Exhibit 13.1
The following information appears on pages 7-10 of the Company's 1999 Annual
Report to Shareholders.
Management's Discussion and Analysis of Financial Condition and Results of
- --------------------------------------------------------------------------
Operations
- ----------
Forward-Looking Statements: Certain statements contained in this Annual Report
include "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. All forward-looking statements in
this document are based on information currently available to the Company as of
the date hereof, and the Company assumes no obligation to update any forward-
looking statements. Forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results to differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements. Such factors may include, among
others, the risk factors listed from time to time in the Company's filings with
the Securities and Exchange Commission, such as the year-end Annual Report on
Form 10-K.
Overview
The Company develops, manufactures and markets branded proprietary and patented
specialty medical products for use in thoracic, cardiac, neuro, vascular and
ophthalmic surgery. The Company's branded products include the Tissue-Guard(TM)
product line, the Biograft(R) peripheral vascular graft, and surgical
productivity tools used in cardiac and vascular surgery. The Company's wholly-
owned subsidiary, Jer-Neen Manufacturing Co., Inc. (Jerneen) is a value-added,
original equipment manufacturer of micro-precision wire-based component
products, including precision coils, stylets and guidewire components and sub-
assemblies used in the medical industry.
The acquisition of Jerneen was completed July 31, 1998, the end of the Company's
fiscal 1998 third quarter. Jerneen's financial results were included in the
Company's consolidated results of operations during the fourth quarter of 1998
and all four quarters of 1999. The Company believes that the addition of
Jerneen's medical component business broadens the Company's participation in the
medical device industry, increases the Company's immediate and long-term revenue
potential and achieves a balance of market opportunities consistent with the
strategic objectives targeted by the Company.
The Company's consolidated net revenue in fiscal 1999 increased to a record
$18,904,000, up $6,887,000 or 57% from fiscal 1998 net revenue of $12,017,000.
The branded products business reported revenues of $11,681,000, up $1,061,000 or
10% from the 1998 revenue level of $10,620,000. Total 1999 branded product net
revenue represents the highest annual revenue in the Company's history recorded
by this business segment. The Jerneen component business contributed net
revenues of $7,223,000 in 1999, up $5,826,000 from revenues of $1,397,000
contributed during the fourth quarter of 1998. The Company reduced its
operating loss for the year by $621,000 from $1,415,000 in fiscal 1998 to
$794,000 in fiscal 1999. The consolidated net loss for fiscal 1999 was
$520,000, or $0.06 per share, as compared with a fiscal 1998 net loss of
$483,000, or $0.05 per share, due in part to a $563,000 decrease in net interest
income from fiscal 1998 to fiscal 1999 which offset the Company's operating
income improvements. The Company used cash primarily for stock repurchases,
capital equipment and the July 1998 purchase of Jerneen, lowering the Company's
interest-bearing balances.
The Company has continued to advance its strategy for growth at both business
units, focusing on opportunities to grow through acquisition, licensing and
distribution, expansion of markets for its current products, and internal new
product research and development (R&D) activities.
The Company's 1999 product development activities included a number of projects,
including a small diameter graft, a sling for the surgical treatment of female
urinary stress incontinence and a stent covering. All three of these projects
involve new and advanced tissue formats which have been in R&D for almost two
years. The animal testing phases for each of these projects will be continuing
in fiscal 2000. During fiscal 1999, the component products business opened its
Technology Development Center (TDC), which was established to provide creative
solutions for their customers in addition to rapid response prototyping. Also,
the Company's product development
1
efforts resulted in the filing of two patents during fiscal 1999 to protect new
and proprietary technologies. One of the applications related to the manufacture
and use of stent coverings formed of biological tissues, and the other pertains
to the Company's new "resorbable" line of tissue implant materials. The
Company's R&D activities are expected to increase as projects under development
continue to progress.
Results of Operations
Years Ended October 31, 1999 and 1998
Consolidated net revenue in fiscal 1999 increased to a record $18,904,000, up
$6,887,000 or 57% from fiscal 1998 net revenue of $12,017,000. The branded
products business reported revenues of $11,681,000, up $1,061,000 from the 1998
revenue level of $10,620,000. The Jerneen component business contributed net
revenues of $7,223,000 in 1999, as compared to revenues of $1,397,000
contributed during the fourth quarter of 1998. Jerneen's net revenues in 1999
represent a 31% increase over 1998 revenues of $5,560,000, of which the first
three quarters were not included in the Company's 1998 results. The 31% revenue
growth of the component business unit is attributable to both increased sales
unit volume as well as new products resulting from its quick turn prototyping
emphasis.
The branded products business experienced 25% revenue growth from its surgical
productivity tools to $2,560,000 in 1999 from $2,051,000 in 1998. Revenue from
the Flo-Thru Intraluminal Shunt(TM), which received market clearance in August
1998, accounted for approximately 57% of the increase in surgical productivity
tools revenue during the year. The Tissue-Guard product line, exclusive of
Peri-Strips(R), contributed 14% revenue growth in 1999 over 1998 driven by sales
of Vascu-Guard(R) and Dura-Guard(R). While Peri-Strips revenue increased in
each of the last three quarters of 1999 compared to the same periods in 1998,
competitive activities in the first quarter of the year resulted in a 3%
decrease in Peri-Strips revenue in fiscal 1999. Sales of Biograft increased 1%
to $756,000 in 1999 from $748,000 in 1998 as a result of the Company's efforts
to bring attention to the excellent efficacy of this product in limb salvage.
The Company's consolidated gross margin percentage decreased to 50% in fiscal
1999 from 57% in fiscal 1998, due primarily to the inclusion of the component
products business in the consolidated operating results for the full year in
1999 as compared to one quarter in 1998. In 1999, the component products
business gross margin was 38% while the branded products business gross margin
was 57%. In fiscal 2000, the Company expects an increase in branded business
gross margins associated with the positive leverage of existing production fixed
costs and a decrease, in percentage terms, in the component business gross
margins primarily associated with precious metals handling agreements with key
customers. Late in fiscal 1999, Jerneen agreed to purchase critical precious
metals on behalf of certain customers for use in Jerneen's manufacturing of
products for which it will be paid a handling fee for the incremental personnel
and working capital resource commitments it is undertaking. Although the impact
is a reduction in the gross margin percentage, the substance of the transactions
adds in absolute dollars to the gross margin of the business unit. As a result,
the Company expects a decreased consolidated gross margin percentage in fiscal
2000 as compared to 1999. This forward-looking statement is influenced
primarily by the Company's current estimate of production forecasts and costs
and would be impacted by significant increases or decreases in production
volumes of the Company's products, by material changes in the Company's product
mix and by the accuracy of the Company's estimates of production and other
manufacturing costs.
Selling, general and administrative (SG&A) expense increased $1,928,000, or 29%,
from 1998 to 1999. The full year inclusion of the component business accounts
for approximately 73% of the overall period-to-period increase in SG&A expense.
Since Jerneen has less SG&A infrastructure than does the branded products
business, SG&A as a percentage of net revenues decreased from 55% for the 1998
period to 45% for the 1999 period. The remaining SG&A increase is primarily due
to increased sales and marketing costs within the branded products segment.
R&D expense for the period increased $117,000, or 8%, between 1999 and 1998, to
$1,665,000. The inclusion of the engineering and development activities of the
component business was the primary reason for the overall period-to-period
increase in R&D expense. The Company continued to focus its efforts on new
product development, as demonstrated through its allocation of significant
resources to R&D at both its branded and component products businesses. The
Company's 1999 product development activities included a number of projects,
including a small
2
diameter graft, a sling for the surgical treatment of female urinary stress
incontinence and a stent covering. All three of these projects involve new and
advanced tissue formats which have been in R&D for almost two years. The animal
testing phases for each of these projects will be continuing in fiscal 2000.
During fiscal 1999, the component products business opened its Technology
Development Center (TDC), which was established to provide creative solutions
for their customers in addition to rapid response prototyping. Also, the
Company's product development efforts resulted in the filing of two patents
during fiscal 1999 to protect new and proprietary technologies. One of the
applications related to the manufacture and use of stent coverings formed of
biological tissues, and the other pertains to the Company's new "resorbable"
line of tissue implant materials. The Company's R&D activities and expense are
expected to increase as projects under development continue to progress. This
forward-looking statement will be influenced primarily by the number of projects
and the related R&D personnel requirements, development and regulatory approval
path, expected costs and the timing of those costs for each project.
The consolidated operating loss in 1999 was reduced by $621,000, or 44%, to
$794,000 from an operating loss of $1,415,000 in 1998. The component business
contributed $617,000 to operating income in 1999, up $555,000 from operating
income of $62,000 contributed in the fourth quarter of 1998.
Other income, primarily net interest income, was $183,000 in 1999 and $746,000
in 1998. The $563,000 decrease in net interest income is related to
significantly lower average cash and investment balances in 1999, primarily due
to cash expenditures for the Company's stock repurchase program, capital
additions and the July 1998 Jerneen acquisition, and an increase in interest
expense related to acquired capital equipment leases and other liabilities. The
Company's loss before income taxes was $611,000 in 1999 as compared to a loss of
$669,000 in 1998.
The Company recorded a benefit from income taxes of $91,000 in 1999,
representing an effective tax rate of 15%, as compared to an effective tax rate
of 28% in 1998. The 1999 effective tax rate is less than the statutory rates
primarily due to the impact of permanent differences, including nondeductible
goodwill associated with the acquisition of Jerneen, partially offset by the
impact of research and experimentation credits. The decrease in the effective
tax rate from 1998 to 1999 is primarily due to a lower operating loss before tax
benefit combined with an increase in nondeductible goodwill amortization in 1999
as compared to 1998. At October 31, 1999, the Company has recorded $165,000 of
deferred tax assets as a result of the net operating loss carryforwards
generated in recent years. In addition, the Company has $417,000 of deferred
tax assets related to certain credit carryforwards, primarily research and
experimentation credits, and $265,000 of other net deferred tax assets. The
Company expects to fully apply its net deferred tax assets against future
taxable income. The Company expects it would have to generate at least
$2,400,000 in taxable income in future years to realize the full benefit of the
net deferred tax assets recorded at October 31, 1999. Net operating loss
carryforwards expire from 2012-2014 and credit carryforwards expire from 2009-
2014. The 1999 net loss was $520,000, or $0.06 per share, compared to a net
loss of $483,000, or $0.05 per share in 1998.
Years Ended October 31, 1998 and 1997
Consolidated net revenue increased $2,323,000, or 24%, to $12,017,000 from
$9,694,000. The Jerneen component business contributed $1,397,000 to 1998
revenue. Branded product growth came from the Tissue-Guard product line, which
grew at a 19% pace, led by sales of Vascu-Guard and Dura-Guard. Aided by
international growth of 27%, Peri-Strips revenue increased $318,000, or 11%.
Domestic Peri-Strips revenue increased 6% with only a minimal contribution from
the National Emphysema Treatment Trial (NETT). Bio-Graft revenue decreased
$52,000, or 7%, to $748,000 from $800,000, continuing a trend. Revenue from
sales of surgical productivity tools decreased 4% to $2,051,000 from $2,127,000.
The Company's gross margin percentage was 57% for 1998 as compared to 59% for
1997. In 1998, the component product line margin was 37%, while the branded
products' margin was 59%. The gross margin in the fourth quarter of 1998, the
first quarter including the operations of both businesses, was 52%.
SG&A expense increased $888,000, or 15%, between 1998 and 1997. The inclusion
of the component business beginning in the fourth quarter of 1998 accounted for
nearly half of the overall year-to-year increase in SG&A
3
expense. The remaining increase was due to the continuing investment in
personnel in the areas of regulatory and clinical affairs, product development,
and sales and marketing required to advance the Company's revenue growth
initiatives. SG&A expense as a percentage of net revenues, however, decreased
from 60% in 1997 to 55% in 1998, due mainly to Jerneen having less SG&A
infrastructure as compared to the branded products business.
R&D expense increased $290,000, or 23%, between 1998 and 1997 to $1,548,000.
The product development activities in 1998 focused on both near and long-term
opportunities. The near-term opportunities included leveraging current tissue
expertise through product line expansions while long-term projects included a
focus on proactively seeking to obsolete current technology. During fiscal
1998, the Company's product development efforts resulted in 510(k) marketing
clearance from the FDA for three new products.
The operating loss in 1998 was $1,415,000 as compared to an operating loss of
$1,305,000 for 1997. The component business contributed $62,000 to operating
income in 1998.
Other income, primarily net interest income, was $746,000 in 1998 and $1,066,000
in 1997. The $320,000 decrease in interest income is related to lower average
investment balances in 1998, primarily due to 1998 cash expenditures of
$4,095,000 for the Company's stock repurchase program and $5,224,000 associated
with the Jerneen acquisition. As a result, continuing operations had a loss
before income taxes of $669,000 in 1998 as compared to $239,000 in 1997.
Operating activities generated positive cash flow of $322,000 in 1998.
The Company's benefit for income taxes in 1998 was $186,000. The 1998 effective
tax rate of 28% was less than the statutory rates primarily due to the impact of
permanent differences including nondeductible goodwill, partially offset by the
impact of research and experimentation credits. The Company recorded a tax
provision of $365,000 in 1997 due to a $421,000 write-off of an income tax asset
associated with net operating loss carryforwards of its former subsidiary, Vital
Images.
The 1998 loss from continuing operations was $483,000, or $0.05 per share,
compared to $604,000, or $0.06 per share in 1997. In 1997, the Company also
recorded a loss from discontinued operations of $920,000, or $0.10 per share.
Liquidity and Capital Resources
Cash, cash equivalents and marketable securities were $5,596,000 at October 31,
1999, as compared to $8,374,000 at October 31, 1998, a reduction of $2,778,000.
Major uses of available cash during 1999 totaling $2,738,000 were the repurchase
of common stock and the purchase of equipment and leasehold improvements.
Operating activities provided cash of $740,000 in 1999 as compared to providing
cash of $322,000 in 1998, with the component products business incrementally
providing $678,000 in operating cash flow during 1999 over the prior year.
Operating cash flows provided by the branded products business decreased from
1998 to 1999 primarily as a result of changes in working capital activities.
Cash was provided by operations in 1999 through non-cash expenses in excess of
the loss from operations, partially offset by increases in working capital used
for inventories and accounts receivable.
The Company invested $1,334,000 in equipment and leasehold improvements,
primarily related to manufacturing processes. As a result of interest rate
yield curves during 1999, net investments in marketable securities totaling
$3,991,000 were liquidated and invested in short-term, highly liquid cash
equivalents. The cash reserves are maintained to provide for current and future
financing and other investing activities.
Financing activities used $2,024,000 of cash during 1999, including $616,000
used to repay a bank note and other long-term obligations and $1,404,000 used to
repurchase 484,834 shares of Company common stock under the Company's stock
repurchase program. The repurchase program was completed during fiscal 1999.
The program will have a positive impact on earnings per share in periods of
profitability. However, while the Company is generating losses, the stock
repurchases have a dilutive impact on current earnings per share. The Company
has long-term obligations of $686,000 at October 31, 1999, requiring payments
through 2004.
4
The Company believes existing cash and cash equivalents will be sufficient to
satisfy its cash requirements for the foreseeable future. This forward-looking
statement, as well as the Company's long-term cash requirements, will be a
function of a number of variables, including R&D priorities, acquisition
opportunities and the growth and profitability of the business.
Year 2000 Matters
The "Year 2000" problem refers to the potential for computational errors or
system malfunctions by computer hardware or software that fail to properly
recognize dates beginning with January 1, 2000, or which fail to recognize the
year 2000 as a leap year. In anticipation of this problem, the Company
instituted and followed a Year 2000 readiness program intended to identify,
evaluate and address its Year 2000 exposure.
At the time that this report was prepared (shortly after the new year), the
Company had not experienced any material Year 2000 problems with its internal
systems, and was not aware of any such problems experienced by its customers,
vendors and other service providers. As a result, no material adverse impact of
the Year 2000 problem on the Company's business and operations was expected,
based upon the information then available to the Company. However, this
forward-looking statement will be impacted by the extent to which latent Year
2000 problems remain undiscovered, or, in the case of Year 2000 problems with
business partners, undisclosed, and the extent of any future problems caused by
the failure of computer hardware or software to recognize the year 2000 as a
leap year. There can be no assurance that any such issues will not result in
material cost to the Company or have a material, adverse impact on its business,
financial condition or results of operations.
Inflation
Management believes inflation has not had a material effect on the Company's
operations or on its consolidated financial condition.
Foreign Currency Transactions
Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars. Fluctuations in currency exchange rates in other
countries may therefore reduce the demand for the Company's products by
increasing the price of the Company's products in the currency of the countries
in which the products are sold.
Quantitative and Qualitative Disclosures About Market Risk
The principal financial instruments the Company maintains are in accounts
receivable and long-term obligations. The Company believes that the interest
rate, credit and market risk related to these accounts is not significant. The
Company manages the risk associated with these accounts through periodic reviews
of the carrying value for non-collectibility of assets and establishment of
appropriate allowances in connection with the Company's internal controls and
policies.
New Accounting Standards
In fiscal 1999, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 130, Comprehensive Income, and SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. (See Note 1 to consolidated
financial statements for further information). In June 1998, SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, was issued. SFAS
No. 133 establishes accounting and reporting standards for derivative and
hedging activities. SFAS No. 133 is effective for all fiscal years beginning
after June 15, 2000. The Company's management is currently evaluating the
potential impact of adopting SFAS No. 133 on the Company's consolidated
financial statements.
5
The following consolidated financial statements and related notes appears on
pages 11-23 of the Company's 1999 Annual Report to Shareholders.
BIO-VASCULAR, INC.
CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
(in thousands, except share and per share data)
1999 1998
---- ----
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 5,596 $ 4,383
Marketable securities............................................................ - 3,991
Accounts receivable, net......................................................... 3,123 2,456
Inventories, net................................................................. 2,576 2,306
Deferred income taxes............................................................ 307 220
Other............................................................................ 398 527
-------- -------
Total current assets......................................................... 12,000 13,883
Equipment and leasehold improvements, net........................................ 4,936 4,354
Goodwill and other intangible assets, net........................................ 6,594 7,241
Deferred income taxes............................................................ 540 504
-------- --------
Total assets................................................................. $ 24,070 $ 25,982
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................. $ 680 $ 460
Accrued expenses................................................................. 1,551 1,421
Current maturities of long-term obligations...................................... 369 616
-------- --------
Total current liabilities.................................................... 2,600 2,497
Capital lease obligations........................................................ 159 393
Other liabilities................................................................ 527 662
-------- --------
Total liabilities............................................................ 3,286 3,552
-------- --------
Commitments (Note 7)
Shareholders' equity:
Preferred stock: authorized 5,000,000 shares of $.01 par value;
none issued or outstanding at October 31, 1999 and 1998...................... - -
Common stock: authorized 20,000,000 shares of $.01 par value;
issued and outstanding, 8,960,633 and 9,317,183
at October 31, 1999 and 1998, respectively................................... 90 93
Additional paid-in capital....................................................... 27,661 28,696
Unearned compensation............................................................ (601) (514)
Unrealized marketable securities holding gain.................................... - 1
Accumulated deficit.............................................................. (6,366) (5,846)
-------- --------
Total shareholders' equity................................................... 20,784 22,430
-------- --------
Total liabilities and shareholders' equity................................... $ 24,070 $ 25,982
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
6
BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997
- -------------------------------------------------------------------------------
(in thousands, except per share data)
1999 1998 1997
----- ----- ----
Net revenue.................................... $ 18,904 $12,017 $ 9,694
Cost of revenue................................ 9,443 5,222 3,967
--------- ------- -------
Gross margin................................... 9,461 6,795 5,727
Operating expenses:
Selling, general and administrative............ 8,590 6,662 5,774
Research and development....................... 1,665 1,548 1,258
--------- ------- -------
Operating loss................................. (794) (1,415) (1,305)
Other income, net, primarily interest.......... 183 746 1,066
--------- ------- -------
Loss from continuing operations
before provision for (benefit from)
income taxes................................. (611) (669) (239)
Provision for (benefit from) income taxes...... (91) (186) 365
--------- ------- -------
Loss from continuing operations................ (520) (483) (604)
Discontinued operations:
Loss on disposal of discontinued
business, net of income taxes................ - - (920)
--------- ------- -------
Net loss....................................... $ (520) $ (483) $(1,524)
========= ======= =======
Basic and diluted earnings per share:
Continuing operations.......................... $ (0.06) $ (0.05) $ (0.06)
Discontinued operations........................ - - (0.10)
--------- ------- -------
Net loss....................................... $ (0.06) $ (0.05) $ (0.16)
========= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
7
BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME AND SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED OCTOBER 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
(in thousands, except share data) Unrealized
Marketable
Additional Unearned Securities
Common Stock Paid -In Compen- Holding Accumulated
Shares Par Value Capital sation Gain (Loss) Deficit Total
------ --------- ------- ------ ---------- ------- ----------
Balance at October 31, 1996......... 9,484,898 $ 95 $ 39,500 $ (485) $ (51) $ (3,839) $ 35,220
Stock option activity, net of tax
benefit........................... 48,236 1 655 (332) 324
Employee Stock Purchase Plan
activity.......................... 9,190 37 37
Employee restricted stock
activity.......................... 22,185 63 23 86
Non-employee restricted stock
activity............................ 36,000 1 143 (113) 31
Stock repurchased by the Company.... (36,900) (1) (149) (150)
Distribution of net investment in
Vital Images........................ (10,584) 460 (10,124)
Comprehensive loss:
Unrealized marketable securities
holding gain, net................... 52 52
Net loss............................ (1,524) (1,524)
----------
Comprehensive loss.................. (1,472)
--------- --------- -------- ------- --------- --------- ----------
Balance at October 31, 1997......... 9,563,609 96 29,665 (447) 1 (5,363) 23,952
Stock option activity, net of tax
benefit........................... 80,760 1 248 23 272
Employee Stock Purchase Plan
activity............................ 8,247 25 25
Employee restricted stock
activity.......................... 56,961 1 248 (135) 114
Non-employee restricted stock
activity.......................... 45 45
Stock repurchased by the Company.... (978,266) (10) (4,085) (4,095)
Stock issued in conjunction with
the acquisition of Jerneen.......... 585,872 5 2,595 2,600
Net and comprehensive loss.......... (483) (483)
--------- --------- -------- ------- --------- --------- ----------
Balance at October 31, 1998......... 9,317,183 93 28,696 (514) 1 (5,846) 22,430
Stock option activity, net of tax
benefit........................... (1) (1)
Employee Stock Purchase Plan
activity.......................... 22,396 1 44 45
Employee restricted stock
activity.......................... 100,888 1 307 (124) 184
Non-employee restricted stock
activity.......................... 5,000 14 37 51
Stock repurchased by the Company.... (484,834) (5) (1,399) (1,404)
Comprehensive loss:
Unrealized marketable securities
holding loss, net................. (1) (1)
Net loss............................ (520) (520)
----------
Comprehensive loss.................. (521)
--------- --------- -------- ------- --------- --------- ----------
Balance at October 31, 1999 8,960,633 $ 90 $ 27,661 $ (601) $ - $ (6,366) $ 20,784
========= ========= ======== ======= ========= ========= ==========
The accompanying notes are an integral part of the consolidated financial
statements.
8
BIO-VASCULAR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED OCTOBER 31, 1999, 1998 and 1997
- --------------------------------------------------------------------------------
(In thousands) 1999 1998 1997
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITES:
Net loss ................................................................................. $ (520) $ (483) $ (1,524)
Net loss from discontinued operations .................................................... -- -- (920)
-------- -------- --------
Loss from continuing operations .......................................................... (520) (483) (604)
Adjustments to reconcile loss from continuing
operations to net cash provided by (used in)
operating activities:
Depreciation and amortization of equipment
and leasehold improvements ........................................................... 861 494 354
Amortization of goodwill and other intangible assets ..................................... 748 384 266
Provision for uncollectible accounts ..................................................... 14 88 --
Provision for inventory obsolescence ..................................................... 118 179 116
Non-cash compensation .................................................................... 283 220 212
Deferred income taxes .................................................................... (123) (166) 239
Changes in operating assets and liabilities:
Accounts receivable ...................................................................... (681) 139 (380)
Inventories .............................................................................. (388) (485) 237
Other assets ............................................................................. 129 17 314
Accounts payable and accrued expenses .................................................... 299 (65) 297
-------- -------- --------
Net cash provided by continuing operations ........................................... 740 322 1,051
Net cash used in discontinued operations ............................................. -- -- (1,861)
-------- -------- --------
Net cash provided by (used in) operating activities .................................. 740 322 (810)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITES:
Purchase of equipment and improvements ................................................... (1,334) (964) (654)
Investments in marketable securities ..................................................... (987) (8,675) (9,000)
Proceeds upon maturity of marketable securities .......................................... 4,978 13,159 13,750
Proceeds upon sale of marketable securities .............................................. -- 2,750 --
Purchase of Jerneen, net of cash acquired (Note 2)........................................ (59) (2,816) --
Investments in patents and trademarks..................................................... (101) (67) (43)
Discontinued operations, net ............................................................. -- -- (2,328)
-------- -------- --------
Net cash provided by investing activities ............................................ 2,497 3,387 1,725
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITES:
Proceeds from issuance of bank note ...................................................... -- 275 --
Repayments on bank note .................................................................. (261) (14) --
Net proceeds related to stock-based compensation plans ................................... (4) 236 265
Repurchase of the Company's common stock ................................................. (1,404) (4,095) (150)
Repayment of capital lease obligations ................................................... (230) (53) --
Repayments of other long-term obligations ................................................ (125) (34) --
Repayment of debt in conjunction with the acquisition
of Jerneen ........................................................................... -- (2,408) --
-------- -------- --------
Net cash (used in) provided by financing activities .................................. (2,024) (6,093) 115
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS .................................................. 1,213 (2,384) 1,030
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR .............................................................................. 4,383 6,767 5,737
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR ................................................. $ 5,596 $ 4,383 $ 6,767
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
9
BIO-VASCULAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS DESCRIPTION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business Description:
Bio-Vascular, Inc. ("Bio-Vascular" or the "Company") develops, manufactures and
markets branded proprietary and patented specialty medical products for use in
thoracic, cardiac, neuro, vascular and ophthalmic surgery. The Company's
branded products include the Tissue-Guard(TM) product line, the Biograft(R)
peripheral vascular graft and surgical productivity tools used in cardiac and
vascular surgery. Tissue-Guard products are made from bovine pericardium (the
thin membrane surrounding the heart of cattle) processed using proprietary
tissue-fixation technology. The Tissue-Guard products, made in various
configurations, are used in a wide variety of surgical procedures and are
designed to reinforce, reconstruct and repair tissue and prevent leaks of air,
blood and other body fluids.
The Company's wholly-owned subsidiary, Jer-Neen Manufacturing Co., Inc.
("Jerneen"), is a value-added, original equipment manufacturer of micro-
precision wire-based component products, including precision coils, stylets and
guidewire components and sub-assemblies used in the medical industry. The
Company acquired Jerneen in July 1998.
Basis of Consolidation:
The consolidated financial statements include the accounts of Bio-Vascular, Inc.
and its wholly-owned subsidiary, Jerneen, after elimination of intercompany
accounts and transactions.
Use of Estimates:
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Cash and Cash Equivalents:
Cash and cash equivalents consist of cash and highly liquid investments
purchased with an original maturity of three months or less. Cash equivalents
at October 31, 1999 and 1998 consisted primarily of commercial paper and one
money market fund.
Marketable Securities:
Investments having original maturities in excess of three months are classified
as marketable securities and generally consist of commercial paper, U.S.
Government or U.S. Government-backed obligations. Investments are classified as
short-term or long-term in the balance sheet based on their maturity date. At
October 31, 1999, the Company did not have any marketable securities. At
October 31, 1998, all of the Company's marketable securities were classified as
available-for-sale. Available-for-sale investments are recorded at market value
with net unrealized holding gains and losses included as a separate component of
shareholders' equity.
Inventories:
Inventories, which are comprised of component parts, subassemblies and finished
goods, are valued at the lower of first-in, first-out (FIFO) cost or market. On
a quarterly basis, the Company compares the amount
10
of the inventories on hand with its latest forecasted requirements to determine
its reserves for excess or obsolete inventories.
Equipment and Leasehold Improvements:
Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are calculated using the straight-line method over the estimated
useful lives of the related assets. Furniture, fixtures and computer equipment
are depreciated over a 3- to 7-year life and manufacturing equipment is
depreciated over a 5- to 10-year life. Leasehold improvements are amortized
over the life of the related facility leases or the assets, whichever is
shorter. Major replacements and improvements are capitalized and maintenance
and repairs which do not improve or extend the useful lives of the respective
assets are charged to operations. The asset and related accumulated
depreciation or amortization accounts are adjusted for asset retirements and
disposals with the resulting gain or loss, if any, recorded in the Consolidated
Statements of Operations at the time of disposal.
Long-Lived Assets:
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset in
question may not be recoverable. Impairment losses are recorded whenever
indicators of impairment are present.
Goodwill and Other Intangible Assets:
Goodwill and other intangible assets are recorded at cost and are amortized
using the straight-line method over their estimated useful lives, ranging from
10 to 17 years. The Company evaluates the net realizability of goodwill and
other intangible assets on an ongoing basis based on current and anticipated
undiscounted cash flows.
Revenue Recognition:
Revenue is recognized upon shipment of goods to customers, net of estimated
returns.
Research and Development:
Research and development costs are expensed as incurred.
Income Taxes:
The Company accounts for income taxes using the asset and liability method. The
asset and liability method provides that deferred tax assets and liabilities are
recorded based on the differences between the tax basis of assets and
liabilities and their carrying amounts for financial reporting purposes
("temporary differences"). Temporary differences relate primarily to operating
and capital loss carryforwards, research and experimentation tax credit
carryforwards, depreciation, non-compete obligations, and receivable and
obsolete inventory reserves.
Net Income (Loss) Per Common Share:
Basic earnings per share ("EPS") is computed based on the weighted average
number of common shares outstanding, while diluted EPS is computed based on the
weighted average number of common shares outstanding adjusted by the weighted
average number of additional shares that would have been outstanding had the
potential dilutive common shares been issued. Potential dilutive shares of
common stock include stock options and other stock-based awards granted under
the Company's stock-based compensation plans, when their impact is not anti-
dilutive.
11
Adoption of New Accounting Pronouncements:
In June 1997, Statement of Financial Accounting Standards ("SFAS") No. 130,
Comprehensive Income, was issued by the Financial Accounting Standards Board,
which the Company adopted in fiscal year 1999. SFAS No. 130 establishes
standards for reporting and displaying comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general purpose
financial statements and requires that all items required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. The Consolidated Statements of Comprehensive Income and
Shareholders' Equity reflects the adoption of SFAS No. 130. For the Company,
comprehensive income included net income and unrealized marketable securities
holding gains and losses.
In fiscal 1999, the Company adopted SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. See Note 4 for the required segment
disclosures under SFAS No. 131. In June 1998, SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, was issued. SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
hedging activities. SFAS No. 133 is effective for all fiscal years beginning
after June 15, 2000. The Company's management has not yet fully evaluated the
potential impact of adopting SFAS No. 133 on the Company's consolidated
financial statements.
(2) ACQUISITION OF BUSINESS:
On July 31, 1998, the Company completed the acquisition of Jerneen of Lino
Lakes, Minnesota, which was accounted for as a purchase. Pursuant to the terms
of the acquisition agreement, all of the issued and outstanding shares of common
stock of Jerneen were exchanged for 585,872 shares of Bio-Vascular common stock,
valued at $2,600,000, and an aggregate of $1,750,000 in cash, excluding
transaction costs. The Company also paid $950,000 for a 10-year non-compete
agreement covering the former Jerneen shareholders. Goodwill acquired by the
Company amounted to $5,200,000 and is being amortized using the straight-line
method over 15 years. The Company acquired $2,400,000 of Jerneen's outstanding
debt, which was paid immediately upon completion of the transaction. The
remaining fair value of net identifiable assets of Jerneen acquired in the
transaction totaled $1,772,000, including equipment and improvements of
$2,217,000, patents of $387,000, receivables of $848,000, inventories of
$381,000, less capital lease obligations of $677,000, accounts payable and
accrued expenses of $713,000 and other long-term obligations of $815,000.
The acquisition occurred on July 31, 1998, therefore only the results of
Jerneen's operations for the three-month period ended October 31, 1998 are
included in the Company's Consolidated Statement of Operations for 1998. The
Company's Consolidated Statement of Operations for 1999 includes the full year
results of Jerneen's operations.
The following unaudited pro forma financial information reflects the combined
results of the Company and Jerneen had the acquisition occurred at the beginning
of each of the fiscal periods presented. The pro forma financial information
presented is not necessarily indicative of either the future consolidated
operations of the Company or the actual results that would have occurred had the
acquisition of Jerneen been consummated on November 1, 1997 or 1996.
1998 1997
------------ ------------
Net revenue $16,180,000 $13,828,000
Operating loss (1,158,000) (1,099,000)
Loss from continuing operations (561,000) (769,000)
Basic and diluted earnings per share (0.06) (0.08)
12
(3) DISCONTINUED OPERATIONS:
On May 12, 1997, the Company completed the spin-off distribution of all shares
of Vital Images, Inc. ("Vital Images") to shareholders of Bio-Vascular, Inc.,
with Vital Images thereafter operating as an independent company with its own
publicly-traded securities. All Bio-Vascular shareholders of record received
one share of Vital Images common stock for every two shares of Bio-Vascular
common stock held, with cash issued in lieu of fractional shares. The spin-off
distribution was recorded by reducing shareholders' equity by $10,124,000, which
represents $10,000,000 of cash and investments, plus the carrying value of Vital
Images' net assets. A loss on disposal of $920,000 recorded in 1997 represents
additional losses and costs associated with the spin-off transactions, which
took longer to complete than anticipated and which exceeded amounts previously
estimated and recorded prior to fiscal 1997.
13
(4) SUPPLEMENTAL FINANCIAL STATEMENT AND SEGMENT INFORMATION:
October 31,
1999 1998
- -----------------------------------------------------------------------------------------------
MARKETABLE SECURITIES:
Commercial paper - $ 1,999,000
U.S. Government and
government agency obligations - 1,992,000
- -----------------------------------------------------------------------------------------------
- $ 3,991,000
===============================================================================================
ACCOUNTS RECEIVABLE, NET:
Trade receivables $ 3,221,000 $ 2,584,000
Less allowance for doubtful accounts (98,000) (128,000)
- -----------------------------------------------------------------------------------------------
$ 3,123,000 $ 2,456,000
===============================================================================================
INVENTORIES, NET:
Raw materials and supplies $ 1,534,000 $ 1,242,000
Work in process 549,000 519,000
Finished goods 1,071,000 1,024,000
Less reserve for inventory obsolescence (578,000) (479,000)
- -----------------------------------------------------------------------------------------------
$ 2,576,000 $ 2,306,000
===============================================================================================
EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET:
Furniture, fixtures and computer equipment $ 1,412,000 $ 1,101,000
Manufacturing equipment 2,934,000 1,999,000
Leasehold improvements 1,929,000 1,759,000
Equipment in process 256,000 235,000
Furniture, fixtures and computer equipment under
capital leases 154,000 154,000
Manufacturing equipment under capital leases 604,000 604,000
Less accumulated depreciation and leasehold
improvement amortization (2,230,000) (1,474,000)
Less accumulated amortization of capital leases (123,000) (24,000)
- -----------------------------------------------------------------------------------------------
$ 4,936,000 $ 4,354,000
===============================================================================================
GOODWILL AND OTHER INTANGIBLE ASSETS, NET:
Goodwill $ 6,764,000 $ 6,756,000
Patents and other intangibles 1,266,000 1,163,000
Non-compete agreement 950,000 950,000
Less accumulated amortization (2,386,000) (1,628,000)
- -----------------------------------------------------------------------------------------------
$ 6,594,000 $ 7,241,000
===============================================================================================
ACCRUED EXPENSES:
Payroll, other employee benefits and related taxes $ 827,000 $ 599,000
Accrued income taxes 239,000 281,000
Other accrued expenses 485,000 541,000
- -----------------------------------------------------------------------------------------------
$ 1,551,000 $ 1,421,000
===============================================================================================
During fiscal year 1999, the Company adopted SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information. SFAS No. 131 supersedes SFAS
No. 14, Financial Reporting for Segments of a Business Enterprise, replacing the
"industry segment" approach with the "management" approach. The "management"
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and
14
major customers. The adoption of SFAS No. 131 did not affect the Company's
consolidated results of operations or financial position.
The Company's operations, which are based mainly in Minnesota, are comprised of
two segments, "branded products" and "component products," based upon the
similarities of the underlying business operations and products of each.
Branded products business develops, manufactures and markets proprietary and
patented specialty medical products for use in thoracic, cardiac, neuro,
vascular and ophthalmic surgery. Component products business represents the
value-added, original equipment manufacturing of micro-precision wire-based
component products, including precision coils, stylets and guidewire components
and sub-assemblies used in the medical industry. The Company evaluates the
performance of its business segments and allocates resources to them based upon
their respective earnings contribution to the consolidated earnings of the
Company or based on the segment's product R&D efforts in process at that time.
Information for the business segments for fiscal years 1999, 1998 and 1997 is
presented in the table below.
- -----------------------------------------------------------------------------------------------------------------
1999 1998 1997
Net revenue
Branded $11,681,000 $10,620,000 $ 9,694,000
Component 7,223,000 1,397,000 -
----------- ----------- -----------
Total 18,904,000 12,017,000 9,694,000
Operating income (loss)
Branded (1,411,000) (1,477,000) (1,305,000)
Component 617,000 62,000 -
----------- ----------- -----------
Total (794,000) (1,415,000) (1,305,000)
Depreciation and amortization
Branded 784,000 690,000 620,000
Component 825,000 188,000 -
----------- ----------- -----------
Total 1,609,000 878,000 620,000
Capital expenditures
Branded 443,000 848,000 654,000
Component 1,000,000 116,000 -
----------- ----------- -----------
Total 1,443,000 964,000 654,000
Identifiable assets
Branded 16,704,000 16,114,000 25,134,000
Component 7,366,000 9,868,000 -
----------- ----------- -----------
Total 24,070,000 25,982,000 25,134,000
- -----------------------------------------------------------------------------------------------------------------
See Note 12 - Major Customers and Net Revenue by Geographic Area, for additional
information regarding concentrations.
Supplemental Cash Flow Information:
The Company paid interest of $129,000, $39,000 and $0 during fiscal 1999, 1998
and 1997, respectively. Income tax payments made by the Company totaled
$107,000, $3,000 and $6,000 for the years ended October 31, 1999, 1998 and 1997,
respectively. Also, at October 31, 1999, the Company recorded $109,000 in
accounts payable for equipment purchases made during the year then ended.
15
(5) INCOME TAXES:
Provision for (Benefit from) Income Taxes:
----------------------------------------------------------------------------------------------
1999 1998 1997
----------------------------------------------------------------------------------------------
CURRENT:
Federal $ 21,000 $ (22,000) $ 96,000
State 11,000 2,000 44,000
----------------------------------------------------------------------------------------------
32,000 (20,000) 140,000
----------------------------------------------------------------------------------------------
DEFERRED:
Federal (101,000) (143,000) 286,000
State (22,000) (23,000) (61,000)
----------------------------------------------------------------------------------------------
(123,000) (166,000) 225,000
----------------------------------------------------------------------------------------------
Total $ (91,000) $(186,000) $365,000
===============================================================================================
Reconciliation of effective income tax rate:
--------------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes $ (611,000) $ (669,000) $ (239,000)
========================================================================================================
Statutory federal rate (208,000) (227,000) (81,000)
State taxes, net of federal benefit (7,000) (14,000) (11,000)
Permanent differences 194,000 101,000 26,000
Research and experimentation credits (65,000) (45,000) (46,000)
Write-off of deferred tax asset associated
with discontinued operations 421,000
Increase (decrease) in valuation allowance 2,000 (3,000) 69,000
Other, net (7,000) 2,000 (13,000)
--------------------------------------------------------------------------------------------------------
Provision for (benefit from) income taxes $ (91,000) $ (186,000) $ 365,000
========================================================================================================
Components of Deferred Tax Assets (Liabilities):
--------------------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------------------------------------
Inventory reserve $ 213,000 $ 173,000 $ 138,000
Other, net 94,000 47,000 7,000
--------- --------- ---------
Net current deferred tax assets $ 307,000 $ 220,000 $ 145,000
Operating loss carryforwards $ 165,000 $ 228,000 $ 170,000
Capital loss carryforwards 143,000 141,000 149,000
Credit carryforwards 417,000 325,000 269,000
Depreciation (238,000) (220,000) (36,000)
Non-compete obligation 247,000 240,000 -
Other, net (51,000) (69,000) (26,000)
Less valuation allowance (143,000) (141,000) (144,000)
--------- --------- ---------
Net long-term deferred tax assets $ 540,000 $ 504,000 $ 382,000
==============================================================================================================
Net deferred tax assets $ 847,000 $ 724,000 $ 527,000
===============================================================================================================
16
A tax benefit of $8,000, $12,000 and $78,000 related to the exercise of stock
options was recorded to additional paid-in capital in 1999, 1998 and 1997,
respectively.
In conjunction with the acquisition of Jerneen, the Company acquired net
deferred tax assets of $31,000.
The valuation allowance relates solely to capital loss carry-forwards, which
have been determined to be unrealizable. Net operating loss carryforwards
expire from 2012-2014 and credit carryforwards expire from 2009-2014.
Management expects to fully utilize its remaining deferred tax assets against
future taxable income.
(6) CAPITAL LEASES AND LONG-TERM OBLIGATIONS:
Long-term obligations consist of the following at October 31:
1999 1998
-----------------------------------------------------------------------------------
Capital leases $ 393,000 $ 623,000
Term note payable to bank - 261,000
Contractual obligations to landlord 245,000 306,000
Contractual obligations to former shareholder of
Jerneen 417,000 477,000
Other note payable to bank - 4,000
-----------------------------------------------------------------------------------
1,055,000 1,671,000
Less current portion (369,000) (616,000)
-----------------------------------------------------------------------------------
$ 686,000 $1,055,000
===================================================================================
The Company is the lessee of certain machinery and equipment under capital lease
obligations expiring from 2000 through 2002. The assets and liabilities under
capital leases have been recorded at the fair value of the asset when placed in
service. Interest rates on capitalized leases vary from 9.75% to 15.24% and are
imputed based on the lessor's implicit rate of return.
During fiscal 1999, the Company repaid the term note payable in full.
The contractual obligations to the landlord relate to leasehold improvements and
are payable in monthly installments of $8,000 through January 2003. The
obligations were financed at fixed interest rates ranging from 10% to 12%.
The contractual obligation to a former shareholder of Jerneen is payable in
monthly installments of $8,000 through October 2004. The interest is imputed
based on the Company's borrowing rate of 10%.
Aggregate maturities of capital leases and long-term obligations are as follows:
------------------------------------------------------------------------------
Year Ending October 31 Amount
2000 $ 369,000
2001 294,000
2002 181,000
2003 107,000
2004 104,000
-------------------------------------------------------------------------------
$1,055,000
===============================================================================
17
(7) COMMITMENTS:
Operating Leases:
The Company is committed under non-cancelable operating leases for the rental of
its office and production facilities. At October 31, 1999, the remaining terms
on the leases range from three to six years. The component products business
facility leases include a renewal option for one additional five-year term. In
addition to base rent charges, the Company also pays apportioned real estate
taxes and common costs on its leased facilities. Total facilities rent expense,
including real estate taxes and common costs, was $525,000, $458,000 and
$383,000 for the years ended October 31, 1999, 1998 and 1997, respectively. The
Company paid real estate taxes and common costs of $149,000 during fiscal 1999.
As of October 31, 1999, future minimum lease payments, excluding real estate
taxes and common costs, due under existing non-cancelable operating leases are
as follows:
------------------------------------------------------
Year Ending October 31
2000 $ 459,000
2001 446,000
2002 413,000
2003 308,000
2004 270,000
Thereafter 192,000
------------------------------------------------------
$2,088,000
======================================================
Royalties:
In connection with the acquisition of product licenses and product manufacturing
rights, the Company is obligated for the payment of royalties as follows:
* 5% on net sales of Peri-Strips and Peri-Strips Dry until the expiration of the
related patents through May 2015.
* 3% of the net sales of the Bio-Vascular Probe through 2001.
Royalty expense was approximately $185,000, $203,000 and $191,000 for the
years ended October 31, 1999, 1998 and 1997, respectively, and is included
in cost of revenue.
(8) SHAREHOLDERS' EQUITY:
Authorized Shares and Designation of Preferred Class of Stock:
In 1997, the shareholders approved an increase in authorized shares of capital
stock from 20,000,000 shares to 25,000,000 shares and reserved 5,000,000 such
shares as undesignated shares of preferred stock, having such rights,
preferences and designations as determined by the Board of Directors. As a
result, the Company's authorized capital stock consists of 20,000,000 shares of
common stock and 5,000,000 shares of undesignated preferred stock.
Stock Repurchase Plan:
In 1997, the Company's Board of Directors adopted a stock repurchase plan and
authorized the purchase of up to 500,000 shares of its common stock. During
1998, the Company's Board of Directors amended the plan to authorize the
repurchase of up to 1,500,000 common shares. As of October 31, 1999, the
Company had completed its repurchase of 1,500,000 shares of its common stock for
an aggregate cash outlay of $5,649,000 since the inception of the plan.
18
Warrants:
Warrants issued to an underwriter in fiscal 1995 to purchase 90,000 shares of
the Company's common stock at an exercise price of $16.375 expired in fiscal
1999.
Shareholder Rights Plan:
In June 1996, the Company's Board of Directors declared a dividend distribution
of one common stock purchase right (a "Right") for each outstanding share of the
Company's common stock on July 15, 1996. The Company also entered into a Rights
Agreement governing the terms of the Rights, and each share of common stock
issued subsequent to July 15, 1996, has been issued with an attached Right
pursuant to the terms of the Rights Agreement.
Upon exercise, each Right entitles the holder thereof to purchase one-tenth of a
share of common stock at a purchase price currently set at $6.00 per share,
subject to adjustment to reflect the value of the Company following the spin-off
of Vital Images, Inc. Upon the occurrence of certain events in connection with:
(i) a person or group acquiring 15% or more of the Company's outstanding common
stock; (ii) a third party announcing an offer to purchase a 15% or greater stake
in the Company; or (iii) the Board of Directors declaring a person to be an
"adverse person" based upon such person being a holder of 10% or more of the
Company's outstanding stock and the Board's belief that such person's shares
were acquired for short-term financial gain or that the shareholder might
otherwise adversely affect the Company's business or prospects, the Rights
become exercisable and entitle each holder thereof (other than the acquiring
person or "adverse person") to purchase, for a price equal to 10 times the then-
current purchase price of the Right, shares of common stock (or other securities
of the Company) or equity securities of the acquiring company, as the case may
be, having a market value equal to 20 times the then-current purchase price of
the Right. In general, the Company is entitled to redeem the Rights in whole at
a price of $.001 per Right (payable in cash, stock or other consideration deemed
appropriate by the Board of Directors) prior to the first to occur of any such
events. Each Right will expire on June 11, 2006, if not previously redeemed or
exercised.
Stock-Based Compensation:
The Company has various stock award and stock option plans and an employee stock
purchase plan ("ESPP"). Under the stock award and stock option plans, the
Company is authorized to grant up to 1,907,636 shares of its common stock for
issuance under these plans, which includes 400,000 new shares of common stock
for grant approved by the Company's shareholders in fiscal 1999. At October 31,
1999, 382,802 shares remained available for grant under these plans. Under the
ESPP, the Company is authorized to sell and issue up to 300,000 shares of its
common stock to its full-time employees. At October 31, 1999, 254,452 shares
remained available for purchase under the ESPP.
At October 31, 1999, the Company has also reserved and granted 191,720 shares of
its common stock for issuance in connection with outstanding stock option grants
that were not made pursuant to a formal stock incentive plan.
The Company applies Accounting Principles Board ("APB") No. 25, Accounting for
Stock Issued to Employees, and related interpretations to account for its stock-
based compensation plans, when applicable, but has adopted the disclosure-only
provisions of SFAS No. 123, Accounting for Stock-Based Compensation, which
requires pro forma disclosures regarding the Company's stock-based compensation
plans.
19
Stock Awards:
Under certain compensation agreements, an arrangement which provides for awards
of common stock to key management was adopted in 1992. These awards of common
stock are subject to forfeiture if employment terminates prior to the end of the
prescribed periods. Vesting periods range from three to five years. The market
value of the shares at the time of grant is recorded as unearned stock
compensation. The unearned amount is amortized to compensation expense over the
periods during which the vesting lapses. As part of these same compensation
agreements, the Company agreed to buy back the number of shares which would
allow the employees to meet their income tax obligations arising from the non-
cash compensation related to the earned shares. The number of shares bought
back by the Company from employees totaled 10,831, 7,911 and 10,655 during 1999,
1998 and 1997, respectively. Stock awards granted to employees are summarized
as follows:
Unearned Stock
Awards Market Value
Balance Shares at Grant
--------------------------------------------------------------------------------------------
Balance October 31, 1996 $ 311,000 49,333 $3.25 - $ 14.50
Granted 220,000 46,545 4.25 - 6.50
Earned (134,000) (27,101) 3.25 - 14.50
Cancelled / Forfeited (109,000) (13,705) 4.75 - 14.50
--------------------------------------------------------------------------------------------
Balance October 31, 1997 288,000 55,072 4.25 - 14.00
Granted 428,000 99,548 3.50 - 5.13
Earned (142,000) (27,937) 3.50 - 14.00
Cancelled / Forfeited (151,000) (34,676) 3.69 - 4.75
--------------------------------------------------------------------------------------------
Balance October 31, 1998 423,000 92,007 3.50 - 14.00
Granted 424,000 124,351 2.69 - 3.63
Earned (231,000) (53,464) 2.69 - 14.00
Cancelled / Forfeited (70,000) (12,632) 4.05 - 11.88
--------------------------------------------------------------------------------------------
Balance at October 31, 1999 $ 546,000 150,262 $2.69 - $ 5.13
============================================================================================
Shares of common stock have also been awarded to certain medical professionals
as compensation for services provided in the Company's product development
activities. These awards vest in accordance with the service agreement and
totaled 36,000 shares granted in 1997 and 5,000 shares granted in 1999. There
were no such awards in 1998.
The weighted average market value at grant date for stock awards was $3.20,
$4.29 and $4.41 for 1999, 1998 and 1997, respectively.
Stock Options:
The exercise price of each stock option generally equals 100% of the market
price of the Company's stock on the date of grant and has a maximum term of up
to 10 years. Employee option grants generally vest ratably over four to five
years, while options granted to non-employee directors of the Company generally
vest ratably over three years.
20
The following table summarizes information about stock options outstanding at
October 31, 1999:
============================================================================================
--------------------------------------------------------------------------------------------
Weighted
Weighted Average
Weighted Average Exercise
Number of Average Remaining Number of Price of
Options Exercise Contractual Options Exercisable
Range of Prices Outstanding Price Life (years) Exercisable Options
---------------------------------------------------------------------------------------------
$1.87 - $3.50 266,277 $2.78 4.35 163,673 $2.67
3.63 - 4.25 353,838 3.80 5.25 185,404 3.82
4.37 - 4.85 275,384 4.47 6.28 161,668 4.50
4.92 - 7.54 391,376 5.36 5.40 174,209 5.79
8.53 - 12.21 84,929 9.08 4.33 84,929 9.08
------------ --------- ----- ---- ------- -----
$1.87 -$12.21 1,371,804 $4.51 5.27 769,883 $4.74
---------------------------------------------------------------------------------------------
A summary of the status of the Company's stock options for the years ended
October 31 is as follows:
-------------------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 1,221,539 $4.82 1,305,106 $5.43 1,148,764 $5.60
Granted 296,936 3.44 463,989 4.50 419,262 5.16
Exercised (80,760) 2.91 (48,236) 3.23
Cancelled (146,671) 5.25 (466,796) 6.52 (214,684) 5.20
-------------------------------------------------------------------------------------------------------------
Outstanding at end of year 1,371,804 4.51 1,221,539 4.82 1,305,106 5.43
-------------------------------------------------------------------------------------------------------------
Options exercisable at end of year 769,883 4.74 669,920 4.99 794,743 4.98
=============================================================================================================
Employee Stock Purchase Plan:
The Company sponsors an employee stock purchase plan ("ESPP") under which
300,000 shares of common stock were reserved for future issuance. The ESPP was
established to enable employees of the Company to invest in Company stock
through payroll deduction. Options are granted to employees to purchase shares
of stock at a price that is the lower of 85% of the fair market value of the
stock on the first or last day of each offering period. There were 22,396,
8,247 and 9,190 shares purchased through the ESPP in 1999, 1998 and 1997,
respectively.
For the years ended October 31, compensation expense recorded for stock-based
compensation awards (stock awards and stock options) was as follows:
-----------------------------------------------------------------------------------------------
1999 1998 1997
-----------------------------------------------------------------------------------------------
Employee $209,000 $135,000 $150,000
Non-employee 74,000 85,000 62,000
-----------------------------------------------------------------------------------------------
Total $283,000 $220,000 $212,000
-----------------------------------------------------------------------------------------------
Non-employee compensation expense includes amounts related to performance option
awards for up to 37,000 shares.
21
SFAS No. 123 Disclosure:
Had compensation expense for the Company's stock-based compensation plans been
determined based on the fair market value at the grant dates consistent with
SFAS No. 123, the Company's net loss and loss per share would have been
increased to the pro forma amounts indicated below for the years ended
October 31:
- -------------------------------------------------------------------------------
1999 1998 1997
- -------------------------------------------------------------------------------
NET LOSS
As reported $ (520,000) $(483,000) $(1,524,000)
Pro forma (1,128,000) (946,000) (4,634,000)
BASIC AND DILUTED LOSS PER SHARE
As reported
Pro forma (0.06) (0.05) (0.16)
(0.12) (0.10) (0.49)
- -------------------------------------------------------------------------------
The pro forma information includes stock options granted and purchases under the
ESPP in 1999, 1998 and 1997. Additionally, the 1997 pro forma information
reflects the impact of the modification of previously granted stock options
occurring as part of the spin-off of Vital Images, Inc., a former subsidiary of
the Company.
The weighted average fair value per option granted during 1999, 1998 and 1997
was $0.76, $1.40 and $2.18, respectively, for the ESPP and $1.98, $3.04 and
$2.99 for all other options. The weighted average fair value was calculated by
using the fair value of each option on the date of grant. The fair value of the
ESPP options was based on the 15% purchase discount. The fair value of all
other options for the years ended October 31 was estimated using the Black-
Scholes option pricing model with the following weighted average assumptions:
- -------------------------------------------------------------------------------
1999 1998 1997
- --------------------------------------------------------------------------------
Expected option term 5.0 years 6.4 years 4.2 years
Expected volatility factor 67% 69% 72%
Expected dividend yield 0% 0% 0%
Risk-free interest rate 5.17% 5.73% 6.33%
- --------------------------------------------------------------------------------
22
(9) EARNINGS PER SHARE:
The Company adopted SFAS No. 128 during the first quarter of fiscal year 1998.
Earnings per share for all periods presented have been prepared in accordance
with the provisions of SFAS No. 128. The following table sets forth the
computation of basic and diluted shares outstanding for the years ended October
31:
- --------------------------------------------------------------------------------
1999 1998 1997
- --------------------------------------------------------------------------------
NUMERATOR:
Loss from continuing operations $ (520,000) $ (483,000) (604,000)
Loss on disposal of discontinued
business, net of income taxes (920,000)
- --------------------------------------------------------------------------------
Net loss $ (520,000) $ (483,000) (1,524,000)
================================================================================
DENOMINATOR:
Denominator for basic earnings
per share -
weighted average
common shares 9,025,823 9,228,265 9,498,827
- --------------------------------------------------------------------------------
Denominator for diluted earnings
per share -
weighted average common
shares and dilutive
potential common shares 9,025,823 9,228,265 9,498,827
================================================================================
In fiscal 1999, 1998 and 1997, none of the options outstanding or unearned
restricted stock awards ("awards") were included in the computation of diluted
earnings per share for the year then ended because the Company had incurred net
losses during those periods and the inclusion of the options and awards would
have been anti-dilutive. Additionally, none of the awards are included in the
computation of basic earnings per share for any of the years then ended.
(10) RELATED PARTY TRANSACTIONS:
In fiscal 1997, the Company entered into a distribution agreement with Scanlan
International, Inc., a medical and surgical products distributor. The Chairman
of the Board of Directors of the Company is President and Chief Executive
Officer of the Scanlan Group of Companies, the parent company of Scanlan
International. The agreement grants Scanlan International the exclusive right,
acting as a sales representative of Bio-Vascular, to solicit orders, work with
distributors and market listed products within Latin America until October 31,
2000, subject to annual renewal thereafter. Scanlan International receives a
commission of 20% on net sales to Latin America during the term of the
agreement. Commissions paid to Scanlan International totaled $4,000 and $2,000
for 1999 and 1998, respectively. There was no sales activity resulting from
this agreement in 1997.
23
(11) EMPLOYEE BENEFIT PLANS:
Salary Reduction Plan:
The Company sponsors salary reduction defined contribution benefit plans for all
full-time employees which qualify under Section 401(k) of the Internal Revenue
Code. Employee contributions are limited to 15% of their annual compensation,
subject to annual limitations. At its discretion, the Company may make matching
contributions equal to a percentage of the salary reduction or other
discretionary amount. The Company has made no contributions to the plans since
inception.
(12) MAJOR CUSTOMERS AND NET REVENUE BY GEOGRAPHIC AREA:
Substantially all of the Company's international net revenues are negotiated,
invoiced and paid in U.S. dollars. The following tables summarize significant
customers and international net revenues by geographic area:
- ----------------------------------------------------------------------------------------------
1999 1998 1997
- ----------------------------------------------------------------------------------------------
PERCENT OF ACCOUNTS RECEIVABLE BY SIGNIFICANT
CUSTOMERS
A. 16% 13% -
B. 15% 9% 20%
C. 12% 11% 13%
D. 9% 11% 10%
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
PERCENT OF NET REVENUES BY SIGNIFICANT CUSTOMERS
A. 25% 6% -
B. 12% 16% 19%
C. 9% 12% 14%
D. 8% 11% 11%
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------------------------
INTERNATIONAL NET REVENUES BY GEOGRAPHIC
AREA
Europe $2,052,000 $1,531,000 $1,355,000
Asia and Pacific region 552,000 825,000 666,000
Canada 278,000 217,000 206,000
Other 183,000 56,000 68,000
- ------------------------------------------------------------------------------------------------
Total $3,065,000 $2,629,000 $2,295,000
- ------------------------------------------------------------------------------------------------
Percent of total net revenue 16% 22% 24%
- ------------------------------------------------------------------------------------------------
The Company does not require collateral from its customers to support their
accounts receivable. Customer A is a customer of the component products segment
and B, C and D are customers of the branded products segment. The Company's
international net revenues are primarily generated from the branded products
business segment. All of the Company's long-lived assets are located in the
United States.
24
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Bio-Vascular, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, comprehensive income and shareholders'
equity, and cash flows present fairly, in all material respects, the financial
position of Bio-Vascular, Inc. as of October 31, 1999, and 1998, and the results
of its operations and its cash flows for each of the three years in the period
ended October 31, 1999, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of Bio-Vascular,
Inc.'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 statement 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.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
December 3, 1999
25
The following information appears on page 24 of the Company's 1999 Annual Report
to Shareholders.
COMMON STOCK INFORMATION
Price Range
The Company's common stock is currently traded on the Nasdaq National Market
under the symbol "BVAS." The following table sets forth, for each of the fiscal
periods indicated, the range of high and low closing sale prices per share as
reported by the Nasdaq National Market. These prices do not include adjustments
for retail mark-ups, mark-downs or commissions.
1999 1998
Quarter Ended High Low High Low
- --------------- ------ ------ ------ ------
January 31 $4.375 $3.125 $4.188 $3.250
April 30 3.375 2.375 5.375 4.063
July 31 3.719 2.438 5.125 4.375
October 31 3.281 2.250 4.500 3.000
Dividends
The Company has not declared or paid any cash dividends on its common stock
since its inception, and the Board of Directors presently intends to retain all
earnings for use in the business for the foreseeable future.
Shareholders
As of November 30, 1999, there were approximately 4,600 beneficial owners and
1,100 record shareholders of the Company's common stock.
26
The following information appears on page 24 of the Company's 1999 Annual Report
to Shareholders.
Bio-Vascular, Inc.
Quarterly Results
Fiscal 1999 First Second Third Fourth
(unaudited) Quarter Quarter Quarter Quarter
- ------------------------- ----------- ----------- ---------- ----------
Net revenue $3,829,000 $4,893,000 $5,169,000 $5,013,000
Gross margin 1,917,000 2,497,000 2,584,000 2,463,000
Operating income (loss) (441,000) (291,000) 23,000 (85,000)
Net income (loss) (318,000) (202,000) 42,000 (42,000)
Net income (loss)
per share (0.03) (0.02) 0.00 (0.00)
Fiscal 1998
(unaudited)
- -------------------------------------------------------------------------------
Net revenue $2,462,000 $2,727,000 $2,760,000 $4,068,000
Gross margin 1,424,000 1,650,000 1,618,000 2,103,000
Operating income (loss) (554,000) (366,000) (276,000) (219,000)
Net income (loss) (205,000) (101,000) (43,000) (134,000)
Net income (loss)
per share (0.02) (0.01) (0.00) (0.01)
Quarterly calculations of net income (loss) per share are made independently
during the fiscal year.
27
The following information appears on page 1 of the Company's 1999 Annual Report
to Shareholders.
Bio-Vascular, Inc. - Financial Highlights
Summary Statements of Operations Data:
For the Year Ended October 31 1999 1998 1997 1996 1995
- ------------------------------ ------------------ ------------------ ------------------ ----------------- -----------------
(in thousands, except per share data)
Net revenue $18,904 $12,017 $ 9,694 $10,125 $10,426
Gross margin 9,461 6,795 5,727 6,682 6,964
Operating income (loss) (794) (1,415) (1,305) 571 2,121
Income (loss) from continuing
operations (520) (483) (604) 1,219 1,659
Income (loss) per share from
continuing operations:
Basic (0.06) (0.05) (0.06) 0.13 0.22
Diluted (0.06) (0.05) (0.06) 0.12 0.21
Weighted average shares outstanding:
Basic 9,026 9,228 9,499 9,387 7,509
Diluted 9,026 9,228 9,499 9,876 8,062
The above information includes the Company's acquisition of Jerneen in July 1998
and excludes discontinued operations; see Notes 2 and 3, respectively, to the
financial statements.
Earnings per share amounts have been presented for all years pursuant to the
provisions of Statement of Financial Accounting Standard No. 128, Earnings Per
Share; see Note 9 to the financial statements.
Summary Balance Sheet Data:
At October 31 1999 1998 1997 1996 1995
- ------------------------------ ------- ------- ------- ------- -------
Working capital $ 9,400 $11,386 $16,906 $22,107 $24,060
Total assets 24,070 25,982 25,134 37,881 37,303
Long-term debt 686 1,055 - - -
Shareholders' equity 20,784 22,430 23,952 35,221 35,355
In connection with the 1997 spin-off of Vital Images Inc., Shareholders' Equity
was reduced by $10,124,000, which represents the contribution of cash
equivalents and marketable securities plus the carrying value of Vital Images'
net assets.
28