreign currency exchange contracts were due to mature
within six months of fiscal year end.
CREDIT FACILITY.
The Company has a $50 million credit facility with a group of four banks which
provides an option to convert outstanding borrowings to a term loan repayable
over four years. The rate of interest payable under this facility is a floating
rate, which is a function of the London Interbank Offered Rate. A facility fee
equal to 0.25% of the total commitment is paid quarterly.
The credit agreement contains various covenants which require the Company to
maintain a specified financial ratio, limit liens, regulate asset disposition
and subsidiary indebtedness and restrict certain acquisitions and investments.
At July 2, 1995, the Company was in compliance with these covenants and no
borrowings had been made.
MARKETABLE SECURITIES.
During fiscal 1995, the Company adopted Statement of Financial Accounting
Standards Number 115 "Accounting for Certain Investments in Debt and Equity
Securities" (SFAS 115). SFAS 115 requires that all such investment securities be
classified into one of three categories: held-to-maturity, available-for-sale,
or trading. Implementation of SFAS 115 did not have a material effect on
Nellcor's financial position or results of operations.
The Company's marketable securities, generally, are in high-quality government,
municipal and corporate obligations with original maturities of up to two years.
The Company has established guidelines relative to investment quality,
diversification and maturities to maintain appropriate levels of safety and
liquidity.
7
At July 2, 1995, the Company had marketable securities totaling $65.0 million,
of which $60.2 million were classified as held-to-maturity. These
held-to-maturity securities, which the Company has the positive intent and
ability to hold to maturity, are stated at cost, which approximates amortized
cost. Realized gains and losses resulting from the sale of marketable securities
during the period and unrealized gains and losses at July 2, 1995, were
immaterial.
As of July 2, 1995, the Company's available-for-sale investments, which the
Company does not intend to hold to maturity, totaled $4.8 million. No sales of
available-for-sale marketable securities, or transfers between hold-to-maturity
and available-for-sale marketable securities, were made during the year. The
difference between the carrying value of the Company's available-for-sale
securities and the market value as shown below was immaterial as of July 2,
1995.
Marketable securities classified as held-to-maturity and available-for-sale at
July 2, 1995 are summarized below (in thousands). Fair value of marketable
securities is based upon quoted market prices.
Gross Gross
Unrealized Unrealized
Security Type Cost Gains Losses Fair Value
- ------------- ------- ---------- ---------- ----------
Current assets:
Marketable securities
HELD-TO-MATURITY:
Debt issued by the U.S. Treasury and other $22,958 $17 $ (8) $22,967
U.S. government corporations and agencies
Debt securities issued by the states of the 37,236 47 (185) 37,098
United States and political subdivisions of
the states
AVAILABLE-FOR-SALE:
Mortgage backed securities 4,845 17 (93) 4,769
------- --- ----- -------
Marketable securities $65,039 $81 $(286) $64,834
======= === ===== =======
CONCENTRATION OF CREDIT RISK.
The Company provides credit in the form of trade accounts receivable to
hospitals, private and governmental institutions and health care agencies,
medical equipment distributors and rental companies, and doctors' offices. The
Company does not generally require collateral to support customer receivables.
The Company performs ongoing credit evaluations of its customers and maintains
allowances which management believes are adequate for potential credit losses.
The credit risk associated with the Company's trade receivables is further
limited due to dispersion of the receivables over a large number of customers in
many geographic areas.
Payment of certain accounts receivable is made by the national health care
systems of several member countries of the European Economic Community. Although
the Company does not currently anticipate credit problems associated with these
receivables, payment is contingent upon the economic stability of these
countries.
The Company limits credit risk exposure to foreign exchange contracts by
periodically reviewing the credit worthiness of the counterparties to the
transactions.
8
NOTE 3
ACQUISITION
ACQUISITION OF PIERRE MEDICAL.
On May 3, 1995, the Company's EdenTec subsidiary acquired Pierre Medical, a
privately-held French manufacturer of respiratory products used in the home, for
$21.5 million in cash. In the event that certain performance milestones are
achieved subsequent to the acquisition, additional compensation totaling 30
million French Francs ($6.2 million as of July 2, 1995) would be payable to the
former principal stockholders of Pierre who continue to manage the company. Such
amounts will be expensed when, and if, earned. Pierre Medical manufactures and
markets noninvasive ventilators, sleep apnea therapy systems, oxygen
concentrators and related respiratory products in Western Europe, primarily in
France.
The acquisition of Pierre Medical has been accounted for as a purchase and,
accordingly, Pierre Medical's results are included in Nellcor's financial
statements subsequent to the acquisition date. Identifiable net assets acquired
consisted of approximately $4.0 million of working capital. The excess of cost
over identifiable net assets of $18.1 million, including acquisition related
costs, is being amortized over 15 years, the period of the estimated future
benefit. The final allocation of the purchase price to other identifiable
intangible assets, including determining or reevaluating the likelihood of the
future recoverability of these intangible assets, is dependent upon the outcome
of the Company's merger with Puritan-Bennett Corporation (see Note 11) and any
resulting effect the merger might have upon the operations of Pierre Medical.
In connection with the acquisition, supplemental cash flow information is as
follows (in thousands):
Fair value of assets acquired, except for cash and cash equivalents $ 26,999
Liabilities assumed (5,584)
========
Cash paid to acquire Pierre Medical, net of cash and cash equivalents acquired $ 21,415
========
The following pro forma combined financial results of Nellcor and Pierre Medical
for Fiscal 1995 and Fiscal 1994 have been prepared assuming that the acquisition
of Pierre Medical occurred at the beginning of each such period. In preparing
the pro forma information, adjustments have been made for the amortization of
goodwill, utilization of the Company's cash and marketable securities to
purchase Pierre Medical, and income taxes.
- -----------------------------------------------------------------------------------
Pro Forma Information (Unaudited) July 2, 1995 July 3, 1994
- -----------------------------------------------------------------------------------
(in thousands, except per share amounts)
Net revenues $275,015 $244,138
Net income 37,729 20,199
Net earnings per share $ 2.23 $ 1.20
======== ========
9
NOTE 4
INTANGIBLES AND OTHER ASSETS
Intangibles and other assets consist of:
(in thousands) July 2, 1995 July 3, 1994
- ---------------------------------------------------------------------------------------
Cost:
Excess of cost over net assets acquired (Note 3) $ 30,142 $ 11,325
Other intangibles from acquisitions, and purchased 9,965 11,040
technologies and rights (Note 3)
Other 11,621 5,844
-------- --------
Total cost 51,728 28,209
-------- --------
Total accumulated amortization (16,439) (12,643)
-------- --------
Intangibles and other assets, net $ 35,289 $ 15,566
======== ========
NOTE 5
RESTRUCTURING CHARGE
The Company incurred a restructuring charge of $500,000 before taxes during the
first quarter of fiscal 1994 associated with the consolidation of the Company's
Instruments and Monitoring Systems divisions. The charge was recorded as an
operating expense in the first quarter of fiscal 1994.
NOTE 6
PROVISION FOR INCOME TAXES
The provision for income taxes consists of the following (in thousands):
Years ended July 2, 1995 July 3, 1994 July 4, 1993
------------------------------------------------------------------------
Federal:
Current $ 18,701 $ 10,796 $10,934
Deferred (260) (1,050) 1,203
-------- -------- -------
18,441 9,746 12,137
-------- -------- -------
State:
Current 3,355 2.683 2,976
Deferred (56) (404) 215
-------- -------- -------
3,299 2,279 3,191
-------- -------- -------
Foreign:
Current 1,294 416 398
Deferred (252) --- ---
-------- -------- -------
1,042 416 398
-------- -------- -------
$ 22,782 $ 12,441 $15,726
======== ======== =======
Pretax income from foreign operations used to determine related tax liabilities
amounted to $2.3 million, $1.3 million and $0.9 million for fiscal 1995, 1994,
and 1993, respectively.
The most significant components of the Company's deferred tax assets and
liabilities at July 2, 1995 and July 3, 1994 are as follows (in thousands):
10
July 2, 1995 July 3, 1994
---------------------------------- -----------------------------------
Deferred Tax Deferred Tax Deferred Tax Deferred Tax
Assets Liabilities Assets Liabilities
------------ ------------ ------------ ------------
Inventory and product $2,899 $ 2,110
allowances
Property, plant and equipment $1,046 $ 453
Intangible Assets 832 1,852
Compensated absences 753 607
State income tax accrual 1,392 979
Accounts receivable 642 693
Tax/book year-end difference 1,504 1,516
Other Accruals 2,550 1,588 1,151 1,061
------ ------ ------- ------
9,068 4,137 7,392 3,030
Less: Valuation Allowance (900) (1,233)
------ ------ ------- ------
Deferred Income Taxes $8,168 $4,138 $ 6,159 $3,030
====== ====== ======= ======
As of July 2, 1995, the Company had net operating loss carry forwards resulting
from the acquisition of EdenTec, which expire beginning in fiscal year 2000 and
ending in fiscal year 2006. A deferred tax asset has been recorded for the tax
benefit of these net operating loss carry forwards, with a corresponding
valuation allowance of $0.9 million provided for the net operating loss carry
forwards which may not be realized. Net operating loss carry forwards realized
during fiscal 1995 resulted in a $0.3 million decrease in the valuation
allowance and a corresponding reduction in the remaining net book value of the
EdenTec goodwill. Tax benefits resulting from future net operating loss carry
forwards will first be applied to reduce the remaining goodwill, and then to any
other intangible assets associated with the acquisition of EdenTec.
Deferred tax assets and liabilities at July 2, 1995 and July 3, 1994, are
comprised of (in thousands):
July 2, 1995 July 3, 1994
-------------------------------------------- -----------------------------------------------
Tax Tax Tax Tax
Assets Liabilities Net Assets Liabilities Net
------ ------------ ------ ------------- ------------ ------
Current $7,244 $(2,346) $4,898 $5,459 $(1,878) $3,581
Long-term 924 (1,792) (868) 700 (1,152) (452)
------ ------- ------ ------------- ------- ------
Total $8,168 $(4,138) $4,030 $6,159 $(3,030) $3,129
====== ======= ====== ============= ======= ======
The difference between the Company's effective income tax rate and the United
States federal statutory income tax rate is summarized as follows:
Years ended July 2, 1995 July 3, 1994 July 4, 1993
- -------------------------------------------------------------------------------------
Federal statutory rate 35.0% 35.0% 34.0%
State income taxes, net of federal 3.6 4.5 5.2
benefit
Research and experimental credits (1.0) (1.5) ---
Tax legislation changes (2.2) ---
Other .4 1.9 (0.7)
---- ---- ----
Effective tax rate 38.0% 37.7% 38.5%
==== ==== ====
The Company paid income taxes of approximately $18.2 million, $13.3 million, and
$11.8 million in fiscal 1995, 1994, and 1993, respectively.
11
NOTE 7
STOCKHOLDERS' EQUITY
COMMON STOCK.
As of July 2, 1995, an aggregate of 4,773,785 shares of authorized but unissued
common stock remained reserved for issuance under the 1994 Equity Incentive Plan
(the "1994 Plan"), the 1991 Equity Incentive Plan, as amended (the "1991 Plan"),
the 1988 Stock Option Plan for Non-Employee Directors, as amended (the "1988
Plan"), and the 1986 Employee Stock Participation Plan, as amended (the "ESPP").
STOCK OPTION PLANS.
1994 and 1991 Plans The Company maintains two employee stock option plans, the
1994 Plan and the 1991 Plan. In October, 1994, the Company obtained stockholder
approval of the 1994 Plan, which authorizes the issuance of up to 1,500,000
shares of common stock to executive officers, other key employees and
consultants in the form of incentive and nonqualified stock options, stock
bonuses and restricted stock. The 1994 Plan satisfies the performance-based
compensation requirements of The Omnibus Budget Reconciliation Act of 1993.
The Company obtained shareholder approval of the 1991 Plan in October, 1991.
Upon stockholder approval of the 1991 Plan, the Company's 1982 Incentive Stock
Option Plan (the "1982 Plan") and the 1985 Equity Incentive Plan (the "1985
Plan") were terminated; however, shares available for issuance under these plans
at the time of termination, including shares underlying outstanding options,
that later expire or are canceled, were pooled with the 750,000 additional
shares reserved for issuance under the 1991 Plan. In October 1992, the Company
obtained stockholder approval to an amendment to the 1991 Plan increasing the
number of shares authorized for issuance under the 1991 Plan by an additional
1,500,000 shares.
Options granted under the 1994 and 1991 Plans generally vest on a quarterly
basis over a period of four years from the date of grant. A one-year waiting
period is required before vesting in the case of initial grants. The 1994 and
1991 Plans authorize the grant of incentive stock options at exercise prices
equal to the fair market value of the Company's common stock on the date of
grant and permit the grant of nonqualified stock options at exercise prices not
less than 85 percent of fair market value on the date of grant. To date, only
nonqualified stock options with exercise prices equal to the fair market value
of the underlying common stock on the date of grant have been granted under both
Plans. No stock bonus or restricted stock grants have been made under the 1994
or 1991 Plans.
As of July 2, 1995, options representing 946,130 shares, including options
issued under the 1994 and 1991 Plans and the terminated 1982 and 1985 Plans,
were outstanding and exercisable at an aggregate exercise price of approximately
$22.8 million, and the Company, as of such date, had 2,201,041 shares available
for issuance under the 1991 and 1994 Plans.
Certain options issued under the 1994 and 1991 Plans permit exercise prior to
vesting. As to these options, if the optionee's relationship with the Company is
terminated prior to the complete vesting of the options, the Company has the
right to repurchase unvested shares at the exercise price plus interest. As of
July 2, 1995, no shares were subject to repurchase by the Company under these
options.
12
The following is a summary of option activity under the 1994 and 1991 Plans:
Range of Exercise
Options Outstanding Prices (Per Share)
---------------------------------------------- -----------------------
Aggregate
Exercise
Available Price (in
for Grant Number thousands) High Low
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JULY 5, 1992 648,958 2,260,813 $ 39,565 $32.00 $ 7.88
Increase in options available for grant 1,500,000
Granted (683,710) 683,710 19,922 34.13 24.00
Exercised (476,739) (6,550) 31.75 7.88
Canceled 235,769 (235,769) (5,085) 32.00 9.38
--------- --------- --------
BALANCE AT JULY 4, 1993 1,701,017 2,232,015 47,852 34.13 7.88
Granted (668,405) 668,405 15,674 28.50 20.00
Exercised (463,672) (6,306) 26.75 9.25
Canceled 301,050 (301,050) (7,294) 32.00 10.00
--------- --------- --------
BALANCE AT JULY 3, 1994 1,333,662 2,135,698 49,926 32.00 9.25
Increase in options available for grant 1,500,000
Granted (836,220) 836,220 25,628 46.25 27.00
Exercised (661,292) (14,012) 34.13 10.00
Canceled 203,599 (203,599) (5,110) 34.13 10.63
--------- --------- --------
BALANCE AT JULY 2, 1995 2,201,041 2,107,027 56,432 46.25 10.00
========= ========= ========
1988 Plan In October, 1988, the Company obtained stockholder approval of the
1988 Plan which authorized the non-discretionary grant of options to
non-employee Directors. Under the 1988 Plan, non-employee Directors
automatically receive stock option grants upon joining the Board of Directors
and annually thereafter. Until amended in May of 1994, the 1988 Plan provided
for an initial grant of an option to purchase 20,000 shares of common stock upon
a Director joining the Board and an annual grant of an option to purchase 10,000
shares of stock. On May 14, 1994, the Board of Directors amended the 1988 Plan
to reduce the number of shares issuable to non-employee Directors in the form of
options to an initial grant of 10,000 shares and annual grants of 5,000 shares.
Options issued to non-employee Directors under the 1988 Plan are nonqualified
stock options having a five-year term and an exercise price equal to the fair
market value of the Company's common stock on the date of grant and vesting over
a four year period in the case of initial option grants and over the succeeding
fiscal year in the case of annual grants.
In October, 1994, the Company obtained stockholder approval to amend the 1988
Plan to increase the number of shares authorized for issuance by 75,000 shares
and the term of options to be issued under the plan from five to ten years.
As of July 2, 1995, options representing 162,500 shares were outstanding and
exercisable under the 1988 Plan at exercise prices ranging from $13.63 to $26.50
for an aggregate exercise price of $3.7million, and the Company, as of such
date, had 130,000 shares available for issuance under the 1988 Plan.
The Board of Directors adopted and, on August 24, 1995, the Company's
stockholders approved, the 1995 Merger Stock Incentive Plan (the "1995 Plan"),
which authorized the issuance of up to 779,000 shares of Company common stock in
the form of stock options. The purpose of the 1995 Plan is to allow the Company
to comply with its obligations in the Agreement and Plan of Merger with
Puritan-Bennett Corporation whereby the Company would issue options to purchase
Company common stock to holders of unexercised options to purchase
Puritan-Bennett stock as of the effective date of the merger.
STOCK PURCHASE PLANS.
Under the ESPP, qualified employees, not including members of the Board of
Directors and executive officers, may purchase semi-annually up to a specified
maximum amount of shares of Nellcor common stock through payroll deductions at a
price equal to 85% of the fair market value of the stock at the beginning or end
of the six month plan period, whichever is less. In October, 1994, the Company
obtained stockholder approval to increase the number of shares available for
purchase under the ESPP by 250,000 shares. As of July 2, 1995, 726,783 shares of
common stock had been purchased under the ESPP since inception and 173,217
shares remained available for purchase by employees.
13
STOCK REPURCHASE PROGRAMS.
During the fourth quarter of fiscal 1993, the Board of Directors approved a
Limited Stock Repurchase Program ("the Limited Program") which commenced early
in fiscal 1994. The objective of the Limited Program is to utilize a portion of
available cash balances to repurchase on the open market shares of the Company's
common stock, to mitigate the dilutive effects of the issuance of shares under
the 1994 Plan, 1991 Plan, 1988 Plan, and ESPP. Repurchases made under the
Limited Program are made on a recurring basis to the extent that stock options
are exercised during the year and totaled $20.9 million (625,500 shares) and
$13.6 million (522,500 shares) during the fiscal years ended July 2, 1995 and
July 3, 1994, respectively.
In addition to the Limited Program, the Board of Directors approved a General
Stock Repurchase Program (the "General Program") during the second quarter of
fiscal 1994 to repurchase and retire up to 1 million shares of the Company's
common stock. The object of this General Program is to more effectively utilize
an additional portion of available cash balances. No repurchases under the
General Program were made in fiscal 1995; 210,000 shares were repurchased and
retired during fiscal 1994, totaling $5.9 million.
STOCK RIGHTS--SERIES A JUNIOR PARTICIPATING PREFERRED STOCK.
During fiscal 1991, the Board of Directors declared a dividend distribution of
one purchase right for each outstanding share of common stock. Each right
entitles the holder to purchase from the Company one one-hundredth of a share of
Series A Junior participating preferred stock, par value $.001, at a price of
$90 per one-hundredth of a preferred share. Each one one-hundredth of a share of
new preferred stock is substantially the economic equivalent of one share of
common stock. In the event that a third party acquires 15 percent or more of the
Company's common stock or announces an offer which would result in such party's
owning 15 percent or more of the Company's common stock, the rights will become
exercisable. The rights expire on June 26, 2001, and subject to certain
conditions, may be redeemed by the Board of Directors at a price of $.001 per
right.
COMPENSATION TO RADIANT STOCKHOLDERS.
As part of the acquisition of Radiant Systems, Inc, (Radiant) in fiscal 1990,
Nellcor issued to escrow on behalf of the majority stockholders of Radiant, who
were also Radiant employees, approximately 115,000 shares of Nellcor's common
stock. The common stock was expected to be released over a three-year period
beginning in fiscal 1991. As of the end of fiscal 1992, the majority
stockholders of Radiant had terminated their employment with Radiant, and the
Company released all of the remaining shares held in escrow in fiscal 1993.
NOTE 8
COMMITMENTS
The Company leases its facilities under agreements that expire at various dates
through June 2006, which include options to renew through June 2016. Rental
expenses were approximately $4.7 million, $4.5 million, and $4.0 million in
fiscal years 1995, 1994, and 1993, respectively.
Aggregate minimum annual rental commitments under long-term operating leases are
as follows (in thousands):
Fiscal years
- -------------------------------------------------------------------------
1996 $4,117
1997 4,290
1998 3,939
1999 3,856
2000 3,454
After 2000 14,433
-------
Total rental commitments $34,089
=======
14
NOTE 9
INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in a single-industry segment: the design, engineering,
manufacture, marketing and servicing of high-performance monitoring, measurement
and therapeutic instruments and related sensors and airway adapters, and
detectors for the hospital, prehospital and home care markets. The principal
methods of distribution are direct sales, corporate accounts and independent
distributors.
Geographic information with respect to the Company's operations is as follows
(in thousands):
Years ended July 2, 1995 July 3, 1994 July 4, 1993
- --------------------------------------------------------------------------------------
Net revenue:
United States domestic $ 221,295 $ 205,352 $ 193,524
Unites States export 16,030 11,208 9,381
Europe 43,825 31,008 28,737
Intersegment eliminations (17,110) (12,596) (13,456)
--------- --------- ---------
Total net revenue $ 264,040 $ 234,972 $ 218,186
========= ========= =========
Income (loss) from operations:
United States $ 50,023 $ 41,434 $ 38,795
Europe 4,647 604 (1,105)
Corporate and eliminations (325) 813 147
--------- --------- ---------
Total operating income $ 54,345 $ 42,851 $ 37,837
========= ========= =========
Identifiable assets:
United States $ 125,774 $ 135,336 $ 128,474
Europe 53,853 21,892 24,363
Corporate and other 154,657 119,173 110,774
Eliminations (39,815) (38,253) (38,005)
--------- --------- ---------
Total assets $ 294,469 $ 238,148 $ 225,606
========= ========= =========
Transfers between geographic areas are generally recorded at amounts above cost
and in accordance with the rules and regulations of the governing tax
authorities. Operating income is total revenue less cost of sales and operating
expenses and does not include either interest income, other income (expense),
net, or income taxes. Identifiable assets of geographic areas are those assets
used in Nellcor's operations in each area. Identifiable corporate assets consist
primarily of cash and cash equivalents, marketable securities and other assets.
NOTE 10
LITIGATION
From time to time the Company has received, and in the future may receive,
notice of claims against it, which in some instances have developed, or may
develop, into lawsuits. The claims may involve such matters, among others, as
product liability, patent infringement, and employment-related claims. In
management's opinion, the ultimate resolution of claims currently pending will
not have a material adverse effect on the Company's financial position or
results of operations.
On July 11, 1995, the U.S. Federal District Court in Delaware issued a decision
in favor of the Company, ruling that four key oximeter and sensor technology
patents are valid and would be infringed by Ohmeda Inc., a subsidiary of BOC
Health Care Inc., if Ohmeda sold either its adult or neonatal OxyTip sensors for
use with non-Ohmeda monitors. BOC Health Care has filed a notice to appeal the
decision of the U.S. Federal District Court in Delaware. BOC Health Care had
filed a suit against the Company in December 1992, seeking a declaratory
judgment that Nellcor's patents were invalid and would not be infringed.
15
In a related matter, in the third quarter of fiscal 1994, the Company agreed to
settle trade secrets and patent litigation with BOC Health Care, Inc. and its
Ohmeda, Inc. subsidiary, and Square One Technology. Under the terms of the
agreement, the patent in issue was assigned to the Company. The Company also
received a pretax $2 million payment and will receive ongoing royalties. The $2
million payment was recorded as non-operating income.
In the fourth quarter of fiscal 1994, the Company agreed to settle its patent
litigation with Camino Laboratories, Inc. ("Camino") of San Diego, CA. Under the
terms of the settlement, Camino agreed not to sue the Company or its current or
future customers relating to the use or sale of the Company's sensors and
monitors intended for use with such sensors. A cash payment of $15 million was
made by the Company to Camino and was recorded as a non-operating expense. This
settlement neither recognizes the validity nor acknowledges infringement of the
Camino patent at issue.
NOTE 11
MERGER WITH PURITAN-BENNETT.
On May 22, 1995, Nellcor and Puritan-Bennett Corporation (Puritan-Bennett)
announced that their Boards of Directors had approved a definitive agreement to
merge the two companies. The issuance of Nellcor common stock in connection with
the Agreement and Plan of Merger was approved by shareholders at special
shareholder meetings held by each company on August 24, 1995. Under the terms of
the agreement, shareholders of Puritan-Bennett will receive 0.88 of a share of
Nellcor common stock for each Puritan-Bennett share. Puritan-Bennett, founded in
1913, operates 11 manufacturing and research plants worldwide and is a world
leader in products related to respiration used in multiple health care settings
and on aircraft. Puritan-Bennett develops, manufactures and markets ventilators,
respiratory monitoring instruments, and certain complementary products such as
medical gases, gas-related equipment, and spirometers. Puritan-Bennett reported
revenue of $336.0 million and net income of $8.4 million for its most recent
fiscal year ended January 31, 1995.
The new company, Nellcor Puritan Bennett Incorporated (Nellcor Puritan Bennett),
will be headquartered in Pleasanton, California, site of Nellcor's current
headquarters. The Board of Directors of Nellcor Puritan Bennett will have nine
members: six from Nellcor, two from Puritan-Bennett and one to be selected by
both companies.
The merger is intended to qualify as a tax-free reorganization and will be
accounted for as a pooling of interests. Pro forma combined financial results
for the two companies, assuming that the merger had occurred on July 6, 1992,
would be as follows (in thousands, except per share amounts):
- ----------------------------------------------------------------------------------
Pro Forma Information July 2, 1995 July 3, 1994 July 4, 1993
(Unaudited)
- ----------------------------------------------------------------------------------
Net revenues $600,066 $ 544,227 $518,246
Net income 49,463 (6,422) 39,715
Net earnings per share $ 1.77 $ (0.23) $ 1.46
The pro forma financial results combine Nellcor's financial data for each of the
three fiscal years ended July 2, 1995, with Puritan-Bennett's financial data for
each of the three fiscal years ended January 31, 1995. The only pro forma
adjustment impacting net income was an adjustment to reduce Puritan-Bennett's
valuation allowance provided for its deferred tax assets based on the combined
income from operations before tax of Nellcor and Puritan-Bennett as required by
Statement of Financial Accounting Standards Number 109, "Accounting for Income
Taxes" (SFAS 109). Intercompany transactions between the two companies for the
periods presented were not material.
Subsequent to the merger, Nellcor expects to incur a charge in the quarter ended
October 1, 1995, currently estimated to be in the range of $50 million to $70
million, to reflect the combination of the two companies, including costs
relating to severance, the elimination of duplicate systems and facilities,
other integration costs, and transaction fees. Charges relating to goodwill
arising from the companies' prior acquisitions may also be taken in the first
quarter as a result of the merger. This amount is a preliminary estimate only
and is therefore subject to change. In addition, there can be no assurance that
Nellcor will not incur additional charges in subsequent quarters to reflect
costs associated with the merger.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS:
Nellcor's net income for fiscal 1995 was $37.2 million, or $2.20 per share,
compared to $20.6 million, or $1.22 per share, for fiscal 1994. Fiscal 1994 net
income includes the effect of a net $13.0 million pretax charge ($8.0 million or
$0.48 per share after tax) for trade secrets and patent litigation settlements.
Excluding the after-tax effect of these settlements, fiscal 1995 net income
increased 30 percent over net income of $28.6 million, or $1.70 per share, for
fiscal 1994.
The Company's net revenue for fiscal 1995 increased 12 percent to $264.0 million
from $235.0 million in fiscal 1994. The increase in net revenue principally
resulted from higher sales of oximetry products across the Company's domestic
and international markets, increased sales of EdenTec apnea monitoring and
recording products, and the favorable effect foreign currency exchange rates had
upon revenue. The Company's oximetry products include oximetry instruments,
sensors, and OEM modules.
The Company's principal oximetry instruments include the N-20 portable pulse
oximeter, the N-180, N-185, N-200, and N-250 standalone pulse oximeters, and the
N-3000 pulse oximeter, a module of the NELLCOR SYMPHONY (TM) monitoring system.
Oximetry instrument revenue for fiscal 1995 increased slightly as higher unit
sales of the N-3000 pulse oximeter and the N-20 portable pulse oximeter were
partially offset by lower average selling prices.
Oximetry sensors include adhesive, reusable, and recycled sensor product lines.
Revenue from oximetry sensors increased moderately during fiscal 1995 primarily
due to continued growth in the installed base of the Company's monitors and
products of the Company's licensees and OEM customers that use the Company's
sensors. Higher unit sales were partially offset by slightly lower average
selling prices for adhesive and recycled sensors.
OEM oximetry module revenue increased significantly in fiscal 1995 as higher
unit shipments were partially offset by moderately lower average selling prices.
At the end of fiscal 1995, the Company had OEM or licensing agreements in place
with 40 medical systems and monitor manufacturers worldwide.
The principal apnea monitoring and recording products sold by EdenTec
Corporation into the home health care market include the ASSURANCE 2000 heart
and respiration monitor, the ASSURANCE 3000 heart and respiration monitor, and
the EdenTrace II and EdenTrace II Plus (TM) multi-channel recording systems, and
related products. During the fourth quarter of fiscal 1995, EdenTec acquired
Pierre Medical, a privately held French manufacturer of respiratory products
used in the home. Pierre Medical markets the O'nyx(TM) non-invasive ventilation
system, the O'mega(TM) oxygen concentrator, and the Morphee(TM) and Morphee
Plus(TM) sleep apnea therapy systems in Western Europe, primarily in France.
Revenue from these home health care products significantly increased during
fiscal 1995 primarily due to higher sales of the EdenTrace II Plus and the
ASSURANCE 3000 as well as sales from Pierre Medical included in EdenTec's
results subsequent to the acquisition, which was consummated May 3, 1995.
International revenue increased 42 percent to $59.9 million in fiscal 1995 from
$42.1 million in fiscal 1994. International revenue increased significantly
across all markets principally due to higher sales of oximetry sensors, the
N-3000 pulse oximeter, and OEM oximetry modules. Favorable foreign currency
exchange rates accounted for 10 percentage points of the international revenue
growth during fiscal 1995.
Sales of the HEALTHQUIZ (TM) system, a patient-driven automated medical history
system that electronically captures patient information, have been limited since
the product was introduced in the fourth quarter of fiscal 1994. The Company
regularly reviews its net investment in HEALTHQUIZ system assets and the related
market opportunities.
17
Nellcor's net revenue increased 8 percent to $235.0 million in fiscal 1994 from
$218.2 million in fiscal 1993. The increase in net revenue principally resulted
from higher sales of adhesive and reusable sensors, as well as increased sales
of apnea and oximetry products by EdenTec Corporation into the home health care
market. Sales of adhesive and reusable sensors increased primarily due to
continued growth in the installed base of the Company's monitors and the
products of the Company's licensees and OEM customers that use the Company's
sensors.
Oximetry instrument revenue decreased slightly in fiscal 1994 primarily due to
lower average selling prices and a continued shift to lower-priced, portable
pulse oximeters such as the N-20. Unit sales of oximetry instruments decreased
slightly in fiscal 1994.
OEM oximetry module revenue increased in fiscal 1994 principally due to
significantly higher unit shipments, partially offset by lower average selling
prices. Selling prices for certain OEM modules were reduced beginning in the
third quarter of fiscal 1993.
International revenue increased 11 percent to $42.1 million in fiscal 1994
principally due to higher sales of adhesive and reusable sensors, the ULTRA CAP
and the E-300, a multi-parameter monitoring system sold exclusively in Europe.
International growth occurred principally in the Asia Pacific and European
regions. Fiscal 1994 international revenue would have been approximately 6
percent higher had foreign currency exchange rates remained the same as those in
effect in the comparable periods in fiscal 1993.
The following sets forth, for the indicated periods, the relationship that
certain items bear to net revenue:
Years Ended July 2, 1995 July 3, 1994 July 4, 1993
- ------------------------------------------------------------------------------------
Net revenue 100% 100% 100%
Gross Margin 61 60 59
Operating expenses:
Research and development 10 10 10
Selling, general and administrative 30 32 32
Total operating expenses 40 42 42
Income from operations 21 18 17
Litigation settlements, net -- 6 --
Income before income taxes 23 14 19
Net income 14 9 12
Gross margin increased to 61 percent in fiscal 1995 from 60 percent in fiscal
1994 primarily due to improved margins at EdenTec and the favorable effect which
foreign currency exchange rates had upon revenue, partially offset by a slight
shift in mix to lower margin instruments.
Gross margin increased to 60 percent in fiscal 1994 from 59 percent in fiscal
1993. This increase was primarily due to a slight shift in mix to higher margin
sensors and lower manufacturing and service costs, partially offset by lower
oximetry instrument pricing and the unfavorable impact which foreign currency
exchange rates had upon revenue.
Research and development expenses at 10 percent of net revenue in fiscal 1995
were comparable to the prior year. Research and development expenses increased
in absolute dollars due primarily to costs incurred related to the development
of additional modules of the NELLCOR SYMPHONY monitoring system, increased sleep
product development work at EdenTec and higher patent filing fees and legal
costs. The Company expects to continue to invest in the research and development
of new products and to defend its patents.
18
Research and development expenses at 10 percent of net revenue in fiscal 1994
were comparable to the prior year. Research and development expenses increased
in absolute dollars due primarily to costs incurred related to the development
of the HEALTHQUIZ(TM) PRESCREEN(TM) automated preanesthetic medical history
system.
Selling, general, and administrative expenses in fiscal 1995 decreased to 30
percent of net revenue from 32 percent of net revenue in fiscal 1994. Selling,
general and administrative expenses increased in absolute dollars due primarily
to the unfavorable effect foreign currency exchange rates had upon international
operating expenses, the inclusion of operating expenses from Pierre Medical
subsequent to its acquisition, and increased funding of the Company's profit
sharing and bonus plans, partially offset by lower patent litigation expenses.
In comparison to fiscal 1993, fiscal 1994 selling, general and administrative
expenses remained unchanged at 32 percent of net revenue. Selling, general and
administrative expenses increased in absolute dollars due primarily to higher
patent litigation expenses.
During the first quarter of fiscal 1994, a $.5 million restructuring charge was
recorded. Under the restructuring, two of the Company's divisions were
consolidated into a single business unit.
During the third quarter of fiscal 1994, the Company agreed to settle trade
secrets and patent litigation with BOC Health Care, Inc., and its Ohmeda, Inc.
subsidiary, and Square One Technology. Under the terms of the agreement, the
patent in issue was assigned to the Company. The Company also received a $2
million payment and will receive ongoing royalties. The $2 million payment was
recorded as nonoperating income in the third quarter of fiscal 1994.
During the fourth quarter of fiscal 1994, the Company announced that it had
agreed to settle its patent litigation with Camino Laboratories Inc. ("Camino")
of San Diego, CA. Under the terms of the settlement, Camino agreed not to sue
the Company or its current or future customers relating to the use or sale of
the Company's sensors and monitors intended for use with such sensors. A cash
payment of $15 million was subsequently made by the Company to Camino. The
payment was recorded as a nonoperating expense in the fourth quarter of fiscal
1994.
In July, 1995, the Company announced that the U.S. Federal District Court in
Delaware had issued a decision in favor of Nellcor in the Company's patent
litigation with Ohmeda and BOC Health Care, Inc. The Court ruled that Nellcor
oximeter and sensor technology patents are valid and would be infringed if
Ohmeda, a subsidiary of BOC Health Care, Inc., sold its adult or neonatal Oxy
Tip sensors for use with non-Ohmeda monitors. BOC Health Care has filed a notice
to appeal the decision of the U.S. Federal District Court in Delaware.
BUSINESS FACTORS:
ACQUISITIONS. During the fourth quarter of fiscal 1995, EdenTec acquired Pierre
Medical, a privately-held French manufacturer of respiratory products used in
the home for $21.5 million in cash. In the event that certain profitability
targets are achieved or certain of Pierre Medical's products receive FDA
approval subsequent to the acquisition, additional compensation totaling 30
million French Francs ($6.2 million as of July 2, 1995) would be payable to the
former principal stockholders of Pierre Medical who will continue to manage the
company. Pierre Medical manufactures and markets noninvasive ventilators, sleep
apnea therapy systems, oxygen concentrators and related respiratory products in
Western Europe, primarily France. Pierre Medical reported revenue of
approximately $10.0 million for its most recent fiscal year ended September 30,
1994.
The acquisition was accounted for under the purchase method and is intended to
broaden the Company's product offerings and to provide opportunities to expand
sales into the home health and emergency care market segments. The final
allocation of the purchase price to other identifiable intangible assets,
including determining or reevaluating the likelihood of the future
recoverability of these intangible assets, is dependent upon the outcome of the
Company's merger with Puritan-Bennett Corporation (see Note 11) and any
resulting effects the merger has upon the operations of Pierre Medical.
19
MERGER WITH PURITAN-BENNETT. During the fourth quarter of fiscal 1995, Nellcor
and Puritan-Bennett Corporation (Puritan-Bennett) announced that their Boards of
Directors had approved a definitive agreement to merge the two companies. The
issuance of Nellcor common stock in connection with the Agreement and Plan of
Merger was approved by shareholders at special shareholder meetings held by both
companies on August 24, 1995. Under the terms of the agreement, shareholders of
Puritan-Bennett will receive 0.88 of a share of Nellcor common stock for each
Puritan-Bennett share. Puritan-Bennett, founded in 1913, operates 11
manufacturing and research plants worldwide and is a world leader in products
related to respiration used in multiple health care settings and on aircraft.
Puritan-Bennett develops, manufactures and markets ventilators, respiratory
monitoring instruments, and certain complementary products such as medical
gases, gas-related equipment, and spirometers. Puritan-Bennett reported revenue
of $336.0 million and net income of $8.4 million for its most recent fiscal year
ended January 31, 1995.
The merger will combine companies who are worldwide leaders in two complementary
areas, patient safety monitoring and respiratory therapy. In addition, the
merger will allow the new company to potentially realize synergies in research
and development, manufacturing, and operations. Subsequent to the merger,
Nellcor expects to incur a charge in the quarter ended October 1, 1995,
currently estimated to be in the range of $50 million to $70 million, to reflect
the combination of the two companies, including costs relating to severance, the
elimination of duplicate systems and facilities, other integration costs, and
transaction fees. Charges relating to goodwill arising from the companies' prior
acquisitions may also be taken in the first quarter as a result of the merger.
This amount is a preliminary estimate only and is therefore subject to change.
In addition, there can be no assurance that Nellcor will not incur additional
charges in subsequent quarters to reflect costs associated with the merger.
The new company, Nellcor Puritan Bennett, will be headquartered in Pleasanton,
California, site of Nellcor's current headquarters. The Board of Directors of
Nellcor Puritan Bennett will have nine members: six from Nellcor, two from
Puritan-Bennett and one to be selected by both companies. The merger is intended
to qualify as a tax-free reorganization and will be accounted for as a pooling
of interests.
PRODUCTS. In the second quarter of fiscal 1995, the Company received marketing
clearance from the U.S. Food and Drug Administration (FDA) for the Pedi-CAP
pediatric end-tidal CO2 detector. This disposable device, in combination with
the EASY CAP(R) CO2 detector, will allow customers to verify and monitor correct
endotracheal tube placement in a full range of patients, from infants to adults.
Both the Pedi-CAP and EASY CAP CO2 detectors were designed to be used in
transport and emergency settings as well as areas where capnography is not
available.
In the fourth quarter of fiscal 1995, the Company received marketing clearance
from the FDA for the N-3000 pulse oximeter and the N-3100 noninvasive blood
pressure monitor. The N-3000, the first module of a planned monitoring system
for use on the hospital general care floor and in mobile environments, was
shipped to international markets beginning in the third quarter of fiscal 1994.
International shipments of the N-3100 noninvasive blood pressure monitor, the
second module of the NELLCOR SYMPHONY monitoring system, began in the first
quarter of fiscal 1995. Commercial shipment of both products in the U.S. market
commenced late in the fourth quarter of fiscal 1995. The N-3000 and the N-3100
can be used as standalone monitors or as part of the NELLCOR SYMPHONY system.
Nellcor began limited shipments of the N-400 fetal pulse oximeter in Europe in
the second quarter of fiscal 1995. The N-400 is used to measure fetal oxygen
levels during labor and delivery, and is expected to aid obstetricians in
evaluating fetal well-being. In the first quarter of fiscal 1994, the FDA
notified the Company that the N-400 fetal oximeter must be submitted under the
Pre-Market Approval (PMA) Application Regulations. The PMA process, as compared
to the 510(k) procedures, requires more laboratory and clinical testing data,
and more detailed design and manufacturing information. This process in turn
takes the manufacturer longer to gather data and prepare the PMA application.
Historically, the time elapsed between submission of a PMA application and
receipt of premarket approval is significantly longer than for the clearance to
market granted under the 510(k) process. In June 1995, the Company filed an
application for an Investigational Device Exemption with the FDA. Clinical
trials of the product are expected to begin by the end of the second quarter of
fiscal 1996.
The Company is continuing to develop new products to address existing and new
markets. The introduction of new products may be prevented or delayed by
engineering obstacles, regulatory procedures, clinical trials, production
difficulties, and other factors. In addition, the costs of producing, promoting,
and servicing new products are generally greater than in the case of mature,
higher volume products. New product introductions can also temporarily reduce
revenues by interfering with sales of existing products.
20
As Nellcor's existing products reach life cycle maturity, the Company's ability
to develop or acquire new products and technologies increases in importance. The
Company has and will continue to pursue technology, new product, and business
acquisition opportunities intended to broaden the Company's product offerings.
Examples of such activities include the acquisition of Pierre Medical in fiscal
1995, and the pending merger of Nellcor and Puritan-Bennett. Such activities may
result in increased expenses which could have an adverse impact on the Company's
net income.
MARKET CONDITIONS. As health care increasingly becomes managed care, patient
care is shifting to lower cost areas of the hospital and alternate care sites
outside the hospital, including subacute care centers, skilled nursing
facilities and the home. Additionally, in an effort to create larger, more
cost-effective entities capable of competing for managed care contracts, health
care providers are consolidating and vertically integrating, and hospitals are
joining local or regional multiple hospital systems in greater numbers. As a
result of these ongoing changes in the delivery of health care, the Company
expects that a greater proportion of its future revenue will come from sales of
its products to a smaller customer base, primarily comprised of larger,
consolidated health care providers and buying groups, and from sales of its
products into the growing alternate care markets.
In the current health care business environment, hospitals, which are the
Company's principal customers, face increasing pressure to control costs. These
pressures may in the future lead to a decrease in the average selling price for
a number of the Company's products, which could adversely affect the Company's
gross margin.
During fiscal 1995 and fiscal 1994, the Company offered a number of promotional
programs in an effort to increase the installed base of Nellcor oximetry
instruments and OEM modules. These programs also had the effect of reducing
pulse oximetry pricing. Competition in fiscal 1995 caused further price
reductions for oximeters and multi-function monitors. The Company is continually
seeking manufacturing cost reductions; however, these reductions may not offset
the impact of future price declines.
INTERNATIONAL MARKETS. The Company has devoted significant resources to
development of its European markets and administrative infrastructure. Over the
past five years, the Company has experienced growth in European revenues and
continues to expand sales, service, and distribution operations in this market.
Through its acquisition of Pierre Medical, the Company has broadened its product
offerings in the European home care market.
During fiscal 1995, sales to the Asia/Pacific region increased significantly.
Additionally, in July of fiscal 1995, Nellcor increased its ownership interest
in the Company's Tokyo-based joint venture, NCI, to 50 percent. The Company's
investment in the joint venture, which it accounts for under the equity method,
was immaterial at July 2, 1995. With a greater level of investment in the
venture, and increased management involvement and marketing resources, the
Company plans to more aggressively pursue opportunities for Nellcor and EdenTec
products in Japan.
The Company received ISO 9001 certification for all of its facilities in March,
1995. This certification signifies that the Company has met a rigorous set of
international standards for product design, installation, and service. ISO 9001
certification is the first step necessary to be able to affix the CE
(Conformitee European) mark to Nellcor products and requires the implementation
of a company-wide quality system. The Company believes ISO 9001 certification
provides a significant competitive advantage in global markets.
The Company believes that the continued growth in international revenue and
market share will be a key factor in its overall long-term performance and
accordingly intends to continue to invest in its international operations.
TIMING OF ORDERS AND SHIPMENTS. Historically, orders in the first quarter have
been lower than in the second, third and fourth quarters.
Of the monitor orders received by the Company in any quarter, a
disproportionately large percentage has typically been received and shipped
toward the end of the quarter. Accordingly, monitor backlog has historically
been modest and not an accurate predictor of future revenues, and results for a
given quarter can be adversely affected if there is a substantial order
shortfall in that quarter. Backlog at the end of fiscal 1995 was approximately
$9.8 million compared to $10.7 million at the end of fiscal 1994. The decrease
in backlog in fiscal 1995 was primarily due to increased shipments of the N-3000
at the end of the fiscal year.
21
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 1995, the Company generated a net increase in cash and cash
equivalents and marketable securities of $19.1 million. At July 2, 1995, the
Company had cash, cash equivalents and marketable securities amounting to
approximately $140.7 million compared to $121.6 million at the end of fiscal
1994.
The Company has met its liquidity requirements from internally generated cash.
The Company's operating activities provided positive cash flows of $55.7 million
during fiscal 1995. Depreciation expense and amortization expense were
significant non-cash operating activities for all years presented. Purchases of
marketable securities and fixed assets, principally manufacturing equipment, and
the acquisition of Pierre Medical were the principal uses of cash from investing
activities.
Shares of Nellcor common stock issued due to the exercise of stock options under
one of the Company's stock option plans were significant sources of cash from
financing activities in fiscal 1994. Shares of common stock repurchased in
fiscal 1995 under the Company's Limited Stock Repurchase Program were
significant uses of cash from financing activities. Shares repurchased under the
Limited Stock Repurchase Program are repurchased to offset the dilutive effects
of the Company's stock plans. No repurchases of shares under the General Stock
Repurchase Program, which authorizes the repurchase and retirement of up to one
million shares of common stock from time to time in the open market, were made
in fiscal 1995.
During the second quarter of fiscal 1995, the Company secured a $50 million
credit facility with a syndicate of 4 banks led by ABN AMRO Bank N.V. The credit
facility was obtained to provide Nellcor with additional financial resources and
flexibility to take advantage of strategic business opportunities. Under the
terms of the credit facility, a commitment fee of 0.25% is paid quarterly and at
the end of November, 1996, outstanding borrowings are convertible into four year
term loans. As of July 2, 1995, the Company had not drawn against this credit
facility.
The Company anticipates that current capital resources combined with cash
generated from operating activities will be sufficient to meet its liquidity and
capital expenditure requirements at least through the end of fiscal 1996. When
the Company's merger with Puritan-Bennett is consummated, it is expected that
costs associated with the merger as well as other merger-related cash outlays,
will lead to a net reduction in the Company's cash and cash equivalents during
fiscal 1996. The Company may consider using debt to fund certain capital and
other strategic opportunities when deemed necessary and financially
advantageous.
22
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND
STOCKHOLDERS OF NELLCOR INCORPORATED
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Nellcor
Incorporated and its subsidiaries at July 2, 1995 and July 3, 1994, and the
results of their operations and their cash flows for each of the three years in
the period ended July 2, 1995, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
San Francisco, California
July 26, 1995, except as to Note 11, which is as of August 24, 1995
23
SELECTED QUARTERLY DATA
Unaudited (in thousands, except per share amounts)
Year ended July 2, 1995 1st quarter 2nd quarter 3rd quarter 4th quarter
- --------------------------------------------------------------------------------------------------------------
Net revenue $55,714 $64,017 $71,035 $73,274
Gross profit 32,878 38,690 43,119 46,172
Income from operations 8,380 12,390 15,967 17,608
Net Income 5,859 8,483 11,058 11,765
Net income per share 0.35 0.50 0.65 0.69
- --------------------------------------------------------------------------------------------------------------
Year ended July 3, 1994 1st quarter 2nd quarter 3rd quarter 4th quarter
- --------------------------------------------------------------------------------------------------------------
Net revenue $50,148 $58,113 $61,646 $65,065
Gross profit 29,222 34,695 37,648 39,701
Income from operations 6,638 10,543 12,373 13,297
Litigation settlements --- --- 2,000 (15,000)
Net Income 4,859 6,856 9,352 (510)
Net income per share 0.29 0.41 0.55 (0.03)