10-Q 1 e10-q.txt FORM 10-Q QUARTERLY PERIOD ENDED JUNE 30, 2000 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------------- FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly Period ended June 30, 2000 [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from _________ to _________ Commission file number 0-19880 ENDOSONICS CORPORATION (Exact name of registrant as specified in its charter) Delaware 68-0028500 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2870 Kilgore Road, Rancho Cordova, California 95670 (Address of principal executive offices) Registrant's telephone number, including area code: (916) 638-8008 Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of July 31, 2000, the registrant had 17,798,165 shares of Common Stock, $.001 par value, outstanding. 1 2 ENDOSONICS CORPORATION FORM 10-Q SECOND QUARTER INDEX
Page No. PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets at June 30, 2000 and December 31, 1999 .... 1 Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2000 and 1999 ......................................... 2 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2000 and 1999 .................................................... 3 Notes to Condensed Consolidated Financial Statements ............................ 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ....................................................... 7 PART II. OTHER INFORMATION Item 1. through 3. Not Applicable. Item 4. Submission of Matters to a Vote of Security Holders ............................. 18 Item 5. Other Information ............................................................... 18 Item 6. Exhibits and Reports on Form 8-K ................................................ 18
2 3 PART I. FINANCIAL INFORMATION Item 1. ENDOSONICS CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands, except share and per share amounts)
June 30, 2000 December 31, 1999 ------------- ----------------- ASSETS Current assets: Cash and cash equivalents $ 5,374 $ 4,990 Short-term investments 12,689 13,741 Investment in Radiance Medical Systems, Inc. 11,480 6,668 Trade accounts receivable, net 10,939 10,688 Inventories 9,900 12,981 Accrued interest receivable and other current assets 265 517 --------- --------- Total current assets 50,647 49,585 Property and equipment, net 7,127 5,898 Intangible assets, net 9,606 10,534 --------- --------- Total assets $ 67,380 $ 66,017 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 7,112 $ 7,759 Accrued restructuring and integration expenses 403 786 --------- --------- Total current liabilities 7,515 8,545 Other liabilities 482 523 --------- --------- Total liabilities 7,997 9,068 STOCKHOLDERS' EQUITY Convertible preferred stock, $.001 par value 5,000,000 shares authorized, no shares issued and outstanding -- -- Common stock, $.001 par value; 25,000,000 shares authorized, and 17,743,652 and 17,686,958 shares issued and outstanding as of June 30, 2000 and December 31, 1999 respectively 19 19 Additional paid-in capital 179,751 179,674 Common stock in treasury, at cost, 1,189,642 and 1,212,692 shares at June 30, 2000 and December 31, 1999 respectively (6,734) (6,926) Accumulated other comprehensive income 6,137 1,360 Accumulated deficit (119,790) (117,178) --------- --------- Total stockholders' equity 59,383 56,949 --------- --------- $ 67,380 $ 66,017 ========= =========
See accompanying notes. 3 4 ENDOSONICS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except share and per share amounts)
Three months ended Six months ended June 30, June 30, 2000 1999 2000 1999 ------------ ------------ ------------ ------------ Total revenue $ 13,148 $ 13,965 $ 26,060 $ 26,026 Cost of sales 7,547 6,515 14,216 12,379 ------------ ------------ ------------ ------------ Gross profit 5,601 7,450 11,844 13,647 Operating expenses: Research, development and clinical 2,099 2,100 3,926 3,650 Marketing and sales 4,003 2,808 7,435 5,085 General and administrative 1,394 1,246 2,583 2,181 Restructuring (297) (738) (81) (738) Amortization of intangibles 468 462 933 923 ------------ ------------ ------------ ------------ Total operating expenses 7,667 5,878 14,796 11,101 ------------ ------------ ------------ ------------ Income (loss) from operations (2,066) 1,572 (2,952) 2,546 Interest income 250 260 460 574 ------------ ------------ ------------ ------------ Net income (loss) before tax (1,816) 1,832 (2,492) 3,120 Tax provision (benefit) -- 73 -- 125 ------------ ------------ ------------ ------------ Net loss $ (1,816) $ 1,759 $ (2,492) $ 2,955 ============ ============ ============ ============ Basic net income (loss) per share $ (0.10) $ 0.10 $ (0.14) $ 0.17 ============ ============ ============ ============ Diluted net income (loss) per share $ (0.10) $ 0.10 $ (0.14) $ 0.16 ============ ============ ============ ============ Shares used in computing basic net income (loss) per share: Basic 17,751,842 17,754,644 17,737,857 17,876,553 ------------ ------------ ------------ ------------ Effect of dilutive common stock options - 243,699 -- 451,163 ------------ ------------ ------------ ------------ Diluted 17,751,842 17,998,343 17,737,857 18,327,716 ============ ============ ============ ============
See accompanying notes 4 5 ENDOSONICS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
Six months ended June 30, ----------------------- 2000 1999 -------- -------- Cash flows from operating activities Net income (loss) $ (2,492) $ 2,995 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 1,977 1,470 Net changes in : Operating assets 3,444 (11,166) Operating liabilities (904) 1,624 -------- -------- Net cash provided by (used in) operating activities 2,025 (5,077) -------- -------- Cash flows from investing activities: Purchase of short-term investments (12,760) (10,169) Maturities of short-term investments 13,812 9,435 Capital expenditures for property and equipment (2,289) (1,859) -------- -------- Net cash (used in) investing activities (1,237) (2,593) -------- -------- Cash flows from financing activities: Treasury shares acquired (104) (2,482) Proceeds from the issuance of common stock 253 2,223 -------- -------- Net cash provided by (used in) financing activities 149 (259) -------- -------- Effect of exchange rate changes on cash and cash equivalents (553) (82) -------- -------- Net increase (decrease) in cash and equivalents 384 (8,011) Cash and equivalents, beginning of period 4,990 8,749 ======== ======== Cash and equivalents, end of period $ 5,374 $ 738 ======== ========
See accompanying notes. 5 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The interim financial information is unaudited. In the opinion of the management of EndoSonics Corporation ("EndoSonics" or the "Company"), the condensed consolidated financial statements included in this report reflect all adjustments necessary, consisting only of normal recurring adjustments, to present fairly the Company's consolidated financial position at June 30, 2000 and 1999, and the consolidated results of its operations and cash flows for the six month periods ended June 30, 2000 and 1999. Results for the interim periods are not necessarily indicative of consolidated results to be expected for the entire fiscal year. These financial statements should be read in conjunction with the Company's audited financial statements for the year ended December 31, 1999, contained in the Company's Annual Report on Form 10-K. DEFINITIVE AGREEMENT WITH JOMED Subsequent to June 30, 2000, JOMED N.V. (SWX:JOM), a European medical technology company and the Company entered into a definitive merger agreement wherein JOMED will acquire all of the outstanding stock of EndoSonics Corporation against cash payment of $11.00 per share, or a total of approximately $205 million. Under the terms of the agreement, the cash tender offer will commence on or before August 21, 2000. The transaction has been approved by the boards of both companies. $150 million of the purchase price is intended to be funded through an offering of new JOMED shares and JOMED has arranged for commitments with Credit Suisse First Boston to provide this financing. The balance of the purchase price will come from JOMED's existing cash. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of EndoSonics and its subsidiaries. (EndoSonics and its subsidiaries are collectively referred to hereinafter as "the Company"). All significant intercompany accounts and transactions have been eliminated. RECLASSIFICATIONS Certain reclassifications have been made to the prior period balances to conform to current period presentations. INVESTMENTS In accordance with SFAS 115, the Company has classified its investment portfolio as available-for-sale. Unrealized gains (losses) on available-for-sale securities are included in accumulated other comprehensive income and recorded as a separate component of stockholders' equity. NEW ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"). The SAB states that all registrants are expected to apply the accounting and disclosures described in it. The SEC staff, however, will not object if registrants that have not applied this accounting do not restate prior financial statements provided they report a change in accounting principle in accordance with APB Opinion No. 20, Accounting Changes, by cumulative catch-up adjustment no later than the fourth fiscal quarter of the fiscal year beginning after December 15, 1999. The Company is currently evaluating the impact, if any, of SAB 101 on its financial statements. In June 1997, the FASB issued Statement No. 131, "Disclosure about Segments of an Enterprise and Related Information" (SFAS 131) which establishes standards for the way that public business enterprises report information about operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS 131 was adopted during the year ended December 31, 1999 and did not have a significant impact on the Company's existing disclosures. The Company's three operating segments are engaged in the development, manufacture and marketing of medical devices and have similar characteristics. Accordingly, they have been aggregated pursuant to the provisions of SFAS 131. 6 7 2. INVENTORIES Inventories are stated at the lower of cost, determined on a first in, first out (FIFO) cost basis, or market value. Inventories consist of the following:
June 30, 2000 December 31, 1999 ------------- ----------------- Raw materials $ 4,130 $ 5,930 Work-in-process 2,072 1,867 Finished goods 3,698 5,184 ------- ------- Total $ 9,900 $12,981 ======= =======
3. COMPUTATION OF NET INCOME (LOSS) PER SHARE Net income (loss) per share is computed using the weighted average number of shares of common stock outstanding. Common equivalent shares from stock options and warrants are excluded from the computation of net loss per share because their effect is antidilutive. Conversely, common equivalent shares from stock options are included in the computation of net income per share to the extent that the impact is dilutive. At June 30, 2000 and December 31, 1999 the Company had outstanding options to purchase 3,130,647 and 3,655,145 shares of common stock, respectively (with exercise prices ranging from $0.125 to $16.50) and outstanding warrants to purchase 12,304 shares of common stock (with exercise prices from $11.76 to $12.55). If exercised, these options could potentially dilute basic earnings per share in future periods. 4. COMPREHENSIVE INCOME The following table sets forth the computation of comprehensive income:
Three months ended June 30, 2000 1999 ------- ------- Net income (loss) $(1,816) $ 1,759 Other comprehensive income: Unrealized gain on available-for-sale securities (net tax of $108 and $64 in 2000 and 1999, respectively) (1,243) (1,539) Foreign currency translation (net tax of $6 and $1 in 2000 and 1999, respectively) 63 21 ------- ------- Comprehensive income $(2,996) $ 241 ======= =======
7 8
Six months ended June 30, 2000 1999 ------- ------- Net income (loss) $(2,492) $ 2,995 Other comprehensive income: Unrealized gain on available-for-sale securities (net tax of $385 and $7 in 2000 and 1999, respectively) 4,426 (162) Foreign currency translation (net tax of $3 and $2 in 2000 and 1999, respectively) (32) (58) ------- ------- Comprehensive income $(1,902) $ 2,775 ======= =======
5. RESTRUCTURING AND OTHER CHARGES In January 2000 the Company announced plans to reduce approximately 10% of its non-sales workforce to allow for continued growth in its direct sales force and for investment in certain key research and development projects. Approximately 40 non-sales positions were eliminated. The Company recorded restructuring charges of $216 related to severance and related benefits paid during the quarter to the terminated employees. The elements of the accrual for the 1997 and 1998 restructuring and integration charges as of June 30, 2000 are as follows:
Restructuring Accrual as of Charges Net Accrual as of December 31, of Costs Restructuring June 30, 1999 Incurred Decrease 2000 ------------- ------------- ------------- -------------- Corporate reorganization $ 786 $ (86) $ (297) $ 403 ============= ============= ============== ==============
6. STOCK REPURCHASE The Board of Directors has authorized a stock repurchase program whereby the Company may repurchase up to 1.7 million shares of its common stock from time-to-time in the open market or private transactions. As of December 31, 1999, the Company held 1,212,692 shares of its common stock in treasury. During the six months ended June 30, 2000, 43,050 shares of common stock held in treasury were re-issued to participants of the Company's Employee Stock Purchase Plan at approximately $4.09 per share. The Company also purchased an additional 20,000 shares of its common stock at approximately $5.18 per shares. As a result, a total of 1,189,642 shares were held in treasury at June 30, 2000 at an aggregate cost of approximately $6,734. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains forward-looking statements. These statements are generally indicated by words or phrases such as "anticipates", "estimates", "projects", "believes", "intends", "expects", and similar words and phrases. The Company's business is subject to risks and uncertainties and the Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, the Company's ability to transition to new distribution arrangements in Europe and North America, the introduction of new products, FDA approval of new products and changes in regulatory requirements and third-party reimbursement policies. For discussion of these and other factors, please see "Risks Factors" on page 10 of this Form 10-Q and in the Company's Annual Report on Form 10-K (starting on page 19) for the fiscal year ended December 31, 1999. RESULTS OF OPERATIONS SECOND QUARTER OF 2000 COMPARED TO THE SAME PERIOD IN 1999 Total Revenue. Total revenue decreased 6% to $13.1 million for the second quarter of 2000 from $13.9 million for the second quarter of 1999. The decrease is primarily due to a reduction in revenue in Europe, particularly Germany, over the second quarter of 1999. In the United States where the Company utilizes a direct sales force revenues increased 44% over 1999 levels. Second quarter revenues for the Intravascular Ultrasound ("IVUS") business decreased by $0.3 million or 3%, due primarily to lower IVUS system revenue shipments. This decrease was only partially offset by the increase in disposable shipments. Revenues for the Cardiometrics business decreased by $0.6 million, or 20%, primarily due to decreased Wavewire shipments. Cost of Sales. Cost of sales as a percentage of sales increased to 57% for the second quarter of 2000, as compared to 47% for the second quarter of 1999. Cost of sales as a percentage of total revenues increased primarily due to manufacturing inefficiencies, including low manufacturing yields, related to the transition of certain product lines to the Company's San Diego facility, availability of quality sensors for the Company's Wave Wire production, and downward pressure on IVUS system prices. Due to the uncertainty associated with improvements in the efficiency of the Company's manufacturing process, the availability of quality sensors and the impact of increasingly competitive pricing, there can be no assurance that the Company's gross profit margin will be maintained or improve in future periods. Research, Development, and Clinical. Research, development and clinical expenses remained constant at $2.1 million for the second quarter of 2000 and the second quarter of 1999. In May 2000 the Company announced that it has received FDA approval to begin human clinical trials of its directional radiation (brachytherapy) device. The Company expects an increase in research development and clinical expenses as it dedicates significant resources to this clinical trial, as well as various other research and development projects related to bringing new products to market. Marketing and Sales. Marketing and sales expenses increased to $4.0 million in the second quarter of 2000 as compared to $2.8 million in the second quarter of 1999. The 43% increase is due to increased headcount and marketing programs related to staffing a direct sales force in the United States, France, Germany and the Benelux Region. As a percentage of total revenues, marketing and sales expenses increased to 30% in the second quarter of 2000 from 20% in the second quarter of 1999. The Company anticipates that it will continue to expand its direct sales force and marketing efforts in the United States and certain European territories. General and Administrative. General and administrative expenses increased to $1.4 million or 11% of revenues in the second quarter of 2000 from $1.2 million or 9% of revenues during the same quarter in 1999. The increase is attributable to an overall increase in the level of operations, including an increase in headcount and facility related expenses over the second quarter of 1999. Restructuring. Restructuring charges of ($0.3) million relate to a reduction in reserve requirement for the Company's termination agreement with a certain distribution partner. Amortization of Intangibles. Amortization of intangibles was $0.5 million in the second quarter of 2000 and 1999. The amortization relates to goodwill and other intangible assets acquired in the acquisition of 9 10 Navius in August 1998 and Cardiometrics in July 1997. Goodwill and other intangibles are being amortized over periods ranging from three-to-nine years. Other Income. Other income remained at $0.3 million in the second quarter of 2000 compared to $0.3 million in the second quarter of 1999. Net Income (Loss). Net loss was ($1.8) million, or ($0.10) per basic share, in the second quarter of 2000 as compared to net income of $1.8 million, or $0.10 per basic share, in the second quarter of 1999. FIRST SIX MONTHS OF 2000 COMPARED TO THE SAME PERIOD IN 1999 Total Revenue. Total revenue remained constant at $26.1 million for the first six months of 2000 from $26.0 million for the first six months of 1999. In the United States where the Company utilizes a direct sales force revenues increased 22% over 1999 levels. Six month revenues for the Intravascular Ultrasound ("IVUS") business decreased by $3.8 million or 21%, due primarily to lower IVUS system revenue shipments. This decrease was only partially offset by the increase in disposable shipments. Revenues for the Cardiometrics business decreased by $1.4 million, or 24%, primarily due to decreased Wavewire shipments. Cost of Sales. Cost of sales as a percentage of sales increased to 55% for the first six months of 2000, as compared to 47% for the first six months of 1999. Cost of sales as a percentage of total revenues increased due primarily to manufacturing inefficiencies, including low manufacturing yields, related to the transition of certain product lines to the Company's San Diego facility, availability of quality sensors for the Company's Wave Wire production, and downward pressure on IVUS system prices. Due to the uncertainty associated with improvements in the efficiency of the Company's manufacturing process, the availability of quality sensors and the impact of increasingly competitive pricing, there can be no assurance that the Company's gross profit margin will be maintained or improve in future periods. Research, Development, and Clinical. Research, development and clinical expenses increased to $3.9 million for the first six months of 2000 from $3.6 million for the first six months of 1999. The increase primarily relates to product enhancements and new products for the IVUS and functional measurement product lines. In May 2000 the Company announced that it has received FDA approval to begin human clinical trials of its directional radiation (brachytherapy) device. The Company expects an increase in research development and clinical expenses as it dedicates significant resources to this clinical trial, as well as various other research and development projects related to bringing new products to market. Marketing and Sales. Marketing and sales expenses increased to $7.4 million in the first six months of 2000 as compared to $5.1 million in the first six moths of 1999. The 46% increase is due to increased headcount and marketing programs related to staffing a direct sales force in the United States, France, Germany and the Benelux Region. As a percentage of total revenues, marketing and sales expenses increased to 29% in the six months of 2000 from 20% in the first six months of 1999. The Company anticipates that it will continue to expand its direct sales force and marketing efforts in the United States and certain European territories. General and Administrative. General and administrative expenses increased to $2.6 million or 10% of revenues in the first six months of 2000 from $2.2 million or 8% of revenues during the same six months in 1999. The increase is attributable to an overall increase in the level of operations, including an increase in headcount and facility related expenses over the first quarter of 1999. Restructuring. Restructuring charges of ($0.1) million relate to a reduction in non-sales headcount in January 2000, offset by the reduction in reserve requirement for the Company's termination agreement with a certain distribution partner. 6 11 Amortization of Intangibles. Amortization of intangibles was $0.9 million in the first six months of 2000 and 1999. The amortization relates to goodwill and other intangible assets acquired in the acquisition of Navius in August 1998 and Cardiometrics in July 1997. Goodwill and other intangibles are being amortized over periods ranging from three-to-nine years. Other Income. Other income decreased to $0.5 million in the first six months of 2000 compared to $0.6 million in the first six months of 1999. This is due to a decrease in interest income resulting from lower cash balances. Net Income (Loss). Net loss was ($2.5) million, or ($0.14) per share, in the first six months of 2000 as compared to net income of $3.0 million, or $0.17 per basic share, in the first six months of 1999. LIQUIDITY AND CAPITAL RESOURCES On June 30, 2000, the Company had cash and cash equivalents of $5.4 million, short-term investments of $24.2 million and $10 million available under a revolving line of credit. Net cash provided by (used in) operations was $2.0 million in the six months ended June 30, 2000 as compared to ($5.1) million in the same period in 1999. The improvement is primarily due to a reduction in the amount the Company invested under its stock repurchase program, and a reduction in inventory, partially offset by an increase in accounts receivable. Net cash used in investing activities was $1.2 million in the six months ended June 30, 2000 as compared to $2.6 million in the same period of 1999. The increase was due primarily to the maturities of short-term investments, offset partially by capital expenditures and the purchase of short-term investments. Net cash provided by (used in) financing activities was $0.1 million for the six months ended June 30, 2000 as compared to ($0.3) million in the same period of 1999. In the six months ended June 30, 2000 the Company repurchased 20,000 shares of its stock under its stock repurchase program at an aggregate cost of $0.1 million and received $0.2 million from the issuance of common stock related to the Employee Stock Purchase Plan and the exercise of stock options. In the six months ended June 30, 1999 the Company used $2.5 million to acquire treasury stock under its repurchase program and received $2.2 million from the exercise of stock options. The Company anticipates using cash resources primarily for capital expenditures, product development, sales and marketing efforts, stock repurchases and working capital purposes. The Company believes that its existing cash, cash equivalents, and short-term investments as of June 30, 2000 will be sufficient to meet the Company's operating expenses and capital requirements through 2000. However, there can be no assurance that the Company will not be required to seek other financing or that such financing, if required, will be available at all or on terms satisfactory to the Company. IMPACT OF YEAR 2000 Independent of the "Year 2000 Issue" the Company had plans to implement an enterprise-wide software platform. In late 1999, this installation was completed and the Company began using a new Enterprise Resource Planning system (ERP), which was Year 2000 compliant. As a result of this installation the Company experienced no significant disruptions of its internal systems related to the date change. In addition, the Company experienced no significant disruptions related to the systems, products and services of the Company's vendors and customers. 11 12 SUBSEQUENT EVENT Subsequent to June 30, 2000, JOMED N.V. (SWX:JOM), a European medical technology company and the Company entered into a definitive merger agreement wherein JOMED will acquire all of the outstanding stock of the Company against cash payment of $11.00 per share, or a total of approximately $205 million. Under the terms of the agreement, the cash tender offer will commence on or before August 21, 2000. RISK FACTORS History of Operating Losses; Anticipated Future Losses. The Company was founded in 1984 and has experienced annual operating losses since its inception. The Company's accumulated deficit at June 30, 2000 is approximately $120 million. There can be no assurance that the Company will be able to achieve or sustain profitability in the future. Although the Company believes that its existing cash, cash equivalents and short-term investments will be sufficient to meet its liquidity requirements through 2000, there can be no assurance that the Company will not require additional financing or that such financing, if required, will be available on satisfactory terms, if at all. Uncertainty of Market Acceptance. Although external ultrasound imaging and balloon angioplasty are widely used technologies, the use of IVUS imaging in connection with interventional cardiology is relatively new. The commercial success of the Company's products will depend upon their acceptance by the medical community as a useful, cost-effective component of interventional cardiovascular and peripheral vascular procedures. IVUS imaging is used in conjunction with angioplasty and other intravascular procedures such as vascular stenting. Accordingly, the medical community must determine that the information obtained from the use of the Company's ultrasound products will increase the safety or effectiveness or lower the overall cost of the care being provided and that the value of such information justifies the incremental expense of obtaining IVUS imaging. In addition, market acceptance of the Company's combination balloon angioplasty/IVUS imaging catheters will depend, among other things, on a determination by the medical community that the efficacy of the therapeutic component of the Company's combination catheters is at least comparable to that of competing non-imaging angioplasty catheters and other types of therapy. Although IVUS imaging devices have been available for over ten years, the market for such products has remained relatively small. Although the Company believes the benefits of IVUS imaging can be demonstrated, there can be no assurance that the benefits will be considered sufficient by the medical community to enable the Company's products to achieve widespread market acceptance. Failure of the Company's products to achieve market acceptance would have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Strategic Relationships. In recent years there has been significant consolidation among medical device suppliers as the major suppliers have attempted to broaden their product lines in order to focus on product configurations that address a given procedure or treatment and in order to respond to cost pressures from health care providers. This consolidation has made it increasingly difficult for smaller suppliers, such as the Company, to effectively distribute their products without a major relationship with one of the major suppliers. There can be no assurance that the Company will be able to maintain its relationship with its key distributors or replace one of these distributors in the event that a distributor relationship would be terminated. In the event of such a termination, the Company's ability to distribute its products would be materially adversely affected, which would have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on New Products; Rapid Technological Change. The medical device industry generally, and the IVUS imaging device market in particular, are characterized by rapid technological change, changing customer needs, and frequent new product introductions. The Company's future success will depend upon its ability to develop and introduce new products that address the increasingly sophisticated needs of its customers. There can be no assurance that the Company will be successful in developing and marketing new products that achieve market acceptance or that the Company will not experience 12 13 difficulties that could delay or prevent the successful development, introduction and marketing of new products. Dependence on International Sales. The Company derives, and expects to continue to derive, a significant portion of its revenue from international sales. In 1997, 1998, and 1999, the Company's international sales were $21.9 million, $32.2 million and $30.8 million respectively, or 64%, 73% and 64% of total revenue. Therefore, a significant portion of the Company's revenues will continue to be subject to the risks associated with international sales, including economic or political instability, shipping delays, changes in applicable regulatory policies, fluctuations in foreign currency exchange rates and various trade restrictions, all of which could have a significant impact on the Company's ability to deliver products on a competitive and timely basis. Future imposition of, or significant increases in the level of, customs duties, import quotas or other trade restrictions, could have an adverse effect on the Company's business, financial condition and results of operation. The regulation of medical devices, particularly in the European Community, continues to expand and there can be no assurance that new laws or regulations will not have an adverse effect on the Company. Suppliers. The Company purchases many standard and custom built components from independent suppliers, and contracts with third parties for certain specialized electronic component manufacturing processes. Most of these purchased components and processes are available from more than one vendor. However, the manufacturing of the connection points on certain integrated circuit microchips and the pressure microchip are currently performed by single vendors. Although the Company is in the process of identifying alternative vendors, the qualification of additional or replacement vendors for certain components or services is a lengthy process. Any supply interruption from these single source vendors would have a material adverse effect on the Company's ability to manufacture its products until a new source of supply was qualified and, as a result, could have an adverse effect on the Company's business, financial condition and results of operations. Limitations on Third-Party Reimbursement. In the United States, the Company's products are purchased primarily by medical institutions that then bill various third-party payors. Medical institutions are reimbursed for the care of Medicare hospital patients based at a predetermined lump sum amount for diagnostic related groups, or DRGs regardless of the costs involved. The amount of money paid for a specific DRG is determined by the average consumption needed to treat a specific disease, including the nursing time, operating room time and supplies. The amount of reimbursement is fixed and thus the amount of potential profit for the medical institution relating to the procedure may be reduced to the extent the physician performs additional procedures such as IVUS imaging, pressure measurement or uses a more expensive product that combines ultrasound imaging with therapeutic capabilities. Private insurers and other payors determine whether to provide coverage for a particular procedure and reimburse hospitals for medical treatment also usually at a fixed rate. The fixed rate of reimbursement is based on the procedure performed, and is unrelated to the specific type or number of devices used in a procedure. Some payors may deny reimbursement if they determine that the device used in a treatment was unnecessary, inappropriate or not cost-effective, experimental or used for a non-approved indication. Physicians are reimbursed for performing medical procedures based on the amount of resource costs needed to provide the services. Included in the cost of providing each service is the physician work, practice expense and malpractice insurance. Payments are adjusted for geographic differences. Current Procedural Terminology or CPT codes are now available for all EndoSonics technology. CPT codes have been available for ultrasound procedures since 1997 and since January 1999 for Doppler flow and pressure measurement. Physicians are responsible to determine that the clinical benefits of intravascular ultrasound imaging and physiological assessment justify the additional costs for the medical institutions. 13 14 Although the Company believes that less invasive procedures generally provide less costly overall therapies as compared to alternative surgical procedures, there can be no assurance that reimbursement for such less invasive procedures will continue to be available, or that future reimbursement policies of payors will not adversely affect the Company's ability to sell its products on a profitable basis. Failure by hospitals and other users of the Company's products to obtain reimbursement from third-party payors, or changes in government and private third-party payors' policies toward reimbursement for procedures employing the Company's products, would have a material adverse effect on the Company's business, financial condition and results of operations. The market for the Company's products could be adversely affected by changes in governmental and private third-party payors' policies. A portion of capital costs for medical equipment purchased by hospitals are currently reimbursed separately from DRG payments. Moreover, the Company is unable to predict what additional legislation or regulation if any, relating to the health care industry or third-party coverage and reimbursement may be enacted in the future, or what effect such legislation or regulation would have on the Company. Competition. Competition in the market for devices used in the diagnosis and treatment of cardiovascular and peripheral vascular disease is intense, and is expected to increase. The interventional cardiology market is characterized by rapid technological innovation and change, and the Company's products could be rendered obsolete as a result of future innovations. The Company's digital, all-electronic IVUS imaging catheters compete with mechanical ultrasound devices manufactured by Cardiovascular Imaging Systems ("CVIS"), a division of Boston Scientific Corporation. CVIS is significantly larger than the Company, and has significantly greater financial, sales and marketing and technical resources available. CVIS has also developed IVUS imaging products with high quality images and the Company believes that its competitive position is dependent upon its ability to establish its reputation as a producer of high quality IVUS imaging products. The Company's combination balloon angioplasty/IVUS imaging catheters compete or will compete with therapeutic catheters marketed by a number of manufacturers, including CVIS, Cordis, Guidant and Medtronic, Inc. Such companies have substantial resources, established market positions, and significantly larger sales and marketing organizations. In addition, the Company faces competition from manufacturers of atherectomy devices, vascular stents and pharmaceutical products intended to treat cardiovascular disease. There can be no assurance that these companies are not currently developing, or will not attempt to develop, combination balloon angioplasty/IVUS imaging catheters that would compete with the Company's combination balloon angioplasty/IVUS imaging products. Moreover, companies currently engaged in the manufacture and marketing of non-imaging angioplasty catheters could attempt to expand their product lines to include combination balloon angioplasty/IVUS imaging products. Reliance on Patents and Proprietary Technology; Risk of Patent Infringement. The Company holds six issued United States patents and has other United States and several foreign patent applications pending covering various aspects of its IVUS imaging technology. No assurance can be given, however, that the Company's patent applications will issue as patents or that any issued patents will provide competitive advantages for the Company's products or will not be successfully challenged or circumvented by its competitors. Although the Company attempts to ensure that its products do not infringe other party's patents and proprietary rights, there can be no assurance that its products do not infringe such patents or rights. There can be no assurance that such licenses would be available or, if available, would be so on terms acceptable to the Company or that the Company would be successful in any attempt to redesign its products or processes to avoid infringement. The Company also relies on trade secrets and proprietary technology and enters into confidentiality and non-disclosure agreements with its employees and consultants. There can be no assurance that the confidentiality of such trade secrets or proprietary information will be maintained by employees, consultants, advisors or others, or that the Company's trade secrets or proprietary technology will not otherwise become known or be independently developed by competitors in such a manner that the Company has no practical recourse. Litigation may be necessary to defend against claims of infringement or invalidity, to enforce patents issued to the 14 15 Company or to protect trade secrets and could result in substantial cost to, and diversion of effort by, the Company. Litigation. The interventional cardiovascular market has been characterized by substantial litigation regarding patent and other intellectual property rights. In the event that any relevant claims of third-party patents are upheld as valid and enforceable, the Company could be prevented from practicing the subject matter claimed in such patents, or would be required to obtain licenses from the owners of any such patents or redesign its products or processes to avoid infringement. The Company filed a complaint against Radiance Medical Systems, Inc. ("Radiance"), seeking a judicial determination that the Company has rights under a certain license agreement with Radiance to market and sell a catheter combining Focus Technology, a Company Transducer and a stent for coronary applications. The complaint does not currently seek damages but only a declaration confirming the Company's interpretation of the contract language over Radiance's interpretation of such language. In the event that Radiance prevails in the litigation, there may be a material adverse impact on the Company's future development efforts. In October 1998, the Company entered into a five year litigation standstill agreement with Intravasular Research Limited with respect to certain intellectual property claims. The agreement includes the dismissal without prejudice of a pending Delaware lawsuit involving patent infringement claims. The agreement does not toll any potential patent infringement damages that may be accruing. Management believes the outcomes of these matters will have no material adverse effect on the Company's financial position, results of operations or cash flows. The Company is subject to various legal actions and claims arising in the ordinary course of business. Management believes the outcomes of these matters will have no material adverse effect on the Company's financial position, results of operations or cash flows. Defending and prosecuting intellectual property suits and related legal and administrative proceedings are costly and time-consuming. Further litigation may be necessary to enforce our patents, to protect our trade secrets or know-how or to determine the enforceability , scope and validity of the proprietary rights of others. Any litigation or other proceedings will be costly and will result in significant diversion of effort by our technical and management personnel. Government Regulation. The manufacturing and marketing of the Company's products are subject to extensive and rigorous government regulation in the United States and in other countries. The Company believes that its success will be significantly dependent upon commercial sales of improved versions of its imaging systems and catheter products. The Company will not be able to market these new products in the United States unless and until the Company obtains approval from the FDA. If a medical device manufacturer can establish that a newly developed device is "substantially equivalent" to a device that was legally marketed prior to May 1976, or to a device that the FDA has found to be substantially equivalent to a legally marketed pre-1976 device, the manufacturer may seek clearance from the FDA to market the device by filing a premarket notification with the FDA under Section 510(k) of the Federal Food, Drug, and Cosmetic Act ("510(k)"). There can be no assurance that 510(k) clearance for any future product or modification of an existing product will be granted or that the process will not be unduly lengthy. All of the 510(k) clearances received for the Company's catheters were based on substantial equivalence to legally marketed pre-1976 devices. Review of the substantially equivalent pre- 1976 devices on which the 510(k) clearances for the Company's catheters were based and any resulting restrictions on the Company or requirements imposed to present additional data could have a material adverse effect on the Company's business, financial condition and results of operations. If substantial equivalence cannot be established, or if the FDA determines that the device or the particular application for the device requires a more rigorous review, the FDA will require that the manufacturer submit a PMA application that must be reviewed and approved by the FDA prior to sales and marketing of the device in the United States. The PMA process is significantly more complex, expensive and time consuming than the 510(k) clearance process and frequently requires the submission of clinical data. It is expected that certain of the Company's combination angioplasty/IVUS imaging products under development will be subject to this PMA process. Failure to comply with applicable regulatory requirements can, among other consequences, result in fines, injunctions, civil penalties, suspensions or loss of regulatory approvals, product recalls, seizure of products, operating restrictions 15 16 and criminal prosecution. In addition, governmental regulations may be established that could prevent or delay regulatory approval of the Company's products. Delays in receipt of approvals, failure to receive approvals or the loss of previously received approvals would have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also required to register as a medical device manufacturer with the FDA and certain state agencies, such as the Food and Drug Branch of CDHS. As such, the Company is inspected on a routine basis by both the FDA and the CDHS for compliance with the GMP regulations. These regulations require that the Company manufacture its products and maintain related documentation in a prescribed manner with respect to manufacturing, testing and control activities. Further, the Company is required to comply with various FDA requirements for labeling. The Medical Device Reporting regulation requires that the Company provide information to the FDA on deaths or serious injuries alleged to have been associated with the use of its devices, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. In addition, the FDA prohibits an approved device from being marketed for unapproved applications. Specifically, the Company's FOCAL balloon catheters are approved in certain European countries. The Company believes that these catheters are being used in those countries principally for deployment of coronary stents and balloon angioplasty. In October 1995, EndoSonics received FDA approval to market Radiance's line of FACT catheters, which utilize the FOCAL technology, for coronary balloon angioplasty. Without specific FDA approval for use in stent deployment, these catheters may not be marketed by the Company in the United States for such use. If the FDA believes that a company is not in compliance with applicable laws and regulations, it can institute proceedings to detain or seize products, issue a recall, prohibit marketing and sales of the company's products and assess civil and criminal penalties against the company, its officers or its employees. The Company is also subject to other federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices. The extent of government regulation that might result from any future legislation or administrative action cannot be accurately predicted. Failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. International sales of the Company's products are subject to the regulatory agency product registration requirements of each country. The regulatory review process varies from country to country and may in some cases require the submission of clinical data. The Company typically relies on its distributors in such foreign countries to obtain the requisite regulatory approvals. There can be no assurance, however, that such approvals will be obtained on a timely basis or at all. The Company has received ISO 9001 certification of its Quality System as well as CE Mark certifications for most of its products. The ISO 9000 series of standards for quality operations has been developed to ensure that companies know the standards of quality to which they must adhere to receive certification. The European Union has promulgated rules which require that medical products obtain the right to affix the CE Mark, an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. All medical devices placed on the market within the European Union are required to bear the CE Mark. ISO 9000 certification is one of the CE Mark certification requirements. Failure to receive the right to affix the CE Mark for any product will prohibit the Company from selling that product in member countries in the European Union. In Europe, the Company has obtained ISO 9001 certification for operations at the EndoSonics Europe, B.V. office. There can be no assurance that the Company will be successful in meeting ongoing certification requirements. Potential Product Liability; Limited Insurance. The Company faces the risk of financial exposure to product liability claims. The Company's products are often used in situations in which there is a high risk of serious injury or death. Such risks will exist even with respect to those products that have received, or 16 17 in the future may receive, regulatory approval for commercial sale. The Company maintains product liability insurance with coverage limits of $1.0 million per occurrence and $5.0 million per year in the aggregate. There can be no assurance that the Company's product liability insurance is adequate or that such insurance coverage will remain available at acceptable costs. There can be no assurance that the Company will not incur significant product liability claims in the future. A successful claim brought against the Company in excess of its insurance coverage could have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, adverse product liability actions could negatively affect the reputation and sales of the Company's products as well as the Company's ability to obtain and maintain regulatory approval for its products. Volatility of Stock Price. The Company's Common Stock has experienced and can be expected to continue to experience substantial price volatility in response to actual or anticipated quarterly variations in operating results, announcements of technological innovations or new products by the Company or its competitors, developments related to patents or other intellectual property rights, developments in the Company's relationships with its customers, distributors or suppliers, acquisitions or divestitures of other companies in the health care industry, and other events or factors. In addition, any shortfall or changes in revenue, gross margins, earnings, or other financial results from analysts' expectations could cause the price of the Company's Common Stock to fluctuate significantly. In recent years, the stock market in general has experienced extreme price and volume fluctuations, which have particularly affected the market price of many technology and health care companies and which have often been unrelated to the operating performance of those companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. 17 18 PART II. OTHER INFORMATION ITEMS 1 through 3. Not applicable. ITEM 4. Submission of Matters to a Vote of Security Holders The Company's Annual Meeting of Stockholders was held on June 22, 2000. The three matters voted upon at the meeting were: (i) to elect the members of the Board of Directors of the Company set forth below to a one-year term of office; (ii) to approve an amendment to the Company's 1998 Stock Option Plan, increasing the number of shares of common stock authorized for issuance under such plan by 500,000 shares; and (iii) to ratify the selection of Ernst & Young LLP as independent auditors of the Company for the year ending December 31, 2000. The three matters were approved by the stockholders at such meeting by the number of votes set forth below:
Abstentions Affirmative Negative and Broker Votes Votes Non-Votes ----------- -------- ----------- A. Election of Directors: Julie A. Brooks 9,207,978 791,626 7,745,107 Thomas J. Cable 9,207,078 791,526 7,746,107 Dale Conrad 9,207,978 791,626 7,745,107 Jakob Stapfer 9,270,078 729,526 7,808,107 Gregg W. Stone, M.D. 9,208,078 791,826 7,744,807 Reinhard J. Warnking 9,207,978 791,626 7,745,107 W. Michael Wright 9,207,978 791,626 7,745,107 B. Amendment to the 1998 Stock: Option Plan 6,509,152 3,436,942 7,798,617 C. Ratification of Ernst & Young LLP As Independent Auditors: 9,937,679 46,822 7,760,210
ITEM 5. Other Information. None ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit 27 Financial Data Schedule (b) No reports on Form 8-K were filed during the quarterly period ending June 30, 2000. The Company filed a Current Report on Form 8-K on August 8, 2000 to report the execution of a definitive merger agreement with JoMed N.V. pursuant to which JoMed, N.V. will acquire all of the outstanding common stock of the Company at a price of $11.00 per share. 18 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ENDOSONICS CORPORATION /s/ REINHARD J. WARNKING -------------------------------------- Reinhard J. Warnking President and Chief Executive Officer Date: August 14, 2000 /s/ JEFFREY L. ELDER -------------------------------------- Jeffrey L. Elder Sr. Vice President and Chief Financial Officer Date: August 14, 2000 /s/ KATHLEEN E. REDD -------------------------------------- Kathleen E. Redd Vice President and Corporate Controller Principal Accounting Officer Date: August 14, 2000 19