SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
February 11, 1998
-----------------
Date of Report (Date of earliest event reported)
ST. JUDE MEDICAL, INC.
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(Exact name of registrant as specified in charter)
Minnesota 0-8672 41-1276891
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(State or other (Commission (IRS Employer
jurisdiction of File Number) Identification No.)
incorporation)
One Lillehei Plaza, St. Paul, MN 55117
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(Address of principal executive offices) (Zip Code)
(612) 483-2000
----------------
Registrant's telephone number including area code
Not Applicable
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(Former name or former address, if changed since last report)
1
Item 5. Other Events
St. Jude Medical, Inc. (the "Company") is filing this Current Report on Form 8-K
to present the supplemental financial statements, supplemental management's
discussion and analysis of financial condition and results of operations, and
other financial information that give effect to the May 15, 1997 acquisition of
Ventritex, Inc. ("Ventritex") (previously reported on Form 8-K dated May 15,
1997), accounted for as a pooling of interests, by restating 1996 and certain
prior years financial statements and information as if the Company and Ventritex
always had been combined.
Effective May 15, 1997, the Company and Pacesetter, Inc. acquired Ventritex
under an Agreement and Plan of Merger (the "Agreement"). Pursuant to this
Agreement, the Company acquired all the outstanding shares of Ventritex common
stock in exchange for Company common stock. Each share of Ventritex's
outstanding common stock was converted into the right to receive .5 shares of
Company common stock.
Based on the shares of Ventritex common stock shares outstanding, St. Jude
issued 10,437,800 shares of its common stock to acquire Ventritex. The
acquisition was accounted for as a pooling of interests and is intended to
qualify as a reorganization (tax free to the Ventritex shareholders) under the
provisions of Section 368(a) of the Internal Revenue Code.
Ventritex is a California based manufacturer of implantable cardioverter
defibrillators and related products for the treatment of ventricular tachycardia
and ventricular fibrillation. Ventritex merged into Pacesetter, Inc., a wholly
owned subsidiary of the Company.
2
Item 7. Financial Statements and Exhibits
The following supplemental consolidated financial statements of the
Company that give effect to the merger of Ventritex, Inc. are
included herein:
Supplemental Management's Discussion and Analysis
of Financial Condition and Results of Operations
Report of Management
Report of Independent Auditors
Supplemental Consolidated Statements of Income
-Years Ended December 31, 1996, 1995 and 1994
Supplemental Consolidated Balance Sheets -
December 31, 1996 and 1995
Supplemental Consolidated Statements of
Shareholders' Equity - Years ended December 31,
1996, 1995 and 1994
Supplemental Consolidated Statements of Cash Flows
- Years ended December 31, 1996, 1995 and 1994
Notes to Supplemental Consolidated Financial
Statements
Exhibit 23 Consent of Independent Auditors
Exhibit 27 Financial Data Schedule
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
ST. JUDE MEDICAL, INC.
Date February 11, 1998 By /s/ ROBERT E. MUNZENRIDER
---------------------- -----------------------------
Robert E. Munzenrider
Vice President - Finance
and Chief Financial Officer
3
Supplemental Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
Year Ended December 31 1996 1995 1994
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Net sales $ 876,747 $ 848,078 $ 517,433
Cost of sales 294,888 292,788 163,810
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Gross profit 581,859 555,290 353,623
Selling, general and administrative expense 311,470 284,940 138,789
Research and development expense 107,644 101,264 50,518
Purchased research and development charges 40,350 -- 40,800
Special charges 47,808 -- --
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Operating profit 74,587 169,086 123,516
Other income (expense), net 16,022 (1,992) 9,946
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Income before taxes 90,609 167,094 133,462
Income tax provision 29,972 49,978 37,713
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Net income $ 60,637 $ 117,116 $ 95,749
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Earnings per share:
Primary $ 0.66 $ 1.28 $ 1.06
Fully diluted $ 0.65 $ 1.28 $ 1.05
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Cash dividends paid per share $ -- $ -- $ --
Average shares outstanding:
Primary 92,372,000 91,326,000 90,514,000
Fully diluted 92,663,000 91,802,000 90,861,000
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See notes to supplemental consolidated financial statements.
4
Supplemental Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
December 31 1996 1995
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Assets
Current Assets
Cash and cash equivalents $ 49,388 $ 62,638
Marketable securities 186,007 176,983
Accounts receivable, less allowance (1996 - $8,160, 1995 - $9,845) 216,813 175,405
Inventories:
Finished goods 119,736 84,542
Work in process 30,227 28,229
Raw materials 67,698 60,255
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Total inventories 217,661 173,026
Prepaid income taxes 44,234 17,409
Other current assets 33,781 16,446
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Total current assets 747,884 621,907
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Property, Plant and Equipment
Land 14,232 9,949
Buildings and improvements 64,717 53,108
Machinery and equipment 249,550 180,539
Construction in progress 69,175 23,124
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Gross property, plant and equipment 397,674 266,720
Less accumulated depreciation (108,400) (77,792)
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Net property, plant and equipment 289,274 188,928
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Other Assets 435,336 381,400
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Total Assets $ 1,472,494 $ 1,192,235
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Liabilities and Shareholders' Equity
Current Liabilities
Accounts payable $ 201,107 $ 85,886
Accrued income taxes 24,267 41,346
Accrued employee compensation and related taxes 47,645 50,120
Other accrued expenses 47,914 39,495
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Total current liabilities 320,933 216,847
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Long-Term Liabilities
Long-term debt 229,500 120,000
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Contingencies
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Shareholders' Equity
Preferred stock, par value $1.00 per share --
25,000,000 shares authorized; no shares issued
Common stock, par value $.10 per share --
250,000,000 shares authorized; issued and outstanding
1996 - 91,447,656 shares; 1995 - 90,282,312 9,145 9,028
Additional paid-in capital 228,106 200,535
Retained earnings 692,892 632,255
Cumulative translation adjustment 386 4,319
Unrealized gain (loss) on available-for-sale securities (8,028) 9,691
Receivable for stock issued (440) (440)
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Total shareholders' equity 922,061 855,388
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Total Liabilities and Shareholders' Equity $ 1,472,494 $ 1,192,235
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See notes to supplemental consolidated financial statements.
5
Supplemental Consolidated Statements of Cash Flows
(Dollars in thousands)
Year Ended December 31 1996 1995 1994
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Operating Activities
Net income $ 60,637 $ 117,116 $ 95,749
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 38,533 30,667 14,850
Amortization 19,649 20,102 7,816
Purchased research and development charges 40,350 -- 40,800
Special charges 20,586 -- --
Gain on sale of business (10,486) -- --
Changes in operating assets and liabilities, net of acquisitions:
Increase in accounts receivable (27,267) (3,997) (26,704)
Increase in inventories (9,331) (11,492) (6,089)
Decrease (increase) in other current assets (14,411) 1,354 (10,771)
Increase in accounts payable and accrued expenses 16,113 41,527 12,016
Increase (decrease) in accrued income taxes (31,380) 7,153 2,637
Increase in prepaid and deferred income taxes (13,208) (12,617) (14,331)
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Net cash provided by operating activities 89,785 189,813 115,973
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Investing Activities
Purchase of property, plant and equipment (103,001) (57,203) (34,196)
Purchase of marketable securities (90,018) (85,097) (156,261)
Proceeds from sale or maturity of marketable securities 65,869 68,323 364,058
Investments in companies, joint ventures and partnerships (155) (3,701) (13,564)
Acquisitions, net of cash acquired (117,800) 13,000 (524,300)
Proceeds from sale of business 24,204 -- --
Other investing activities (5,393) 2,394 (7,675)
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Net cash used in investing activities (226,294) (62,284) (371,938)
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Financing Activities
Proceeds from issuance of stock 20,818 6,187 2,622
Cash dividends paid -- -- (13,935)
Common stock repurchased (6,727) -- (125)
Proceeds from the issuance of long-term debt 229,500 -- 255,000
Repayment of long-term debt (120,000) (135,029) (96)
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Net cash provided by (used in) financing activities 123,591 (128,842) 243,466
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Effect of currency exchange rate changes on cash (332) 647 567
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Increase (decrease) in cash and cash equivalents (13,250) (666) (11,932)
Cash and cash equivalents at beginning of year 62,638 63,304 75,236
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Cash and cash equivalents at end of year $ 49,388 $ 62,638 $ 63,304
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See notes to supplemental consolidated financial statements.
6
Supplemental Consolidated Statements of Shareholders' Equity
(Dollars in thousands, except per share amounts)
Common Stock
--------------------- Additional Cumulative Unrealized Receivable Total
Number of Paid-In Retained Translation Gain (Loss) on for Stock Shareholders'
Shares Amount Capital Earnings Adjustment Investments Issued Equity
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Balance December 31, 1993 89,424,019 $ 8,942 $ 187,280 $ 433,325 $ (3,609) $ - $ - $ 625,938
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Net income 95,749 95,749
Issuance of common stock
upon exercise of stock
options, net of taxes
withheld 345,541 35 2,657 2,692
Tax benefit realized upon
exercise of stock options 1,337 1,337
Cash dividends ($.20
per share) (13,935) (13,935)
Purchase and retirement
of common shares (125) (125)
Translation adjustment 1,125 1,125
Unrealized gain on
investments, net of taxes 686 686
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Balance December 31, 1994 89,769,560 8,977 191,149 515,139 (2,484) 686 - 713,467
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Net income 117,116 117,116
Issuance of common stock
upon exercise of stock
options, net of taxes
withheld 511,752 51 6,581 6,632
Tax benefit realized upon
exercise of stock options 2,805 2,805
Translation adjustment 6,803 6,803
Unrealized gain on
investments, net of taxes 9,005 9,005
Receivable for stock issued (440) (440)
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Balance December 31, 1995 90,281,312 9,028 200,535 632,255 4,319 9,691 (440) 855,388
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Net income 60,637 60,637
Issuance of common stock
upon exercise of stock
options, net of taxes
withheld 1,161,191 116 20,701 20,817
Tax benefit realized upon
exercise of stock options 7,597 7,597
Purchase and retirement
of common shares (145,000) (14) (6,712) (6,726)
Issuance of common stock
for business acquired 149,153 15 5,985 6,000
Translation adjustment (3,933) (3,933)
Unrealized gain (loss) on
investments, net of taxes (17,719) (17,719)
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Balance December 31, 1996 91,446,656 $ 9,145 $ 228,106 $ 692,892 $ 386 $ (8,028) $ (440) $ 922,061
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See notes to supplemental consolidated financial statements.
7
Supplemental Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Note 1 Significant Accounting Policies
Nature of Operations: St. Jude Medical, Inc. develops, manufactures and
distributes medical devices with an emphasis on cardiac care products and
services. The Company's products are sold in more than 100 countries. Principal
products include prosthetic heart valves, pacemakers, implantable
cardioverter-defibrillators (ICD) and electrophysiology and interventional
catheters. The main markets for these products are the United States, Western
Europe and Japan. In the United States, the Company uses a direct employee-based
sales organization for its heart valve and catheter products and a combination
of independent contractors and an employee-based sales organization for its
pacemaker and ICD products. In Western Europe, the Company has a direct sales
presence in 14 countries. Throughout the rest of the world, the Company
principally uses distributor-based sales organizations.
Principles of Consolidation: The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. Significant
intercompany transactions and balances have been eliminated in consolidation.
Certain reclassifications of previously reported amounts have been made to
conform with the current year presentation.
Use of Estimates: The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Accounting Period: The Company's fiscal year is the 52 or 53 week period ending
the Saturday nearest December 31. Fiscal years 1996, 1995 and 1994 consisted of
52 weeks.
Translation of Foreign Currencies: Assets and liabilities of the Company's
foreign subsidiaries are translated at exchange rates in effect on reporting
dates and differences due to changing exchange rates are recorded as "cumulative
translation adjustment" in shareholders' equity. Income and expenses are
translated at rates that approximate those in effect on transaction dates.
Cash Equivalents: Cash equivalents, consisting of liquid investments with a
maturity of three months or less when purchased, are stated at cost which
approximates market.
Inventories: Inventories are stated at the lower of cost or market. Cost is
determined under the first- in, first-out method. Allowances are made for
slow-moving, obsolete, unsalable or unusable inventories.
8
Stock-Based Compensation: Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," encourages but does not require
companies to record compensation cost for stock-based compensation plans at fair
value. The Company elected to continue to account for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
Interpretations. See Note 5.
Property, Plant and Equipment and Depreciation: Property, plant and equipment
are stated at cost and are depreciated using the straight line method based on
useful lives of 31.5 to 39 years for buildings and improvements and three to
seven years for machinery and equipment. Leasehold improvements are amortized
over the shorter of the life of the related asset or the term of the lease.
Accelerated depreciation is used by the Company for tax accounting purposes
only.
Long-Lived Assets: The Company adopted Statement of Financial Accounting
Standards (FAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of," in 1996. FAS No. 121 requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount. There
was no financial impact to the Company upon adopting FAS No. 121.
Revenue Recognition: The Company's general practice is to recognize revenues
from product sales as shipped and for services as performed. For certain
products, the Company maintains consigned inventory at customer locations. For
these products, revenue is recognized at the time the Company is notified that
the device has been used.
Research and Development: Research and development expense includes all
expenditures for general research into scientific phenomena, development of
useful ideas into merchantable products and continuing support and upgrading of
various products. All such expense is charged to operations as incurred.
Earnings Per Share: Primary earnings per share are computed by dividing net
income for the year by the weighted average number of shares of common stock and
common stock equivalents outstanding. For fully diluted earnings per share, both
net income and shares outstanding have been adjusted as if the Company's $57,500
5.75% Convertible Debenture had been converted, unless the effect is
anti-dilutive.
Note 2 Acquisitions
On May 15, 1997, the Company acquired Ventritex, Inc. ("Ventritex"), a
manufacturer of implantable cardioverter defibrillators and related products.
Each share of Ventritex common stock was converted into .5 shares of Company
common stock. The Company issued 10,437,800 shares to Ventritex shareholders.
The transaction qualified as a tax-free reorganization and was accounted for as
a pooling of interests. The accompanying financial statements, for all periods
presented, have been restated to include the results of Ventritex.
9
Separate results of operations for the periods prior to the merger with
Ventritex are as follows:
1996 1995 1994
--------- --------- ---------
Net Sales
St. Jude Medical $ 808,780 $ 761,835 $ 391,949
Ventritex 67,967 86,243 125,484
--------- --------- ---------
Combined $ 876,747 $ 848,078 $ 517,433
========= ========= =========
Net Income
St. Jude Medical $ 92,181 $ 138,848 $ 86,450
Ventritex (51,208) (34,535) 15,270
Adjustments 19,664 12,803 (5,971)
--------- --------- ---------
Combined $ 60,637 $ 117,116 $ 95,749
========= ========= =========
Other Changes in Shareholders' Equity
St. Jude Medical $ 7,471 $ 21,676 $ (11,312)
Ventritex (3,331) 1,673 1,978
Adjustments 1,896 1,456 1,114
--------- --------- ---------
Combined $ 6,036 $ 24,805 $ (8,220)
========= ========= =========
On November 29, 1996, the Company acquired substantially all of the worldwide
cardiac rhythm management assets of Telectronics Pacing Systems, Inc.
("Telectronics") for $135 million. The initial price can be adjusted upward or
downward based upon the change in net asset value between June 30, 1996 and
November 29, 1996. The Company and the seller currently disagree about the final
adjustment to the purchase price and are following procedures in the purchase
agreement to resolve their differences. The Company expects that any adjustment
to the purchase price will be recorded in 1997. The acquisition was accounted
for under the purchase accounting method. Goodwill of approximately $76,000
including approximately $43,000 of consolidation charges, is amortized on a
straight line basis over 20 years. The results of Telectronics operations have
been included in the consolidated results of operations from the date of
acquisition. In conjunction with the Telectronics acquisition, the Company in
1996 recorded a pre-tax charge of $32,200 relating to that portion of the
purchase price attributable to purchased research and development.
On September 30, 1994, the Company acquired substantially all the Siemens AG
worldwide cardiac rhythm management business ("Pacesetter") for $511,300. The
acquisition was accounted for under the purchase method accounting. Goodwill is
amortized on a straight line basis over 20 years. The results of Pacesetter's
operations have been included in the consolidated results of operations from the
date of acquisition. In conjunction with the Pacesetter acquisition, the Company
recorded a non-cash pre-tax charge of $40,800 relating to that portion of the
purchase price attributable to purchased research and development. The purchased
research and development charge represents the appraised value of the in-process
research and development that must be expensed under generally accepted
accounting principles.
10
The following unaudited pro forma information has been prepared assuming that
the acquisition of Pacesetter had occurred at the beginning of 1993, the
acquisition of Telectronics had occurred at the beginning of 1995 and the
acquisition of Ventritex had occurred at the beginning of 1994. Pro forma
adjustments include amortization of goodwill, increased interest expense,
decreased interest income and the related income tax effects. Pro forma results
are not necessarily indicative of the results that would have occurred had the
acquisitions actually taken place at the beginning of the specified periods, or
the expected results of future operations.
1996 1995 1994
Net sales $973,262 $1,008,163 $822,223
Net income/(loss) $ (8,400) 71,630 101,381
Earnings per share $ (.09) .78 1.12
On September 23, 1996, the Company acquired Biocor Industria E Pesquisas Ltd.,
a Brazilian tissue heart valve manufacturer for $4,000 in cash and an earn-out
which could result in additional cash payments of up to $4,000 over the next
three years. On January 5, 1996, the Company acquired the remaining shares of
The Heart Valve Company for $1,000 in cash and 149,153 shares of its common
stock. In connection with the acquisitions of Biocor and The Heart Valve
Company, the Company recorded pre-tax charges of $3,150 and $5,000,
respectively, relating to purchased research and development. The results of
Biocor and The Heart Valve Company have been included in the Company's results
of operations since the dates of acquisition and were not material.
On May 31, 1996, the Company acquired Daig Corporation ("Daig"), a manufacturer
of specialized cardiovascular devices for the electrophysiology and
interventional cardiology markets. Each share of Daig common stock was converted
into .651733 shares of Company common stock. The Company issued 9,929,897 shares
to Daig shareholders. Additionally, one outstanding option to acquire 128,000
shares of Daig common stock was converted to an option to acquire 83,422 shares
of Company common stock. The transaction qualified as a tax-free reorganization
and was accounted for as a pooling of interests. The accompanying financial
statements, for all periods presented, have been restated to include the results
of Daig, which were not material.
Note 3 Special Charges
Results of operations for 1996 include pre-tax charges recorded in the fourth
quarter of $47,808 for costs relating to patent and litigation settlements and
repositioning several of the Company's operations. Patent and other legal
disputes between Pacesetter and a third party were settled for $25,000. The
repositioning charges of $22,808 related to the planned consolidation of tissue
heart valve manufacturing operations ($11,100), the termination of various
distributor agreements in conjunction with the conversion to direct sales
($7,700), the realignment of Pacesetter manufacturing operations in connection
with the Telectronics integration ($2,200), and other non-recurring expenses
($1,808).
11
Note 4 Income Taxes
The components of income before taxes were as follows:
1996 1995 1994
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Domestic $ 89,305 $ 149,526 $ 124,411
Foreign 1,304 17,568 9,051
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Income before taxes $ 90,609 $ 167,094 $ 133,462
- -----------------------------------------------------------------
The components of the income tax provision were as follows:
1996 1995 1994
- --------------------------------------------------------------------------------
Current:
Federal $ 63,005 $ 47,389 $ 37,260
State and Puerto Rico 9,676 11,518 10,217
Foreign 1,022 6,226 3,107
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Total current 73,703 65,133 50,584
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Deferred:
Prepaid (28,304) (7,329) (5,757)
Deferred (15,427) (7,826) (7,114)
- --------------------------------------------------------------------------------
Total deferred (43,731) (15,155) (12,871)
- --------------------------------------------------------------------------------
Income tax provision $ 29,972 $ 49,978 $ 37,713
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12
Deferred income tax assets (liabilities) were comprised of the following at
December 31:
1996 1995
- -------------------------------------------------------------------------------------------------
Deferred income tax assets:
Net operating loss carryforwards $ 41,978 $ 22,671
Tax credit carryforwards 3,837 3,883
Inventory (intercompany profit in inventory
and excess of tax over book valuation) 21,598 23,837
Intangibles 33,190 13,931
Accruals not currently deductible 11,676 12,469
Unrealized loss on investments 5,029 -
- -------------------------------------------------------------------------------------------------
Deferred income tax assets: 117,308 76,791
- -------------------------------------------------------------------------------------------------
Deferred income tax liabilities:
Unrealized gain on investments - (5,830)
Accumulated depreciation (7,757) (7,037)
- -------------------------------------------------------------------------------------------------
Deferred income tax liabilities: (7,757) (12,867)
- -------------------------------------------------------------------------------------------------
Net deferred income tax assets $ 109,551 $ 63,924
- -------------------------------------------------------------------------------------------------
The reconciliation of the Company's effective income tax rate to the statutory
U.S. federal income tax rate of 35% is as follows:
1996 1995 1994
- -----------------------------------------------------------------------------------
Income tax provision at
U.S. statutory rate $ 30,807 $ 58,483 $ 46,712
Increase (decrease) in taxes
resulting from:
State income taxes, net of
federal tax benefit 4,309 4,434 1,763
Tax benefits from Foreign
Sales Corporation (3,878) (1,886) (1,557)
Tax benefits from Puerto Rican
operations (3,128) (8,442) (7,880)
Tax exempt income - - (2,274)
Foreign taxes at higher
(lower) rates 1,849 (1,640) 194
Other 13 (971) 755
- -----------------------------------------------------------------------------------
Income tax provision $ 29,972 $ 49,978 $ 37,713
- -----------------------------------------------------------------------------------
Effective income tax rate 33.1% 29.9% 28.3%
- -----------------------------------------------------------------------------------
13
At December 31, 1996, the Company has net operating loss and research and
development tax credit carryforwards for federal tax purposes of approximately
$126,645 and $3,682, respectively, that will expire through 2011, if not
utilized. The Company's effective income tax rate is favorably affected by
Puerto Rican tax exemption grants which result in Puerto Rican earnings being
partially tax exempt through the year 2003.
The Internal Revenue Service ("IRS") is currently examining the Company's
1992-1994 federal income tax returns. In addition, the IRS has completed an
audit examination of the Company's 1990-1991 income tax returns and has proposed
an adjustment of approximately $16,600 in additional taxes, not including
interest or state income taxes, for which the Company anticipates receiving
statutory notices of deficiency in the near future. The proposed adjustment
relates primarily to the Company's Puerto Rican operations. It is likely that
similar adjustments will be proposed for subsequent years. The Company is
vigorously contesting the proposed adjustment and expects that the ultimate
resolution will not have a material adverse effect on its financial position or
liquidity, but could potentially be material to the net income of a particular
future period if resolved unfavorably.
The Company has not recorded deferred income taxes applicable to undistributed
earnings of foreign subsidiaries ($15,906 at December 31, 1996) because
distribution of these earnings generally would not require additional taxes due
to available foreign tax credits.
The Company made income tax payments of $68,525, $53,313 and $49,565 in 1996,
1995 and 1994, respectively.
Note 5 Stock Purchase and Option Plans
Stock Purchase: The Company's employee stock purchase savings plan allows
participating employees to purchase, through payroll deductions, shares of
common stock at 85% of the fair market value at specified dates. Under the terms
of the plan, 750,000 shares of common stock have been reserved for purchase by
plan participants. Employees purchased 108,795, 97,525 and 26,041 shares in
1996, 1995 and 1994, respectively. At December 31, 1996, 494,442 shares were
available for purchase under the plan.
The Ventritex 1991 Employee Stock Purchase Plan that had 162,500 shares of
common stock reserved for purchase by plan participants was dissolved at the
time Ventritex was merged into Pacesetter. Eligible Ventritex employees were
allowed to invest up to 10% of compensation through payroll deductions to
purchase shares of Ventritex stock at 85% of the fair market value at specified
dates. Ventritex issued 40,404 shares under this plan during its 1996 fiscal
year.
14
Stock Based-Compensation: Under the terms of the Company's various stock plans,
7,687,769 shares of common stock have been reserved for issuance to directors,
officers and employees upon the grant of restricted stock or the exercise of
stock options. Stock options are exercisable over periods up to 10 years from
date of grant and may be "incentive stock options" or "non-qualified stock
options" and may have stock appreciation rights attached. At December 31, 1996,
there were a maximum of 2,268,753 shares available for grant and 5,419,016
options outstanding. At December 31, 1996, 1995 and 1994, there were options
exercisable of 2,578,387, 3,029,516 and 1,786,701, respectively. Stock option
and long-term performance award transactions were:
Options/Awards Weighted Average
Outstanding Price Per Share
- --------------------------------------------------------------------------------
Balance at December 31, 1993 3,045,904 $ 21.36
- --------------------------------------------------------------------------------
Granted 1,518,338 27.31
Cancelled (363,563) 27.90
Exercised (218,585) 50.09
- --------------------------------------------------------------------------------
Balance at December 31, 1994 3,982,094 24.33
- --------------------------------------------------------------------------------
Granted 967,477 28.62
Cancelled (220,872) 28.23
Exercised (378,692) 32.87
- --------------------------------------------------------------------------------
Balance at December 31, 1995 4,350,007 26.27
- --------------------------------------------------------------------------------
Granted 2,288,998 36.36
Cancelled (302,785) 39.78
Exercised (917,204) 20.84
- --------------------------------------------------------------------------------
Balance at December 31, 1996 5,419,016 31.27
- --------------------------------------------------------------------------------
In conjunction with the merger of Ventritex into the Company, Ventritex
outstanding options were converted to St. Jude Medical, Inc. options. Each
option to purchase one share of Ventritex common stock was converted to the
right to purchase .5 St. Jude Medical shares at twice the Ventritex strike
price.
Pursuant to the terms of the Company's various stock plans, optionees can use
cash, previously owned shares or a combination of cash and previously owned
shares to reimburse the Company for the cost of the option and the related tax
liabilities. Shares are acquired from the optionee at the fair market value of
the stock on the transaction date.
All options have been granted at not less than fair market value at dates of
grant. When stock options are exercised, the par value of the shares issued is
credited to common stock and the excess of the proceeds over the par value is
credited to additional paid-in capital. When non-qualified options are
exercised, the Company realizes income tax benefits based on the difference
between the fair value of the stock on the date of exercise and the stock option
exercise price. These tax benefits do not affect the income tax provision, but
rather are credited directly to additional paid-in capital.
15
In July 1996, the Board of Directors approved a stock option grant of 1,000,000
shares at an exercise price of $31.38 per share to the Company's CEO. This grant
is subject to shareholder approval at the May 1997 shareholders' meeting of a
one-time waiver of the 300,000 share annual limitation under the Company's 1994
Stock Option Plan which will have the effect of ratifying this grant.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations, in accounting for its
stock-based compensation plans. Accordingly, no compensation expense has been
recognized for its stock option awards. Had compensation expense for the
Company's stock option awards been determined based upon their grant date fair
value consistent with the methodology prescribed under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation", the
Company's net income and earnings per share would have been reduced by $ 4,985,
or $ .05 per share and $ 3,115, or $ .04 per share for 1996 and 1995,
respectively. These amounts are not necessarily indicative of the amounts that
will be reported in the future. The fair value of the options at the grant date
was estimated using the Black-Scholes model with the following weighted average
assumptions:
1996 1995
------ ------
Expected life (years) 6 6
Interest rate 6.3% 7.2%
Volatility 40.5% 31.1%
Dividend yield 0% 0%
Under the terms of the Company's shareholder rights agreement, upon the
occurrence of certain events which result in a change in control as defined by
the agreement, registered holders of common shares are entitled to purchase
one-tenth of a share of Series A Junior Participating Preferred Stock at a
stated price, or to purchase either the Company's shares or shares of the
acquiring entity at half their market value.
Note 6 Financial Instruments and Off-Balance Sheet Risk
Foreign Currency Instruments and Hedging Activities: The Company may enter into
foreign exchange contracts to manage its exposure to fluctuations in foreign
currency exchange rates. These contracts involve the exchange of foreign
currencies for U.S. dollars at specified rates at future dates. Counterparties
to these contracts are major international financial institutions. Maturities of
these instruments are typically one year or less from the transaction date.
Gains or losses from these contracts are included in other income (expense).
The Company had contracts totaling $25,217 and $12,483 at December 31, 1996 and
December 31, 1995, respectively. These contracts are related to the exchange of
French Francs, German Marks and Canadian Dollars into U.S. dollars. These
instruments were recorded at their fair value at each balance sheet date. The
cumulative unrealized gain (loss) on these contracts totaled $905, $45 and
$(128) at December 31, 1996, 1995 and 1994, respectively, and was recorded as
other income (expense).
16
Long-Term Debt: The Company has an unsecured $130,000 committed revolving line
of credit with a group of seven banks that terminates in July 2001. The Company
also maintains $100,000 of non- committed lines of credit with two banks to
supplement the revolving line of credit, that expires in November 1999. The rate
of interest payable under these borrowing facilities is a floating rate and is a
function of the London Interbank Offered Rate. The weighted average interest
rates at December 31, 1996 and 1995 were 5.6% and 6.1%, respectively. A facility
fee of .08% of the revolving line commitment is paid quarterly. At December 31,
1996, the Company had borrowings under the committed line of $120,000 and
$52,000 under the non-committed lines.
The credit agreement contains various covenants that require the Company to
maintain a specified financial ratio, limit liens, regulate asset disposition
and subsidiary indebtedness and restrict certain acquisitions and investments.
At December 31, 1996, the Company was in compliance with these covenants.
Convertible Subordinated Debentures: In August 1996, the Company issued $57,500
aggregate principal amount of 5.75% convertible subordinated debentures due
August 15, 2001. The notes are convertible at any time prior to maturity, unless
previously redeemed or repurchased, into shares of common stock at a conversion
rate of 29.0909 shares per thousand dollars of principal amount of notes
(equivalent to a conversion price of $34.375 per share).
Other Financial Instruments: Marketable securities consist of equity
instruments, bank certificates of deposit, U.S. government obligations,
commercial paper, and Puerto Rico industrial development bonds. Under Statement
of Financial Accounting Standards (FAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," debt securities that the Company
does not have the positive intent to hold to maturity and all marketable equity
securities are classified as available-for-sale and are carried at fair value.
Unrealized holding gains and losses on securities classified as
available-for-sale are carried as a separate component of shareholders' equity.
A net realized gain of $1,195 was recorded on sales of available-for-sale
securities in 1996. No net realized gains or losses were recorded in 1995. The
net unrealized holding loss on available-for-sale securities included as a
separate component of shareholders' equity was $8,028 (net of $5,029 of current
deferred income taxes) at December 31, 1996.
1996 1995
-------------------------- --------------------------
Estimated Estimated
Fair Fair
Cost Value Cost Value
Assets:
Cash and Cash Equivalents $ 49,388 $ 49,388 $ 62,638 $ 62,638
Marketable Securities $ 199,064 $ 186,007 $ 161,462 $ 176,983
17
The Company also guarantees certain obligations of its subsidiaries. As of
December 31, 1996 and 1995, the maximum amount of such guarantees was $7,500.
Concentration of Credit Risk: Trade accounts receivables, certain marketable
securities and foreign exchange contracts are the financial instruments which
may subject the Company to concentration of credit risk.
Within the European Economic Union, payment of certain accounts receivable is
made by the national healthcare system within several countries. Although the
Company does not anticipate collection problems with these receivables, payment
is contingent to a certain extent upon the economic situation within these
countries. The credit risk associated with the balance of the trade receivables
is limited due to dispersion of the receivables over a large number of customers
in many geographic areas. The Company monitors the credit worthiness of its
customers to which it grants credit terms in the normal course of business.
Marketable securities are placed with high credit qualified financial
institutions and Company policy limits the credit exposure to any one financial
institution. Counterparties to foreign exchange contracts are major financial
institutions; therefore, credit loss from counterparty nonperformance is
unlikely.
Note 7 Retirement Plans
Defined Contribution Plan: The Company has a defined contribution profit sharing
plan, including features under section 401(k) of the Internal Revenue Code,
which provides retirement benefits to substantially all full-time U.S.
employees. Under the 401(k) portion of the plan, eligible employees may
contribute a percentage of their annual compensation, subject to IRS
limitations, with the Company matching certain eligible contributions. The
Company's level of contribution to the profit sharing portion of the plan is
subject to Board of Directors approval and is based on Company performance. The
Company has additional defined contribution programs for employees outside the
United States. The benefits under these plans are based primarily on
compensation levels. Total retirement plan expense was $5,783, $6,977 and $2,873
in 1996, 1995 and 1994, respectively.
Defined Benefit Plans: In certain countries outside the United States, the
Company maintains defined benefit plans. An accrual of $5,023 was recorded as of
December 31, 1996 which is approximately equal to the actuarially calculated
unfunded liability.
Note 8 Geographic Area
The Company operates in the medical products industry and is segmented into
three geographic areas - the United States (including export sales to
unaffiliated customers except to customers in Europe, the Middle East and
Africa), Europe (including export sales to unaffiliated customers in the Middle
East, Africa, Latin America and Asia-Pacific) and other international. Operating
profit for export sales is reported in the exporting geography.
18
Sales between geographic areas are made at transfer prices which approximate
prices to unaffiliated third parties. Export sales to unaffiliated customers
included in United States sales were $ 67,639 $ 62,419 and $46,321 for 1996,
1995 and 1994, respectively.
Net sales by geographic area were as follows:
Other
United Inter- Elimina-
States Europe national tions Total
- --------------------------------------------------------------------------------------------------------------
1996
Customer
sales $ 586,879 $ 274,368 $ 15,500 $ -- $ 876,747
Inter-
company
sales 105,822 -- 8,198 (114,020) --
- --------------------------------------------------------------------------------------------------------------
1995 $ 692,701 $ 274,368 $ 23,698 $(114,020) $ 876,747
- --------------------------------------------------------------------------------------------------------------
Customer
sales $ 595,056 $ 249,052 $ 3,970 $ -- $ 848,078
Inter-
company
sales 91,523 -- 8,869 (100,392) --
- --------------------------------------------------------------------------------------------------------------
1994 $ 686,579 $ 249,052 $ 12,839 $(100,392) $ 848,078
- --------------------------------------------------------------------------------------------------------------
Customer
sales $ 402,869 $ 113,236 $ 1,328 $ -- $ 517,433
Inter-
company
sales 68,604 -- 3,800 (72,404) --
- --------------------------------------------------------------------------------------------------------------
$ 471,473 $ 113,236 $ 5,128 $ (72,404) $ 517,433
- --------------------------------------------------------------------------------------------------------------
Operating profit (loss) by geographic area was as follows:
Other
United Inter-
States Europe national Corporate Total
- --------------------------------------------------------------------------------
1996 $ 62,965 $ 59,264 $ (2,582) $ (45,060) $ 74,587
1995 $ 131,955 $ 50,924 $ (90) $ (13,703) $ 169,086
1994 $ 96,767 $ 38,799 $ (509) $ (11,541) $ 123,516
- --------------------------------------------------------------------------------
19
Identifiable assets by geographic area were as follows:
Other
United Inter-
States Europe national Corporate Total
- -----------------------------------------------------------------------------
1996 $ 811,588 $ 282,610 $ 52,209 $ 326,087 $ 1,472,494
1995 $ 691,603 $ 204,054 $ 9,772 $ 286,806 $ 1,192,235
1994 $ 685,738 $ 181,470 $ 4,523 $ 229,552 $ 1,101,283
- -----------------------------------------------------------------------------
1996 operating profit reflects purchased research and development charges of
$40,350 and special charges of $47,808 and 1994 operating profit reflects
purchased research and development charges of $40,800.
Corporate expenses consist principally of non-allocable general and
administrative expenses. Corporate identifiable assets consist principally of
cash and cash equivalents and marketable securities.
Note 9 Other Income (Expense), Net
Other income (expense), net consisted of the following:
1996 1995 1994
Interest income $ 9,463 $ 11,926 $ 16,620
Interest expense (4,725) (12,967) (3,798)
Foreign exchange gains (losses) 2,165 474 (1,918)
Gain on the sale of a business 10,486 - -
Acquisition transaction costs (5,118) - -
Other 3,751 (1,425) (958)
-------- --------- --------
Other income (expense), net $ 16,022 $ (1,992) $ 9,946
======== ========= ========
Note 10 Other Assets
Other assets as of December 31, 1996 and 1995, net of accumulated amortization
of $42,792 and $34,923, respectively, consisted of the following:
1996 1995
Investments in companies, joint ventures and partnerships $ 7,984 $ 22,356
Intangibles and other 361,359 317,176
Other assets 65,993 41,868
-------- ---------
$435,336 $ 381,400
======== =========
20
Investments in companies, joint ventures, and partnerships are stated at cost
which approximates market. Intangibles and other assets consist principally of
the excess of cost over net assets of certain acquired businesses and
technology. Intangibles and other assets are being amortized over periods
ranging from 10 to 20 years.
Note 11 Contingencies
The Company is involved in various products liability lawsuits, claims and
proceedings of a nature considered normal to its business with the exception
noted below. Subject to self-insured retentions, the Company has products
liability insurance sufficient to cover such claims and suits. In connection
with two pacemaker lead models, the Company may be subject to future uninsured
claims. The Company's products liability insurance carrier has denied coverage
for these models and has filed suit against the Company seeking rescission of
the policy covering Pacesetter business retroactive to the date the Company
acquired Pacesetter. The Company was a codefendant in a 1995 class action suit
with respect to these leads. This case was settled in November 1995. The
Company's share of the settlement is approximately $5,000. Additional claims
could be filed by patients with these leads who were not class members. Further,
claims may be filed in the future relative to events currently unknown to
management. Management believes losses that might be sustained from such actions
would not have a material adverse effect on the Company's liquidity or financial
condition, but could potentially be material to the net income of a particular
future period if resolved unfavorably.
Note 12 Shareholders' Equity
On October 17, 1995, the Board of Directors declared a three-for-two stock split
in the form of a 50% stock dividend to shareholders of record on November 2,
1995. Earnings per share, dividends per share, shares outstanding and weighted
average shares outstanding have been restated to reflect the stock dividend.
21
Note 13 Quarterly Financial Data (Unaudited)
Quarterly data for 1996 and 1995 was as follows:
Quarter
First Second Third Fourth
Year Ended
December 31, 1996:
Net sales $ 211,829 $ 220,498 $ 212,456 $ 231,964
Gross profit 141,290 147,438 142,992 150,139
Net income/(loss) 30,058 29,920 30,179 (29,520)*
Earnings per share .33 .32 .33 (.32)*
Year Ended
December 31, 1995:
Net sales $ 231,199 $ 214,394 $ 200,401 $ 202,084
Gross profit 149,992 145,775 128,635 130,888
Net income/(loss) 36,602 32,275 24,186 24,053
Earnings per share .40 .35 .26 .26
*Includes the effect of pre-tax charges of $35,350 for purchased research and
development associated with the Telectronics and Biocor acquisitions and special
charges of $47,808 for patent and litigation settlements and repositioning of
several of the Company's operations.
22
Five-Year Summary of Selected Financial Data
(Dollars in thousands, except per share amounts)
1996(**) 1995 1994(***) 1993 1992
Summary of Operations for the Year Ended:
Net sales $ 876,747 $ 848,078 $ 517,433 $ 339,942 $ 273,823
Gross profit $ 581,859 $ 555,290 $ 353,623 $ 236,375 $ 197,730
Percent of sales 66.4% 65.5% 68.3% 69.5% 72.2%
Operating profit $ 74,587 $ 169,086 $ 123,516 $ 110,099 $ 115,682
Percent of sales 8.5% 19.9% 23.9% 32.4% 42.2%
Net income $ 60,637 $ 117,116 $ 95,749 $ 94,544 $ 100,412
Percent of sales 6.9% 13.8% 18.5% 28.7% 36.7%
Primary earnings per share* $ 0.66 $ 1.28 $ 1.06 $ 1.08 $ 1.11
Financial Position at Year End:
Cash and marketable securities $ 235,395 $ 239,621 $ 209,099 $ 427,721 $ 400,701
Working capital $ 426,951 $ 405,060 $ 426,297 $ 498,758 $ 453,116
Total assets $ 1,472,494 $ 1,192,235 $ 1,101,283 $ 684,015 $ 586,304
Long-term debt $ 229,500 $ 120,000 $ 255,000 $ 36 $ 566
Total shareholders' equity $ 922,061 $ 855,388 $ 772,629 $ 625,938 $ 584,501
Other Data:
Dividends declared per share $ -- $ -- $ 0.20 $ 0.27 $ 0.20
Primary weighted average
shares outstanding* 92,372,000 91,326,000 90,228,000 90,403,000 90,199,000
Total employees 4,168 3,090 2,980 1,272 1,022
Note: The Five-Year Summary of Selected Financial Data includes the results of
Ventritex, Inc. and Daig Corporation for all periods presented.
* Earnings per share and share data have been adjusted for a 50% stock
dividend paid in 1995.
** Results for 1996 include $88,158 pre-tax for purchased research and
development and special charges.
*** Results for 1994 include a $40,800 pre-tax charge for purchased research and
development.
23
Supplemental Management's Discussion and Analysis of Results of Operations and
Financial Condition
(Dollars in thousands, except per share amounts)
Results of Operations
Introduction: The Company designs, manufactures and markets medical devices and
provides services primarily for the cardiovascular segment of the medical device
market. Principal products include mechanical heart valves, tissue heart valves,
bradycardia pacemakers, pacemaker leads, implantable cardioverter defibrillators
and specialty catheters.
The principal objective for management is to increase shareholder value. This is
accomplished through a focus on customer satisfaction, product innovation,
continual product and process improvement and investment in medical
technologies. The Company has implemented a long-term business strategy which
focuses investment on specific medical device technologies which will provide
innovative solutions to health care providers and patients.
Effective May 15, 1997, the Company acquired Ventritex, Inc. ("Ventritex"), a
manufacturer of implantable cardioverter defibrillators and related products.
Each share of Ventritex common stock was converted into .5 shares of Company
common stock. The Company issued 10,437,800 shares to Ventritex shareholders.
The transaction qualified as a tax-free reorganization and was accounted for as
a pooling of interests. The accompanying financial statements for all periods
presented, have been restated to include the results of Ventritex.
Effective November 29, 1996, St. Jude Medical acquired substantially all of the
assets of Telectronics Pacing Systems, Inc. ("Telectronics"), a pacemaker
company, and Medtel, a distribution company in the Asia-Pacific region. The
acquisition, which was accounted for as a purchase, included a $135,000 cash
payment and an earnout provision tied to future pacing sales which could result
in additional payments of up to $40,000 over six years if certain revenue
milestones are achieved. The purchase price is also subject to adjustment based
on changes to the net asset value of Telectronics and Medtel between June 30,
1996, and November 29, 1996. The Company and the seller currently disagree on
the amount of the adjustment and are following the process prescribed in the
asset sale agreement to resolve the disagreement. The Company expects that any
adjustment would be made in 1997. The Company's reported results for 1996
include Telectronics and Medtel subsequent to November 29, 1996.
Effective September 23, 1996, the Company acquired Biocor(R) Industria E
Pesquisas Ltd., a Brazilian manufacturer of tissue heart valves for $4,000 in
cash and an earn-out which could result in additional cash payments of up to
$4,000 over the next three years.
24
Effective May 31, 1996, the Company acquired Daig Corporation ("Daig"), a
Minnesota-based manufacturer of specialized cardiovascular devices for the
electrophysiology and interventional cardiology markets. Each share of Daig
common stock was converted into .651733 shares of Company common stock and the
Company issued 10,013,319 shares to Daig shareholders. The transaction qualifies
as a tax-free reorganization and was accounted for as a pooling of interests.
The accompanying financial statements, for all periods presented, have been
restated to include the results of Daig.
Effective September 30, 1994, St. Jude Medical acquired from Siemens AG
substantially all the worldwide assets of its cardiac rhythm management
operations ("Pacesetter") for $511,300. The acquisition represented a
significant diversification and provided the Company with its cardiac rhythm
management technology platform. The Company's fourth quarter 1994 and full year
1995 and 1996 financial results include Pacesetter's operations.
Effective January 19, 1996, the Company sold its cardiac assist operations to
C.R. Bard for approximately $24,000. Cardiac assist net sales were approximately
$12,000 and $10,500 in 1995 and 1994, respectively. Also in January, the Company
acquired the remaining 50% of The Heart Valve Company for $1,000 in cash and
149,153 shares of its common stock.
The commentary that follows should be read in conjunction with the Consolidated
Financial Statements and the Notes to the Consolidated Financial Statements. The
Company's fiscal year is the 52 or 53 week period ending the Saturday nearest
December 31. Fiscal years 1996, 1995 and 1994 consisted of 52 weeks.
Shown in the following table for the periods indicated are the net sales by
technology platform and the percentage relationships of certain items in the
consolidated statements of income to consolidated net sales and the percentage
change of the dollar amounts of such items as compared with the prior period.
Due to the impact of the Telectronics, Medtel and Biocor acquisitions, and the
cardiac assist business divestiture, as well as the September 1994 purchase of
Pacesetter, amounts are not directly comparable between years.
25
Percent of Net Sales Year-to-Year Change
- -------------------------------------------------------------------------------------------------
1996 1995
Year Ended December 31 Compared Compared
1996 1995 1994 to 1995 to 1994
- -------------------------------------------------------------------------------------------------
Net Sales
Heart valve 30.7% 30.3% 47.1% 5% 5%
Cardiac rhythm
management 65.3% 64.6% 45.4% 4% 134%
Interventional
cardiology 3.9% 3.7% 5.5% 12% 9%
Cardiac assist .1% 1.4% 2.0% (95%) 15%
- ---------------------------------------------------------
Net Sales 100.0% 100.0% 100.0% 3% 64%
Cost of Sales 33.6% 34.5% 31.7% 1% 79%
- ---------------------------------------------------------
Gross Profit 66.4% 65.5% 68.3% 5% 57%
- ---------------------------------------------------------
SG&A 35.5% 33.6% 26.8% 9% 105%
R&D 12.3% 12.0% 9.7% 6% 100%
Purchased R&D 4.6% - 7.9% - NM
Special Charges 5.5% - - - -
- ---------------------------------------------------------
Operating Profit 8.5% 19.9% 23.9% (56%) 37%
Other income
(expense), net 1.8% (.2%) 1.9% NM NM
- ---------------------------------------------------------
Income Before Tax 10.3% 19.7% 25.8% (46%) 25%
Tax 3.4% 5.9% 7.3% (40%) 33%
- -------------------------------------------------------------------------------------------------
New Income 6.9% 13.8% 18.5% (48%) 22%
- -------------------------------------------------------------------------------------------------
Net Sales: Net sales totalled $876,747 in 1996, a $28,669, or 3%, increase over
1995 net sales of $848,078. Excluding the approximately $8,000 of Telectronics
net sales subsequent to its acquisition and the results of the cardiac assist
business, which was sold in January 1996, net sales increased approximately 4%
over 1995 net sales.
Sales outside the U.S. improved from 39% of net sales in 1995 to 41% in 1996
reflecting increasing sales in higher growth, developing foreign markets.
Unfavorable foreign currency effects due to the stronger U.S. dollar reduced
1996 net sales compared to 1995 by approximately $4,600. This negative impact on
sales was offset by a favorable foreign currency impact on operating expenses
and gains relating to the Company's hedging activities, which were recorded in
other income.
Heart valve net sales of approximately $269,000 increased 5% in 1996 despite
worldwide healthcare reform and increased competition which continued to put
pressure on the number of procedures performed as well as pricing flexibility.
Heart valve 1995 sales levels benefited from substantial non-recurring second
and third quarter sales to Iran. Excluding these non-recurring sales, 1996 net
sales would have increased 7% over 1995 net sales.
26
Domestic mechanical heart valve net sales increased in 1996 due to the full year
availability of the St. Jude Medical(R) mechanical heart valve SJM(R) Masters
Series valve and general price increases that were partially offset by a slight
reduction in unit sales due to a reduction in procedures and hospital inventory
management. International mechanical heart valve net sales in 1996 were more
than 7% higher than 1995. This resulted mainly from increased unit sales in the
developing markets of Latin America, Eastern Europe, Africa and Asia-Pacific
regions. Tissue heart valve net sales in 1996 increased significantly from 1995
levels due to the continuing physician acceptance of the Toronto SPV(R) valve
and the September 1996 acquisition of Biocor(R) Industria E Pesquisas Ltd., a
Brazilian manufacturer of tissue heart valves.
Cardiac rhythm management net sales of approximately $572,000 increased 4% from
1995 levels. Pacesetter's higher sales level resulted from a 12% increase in
units partially offset by a 5% decrease in average selling prices because of
pricing pressures and more units being sold in lower priced developing markets.
Domestic pacemaker sales were affected by the lack of a competitive auto mode
switching feature in the Company's Trilogy(R) line for the first nine months of
1996. Subsequent to the early fourth quarter FDA approval of the Trilogy(R) DR+
pacemaker, which has this feature, domestic sales increased at twice the rate in
the fourth quarter compared with the average sales increase during the first
nine months. Sales in 1996 of implantable cardioverter defibrillators (ICD)
decreased over 20% compared to 1995 due to the effect of competitive products
that could be implanted pectorally. Telectronics sales totalled almost $8,000 in
December 1996. Daig's sales of electrophysiology catheters and related products
increased by over 50% in 1996 compared with 1995.
Interventional cardiology net sales of approximately $34,000 increased 12% over
1995 due to increased sales and marketing activities in the U.S. market and to
the introduction of new products.
Net sales in 1995 of $848,078 were $330,645 or 64% higher than 1994 net sales of
$517,433. Approximately $349,000 of the increase was attributable to the full
year effect of the Pacesetter acquisition and increased Pacesetter sales. The
increase also resulted from higher mechanical heart valve sales in emerging
international markets and increased Daig sales due to new product introductions
and expanded marketing programs. Domestic mechanical heart valve sales increased
due to the full year availability of the St. Jude Medical(R) Hemodynamic Plus
Series valves and general price increases that were partially offset by a
reduction in unit sales. These increases were partially offset by a $39,000
decrease in ICD sales due to the competitive introduction of smaller pectorally
implanted ICDs.
Cost of Sales: As a percentage of net sales, cost of sales in 1996 decreased to
33.6% from 34.5% in 1995 primarily as a result of manufacturing efficiencies, an
increase in the percentage of internally produced mechanical heart valve
components and the elimination of a 2% mechanical heart valve royalty payment
during the first quarter 1995. The decrease in cost of sales was partially
offset by the negative foreign currency impact on net sales, average selling
price decreases due to higher unit sales in lower margin emerging markets and
pricing pressure in the cardiac rhythm management business.
27
In 1995, cost of sales as a percentage of sales increased to 34.5% from 37.1% in
1994 primarily as a result of Pacesetter operations. Although Pacesetter margins
are consistent with the industry, its margins are not as high as the Company's
heart valve margins. In addition, the Company pays an approximate 5.5% royalty
on all cardiac rhythm management product sales. The increase was also
attributable to a higher percentage of mechanical heart valve sales into lower
margin emerging markets and a price increase from the Company's supplier of
pyrolytic carbon components. These increases were partially offset by the
elimination of a 2% mechanical heart valve royalty payment during the first
quarter 1995.
Selling, General and Administrative: Selling, general and administrative (SG&A)
expense increased in 1996 to $311,470 from $284,940 in 1995. As a percentage of
net sales, SG&A increased to 35.5% in 1996 from 33.6% in 1995. The higher dollar
amount and percentage of net sales increases were mainly due to the continued
move to direct sales particularly in Canada, Latin America and the Asia-Pacific
region, as well as increased expenditures for European and information systems
infrastructure. SG&A in 1996 also included Telectronics subsequent to the
November 29, 1996 acquisition date.
During 1995, selling, general and administrative expense increased $146,151 over
1994 levels, which was mainly attributable to the Pacesetter operations. Selling
efforts for pacemakers are much more labor intensive and the Company uses a
commission-based independent contractor sales force in the U.S. and distributors
in all international markets except Western Europe. In addition, Pacesetter
related goodwill amortization was recorded for the full year in 1995 compared to
only one quarter in 1994. SG&A expenses also increased due to additional
marketing costs attributable to expanded coverage in the Pacific Rim and Latin
American markets and an increased infrastructure in Western Europe as a result
of the Pacesetter acquisition.
Research and Development: Research and development (R&D) expense in 1996
increased to $107,644 from $101,264 recorded in 1995, but as a percentage of net
sales decreased to 12.3% from 12.0%. The dollar increase was attributable
primarily to Pacesetter which has major ongoing R&D programs in the areas of
bradycardia pacemakers and tachycardia defibrillators as well as development of
a new programmer. In addition, Ventritex had significant ICD programs ongoing.
R&D spending for the heart valve business increased slightly due to tissue valve
research while Daig R&D spending decreased slightly. R&D in 1996 also included
Telectronics subsequent to the acquisition date.
In 1995, research and development expense increased to $101,264 from $50,518
recorded in 1994. The increase mainly resulted from the full year effect of
Pacesetter's operations. A slight decrease in R&D for the heart valve business
resulted from the completion of certain phases of the development of the SJM
Masters Series rotatable heart valve which was introduced in 1995. Daig R&D
expense increased in 1995 principally due to electrophysiology catheter
development efforts.
Purchased Research and Development: In 1996, the Company incurred $40,350 of
non-cash purchased research and development charges, representing the appraised
value of in-process R&D which must be expensed under generally accepted
accounting principles for purchase accounting. The purchased R&D related to the
acquisitions of The Heart Valve Company ($5,000), Telectronics ($32,200) and
Biocor ($3,150).
28
The Pacesetter acquisition was also accounted for as a purchase and a non-cash
charge of $40,800 for purchased research and development was incurred in 1994.
Special Charges: In 1996 the Company recorded $47,808 of special charges which
consisted of a $25,000 payment to Intermedics, Inc. to resolve various patent
and legal disputes, repositioning charges of $11,100 related to its tissue heart
valve business, distributor termination related charges of $7,700 in support of
the Company's continued move to direct sales, integration charges of $2,200 to
be incurred by Pacesetter as a result of the Telectronics acquisition, and
non-recurring special charges of $1,808.
Other Income (Expense): Other income in 1996 totalled $16,022 compared to other
expense of $1,992 in 1995. Interest expense during 1996 decreased to $4,725 from
$12,967 in 1995 due to the elimination of Pacesetter acquisition debt which was
repaid by the end of third quarter 1996. This was partially offset by interest
expense on the fourth quarter 1996 borrowings in support of the Telectronics and
Medtel acquisitions and a settlement payment to Intermedics, Inc. Also,
Ventritex issued convertible subordinated notes in the third quarter of 1996. In
addition, several non-recurring 1996 transactions increased other income over
1995, including a gain on sale of the Company's cardiac assist business and the
successful completion of litigation related to the terminated Electromedics'
acquisition which were partially offset by transaction costs associated with the
Daig acquisition. The Company also recorded increased foreign exchange hedging
gains and gains on the sale of various investments in 1996.
Other expense totalled $1,992 in 1995 compared to other income of $9,946 in
1994. Interest expense in 1995 increased significantly over 1994 levels as a
result of a full year of debt as opposed to one quarter of debt associated with
the Pacesetter acquisition. Due to fluctuations in the U.S. dollar and a shift
in the relationship between European currencies, foreign exchange contract gains
and foreign exchange transaction gains were recorded in 1995 compared to losses
recorded in 1994.
Income Tax Provision: The Company's 1996 effective income tax rate was 33.1%
compared to 29.9% in 1995. The increase was primarily attributable to changes to
Treasury regulations pertaining to taxation of Puerto Rican operations, which
were finalized in the second quarter 1996 retroactive to the beginning of 1996,
as well as to non-deductible expenses associated with the Daig acquisition and
to separate previously legislated changes relating to taxation of Puerto Rican
operations. The Treasury regulation changes have significantly reduced tax
benefits derived from the Company's Puerto Rican operations.
The Company's 1995 effective income tax rate increased to 29.9% from 28.3% in
1994. The higher rate resulted from lower tax advantaged investment income,
income from Pacesetter operations which is generally taxed at a higher rate than
the Company's previously existing business and reduced tax benefits derived from
the Company's Puerto Rican operations.
The Omnibus Budget Reconciliation Act of 1993 significantly reduced the tax
benefits which were previously available from income generated by the Company's
Puerto Rican operations under Internal Revenue Code (IRC) Section 936. As a
result of this legislation, Puerto Rican tax benefits were reduced by 50% in
1996, 45% in 1995 and 40% in 1994.
29
Net Income: Reported net income for 1996 - including the effect of pre-tax
purchased R&D charges of $40,350, special charges of $47,808 and Telectronics
post-acquisition operating losses of approximately $5,600 - was $60,637, or $.66
per share.
Outlook: The Company expects that market demands, government regulation and
societal pressures will continue to change the healthcare industry worldwide
resulting in further business consolidations and alliances. To meet customer
needs, the Company intends to continue to pursue diversification opportunities
in the form of acquisitions, joint ventures, partnerships and strategic business
alliances. In addition, the Company will participate with industry groups to
promote the introduction and use of advanced medical device technology within a
cost conscious environment. Finally, customer service in the form of
cost-effective clinical outcomes will continue to be a primary focus for the
Company.
In 1996, competition continued to increase in the Company's heart valve
business; however, the Company estimates it held its share of the worldwide
heart valve market. During 1996, increased domestic competition resulted in a
slight reduction in domestic unit demand for the Company's products.
International unit sales growth exceeded 6% reflecting continued penetration of
emerging markets. Competition is anticipated to place pressure on pricing and
terms and healthcare reform is expected to result in further hospital
consolidations over time.
The Company's cardiac rhythm management business is also in a highly competitive
market. During 1996, the Company introduced to the market several new pulse
generators and pacemaker lead products. Rapid technological change is expected
to continue, requiring the Company to invest heavily in R&D and to effectively
market its products.
The medical device market is highly competitive. Competitors, in the past and
may in the future employ litigation to gain a competitive advantage. In
addition, the Company's products must continually improve technologically due to
the competitive nature of the industry.
As provided for in the Private Securities Litigation Reform Act of 1995, the
Company cautions investors that a number of factors could cause actual future
results of operations to vary from those anticipated in previously made
forward-looking statements and any other forward-looking statements made in this
document and elsewhere by or on behalf of the Company. Net sales could be
materially affected by legislative or administrative reforms to the U.S.
Medicare and Medicaid systems or other non-U.S. reimbursement systems in a
manner that would significantly reduce reimbursement for procedures using the
Company's medical devices, the acquisition of key patents by competitors that
would have the effect of excluding the Company from new market segments,
healthcare industry consolidation resulting in customer demands for price
concessions, products introduced by competitors with advanced technology and
better features and benefits or lower prices, fewer procedures performed in a
cost-conscious environment, and the lengthy approval time by the FDA or other
government authorities to clear implantable medical devices for commercial
release. Cost of sales could be materially affected by unfavorable developments
in the area of products liability and price increases from the Company's
suppliers of critical components, a number of which are sole sourced. Operations
could be affected by the Company's ability to execute its diversification
strategy or to integrate acquired companies, a serious earthquake
30
affecting the Company's Pacesetter facility in Los Angeles, California or the
Ventritex facility in Sunnyvale, California, adverse developments in the
litigation arising from the acquisitions of Telectronics and Ventritex,
unanticipated product failures and attempts by competitors to gain market share
through aggressive marketing programs. The Company expects to incur significant
charges in connection with its merger with Ventritex, Inc. and the Telectronics
and Ventritex businesses are presently reporting operating losses.
The Company anticipates that its 1997 effective income tax rate may increase due
to a higher ratio of Pacesetter and Daig income which is generally taxed at a
higher rate than the Company's heart valve income, reduced Puerto Rican income
as a percentage of total income and a lower Puerto Rican tax benefit as IRC
Section 936 tax benefits are reduced by an additional 5% per year through 1998.
Legislation was also passed in 1996 to phase out the Section 936 tax benefit
over a ten year period which will further negatively impact the Company's
effective tax rate. In addition, the IRS has proposed an adjustment of
approximately $16,600 in additional taxes relating primarily to the Company's
Puerto Rican operations in 1990 and 1991. It is likely that similar adjustments
will be proposed for subsequent years. The Company is vigorously contesting the
proposed adjustment.
On January 16, 1997, Ventritex announced that the FDA had authorized it to
proceed with a notification and reprogramming procedure in response to the
recent failure of an electrical component in two implanted Cadence model V-110
defibrillators, which resulted in the delivery of inappropriately rapid pacing
pulses believed to have been associated with the induction of lethal ventricular
tachyarrhythmias. The reprogramming procedure will prevent the delivery of
inappropriately rapid pacing pulses, even in the event of component failure. The
low energy cardioversion, high energy defibrillation and bradycardia pacing
capabilities of the devices will be left intact. The procedure takes only a few
minutes and does not require surgery. The FDA has worked closely with Ventritex
to expedite the reprogramming of the device, and Ventritex is assisting
physicians to the fullest extent possible to notify their patients
(approximately 5,600 patients in total) and arrange for prompt reprogramming of
the devices. As of February 13, 1997, over 85% of the currently implanted
devices have been reprogrammed. In addition, Ventritex has offered Cadet V-115
products as replacements free of charge to physicians whose patients require
antitachycardia pacing (estimated to be approximately 500-800 patients).
Ventritex has offered to reimburse these patients for surgical expenses up to
$2,500. The Company has accrued the estimated costs of these actions in the
quarter ended December 31, 1996. Since commencing the reprogramming of the
devices, Ventritex has become aware of one other incident in which
inappropriately rapid pacing pulses were delivered by a Cadence V-110 which are
believed to be associated with the induction of a lethal ventricular arrhythmia.
Ventritex's current production models (Cadet V-115 and Contour V-145) are not
affected.
31
Financial Condition
Summary: The financial condition of the Company remained strong during 1996. The
$255,000 of debt incurred in the fourth quarter 1994 with respect to the
Pacesetter acquisition was fully repaid by the end of third quarter 1996, but
$172,000 of new debt was incurred in the fourth quarter 1996 relating to the
Telectronics and Medtel acquisitions and the payment to Intermedics. In
addition, the Company assumed the $57,500 convertible subordinated notes of
Ventritex. Cash and marketable securities decreased to $235,395 at December 31,
1996, from $239,621 at December 31, 1995. Working capital, the difference
between current assets and current liabilities, was $426,951 at December 31,
1996, a $21,891 increase from the prior year end level attributable primarily to
the Telectronics acquisition.
Liquidity: Company operations provide a strong, positive cash flow which is
sufficient to meet the Company's operational requirements. Cash provided by
operations in 1996 amounted to $89,785 compared to $189,813 in 1995. The current
ratio was 2.3 to 1 at December 31, 1996.
The Company has a $130,000 long-term revolving line of credit through July 2001
with a seven member banking syndicate comprised of banks in the United States
and other countries where it conducts its business. At December 31, 1996, the
Company had $10,000 available under the line. The Company also maintains other
non-committed credit facilities which it utilizes to supplement the revolving
line of credit.
Accounts receivable increased approximately $41,400 in 1996 principally due to
increased sales, a shift in sales to emerging markets with longer payment cycles
and the acquisition of Telectronics. Inventories increased approximately $44,600
primarily as a result of expanded product offerings in both the heart valve and
cardiac rhythm management businesses and the acquisition of Telectronics. Net
property, plant and equipment increased almost $100,000 due to the construction
of two new Pacesetter facilities in Arizona and Sweden, pacemaker programmer
investments and the acquisitions of Telectronics and Biocor.
Cash flow from operations and access to additional capital will enable the
Company to pursue further diversification opportunities and to fund expected
capital expenditures. During 1997, the Company will fund the completion of
cardiac rhythm management manufacturing facilities in both the U.S. and Sweden.
In addition, the Company will continue to invest in its information systems and
telecommunications infrastructure.
Capital: The Company's capital structure consists of equity and interest bearing
debt. Interest bearing debt as a percent of total capital was 19.9% at December
31, 1996, an increase from 12.3% at December 31, 1995. The ratio of debt to cash
flow from operations increased from .6/1 to 2.6/1.
Cash dividends paid to shareholders in 1994 were $13,935. The Company
discontinued its cash dividend subsequent to the third quarter 1994 in order to
accelerate debt repayment and to provide additional funds for investment in new
businesses.
32
Outlook: Management is unaware of any adverse business trends that would
materially affect the Company's strong financial position. Should suitable
investment opportunities arise that would require additional financing,
management believes that the Company's excellent earnings, strong cash flow and
solid balance sheet provide a substantial basis to obtain additional financing
at highly competitive rates and terms.
Report of Management
The management of St. Jude Medical, Inc. is responsible for the preparation,
integrity and objectivity of the accompanying financial statements. The
financial statements were prepared in accordance with generally accepted
accounting principles and include amounts which reflect management's best
estimates based on its informed judgement and consideration given to
materiality. Management is also responsible for the accuracy of the related data
in the annual report and its consistency with the financial statements.
In the opinion of management, the Company's accounting systems and procedures,
and related internal controls, provide reasonable assurance that transactions
are executed in accordance with management's intention and authorization, that
financial statements are prepared in accordance with generally accepted
accounting principles, and that assets are properly accounted for and
safeguarded. The concept of reasonable assurance is based on the recognition
that there are inherent limitations in all systems of internal control, and that
the cost of such systems should not exceed the benefits to be derived therefrom.
Management reviews and modifies the system of internal controls to improve its
effectiveness. The effectiveness of the controls system is supported by the
selection, retention and training of qualified personnel, an organizational
structure that provides an appropriate division of responsibility and a strong
budgeting system of control.
St. Jude Medical, Inc. also recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according to the
highest standards of personal and business conduct. This responsibility is
reflected in the Company's business ethics policy.
The adequacy of the Company's internal accounting controls, the accounting
principles employed in its financial reporting and the scope of independent and
internal audits are reviewed by the Audit Committee of the Board of Directors,
consisting solely of outside directors. The independent auditors and internal
auditor meet with, and have confidential access to, the Audit Committee to
discuss the results of their audit work.
Ronald A. Matricaria
Chairman and Chief Executive Officer
Robert E. Munzenrider
Vice President, Finance and Chief Financial Officer
33
Report of Independent Auditors
Board of Directors
St. Jude Medical, Inc.
St. Paul, Minnesota
We have audited the supplemental consolidated balance sheets of St. Jude
Medical, Inc. and subsidiaries (formed as a result of the consolidation of St.
Jude Medical, Inc. and Ventritex, Inc.) as of December 31, 1996 and 1995 and the
related supplemental consolidated statements of income, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1996.
The supplemental consolidated financial statements give retroactive effect to
the merger of St. Jude Medical, Inc. and Ventritex, Inc. on May 15, 1997, which
has been accounted for using the pooling of interests method as described in the
notes to the supplemental consolidated financial statements. These supplemental
financial statements are the responsibility of the management of St. Jude
Medical, Inc. Our responsibility is to express an opinion on these supplemental
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the supplemental financial statements referred to above present
fairly, in all material respects, the consolidated financial position of St.
Jude Medical, Inc. and subsidiaries at December 31, 1996 and 1995 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, after giving retroactive
effect to the merger of Ventritex, Inc. as described in the notes to the
supplemental consolidated financial statements, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Minneapolis, Minnesota
February 5, 1997, except for Note 2,
as to which the date is May 15, 1997
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