-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FimSAxqXKOP+7OOmjqR0AAftdn2U5oTEaMLp53Ij6Uy5eS4A16zPo++GZtbwFVUd un1Z6uAtut6Jts7qdgopzA== 0000891618-98-000989.txt : 19980305 0000891618-98-000989.hdr.sgml : 19980305 ACCESSION NUMBER: 0000891618-98-000989 CONFORMED SUBMISSION TYPE: 8-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980304 ITEM INFORMATION: FILED AS OF DATE: 19980304 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MALLINCKRODT INC /MO CENTRAL INDEX KEY: 0000051396 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 361263901 STATE OF INCORPORATION: NY FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 8-K/A SEC ACT: SEC FILE NUMBER: 001-00483 FILM NUMBER: 98557333 BUSINESS ADDRESS: STREET 1: 675 MCDONNELL BLVD STREET 2: PO BOX 5840 CITY: ST LOUIS STATE: MO ZIP: 63134 BUSINESS PHONE: 3146542000 MAIL ADDRESS: STREET 1: 7733 FORSYTH BLVD CITY: ST LOUIS STATE: MO ZIP: 63105-1820 FORMER COMPANY: FORMER CONFORMED NAME: MALLINCKRODT INC /MO DATE OF NAME CHANGE: 19970625 FORMER COMPANY: FORMER CONFORMED NAME: MALLINCKRODT GROUP INC DATE OF NAME CHANGE: 19940322 FORMER COMPANY: FORMER CONFORMED NAME: IMCERA GROUP INC DATE OF NAME CHANGE: 19920703 8-K/A 1 AMENDMENT NO. 2 TO FORM 8-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K/A No. 2 CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 March 4, 1998 Mallinckrodt Inc. (Exact name of registrant as specified in its charter) New York 1-483 36-1263901 (State or other jurisdiction (Commission (I.R.S. Employer of incorporation) File Number) Identification No.) 675 McDonnell Boulevard, St. Louis, MO 63134 (Address of principal executive offices) (Zip Code) Registrant's telephone number, (314) 654-2000 including area code 2 Pursuant to Rule 12b-15 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), this form 8-K/A is hereby filed with respect to that certain Current Report on Form 8-K of Mallinckrodt Inc. ("Mallinckrodt") filed with the Securities and Exchange Commission ("SEC") on September 5, 1997 as amended by that certain Form 8-K/A of Mallinckrodt filed with the SEC on November 3, 1997. In accordance therewith, Item 7(a) Financial Statements of the business acquired are provided. Item 7. Financial Statements, Pro Forma Financial Information and Exhibits (a) Financial Statements of Business Acquired (i) Following are the Nellcor Puritan Bennett Incorporated consolidated balance sheets at July 2, 1995 and July 7, 1996 and the related consolidated statements of operations, of stockholders' equity, and of cash flows for each of the three fiscal years in the period ended July 7, 1996. 3 NELLCOR PURITAN BENNETT INCORPORATED Selected Financial Data
Years ended (in thousands, except per share amounts) 1996 1995 1994 1993 1992 Revenue $706,131 $623,066 $564,132 $536,935 $467,323 R&D expenses 54,322 49,182 50,730 50,357 47,284 Income (loss) from operations (47) 73,404 8,441 60,018 32,982 Income from operations (as adjusted) 108,852 (1) 76,058(2) 52,110 (3) 60,018 32,982 Net income (loss) (9,360) 48,112 (8,695) 41,006 23,680 Net income (as adjusted) 74,953 (1) 53,808(2) 50,864 (3) 41,006 23,680 Net income (loss) per share (.16) 0.82 (0.15) 0.72 0.43 Net income per share (as adjusted) 1.27 (1) 0.92(2) 0.89 (3) 0.72 0.43 Working capital 243,597 266,959 228,363 242,523 197,146 Total assets 587,838 602,390 527,569 497,610 420,253 Long-term obligations 26,054 84,690 66,062 64,351 49,085 Stockholders' equity 405,780 392,265 343,518 352,258 297,214
This summary unaudited combined condensed financial information reflects the August 1995 merger of Nellcor Incorporated (Nellcor) and Puritan-Bennett Corporation (Puritan-Bennett), and the Company's June 1996 acquisition of Infrasonics, Inc. (Infrasonics), both accounted for as a pooling-of-interests; accordingly, the separate historical financial results of Nellcor, Puritan-Bennett and Infrasonics have been combined in this table and throughout the Annual Report. (1) Excludes pretax merger and related charges of $108.9 million, $84.3 million after-tax, or ($1.43) per share. (2) Excludes pretax restructuring charge and unsolicited offer costs of $2.7 million and $5.0 million (nonoperating expense), respectively, $5.7 million after-tax, or ($0.10) per share. (3) Excludes pretax restructuring charges and litigation settlements of $43.7 million and $13.0 million (nonoperating expense), respectively, and a $2.9 million after-tax charge related to the adoption of a new accounting standard. The net after-tax effect of these charges was $59.6 million, or ($1.04) per share. 4 NELLCOR PURITAN BENNETT INCORPORATED Consolidated Balance Sheet
July 7, July 2, (in thousands, except share amounts) 1996 1995 ------- ------- ASSETS Current assets: Cash and cash equivalents $ 68,549 $ 83,193 Marketable securities 5,825 66,028 Accounts receivable 151,461 124,005 Inventories 128,078 95,300 Deferred income taxes 31,658 17,122 Other current assets, net 14,030 6,746 - --------------------------------------------------------------------------------------------------------------------------- Total current assets 399,601 392,394 Property, plant and equipment 130,891 130,712 Intangible and other assets 44,245 73,653 Deferred income taxes 13,101 5,631 - ------------------------------------------------------------------------------------------------------------------------- $587,838 $602,390 ========================================================================================================================= LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 39,198 $ 37,590 Notes payable -- 18,004 Employee compensation and related costs 29,918 25,708 Merger and related costs 32,452 -- Other accrued expenses 33,771 28,879 Current maturities of long-term debt 143 9,527 Income taxes payable 20,522 5,727 - ------------------------------------------------------------------------------------------------------------------------- Total current liabilities 156,004 125,435 Long-term debt, less current maturities 6,493 54,492 Deferred compensation and pensions 9,522 19,303 Deferred revenue 10,039 10,895 - ------------------------------------------------------------------------------------------------------------------------- Total liabilities 182,058 210,125 - ------------------------------------------------------------------------------------------------------------------------- Commitments and contingencies (Notes 15 and 17) Stockholders' equity: Preferred stock, $.001 par value; 5,000,000 shares authorized; none outstanding -- -- Common stock, $.001 par value; 150,000,000 shares authorized; 62,975,926 shares issued and outstanding (60,333,242 in 1995) 63 60 Additional paid-in-capital 230,428 187,264 Retained earnings 232,433 241,103 Accumulated translation adjustment 304 (259) Deferred stock awards and other 1,369 (1,364) Treasury stock, at cost (3,224,020 shares in 1996; 2,296,000 shares in 1995) (58,817) (34,539) - ------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 405,780 392,265 - ------------------------------------------------------------------------------------------------------------------------- $587,838 $602,390 =========================================================================================================================
See accompanying notes to consolidated financial statements. 5 NELLCOR PURITAN BENNETT INCORPORATED Consolidated Statement of Operations
Years Ended ------------------------------------- July 7, July 2, July 3, (in thousands, except per share amounts) 1996 1995 1994 ------- ------- ------- Net revenue $706,131 $623,066 $564,132 Cost of goods sold 346,020 312,970 284,159 - --------------------------------------------------------------------------------------------------------------------------- Gross profit 360,111 310,096 279,973 - --------------------------------------------------------------------------------------------------------------------------- Operating expenses: Research and development 54,322 49,182 50,730 Selling, general and administrative 196,937 184,856 177,133 Restructuring charges -- 2,654 43,669 Merger and related costs 108,899 -- -- - -------------------------------------------------------------------------------------------------------------------------- 360,158 236,692 271,532 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) from operations (47) 73,404 8,441 Interest income and other income (expense), net 4,406 7,182 3,865 Interest expense (3,033) (5,830) (4,565) Litigation settlements, net -- -- (13,000) Costs associated with unsolicited takeover offer -- (5,049) -- - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes and cumulative effect of accounting change 1,326 69,707 (5,259) Provision for income taxes 10,686 21,595 546 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting change (9,360) 48,112 (5,805) Cumulative effect of accounting change, net of income taxes (Note 1) -- -- (2,890) - --------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (9,360) $ 48,112 $ (8,695) - --------------------------------------------------------------------------------------------------------------------------- Income (loss) per common share before cumulative effect of accounting change $ (.16) $ .82 $ (.10) Per common share effect of accounting change -- -- (.05) - --------------------------------------------------------------------------------------------------------------------------- Net income (loss) per common share $ (.16) $ .82 $ (.15) - --------------------------------------------------------------------------------------------------------------------------- Weighted average common and common equivalent shares 59,077 58,343 57,210 - ---------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 6 NELLCOR PURITAN BENNETT INCORPORATED Consolidated Statement of Stockholders' Equity
Common Stock Additional Accumulated Deferred Treasury Stock (in thousands, ---------------------- Paid-in Retained Translation Stock Awards -------------------- except share amounts) Shares Par Value Capital Earnings Adjustment and Other Shares Par Value ---------- --------- ---------- -------- ----------- ------------ --------- --------- Balance at July 4, 1993 56,840,064 $56 $148,096 $204,636 $ (15) $ (515) -- -- Issuance of common stock and related tax benefits of $2,394 under employee stock plans 1,281,622 1 12,177 $ 1,984 Stock awards granted, net of cancellations 16,418 374 (374) Amortization of deferred stock awards 282 Acquisition of treasury stock 1,109,784 (16,258) Acquisition and retirement of common stock (420,000) (5,853) Shares issued in a business combination 751,396 1 8,644 Accumulated translation adjustment 115 Net loss (8,695) Dividends declared (1,432) Unrealized gain on available-for-sale securities 294 - ------------------------------------------------------------------------------------------------------------------------------- Balance at July 3, 1994 58,469,500 58 163,438 194,509 100 (313) 1,109,784 (14,274) Issuance of common stock and related tax benefits of $3,487 under employee stock plans 1,816,665 2 22,642 644 Stock awards granted, net of cancellations 47,077 1,184 (1,184) Amortization of deferred stock awards 427 Acquisition of treasury stock 1,186,216 (20,909) Accumulated translation adjustment (359) Net income 48,112 Dividends declared (1,518) Realized gain on available-for-sale securities (294) - ------------------------------------------------------------------------------------------------------------------------------- Balance at July 2, 1995 60,333,242 60 187,264 241,103 (259) (1,364) 2,296,000 (34,539) Puritan-Bennett net income for the period from 2/1/95 - 6/30/95 690 Issuance of common stock and related tax benefits of $7,199 under employee stock plans 2,642,684 3 43,164 Amortization of deferred stock awards 1,359 Acquisition of treasury stock 928,020 (24,278) Accumulated translation adjustment 563 Net loss (9,360) Unrealized gain on available-for-sale securities 1,374 - ------------------------------------------------------------------------------------------------------------------------------- Balance at July 7, 1996 62,975,926 $63 $230,428 $232,433 $304 $1,369 3,224,020 $(58,817) - -------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 7 NELLCOR PURITAN BENNETT INCORPORATED Consolidated Statement of Cash Flows
Years Ended ------------------------------------- July 7, July 2, July 3, (in thousands) 1996 1995 1994 -------- ------- -------- Cash flows from operating activities: Net income (loss) $ (9,360) $48,112 $ (8,695) Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 30,952 32,849 33,037 Deferred income taxes (18,919) (4,131) (18,054) Cumulative effect of accounting change -- -- 2,890 Restructuring charges -- 2,205 38,404 Merger and related charges 108,899 -- -- Deferred compensation and pensions (11,635) 1,859 2,536 Shares issued to employee benefit plans -- 2,376 3,317 Other 128 113 1,194 Increases (decreases) in cash flows, net of effect of purchased companies, as a result of changes in: Accounts receivable (31,369) (7,179) (2,744) Inventories (23,544) (9,083) (5,643) Other current assets (10,607) (2,540) (799) Intangible and other assets 1,788 (3,703) 1,619 Accounts payable 5,834 (543) (2,714) Merger and related costs (45,366) -- -- Employee compensation and other accrued expenses 5,336 8,271 625 Income taxes payable 14,686 612 2,158 Deferred revenue (920) 933 3,991 - --------------------------------------------------------------------------------------------------------------------------- Cash provided by operating activities 15,903 70,151 51,122 - --------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Puritan-Bennett net cash used during the period from 2/1/95 - 6/30/95 (3,628) -- -- Capital expenditures (29,740) (30,959) (31,555) Purchase of securities held-to-maturity -- (48,235) (89,190) Purchase of available-for-sale securities (2,800) (2,100) -- Proceeds from maturities of securities held-to-maturity -- 37,654 106,634 Proceeds from the sale of available-for-sale securities 66,400 -- -- Proceeds from the sale of capital assets -- 5,893 1,362 Acquisitions, net of cash acquired (4,923) (23,415) (17,617) Other investing activities 220 (599) (1,311) - --------------------------------------------------------------------------------------------------------------------------- Cash provided by (used for) investing activities 25,529 (61,761) (31,677) - --------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Issuance of common stock under the Company's stock plans and related tax benefits, net 43,164 20,901 10,846 Purchase of treasury stock, including shares retired (24,278) (20,909) (22,111) Issuance (repayment) of notes payable, net (18,004) (9,787) 19,890 Additions to loans payable 40,000 -- -- Repayment of loans payable (40,000) -- -- Additions to long-term debt -- 20,000 515 Repayment of long-term debt (57,374) (6,045) (6,680) Payment of dividends -- (1,500) (1,430) - --------------------------------------------------------------------------------------------------------------------------- Cash provided by (used for) financing activities (56,492) 2,660 1,030 - --------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash 416 570 218 - --------------------------------------------------------------------------------------------------------------------------- (Decrease) increase in cash and cash equivalents (14,644) 11,620 20,693 Cash and cash equivalents at beginning of the year 83,193 71,573 50,880 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at the end of the year $68,549 $83,193 $71,573 - ---------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 8 NELLCOR PURITAN BENNETT INCORPORATED Notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization | Nellcor Puritan Bennett Incorporated (together with its wholly-owned subsidiaries, the Company) is a corporation organized under the laws of the State of Delaware in 1986 and, until the acquisition of Puritan-Bennett Corporation (Puritan-Bennett) in August 1995, operated under the name Nellcor Incorporated (Nellcor). The Company develops, manufactures and markets monitoring systems and diagnostic and therapeutic products for management of the respiratory-impaired patient across the continuum of care. The Company's products are primarily sold to hospitals, private and governmental institutions and health care agencies, medical equipment distributors and rental companies, and doctors' offices. Nellcor Puritan Bennett markets its products worldwide with international sales accounting for approximately one-third of the Company's consolidated revenue. Combined financial results | The mergers with Puritan-Bennett and Infrasonics, Inc. (Infrasonics) were intended to qualify as tax-free reorganizations and were both accounted for as a pooling-of-interests. Accordingly, the consolidated historical financial statements for all periods presented combine the financial results of Nellcor, Puritan-Bennett, and Infrasonics. The Company's consolidated balance sheet at July 2, 1995 combines the historical balance sheet of Nellcor at July 2, 1995, Puritan-Bennett at January 31, 1995 and Infrasonics at June 30, 1995. The Company's consolidated statement of operations combines the historical statement of operations of Nellcor for each of the two fiscal years in the period ended July 2, 1995, Puritan-Bennett for each of the two fiscal years in the period ended January 31, 1995, and Infrasonics for each of the two fiscal years in the period ended June 30, 1995, respectively. The results of operations of Puritan-Bennett for the period February 1, 1995 through June 30, 1995 of $690,000 have been recorded as an increase to stockholders' equity for the fiscal year ended July 7, 1996. The Company's consolidated statement of operations for the fiscal year ended July 2, 1995, also reflects an adjustment to reduce Puritan-Bennett's valuation allowance provided for its deferred tax assets based upon the combined income from operations of Nellcor and Puritan-Bennett as required by Statement of Financial Accounting Standard No. 109. The effect of this adjustment was to reduce the provision for income taxes, as presented herein, by $3.9 million and $4.8 million in fiscal 1995 and 1994, respectively. Adjustments made to conform the accounting policies of Nellcor, Puritan-Bennett, and Infrasonics were immaterial. Principles of consolidation | The Company's significant intercompany transactions and balances have been eliminated. The Company uses the equity method of accounting for its investments that represent greater than 20%, but less than 50%, of the investee. Investments which represent less than 20% of the investee are recorded at cost. All such investments were immaterial for all periods presented. Fiscal year | The Company's fiscal year ends on the first Sunday in July, which results in a 52- or 53-week fiscal year. Fiscal 1996 was a 53-week year whereas fiscal 1995 and 1994 were 52-week years. Foreign currency translation | Certain of the Company's foreign subsidiaries use the local currency, while others use the U.S. dollar as their functional currency. Subsidiaries using the local currency translate assets and 9 liabilities denominated in foreign currencies at the rates of exchange at the balance sheet date. Income and expense items are translated at average monthly rates of exchange. Any resulting translation adjustments are recorded as a separate component of stockholders' equity. Subsidiaries using the dollar as the functional currency measure assets and liabilities at the balance sheet date or historical rates depending on their nature; income and expenses are remeasured at the weighted-average exchange rates for the year. Foreign currency gains and losses resulting from transactions are included in operations in the year of occurrence and have not been material. Revenue recognition and product warranty | The Company recognizes revenue at the time of shipment of product and provides currently for the estimated cost to repair or replace products under the warranty provisions in effect at the time of sale. Deferred revenue | Deferred revenue relates to extended warranty agreements offered by the Company which are amortized over the life of the agreement, with the related extended warranty costs charged to expense as incurred. Cash equivalents | The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. These investments are stated at cost which approximates fair value due to their short maturity. Inventories | Inventories are stated at the lower of cost (first-in, first-out) or market. Allowances are made for slow-moving, obsolete, unsalable, or unusable inventories. Property, plant and equipment | Depreciation is provided using the straight-line method over the estimated useful lives of the assets which range from three to twenty-five years. Leasehold improvements are amortized over the life of the lease, or the estimated useful life of the asset, whichever is shorter. Intangible and other assets | Intangible and other assets, including excess of cost over the fair value of identifiable net assets acquired, are amortized on a straight-line basis over the estimated useful lives of the assets which range from two to fifteen years. An impairment of intangible assets is recognized when it is considered probable that the carrying amount of an asset cannot be fully recovered, based on estimated future cash flows of the related business. Fair value of financial instruments | The estimated fair value of long-term debt is determined based upon rates currently available to the Company for debt with similar terms and remaining maturities. Income taxes | Deferred income taxes are computed using the liability method. Under the liability method, taxes are recorded based on the future tax effect of the difference between the income tax and financial reporting bases of the Company's assets and liabilities. In estimating future tax consequences, all expected future events are considered, except for potential income tax law or rate changes. The Company plans to continue to finance foreign expansion and operating requirements by reinvestment of undistributed earnings of its foreign subsidiaries and, accordingly, has not provided for United States federal income tax on these earnings. Stock split | On June 27, 1996, stockholders approved a two-for-one split of the Company's common stock. All share and per share data for all periods presented have been restated to give effect to the split. Net income (loss) per share | Net income (loss) per share is based upon weighted average common shares and includes the dilutive effect of stock options outstanding, if any (using the treasury stock method). Accounting changes | In March 1995, The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of," which requires the Company to review for 10 impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In certain situations, an impairment loss would be recognized. SFAS 121 is effective for the Company's 1997 fiscal year. The Company is evaluating the impact of the new standard on its financial position, results of operations, and cash flows and expects the effect to be immaterial. In October 1995, the FASB issued SFAS 123 "Accounting for Stock-Based Compensation" which also will be effective for the Company's 1997 fiscal year. The Company does not expect SFAS 123 to have a material impact on its financial position, results of operations, and cash flows. SFAS 123 allows companies which have stock-based compensation arrangements with employees to adopt a new fair-value basis of accounting for stock options and other equity instruments, or it allows companies to continue to apply the existing accounting rules under APB Opinion 25 "Accounting for Stock Issued to Employees," but requires additional financial statement footnote disclosure. The company expects to continue to account for stock-based compensation arrangements under APB Opinion 25 and will include additional footnote disclosure in its fiscal 1997 annual report. In fiscal 1994, the Company changed its method of accounting for income taxes to conform with SFAS No. 109 "Accounting for Income Taxes." The cumulative effect of this change resulted in a charge to operations of $2.9 million. Use of estimates | The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses for each fiscal period. Actual results could differ from those estimated. 2. MARKETABLE SECURITIES At July 7, 1996, the Company held available-for-sale marketable securities with a fair market value of $5.8 million. Available-for-sale marketable securities are securities which the Company does not intend to hold to maturity. The Company's marketable securities are, generally, high quality government, municipal, and corporate obligations with original maturities of up to two years. The Company has established guidelines relative to investment quality, diversification and maturities to maintain appropriate levels of safety and liquidity. During the first quarter of fiscal 1996, the Company transferred its remaining marketable securities which had been classified as held-to-maturity as of July 2, 1995, to available-for-sale. The marketable securities which were transferred to available-for-sale were government and corporate issued debt securities with an amortized cost of $41.4 million, which approximated their fair value. The decision to classify all of the Company's marketable securities as available-for-sale was due to the Company's merger with Puritan-Bennett during the first quarter of fiscal 1996, and the significant cash outlays which were expected to be made as part of integrating the two companies. Realized gains and losses resulting from the sale of available-for-sale marketable securities during the period were not material. The difference between the cost and market value of the Company's marketable securities at July 7, 1996, an unrealized gain of approximately $1.4 million associated with equity securities held by the Company, is recorded as a component of deferred stock awards and other in stockholders' equity. 11 3. INVENTORIES Inventories are as follows:
July 7, July 2, (dollars in thousands) 1996 1995 - -------------------------------------------------------------------------------- Raw materials $ 64,205 $52,270 Work-in-process 15,579 11,064 Finished goods 48,294 31,966 - -------------------------------------------------------------------------------- Total inventories $128,078 $95,300 - --------------------------------------------------------------------------------
4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of:
July 7, July 2, (dollars in thousands) 1996 1995 - -------------------------------------------------------------------------------- Land and land improvements $ 10,838 $ 10,713 Buildings 38,575 38,221 Machinery and equipment 178,220 162,775 Leasehold improvements 11,103 9,971 Demonstration equipment 12,259 12,497 Furniture and fixtures 22,142 23,857 - -------------------------------------------------------------------------------- 273,137 258,034 Less accumulated depreciation and amortization (142,246) (127,322) - -------------------------------------------------------------------------------- Property, plant and equipment, net $130,891 $130,712 - --------------------------------------------------------------------------------
The Company leases a facility which is classified as a capital lease and the related asset is being amortized over its estimated useful life of 15 years. As of July 7, 1996, the cost of the asset and accumulated amortization was $4.4 million and $0.69 million, respectively, and is included in Buildings. Depreciation and amortization expense was approximately $23.7 million in fiscal 1996, $22.5 million in fiscal 1995, and $21.2 million in fiscal 1994. 5. FINANCIAL INSTRUMENTS AND OFF BALANCE SHEET RISK Foreign currency instruments | The Company enters into foreign currency exchange contracts, primarily foreign currency forward contracts, to reduce exposure to currency exchange risk. The effect of this practice is to minimize the impact of foreign exchange rate movements on the Company's operating results as gains and losses on these contracts offset losses and gains on the assets, liabilities and transactions being hedged. The Company does not engage in foreign currency speculation. The counterparties to foreign currency exchange contracts are major domestic and international financial institutions. To decrease the risk of non-performance which may result in currency losses, the Company diversifies its selection of counterparties. At July 7, 1996, the Company had foreign currency forward exchange contracts with a notional amount of $65.1 million ($35.4 million at July 2, 1995), and a fair market value of approximately $65.2 million ($35.9 million at July 2, 1995), all of which were denominated in European currencies. The fair market value was determined using foreign currency exchange rates in effect at the end of each fiscal period. The Company records both the amortized premium and any unrealized gain or loss on outstanding foreign currency forward exchange contracts as non-operating income or expense. For both fiscal 1996 and fiscal 1995, all outstanding foreign currency exchange contracts were due to mature within six months of fiscal year end. Concentration of credit risk | The Company provides credit in the form of trade accounts receivable to hospitals, private and governmental institutions and health care agencies, medical equipment distributors and rental companies, and doctors' offices. The Company does not generally require collateral to support customer receivables. The Company performs ongoing 12 credit evaluations of its customers and maintains allowances which management believes are adequate for potential credit losses. At July 7, 1996, the Company was carrying allowances for doubtful accounts totalling $2.4 million ($2.8 million at July 2, 1995). The credit risk associated with the Company's trade receivables is further limited due to dispersion of the receivables over a large number of customers in many geographic areas. Payment of certain accounts receivable is made by the national health care systems of several member countries of the European Economic Community. Although the Company does not currently anticipate credit problems associated with these receivables, payment may be impacted by the economic stability of these countries. The Company limits credit risk exposure to foreign exchange contracts by periodically reviewing the credit-worthiness of the counterparties to the transactions. 6. ACQUISITIONS Melville | On August 23, 1995, the Company acquired Melville Software Ltd. (Melville), a privately held Canadian company that manufactures and markets sleep diagnostic products used primarily in sleep labs for $4.9 million in cash. In the event that certain profitability levels are achieved in the three fiscal years following the acquisition, additional compensation totaling $1.0 million would be payable to the former principal stockholders of Melville who continue to manage the company. Such amounts will be expensed when, and if, earned. At July 7, 1996, no additional compensation amounts had been earned or accrued. The acquisition of Melville has been accounted for as a purchase and, accordingly, Melville's results are included in the Company's financial statements subsequent to the acquisition date. The excess of cost over the fair value of identifiable net assets acquired, primarily working capital, of $3.7 million is being amortized over 7 years. Pierre Medical | On May 3, 1995, the Company acquired Pierre Medical, a privately held French manufacturer of respiratory products used in the home, for $21.5 million in cash. In the event that certain performance milestones were achieved subsequent to the acquisition, additional compensation totaling 30 million French Francs ($5.8 million as of July 7, 1996) would be payable to the former principal stockholders of Pierre Medical who continue to manage the company. During fiscal 1996, $3.8 million of this additional compensation was accrued as a merger and related cost to reflect the effect that integration decisions associated with the Company's merger with Puritan-Bennett were expected to have upon the achievement of certain of the performance milestones. Any additional amounts will continue to be expensed when, and if, earned. Pierre Medical manufactures and markets noninvasive ventilators, sleep apnea therapy systems, oxygen concentrators and related respiratory products in Western Europe, primarily in France. The acquisition of Pierre Medical has been accounted for as a purchase and, accordingly, Pierre Medical's results are included in the Company's financial statements subsequent to the acquisition date. The fair value of identifiable net assets acquired consisted of approximately $4.0 million of working capital. The excess of cost over the fair value of identifiable net assets acquired of $18.1 million, including acquisition-related costs, was subsequently written down by $2.4 million during fiscal 1996 to reflect the effect that certain integration decisions associated with the Company's merger with Puritan-Bennett were expected to have upon Pierre Medical's estimated future cash flows. The remainder of the excess purchase price, $15.7 million, is being amortized over 15 years. In connection with the acquisition, supplemental cash flow information is as follows:
(dollars in thousands) ----------------------------------------------------------------------------- Fair value of identifiable net assets acquired, except for cash and cash equivalents $26,999 Liabilities assumed (5,584) ----------------------------------------------------------------------------- Cash paid to acquire Pierre Medical, net of cash and cash equivalents acquired $21,415 -----------------------------------------------------------------------------
Hoyer Medizintechnik | During fiscal 1994, the Company acquired a German distributor, Hoyer Medizintechnik (Hoyer), for $10.6 million in cash, of which $8.6 million was paid in fiscal 1994 and $2.0 million was paid during fiscal 1995. 13 SEFAM S.A. | The Company also acquired SEFAM S.A., a French supplier of diagnostic and therapeutic sleep products during fiscal 1994 for a total of $21.6 million, of which $12.9 million was paid in cash with the remainder paid through the issuance of 751,396 restricted shares of the Company's common stock. The acquisitions of SEFAM S.A. and Hoyer have been accounted for as purchases and, accordingly, their results are included in the Company's financial statements subsequent to their respective acquisition dates. The excess of cost over the fair value of identifiable net assets acquired, primarily working capital, of $22.5 million, including acquisition related costs, was subsequently written down by $15.9 million during fiscal 1996 to reflect the effect that certain integration decisions associated with the Company's merger with Puritan-Bennett were expected to have upon both entities' future estimated cash flows. The remainder of the excess purchase price, $4.9 million, is being amortized over 15 years. In connection with these acquisitions, supplemental cash flow information is as follows:
(dollars in thousands) - --------------------------------------------------------------------------------------------------------------------------- Fair value of identifiable net assets acquired, except for cash and cash equivalents $34,481 Liabilities assumed (6,464) Stock issued (8,645) Other (1,755) - --------------------------------------------------------------------------------------------------------------------------- Cash paid to acquire SEFAM S.A. and Hoyer, net of cash and cash equivalents acquired $17,617 - ---------------------------------------------------------------------------------------------------------------------------
If these acquisitions had occurred as of the beginning of the respective fiscal years they were acquired, the revenues or results of operations of these acquired businesses would have been immaterial to the results of operations of the Company for fiscal 1996, 1995 and 1994. Costs associated with an unsolicited offer | During fiscal 1995, $5.0 million of costs were incurred in connection with an unsolicited offer to acquire Puritan-Bennett. These costs included investment banking fees, public relations expenses and legal fees, of which $0.9 million was paid during fiscal 1995 and the remaining $4.1 million was paid during fiscal 1996. 7. MERGERS WITH PURITAN-BENNETT AND INFRASONICS Puritan-Bennett | On August 24, 1995, the merger of Nellcor and Puritan-Bennett was approved by stockholders of both companies. On August 25, the merger was consummated, and Nellcor was renamed Nellcor Puritan Bennett Incorporated. Under the terms of the merger agreement, Puritan-Bennett shareholders received .88 of a share of the Company's common stock for each Puritan-Bennett share, resulting in the Company issuing approximately 23.2 million shares, valued at approximately $600 million based upon the closing price of the Company's common stock on August 25, 1995. Additionally, outstanding options to acquire Puritan-Bennett common stock were replaced with options to acquire approximately 1,047,000 shares of the Company's common stock. Puritan-Bennett develops, manufactures, and markets ventilators, oxygen delivery systems, home sleep diagnostic and therapeutic equipment, and certain complementary products such as medical gases, gas-related equipment, and spirometers. Puritan-Bennett reported revenue of $336.0 million and net income of $8.4 million for its fiscal 1995 ended January 31, 1995. Infrasonics | On June 27, 1996, the Company acquired Infrasonics in a stock-for-stock merger. The issuance of the Company's common stock in accordance with the Agreement and Plan of Merger was approved by stockholders at special stockholders meetings held by both companies on June 27, 1996. Under the terms of the Agreement and Plan of Merger, shareholders of Infrasonics received .12 of a share of the Company's common stock for each Infrasonics share, resulting in the Company issuing approximately 2.6 million shares, valued at $62 million based upon the closing price of the Company's common stock on June 27, 1996. Additionally, outstanding options to acquire 14 Infrasonics common stock were assumed by the Company and converted into options to acquire approximately 130,000 shares of the Company's common stock. Infrasonics is a respiratory equipment manufacturer of neonatal, pediatric and adult ventilators and accessories. Separate results for each of Nellcor's, Puritan-Bennett's, and Infrasonics' fiscal 1995, and combined results for the twelve months ended July 2, 1995, including the adjustment described in Note 1, were as follows:
- --------------------------------------------------------------------------------------------------------------------------- Nellcor Puritan-Bennett Infrasonics Combined Twelve months ended (in thousands): July 2, 1995 January 31, 1995 June 30, 1995 Adjustment July 2, 1995 - --------------------------------------------------------------------------------------------------------------------------- Revenue $264,040 $336,026 $23,000 $ -- $623,066 - --------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 37,165 $ 8,398 $(1,351) $3,900 $ 48,112 - ---------------------------------------------------------------------------------------------------------------------------
Merger and related costs | Associated with the Company's mergers with Puritan-Bennett and Infrasonics, one-time merger and related costs totaling $108.9 million were recorded during fiscal 1996. In connection with the merger with Puritan-Bennett, the Company recorded merger and related costs during the first quarter of fiscal 1996 of $92.6 million. Included in this charge were provisions for merger transaction costs ($13.7 million), certain intangible asset write-downs ($19.6 million), costs to combine and integrate operations ($53.8 million), and other merger-related costs ($5.5 million). In connection with the acquisition of Infrasonics, the Company recorded merger and related costs during the fourth quarter of fiscal 1996 of $16.3 million. Included in this charge were provisions for merger transaction costs ($2.5 million), costs to combine and integrate operations ($11.8 million), and certain intangible asset write-downs ($2.0 million). The merger transaction costs include expenses for investment banker and professional fees, and other costs associated with completing the transactions. The write-down of certain intangible assets, primarily goodwill associated with prior acquisitions made by both companies, results from the effect that certain integration decisions are expected to have upon the future realization of these assets. The costs to combine and integrate operations included provisions for the following types of costs:
Puritan- (dollars in millions) Bennett Infrasonics Total - --------------------------------------------------------------------------------------------------------------------------- Employee severance and benefits termination $26.7 $ 4.1 $30.8 Product line integration and facilities closing 18.0 2.9 20.9 Other 9.1 4.8 13.9 - --------------------------------------------------------------------------------------------------------------------------- Total $53.8 $11.8 $65.6 - ---------------------------------------------------------------------------------------------------------------------------
Employee severance and benefits termination costs include amounts associated with the elimination of approximately 300 positions from the Company's total workforce. The positions to be eliminated are primarily associated with corporate administrative groups, field sales and customer service organizations, and the consolidation of manufacturing sites. As of July 7, 1996, approximately 165 positions contemplated by this workforce consolidation, primarily in the Company's field sales and corporate administrative groups, had been eliminated. The Company expects the remainder of these positions to be eliminated during fiscal 1997. Of the $108.9 million in merger and related costs which were accrued, approximately $76.4 million had been utilized as of July 7, 1996, primarily associated with the write-down (non-cash charge) of certain intangible assets to their net realizable value ($21.8 million), the payment of merger transaction costs ($14.3 million), initial costs incurred to combine and integrate operations ($37.2 million, of which $8.5 million was associated with employee severance) and other merger-related costs ($3.1 million). The remaining merger and related costs accrued at July 7, 1996 of $32.5 million, approximately $31 million of which is expected to result in a cash outlay, should be substantially utilized by the end of fiscal year 1997. 15 8. INTANGIBLE AND OTHER ASSETS Intangible and other assets consist of:
July 7, July 2, (dollars in thousands) 1996 1995 - --------------------------------------------------------------------------------------------------------------------------- Excess of cost over fair value of identifiable net assets acquired $43,751 $56,192 Other intangibles from acquisitions, and purchased technologies and rights 10,144 13,502 Other assets 16,073 27,423 - --------------------------------------------------------------------------------------------------------------------------- Total cost 69,968 97,117 Less accumulated amortization (25,723) (23,464) - --------------------------------------------------------------------------------------------------------------------------- Intangible and other assets, net $44,245 $73,653 - ---------------------------------------------------------------------------------------------------------------------------
9. NOTES PAYABLE AND CREDIT FACILITY The Company has a $50 million credit facility with a group of four banks which provides an option to convert outstanding borrowings under the facility to a term loan repayable over four years. The rate of interest payable under this facility is a floating rate, which is a function of the London Interbank Offered Rate. A facility fee equal to 0.25% of the total commitment is paid quarterly. The credit facility contains various covenants which require the Company to maintain specified financial ratios, limit liens, regulate asset dispositions, and subsidiary indebtedness, and restrict certain acquisitions and investments. During fiscal 1996, the Company borrowed $40 million against the credit facility. These funds were in turn used to pay down a portion of the long-term debt the Company had assumed in its merger with Puritan-Bennett. At July 7, 1996, the Company was in compliance with the credit facility covenants and all borrowings had been repaid. 10. LONG-TERM DEBT Long-term debt is summarized as follows:
- --------------------------------------------------------------------------------------------------------------------------- July 7, July 2, (dollars in thousands) 1996 1995 - --------------------------------------------------------------------------------------------------------------------------- Unsecured promissory notes payable: Various notes with interest rates, both fixed and variable, ranging from 5.13% to 9.85%, interest payable semi-annually and principal payable in annual installments with maturities from December 1997 through July 2000 -- $56,843 Secured bank note payable: Interest rate 7.95%, principal payable in monthly installments through August 2003, collateralized by a building $1,530 1,707 Capital lease: Interest rate 7.0%, principal payable in monthly installments through February 2009 4,645 4,782 Other 461 687 - --------------------------------------------------------------------------------------------------------------------------- 6,636 64,019 Less current maturities (143) (9,527) - --------------------------------------------------------------------------------------------------------------------------- Total long-term debt $6,493 $54,492 - ---------------------------------------------------------------------------------------------------------------------------
16 The estimated fair value of total long-term debt at July 7, 1996 was approximately $6.6 million. The future minimum lease payments required under the capital lease are included in the aggregate maturities of long-term debt listed below. As of July 7, 1996, the Company was in compliance with the provisions of its debt agreements. The aggregate maturities of long-term debt during each of the next five fiscal years are as follows: 1997 - $143,000; 1998 - $452,000; 1999 - $487,000; 2000 - $587,000; and 2001 - $631,000. Interest paid related to all Company debt in 1996, 1995 and 1994 totaled $2.7 million, $6.1 million and $4.7 million, respectively. 11. RESTRUCTURING CHARGES During fiscal 1995, Puritan-Bennett recorded a $2.7 million restructuring charge associated with a workforce reduction. During fiscal 1994, Puritan-Bennett restructured the hospital ventilator and portable ventilator portions of its business, consolidated its aviation facilities and substantially reduced a division's operations to improve profitability. In connection with the restructuring, during fiscal 1994 Puritan-Bennett recorded restructuring charges of $43.2 million. Included in these charges were provisions for personnel-related charges ($7.7 million), non-cash asset write-downs ($29.7 million), consolidation of manufacturing and marketing facilities ($1.3 million), and other restructuring-related costs ($4.5 million). During the third quarter of fiscal 1995, Puritan-Bennett completed the shut down of the division. During fiscal 1994, Nellcor recorded a restructuring charge of $.5 million associated with the consolidation of two of Nellcor's divisions. As of July 7, 1996, substantially all of these restructuring charges had been utilized. 12. EMPLOYEE BENEFITS Defined benefit plans | The Company's wholly-owned subsidiary, Puritan-Bennett, has non-contributory, defined benefit pension plans covering certain employees in the U.S., and substantially all employees in Canada, Ireland, and Germany. The Company contributes to each plan on an annual basis the amounts necessary to satisfy the funding requirements of the various jurisdictions in which the plans are established. The U.S. defined benefit pension plan was terminated as of October 24, 1995. The costs associated with terminating the plan were not material. As of June 11, 1996, all participants in the plan had either received a lump sum distribution or had an annuity purchased on their behalf. The Canadian defined benefit pension plan provides retirement benefits based upon the employee's average earnings and years of service. The Irish plan provides benefits equal to a certain percentage of the participant's final salary. Puritan-Bennett has an unfunded supplemental retirement plan covering certain key employees which provides supplemental retirement benefits based upon average earnings. Puritan-Bennett also has an unfunded retirement plan for its former outside directors. A summary of the components of net costs for the defined benefit plans follows:
Pension Supplemental ---------------------------- ----------------------------- (dollars in thousands) 1996 1995 1994 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- Service cost - benefits earned during the year $169 $2,189 $1,832 $105 $ 85 $ 25 Interest cost 148 3,811 3,615 374 287 268 Return on plan assets (341) 466 (615) -- -- -- Net amortization and deferral 98 (3,932) (3,494) 72 105 104 - --------------------------------------------------------------------------------------------------------------------------- Net cost $ 74 $2,534 $1,338 $551 $477 $397 - ---------------------------------------------------------------------------------------------------------------------------
Assumptions used in determining the net cost for the defined benefit plans were:
Pension Supplemental ---------------------------- ------------------------------ 1996 1995 1994 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- Weighted average discount rates 8.00% 7.50% 8.75% 8.00% 8.50% 8.50% Rate of increase in compensation levels 4.50% 4.50% 6.00% 4.50% 4.50% 6.00% Expected long-term rate of return 9.75% 9.00% 10.00% N/A N/A N/A - ---------------------------------------------------------------------------------------------------------------------------
17 The following table sets forth the funded status and amounts recognized in the Company's consolidated balance sheets at July 7, 1996 and July 2, 1995, for the defined benefit plans:
Pension Supplemental --------------------- ---------------------- (dollars in thousands) 1996 1995 1996 1995 - --------------------------------------------------------------------------------------------------------------------------- Vested benefit obligation $1,540 $39,858 $5,117 $3,233 - --------------------------------------------------------------------------------------------------------------------------- Accumulated benefit obligation 1,540 40,897 5,117 3,233 - --------------------------------------------------------------------------------------------------------------------------- Projected benefit obligation 2,233 49,302 -- 3,677 Plan assets at fair value 3,048 35,280 -- -- - --------------------------------------------------------------------------------------------------------------------------- Projected plan assets in (excess of) or less than projected benefit obligation (815) 14,022 5,117 3,677 Unrecognized net gain (loss) (238) (5,788) (770) (592) Unrecognized net (asset) liability 314 2,309 -- (144) - --------------------------------------------------------------------------------------------------------------------------- Net (asset) liability recognized in the consolidated balance sheet $ (739) $10,543 $4,347 $2,941 - ---------------------------------------------------------------------------------------------------------------------------
Assumptions used in determining the actuarial present value of the projected benefit obligation for the pension plans were:
U.S. Canada Ireland ----------------- ----------------- -------------------- 1996(1) 1995 1996 1995 1996 1995 - --------------------------------------------------------------------------------------------------------------------------- Weighted average discount rate 8.00% 8.50% 8.00% 8.50% 8.75% 8.75% Rate of increase in compensation levels 4.50% 4.50% 4.50% 4.50% 6.00% 6.00% Expected long-term rate of return on assets N/A 9.00% 9.50% 9.50% 10.00% 10.00% - ---------------------------------------------------------------------------------------------------------------------------
(1) Supplemental plan only Both the Canadian and Irish plan assets are invested in pooled mutual funds. For the unfunded supplemental retirement benefits plan, the Company has purchased company-owned life insurance policies intended to ultimately fund the cost of the plan. As part of the merger of Nellcor and Puritan-Bennett, future benefit accruals under the supplemental portion of the U.S. defined benefit pension plan were eliminated. As this decision reduced expected years of future service, the event resulted in a curtailment charge of $560,000 which was recorded as a component of merger and related costs. Postretirement benefits other than pensions | The Company provides postretirement health care benefits to certain eligible retirees of its subsidiary, Puritan-Bennett. The cost of the postretirement medical plan is shared by the Company and eligible retirees through such features as annually adjusted contributions, deductibles and coinsurance. The retiree's contribution is a factor of age and service at the time of retirement. The postretirement health care benefits are funded by the Company as claims are paid. The Company accounts for these benefits in accordance with SFAS No. 106, "Employers Accounting for Postretirement Benefits other than Pensions." In the valuation of the liability, an 8.5% discount assumption was used. Medical costs were trended at 7%, trailing down to 6%. The components of the Company's postretirement benefits obligation are as follows:
(dollars in thousands) 1996 1995 - --------------------------------------------------------------------------------------------------------------------------- Accumulated benefit obligation $1,003 $1,754 Less unrecognized amounts: Unrecognized net liability 1,659 Net (gain) (509) (411) - --------------------------------------------------------------------------------------------------------------------------- Net liability $1,512 $ 506 - ---------------------------------------------------------------------------------------------------------------------------
The following summarizes the components of the annual net cost of the postretirement benefits: 18
(dollars in thousands) 1996 1995 - ------------------------------------------------------------------------------- Service cost $ 31 $ 39 Interest cost 125 131 Net amortization and deferral 64 85 - ------------------------------------------------------------------------------- Total $220 $255 - -------------------------------------------------------------------------------
As a result of the merger of Nellcor and Puritan-Bennett, it was determined that employees retiring from Puritan-Bennett on or after January 1, 1997 would no longer be eligible for postretirement medical coverage. This decision resulted in a curtailment charge of $971,000, which was recorded as a component of merger and related costs. Voluntary Investment Plus (VIP) plan | The Company has a Voluntary Investment Plus (VIP) 401(k) Plan under which substantially all U.S. employees may elect to contribute up to 15% of their earnings. The Company matches each employee's contributions, up to a maximum of $1,000 each calendar year. Prior to the merger with Nellcor, Puritan-Bennett had a 401(k) plan under which substantially all U.S. employees were eligible to participate. The Puritan-Bennett Board of Directors amended Puritan-Bennett's 401(k) plan at the merger date to provide a matching consistent with the Company's plan. The plan assets were subsequently merged into the Company's VIP plan. Infrasonics has a 401(k) plan under which substantially all U.S. employees may elect to contribute up to 15% of their earnings. Infrasonics contributes an additional 25% for up to 6% of each individual's contribution. This plan will continue to exist until January 1997, when it will be merged into the Company's VIP plan. The amount charged to expense under all plans was $2.3 million, $1.8 million, and $1.8 million in fiscal 1996, 1995 and 1994, respectively. 13. INCOME TAXES The provision for income taxes consists of the following:
Years Ended - ------------------------------------------------------------------------------- July 7, July 2, July 3, ( in thousands) 1996 1995 1994 - ------------------------------------------------------------------------------- Federal: Current $22,474 $18,978 $12,723 Deferred (17,156) (2,860) (12,336) - ------------------------------------------------------------------------------- 5,318 16,118 387 - ------------------------------------------------------------------------------- State: Current 2,338 3,355 3,246 Deferred (1,562) (456) (3,138) - ------------------------------------------------------------------------------- 776 2,899 108 - ------------------------------------------------------------------------------- Foreign: Current 4,793 3,393 2,631 Deferred (201) (815) (2,580) - ------------------------------------------------------------------------------- 4,592 2,578 51 - ------------------------------------------------------------------------------- $10,686 $21,595 $ 546 - -------------------------------------------------------------------------------
Pretax income from foreign operations used to determine related tax liabilities amounted to $4,151,000; $14,541,000; and $1,372,000 for fiscal 1996, 1995, and 1994, respectively. The Company has manufacturing operations in Ireland which qualify for a reduced tax rate of 10 percent. The reduced rate available on manufacturing profits earned in Ireland will expire in fiscal year 2011. 19 The most significant components of the Company's deferred tax assets and liabilities at July 7, 1996 and July 2, 1995 are as follows:
- ------------------------------------------------------------------------------------------------------- July 7, 1996 July 2, 1995 Deferred Tax Deferred Tax -------------------------- ----------------------- (in thousands) Assets Liabilities Assets Liabilities - ------------------------------------------------------------------------------------------------------- Inventory and product allowances $20,442 $ 1,714 $11,773 -- Property, plant and equipment 2,934 8,070 -- $ 5,657 Intangible assets 3,469 -- 832 759 Employee benefits 7,292 -- 10,144 -- Deferred revenue 3,112 -- 3,785 -- State income tax accrual 1,188 -- 1,392 -- Provision for accounts receivable 983 -- 642 -- Tax/book year end difference -- 2,716 -- 1,504 Losses carried forward 5,254 -- 7,447 -- Merger and related costs 12,394 -- -- -- Credits carried forward 2,842 -- 2,666 -- Other 1,218 381 8,065 2,376 - ------------------------------------------------------------------------------------------------------- Total 61,128 12,881 46,746 10,296 Less: valuation allowance (3,488) -- (13,697) -- - ------------------------------------------------------------------------------------------------------- Deferred income taxes $57,640 $12,881 $ 33,049 $10,296 - -------------------------------------------------------------------------------------------------------
As of July 7, 1996, the Company had net operating loss carryforwards resulting from the acquisition of Puritan-Bennett, which expire beginning in fiscal year 2006 and ending in fiscal year 2010. The valuation allowance decreased by $10.2 million during fiscal 1996, reflecting the portion of Puritan-Bennett's operating loss carryforwards which were realized ($2.1 million), or are expected to be realized ($7.2 million) in the future based upon the current and projected profitability of Puritan-Bennett, and the realization of remaining EdenTec net operating loss carryforwards ($0.9 million). The decrease in the EdenTec valuation allowance was recorded as a reduction of the remaining net book value of the EdenTec goodwill. The Company paid income taxes of approximately $11.1 million, $21.6 million, and $13.9 million in fiscal 1996, 1995, and 1994, respectively. The difference between the Company's actual effective income tax rate and the United States federal statutory income tax rate is reconciled as follows:
Years Ended -------------------------------------------------- July 7, 1996 July 2, 1995 July 3, 1994 ------------------- ------------ ------------- (dollars in thousands) $ % % % - --------------------------------------------------------------------------------------------------------------------------- Federal statutory rate $ 463 35.0% 35.0% (35.0)% State income taxes, net of federal benefit 504 38.1 2.2 (6.9) Research and experimental credits (166) (12.5) (1.7) (43.7) Tax legislation changes -- -- (13.7) Foreign statutory tax rate differences (3,818) (287.9) (6.8) (26.5) Merger and related costs 23,363 1,761.8 -- -- Increase (decrease) in valuation allowance (9,300) (701.4) 1.7 120.7 Net operating loss utilized (1,351) (101.9) -- -- Foreign earnings taxed in U.S. 399 30.1 -- -- Other 592 44.6 .6 15.5 - --------------------------------------------------------------------------------------------------------------------------- Income tax provision $10,686 805.9% 31% 10.4% - ---------------------------------------------------------------------------------------------------------------------------
14. STOCKHOLDERS' EQUITY Common stock | On June 27, 1996, stockholders approved a two-for-one stock split of the Company's common stock. As of July 7, 1996, taking into account the two-for-one stock split, an aggregate of 12,167,110 shares of authorized but unissued Company common stock remained reserved for issuance under the Infrasonics 1995 Stock Option Plan (the "Infrasonics 1995 Plan"), the 1995 Merger Stock Incentive Plan (the "1995 Plan"), the 1994 Equity Incentive Plan, as amended (the "1994 Plan"), the Infrasonics 1991 Stock Option Plan (the "Infrasonics 1991 Plan"), the 1991 Equity Incentive Plan, as amended (the "1991 Plan"), the 1988 Stock Option Plan for Non-Employee Directors, as amended (the "1988 Plan"), the 1985 Equity Incentive Plan (the "1985 20 Plan"), the Infrasonics 1983 Employee Stock Option Plan (the "Infrasonics 1983 Plan"), the 1986 Employee Stock Participation Plan as amended (the "1986 ESPP"), which terminated August 1996, and the 1995 Employee Stock Participation Plan (the "1995 ESPP"). Stock option plans | The Company maintains six employee stock option plans: the Infrasonics 1995 Plan, the 1995 Plan, the 1994 Plan, the Infrasonics 1991 Plan, the 1991 Plan and the Infrasonics 1983 Plan. In August 1995, the Company obtained stockholder approval of the 1995 Plan, which authorized the issuance of up to 1,558,000 shares of Company common stock in the form of replacement stock options to holders of unexercised options to purchase Puritan-Bennett stock as of the effective date of the merger between Nellcor and Puritan-Bennett. Replacement options representing 1,046,996 shares of Company common stock were issued. No additional options will be granted from the 1995 Plan. As of the effective date of the merger between the Company and Infrasonics, the Company assumed the Infrasonics 1995 Plan, the Infrasonics 1991 Plan and the Infrasonics 1983 Plan (the "Infrasonics Plans") and authorized the issuance of Company common stock upon exercise of options outstanding under the Infrasonics Plans. As of the effective date of the merger, options to purchase approximately 130,000 shares of Company common stock were outstanding under the Infrasonics Plans. No additional options will be granted from the Infrasonics Plans. In October 1994, the Company obtained stockholder approval of the 1994 Plan, which authorized the issuance of up to 3,000,000 shares of common stock to executive officers, other key employees and consultants in the form of incentive and nonqualified stock options, stock bonuses and restricted stock. The 1994 Plan satisfies the performance-based compensation requirements of the Omnibus Budget Reconciliation Act of 1993. In August 1995, the stockholders approved an amendment to the 1994 Plan to increase the number of shares authorized for issuance from 3,000,000 to 5,000,000. The Company obtained stockholder approval of the 1991 Plan in October 1991. Upon stockholder approval of the 1991 Plan, the Company's 1982 Incentive Stock Option Plan (The "1982 Plan") and the 1985 Plan were terminated; however, shares available for issuance under these plans at the time of termination, including shares underlying outstanding options that later expire or are canceled, totaling approximately 938,500 shares were pooled with the 1,500,000 additional shares reserved for issuance under the 1991 Plan. In October 1992, the Company obtained stockholder approval for an amendment to the 1991 Plan increasing the number of shares authorized for issuance under the 1991 Plan by an additional 3,000,000 shares. Restricted stock grants totaling 19,400 shares have been made under the 1991 Plan, of which 5,000 shares were subsequently canceled. These grants vest on an annual basis over a three-year period. Stock bonus awards totaling 37,600 shares have been made under the 1991 and 1994 plans. Options granted under the Infrasonics plans vest on an annual basis over a four-year period. Non-employee directors of Infrasonics were granted options that vest 100% at the date of grant. Options granted under the 1995 Plan generally vest on an annual basis over a period of two years. Options granted under the 1994 and 1991 Plans generally vest on a quarterly basis over a period of four years from the date of grant. A one-year waiting period is required before vesting in the case of initial grants under the 1994 and 1991 Plans. The 1995, 1994, 1991, and Infrasonics Plans authorize the grant of incentive stock options at exercise prices equal to the fair market value of the Company's common stock on the date of grant and permit the grant of nonqualified stock options at exercise prices not less than 85 percent of fair market value on the date of grant. To date, only incentive stock options and nonqualified stock options with exercise prices equal to the fair market value of the underlying common stock on the date of grant have been granted under these Plans. As of July 7, 1996, options representing 2,652,711 shares, including options issued under the Infrasonics Plans, the 1995, 1994 and 1991 Plans and the terminated 1982 and 1985 Plans, were outstanding and exercisable, and the Company, as of such date, had 5,084,973 shares available for issuance under the 1994 and 1991 Plans. Certain options issued under the 1994 and 1991 Plans permit exercise prior to vesting. As to these options, if the optionee's relationship with the Company is terminated prior to the complete vesting of the options, the Company has the right to repurchase unvested shares at the exercise price plus interest. As of July 7, 1996, no shares were subject to repurchase by the Company under these options. 21 The following is a summary of option activity under the 1995, 1994, 1991 and Infrasonics Plans:
- --------------------------------------------------------------------------------------------------------------------------- Options Aggregate Range of Exercise Prices Available Options Exercise Price (per share) For Grant Outstanding (in thousands) High Low - --------------------------------------------------------------------------------------------------------------------------- Balance at July 4, 1993 3,613,714 4,556,382 $49,066 34.42 3.94 Granted (1,404,250) 1,404,250 16,561 14.25 10.00 Exercised -- (943,376) (6,517) 18.25 4.63 Canceled 602,100 (642,276) (7,822) 16.00 5.00 - --------------------------------------------------------------------------------------------------------------------------- Balance at July 3, 1994 2,811,564 4,374,980 51,288 34.42 4.63 Increase in options available for grant 3,000,000 -- Granted (1,788,840) 1,788,840 27,159 23.13 13.50 Exercised -- (1,323,328) (14,022) 17.07 5.00 Canceled 407,198 (470,558) (5,943) 17.07 5.32 - --------------------------------------------------------------------------------------------------------------------------- Balance at July 2, 1995 4,429,922 4,369,934 58,482 34.42 5.00 Increase in options available for grant 3,558,000 Granted (2,636,402) 2,636,402 55,184 32.50 5.61 Exercised -- (1,255,745) (16,021) 27.88 5.00 Canceled 248,241 (277,089) (4,802) 32.50 9.38 Unissuable (514,788) - --------------------------------------------------------------------------------------------------------------------------- Balance at July 7, 1996 5,084,973 5,473,502 92,843 34.42 5.00 - ---------------------------------------------------------------------------------------------------------------------------
1988 Plan. In October 1988, the Company obtained stockholder approval of the 1988 Plan which authorized the non-discretionary grant of options to non-employee Directors. Under the 1988 Plan, non-employee Directors automatically receive stock option grants upon joining the Board of Directors and annually thereafter. Until amended in May 1994, the 1988 Plan provided for an initial grant of an option to purchase 40,000 shares of common stock upon a Director joining the Board and an annual grant of an option to purchase 20,000 shares of stock. On May 14, 1994, the Board of Directors amended the 1988 Plan to reduce the number of shares issuable to non-employee Directors in the form of options to an initial grant of 20,000 shares and annual grant of 10,000 shares. Options issued to non-employee Directors under the 1988 Plan are nonqualified stock options having a five-year term and an exercise price equal to the fair market value of the Company's common stock on the date of grant and vesting over a four year period in the case of initial options grants and over the succeeding fiscal year in the case of annual grants. In October 1994, the Company obtained stockholder approval to amend the 1988 Plan to increase the number of shares authorized for issuance by 150,000 shares and the term of options to be issued under the plan from five to ten years. As of July 7, 1996, options representing 250,000 shares were outstanding and exercisable under the 1988 Plan, and the Company, as of such date, had 170,000 shares available for issuance under the 1988 Plan. The following is a summary of option activity under the 1988 Plan:
- --------------------------------------------------------------------------------------------------------------------------- Aggregate Range of Exercise Prices Available Options Exercise Price (per share) For Grant Outstanding (thousands) High Low - --------------------------------------------------------------------------------------------------------------------------- Balance at July 4, 1993 260,000 295,000 $2,991 12.81 4.69 Granted (100,000) 100,000 1,175 11.75 11.75 Exercised -- (10,000) (47) 13.75 4.69 - --------------------------------------------------------------------------------------------------------------------------- Balance at July 3, 1994 160,000 385,000 4,119 12.81 6.81 Increase in options available for grant 150,000 Granted (50,000) 50,000 662 13.25 13.25 Exercised -- (110,000) (1,055) 10.38 7.12 - --------------------------------------------------------------------------------------------------------------------------- Balance at July 2, 1995 260,000 325,000 3,726 13.25 6.81 Granted (90,000) 90,000 2,175 26.81 22.34 Exercised -- (125,000) (1,451) 28.50 24.38 - --------------------------------------------------------------------------------------------------------------------------- Balance at July 7, 1996 170,000 290,000 $4,450 26.81 6.81 - ---------------------------------------------------------------------------------------------------------------------------
Stock purchase plans | Under the 1986 ESPP and the 1995 ESPP, qualified employees, not including members of the Board of Directors and executive officers, may purchase semi-annually, up to a specified maximum amount, shares of the Company's common stock through payroll deductions at a price 22 equal to 85% of the fair market value of the stock at the beginning or end of the six month plan period, whichever is less. In August 1996, the 1986 ESPP expired with 148,635 shares remaining authorized and unissued. In October 1995, the Company obtained stockholder approval of the 1995 ESPP, which authorized the issuance of up to 1,000,000 shares of common stock. As of July 7, 1996, 1,651,365 shares of common stock had been purchased under the 1986 ESPP since inception and 1,000,000 shares remained available for purchase by employees under the 1995 ESPP. Stock repurchase programs | During the fourth quarter of fiscal 1993, the Board of Directors approved a Limited Stock Repurchase Program (the "Limited Program") which commenced early in fiscal 1994. The objective of the Limited Program is to utilize a portion of available cash balances to repurchase on the open market shares of the Company's common stock to mitigate the dilutive effects of the issuance of shares under the Company's stock option and participant plans. Repurchases made under the Limited Program totaled $24.3 million (928,020 shares) and $20.9 million (1,251,000 shares) during the fiscal years ended July 7, 1996, and July 2, 1995, respectively. In addition to the Limited Program, the Board of Directors approved a General Stock Repurchase Program (the "General Program") during the second quarter of fiscal 1994 to repurchase and retire up to 1 million shares of the Company's common stock. The object of this General Program is to more effectively utilize an additional portion of available cash balances. No repurchases under the General Program were made in fiscal 1996 and 1995; 420,000 shares were repurchased and retired during fiscal 1994, totaling $5.9 million. Stock rights -- Series A Junior Participating Preferred Stock | During fiscal 1991, the Board of Directors of the Company declared a dividend of one preferred share purchase right for each outstanding share of common stock. Each right entitles the holder to purchase from the Company one two-hundredth of a share of Series A Junior Participating Preferred Stock, par value $.001 per share, initially at a price of $160 per one two-hundredth of a preferred share. Each one two-hundredth of a preferred share is substantially the economic equivalent of one share of common stock. In the event that a third party acquires 15 percent or more of the Company's common stock or announces an offer which would result in such party's owning 15 percent or more of the Company's common stock, the rights will become exercisable. on March 8, 1996, the Board of Directors of the Company approved amendments which extend the expiration date of the rights to March 8, 2006, and allow for their redemption, subject to certain conditions, at a price of $.01 per right. Supplemental cash flow information | Puritan-Bennett had a restricted stock award program which was terminated following the merger with Nellcor. Non-cash amounts, net of cancellations, included in additional paid in capital for this program were $1.2 million and $.4 million for fiscal 1995 and 1994, respectively. No shares of stock were granted to employees under this program in fiscal 1996. 15. COMMITMENTS The Company leases its facilities under agreements that expire at various dates through June 2011. Rental expense was approximately $11.8 million, $11.7 million and $11.7 million in fiscal years 1996, 1995 and 1994, respectively. Aggregate minimum annual rental commitments under long-term operating leases are as follows: (in thousands)
Fiscal Years - ------------------------------------------------------------------------------- 1997 $ 7,798 1998 7,653 1999 6,130 2000 5,134 2001 4,506 After 2001 16,943 - ------------------------------------------------------------------------------- Total rental commitments $48,164 - -------------------------------------------------------------------------------
23 16. GEOGRAPHIC INFORMATION AND EXPORT SALES The Company operates within a single industry segment in which it develops, manufactures, and markets monitoring systems and diagnostic and therapeutic products for management of the respiratory-impaired patient across the continuum of care. The Company's products are sold worldwide through a direct sales force, assisted by clinical education consultants and supplemented by distributors in selected countries. Geographic information with respect to the Company's operations is as follows:
Transfers Sales to Between Operating Unaffiliated Geographic Income Identifiable (in thousands) Customers Areas Total (Loss) Assets - --------------------------------------------------------------------------------------------------------------------------- 1996: United States domestic $481,154 $-- $481,154 $11,778 $407,271 United States export 92,734 28,071 120,805 -- -- Europe 132,243 131,178 263,421 13,854 151,594 Corporate and other -- -- -- -- 55,893 Eliminations -- (159,249) (159,249) (25,679) (26,920) - --------------------------------------------------------------------------------------------------------------------------- Consolidated 706,131 -- 706,131 (47) 587,838 - --------------------------------------------------------------------------------------------------------------------------- 1995: United States domestic 439,177 -- 439,177 56,338 335,135 United States export 79,142 23,966 103,108 -- -- Europe 104,747 43,063 147,810 17,391 146,860 Corporate and other -- -- -- -- 160,210 Eliminations -- (67,029) (67,029) (325) (39,815) - --------------------------------------------------------------------------------------------------------------------------- Consolidated 623,066 -- 623,066 73,404 602,390 - --------------------------------------------------------------------------------------------------------------------------- 1994: United States domestic 425,782 -- 425,782 6,524 338,769 United States export 69,031 17,628 86,659 -- -- Europe 69,319 25,472 94,791 1,104 103,738 Corporate and other -- -- -- -- 123,315 Eliminations -- (43,100) (43,100) 813 (38,253) - --------------------------------------------------------------------------------------------------------------------------- Consolidated $564,132 $-- $564,132 $ 8,441 $527,569 - ---------------------------------------------------------------------------------------------------------------------------
Transfers between geographic areas are generally recorded at amounts above cost and in accordance with the rules and regulations of the governing tax authorities. Operating income (loss) is total revenue less cost of sales and operating expenses and does not include interest expense, interest income and other income (expense), net, litigation settlements, costs associated with unsolicited takeover offer and income taxes. Identifiable assets of geographic areas are those assets used in the Company's operations in each area. Identifiable corporate assets consist primarily of cash and cash equivalents, marketable securities and other assets. 17. LITIGATION From time to time the Company has received, and in the future may receive, notice of claims against it, which in some instances have developed, or may develop, into lawsuits. The claims may involve such matters, among others, as product liability, patent infringement, and employment-related claims. In management's opinion, the ultimate resolution of claims currently pending will not have a material adverse effect on the Company's financial position or results of operations. On May 15, 1996, the Company brought an action in Kansas Federal District Court, requesting a temporary restraining order, preliminary injunction and damages against Healthdyne Technologies and two former Company employees based on misappropriation of trade secrets, utilization of trade secrets and various other causes of action. The Company was granted a permanent injunction against Healthdyne enjoining it from utilizing the Company's trade secrets and limiting the scope of work of one of the former employees. The second employee was terminated by Healthdyne, and the Company was granted a permanent injunction against that employee relating to use of trade secrets and limiting the scope of the former employee's future work. The Court has ongoing jurisdiction to enforce the injunctions and related matters. On May 3, 1996, the Company and several of its officers and members of its Board of Directors received notice that they had been named as defendants in a class action lawsuit seeking unspecified damages based upon alleged violations of California state securities and other laws. The complaint alleges misrepresentations during the period from September 29, 1995 through April 16, 1996 with respect to the Company's business, particularly about 24 the merger with Puritan-Bennett and the integration of Nellcor and Puritan-Bennett. The Company believes that the action, filed in the Superior Court of the State of California, County of Alameda, is without merit and intends to vigorously defend against the action. On July 11, 1995, the U.S. Federal District Court in Delaware issued a decision in favor of the Company, ruling that four key oximeter and sensor technology patents are valid and would be infringed by Ohmeda, Inc., a subsidiary of BOC Health Care, Inc., if Ohmeda sold either its adult or neonatal OxyTip sensors for use with non-Ohmeda monitors. BOC Health Care filed an appeal with the Court of Appeals Federal Circuit relating to one of these key patents and the Company is awaiting the outcome of that appeal. BOC Health Care had filed a suit against the Company in December 1992, seeking a declaratory judgment that the Company's patents were invalid and would not be infringed. In a related matter, in the third quarter of fiscal 1994, the Company agreed to settle trade secrets and patent litigation with BOC Health Care, Inc., and its Ohmeda, Inc. subsidiary, and Square One Technology. Under the terms of the agreement, the patent in issue was assigned to the Company. The Company also received a $2.0 million pretax payment and receives ongoing royalties. The $2.0 million payment was recorded as non-operating income. In the fourth quarter of fiscal 1994, the Company agreed to settle its patent litigation with Camino Laboratories, Inc., ("Camino") of San Diego, CA. Under the terms of the settlement, Camino agreed not to sue the Company or its current or future customers relating to the use or sale of the Company's sensors and monitors intended for use with such sensors. A cash payment of $15.0 million was made by the Company to Camino and was recorded as a non-operating expense. This settlement neither recognizes the validity nor acknowledges infringement of the Camino patent at issue. NELLCOR PURITAN BENNETT INCORPORATED Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS The following sets forth, for the indicated periods, the relationship that certain items bear to net revenue:
Years Ended ------------------------- July 7, July 2, July 3, 1996 1995 1994 - ------------------------------------------------------------------------------- Net revenue 100% 100% 100% Gross margin 51% 50% 50% Operating expenses: Research and development 8% 8% 9% Selling, general and administrative 28% 30% 31% Restructuring charges -- -- 8% Merger and related costs 15% -- -- Total operating expenses 51% 38% 48% Income (loss) from operations -- 12% 1% Litigation settlements, net -- -- (2%) Costs associated with unsolicited takeover offer -- (1%) -- Income (loss) before income taxes -- 11% (1%) Net income (loss) (1%) 8% (2%) - -------------------------------------------------------------------------------
Revenue 1996 vs 1995. The Company's net revenue for fiscal 1996 increased 13 percent to $706.1 million from $623.1 million in fiscal 1995. Both the hospital and home care product lines experienced revenue growth over fiscal 1995 of 12 percent and 16 percent, respectively. Revenue from sales in the United States increased 10 percent in fiscal 1996 while international revenue grew by 22 percent. 25 Hospital product line revenue, which includes the oximetry, ventilator and clinical information systems product lines, increased to $440.5 million in fiscal 1996 from $394.9 million in fiscal 1995. The increase in hospital product sales is due primarily to higher sales of oximetry and ventilator products. Oximetry product revenue increased due to higher oximetry sensor and instrument sales. Oximetry sensor revenue increased due to continued growth in the installed base of the Company's monitors and the products of the Company's licensees and OEM customers that use the Company's sensors. Oximetry instrument revenue increased due primarily to higher sales of the N-3000 pulse oximeter. Average selling prices for oximetry sensors decreased slightly whereas average selling prices for oximetry instruments were moderately lower in comparison to the prior year. Sales of ventilator products increased due primarily to higher sales of critical care ventilators and Infrasonics' neonatal, pediatric and adult ventilators and accessories. Higher sales volume for the Company's adult ventilators was partially offset by moderately lower average selling prices. Sales from the home care product lines, which include the Oxygen Therapy, Gas Products and Spirometry Group, the Global Sleep Solutions Group and the Aero Systems Group, increased to $265.6 million in fiscal 1996 from $228.2 million in fiscal 1995, due to higher sales volume across all product lines. The revenue growth was also due to the first full year of sales from the Company's Pierre Medical subsidiary and the inclusion of revenue from Melville after its acquisition in the first quarter of fiscal 1996. Revenue from these two acquisitions accounted for approximately one-half of the fiscal 1996 home care product line revenue growth. Overall home care product line revenue growth rates during fiscal 1996 were impacted by changes to the Company's home care product distribution structure. These changes included the termination of the Company's independent home care sales network at the end of the second quarter, and the transition to a newly integrated direct home care sales force during the third quarter of fiscal 1996. Because of these changes to the Company's home care distribution channels, this period of transition may continue to affect home care product line revenue growth rates in the near term. International revenue increased 22 percent to $225.0 million from $183.9 million in fiscal 1995. Much of the international revenue growth occurred in Europe, principally due to higher oximetry and ventilator product unit sales and to the first full year of revenue from the Company's Pierre Medical subsidiary, which was acquired in the fourth quarter of fiscal 1995. The favorable effect of foreign currency exchange rates accounted for 2 percentage points of the international revenue growth. 1995 vs 1994. The Company's net revenue for fiscal 1995 increased 10 percent to $623.1 million from $564.1 million in fiscal 1994. The increase in net revenue principally resulted from higher unit sales across the Company's hospital and home care product lines. Sales of the Company's products into international markets were also particularly strong. Hospital product sales increased 9 percent to $394.9 million in fiscal 1995 from $363.5 million in fiscal 1994. Oximetry instrument revenue for fiscal 1995 increased slightly as higher unit sales of the N-3000 pulse oximeter and the N-20 portable pulse oximeter were partially offset by lower average selling prices. Revenue from oximetry sensors increased moderately during fiscal 1995 primarily due to continued growth in the installed base of the Company's monitors and the products of the Company's licensees and OEM customers that use the Company's sensors. Higher unit sales were partially offset by slightly lower average selling prices for adhesive and recycled sensors. OEM oximetry module revenue increased significantly in fiscal 1995 as higher unit shipments were partially offset by moderately lower average selling prices. At the end of fiscal 1995, the Company had OEM or licensing agreements in place with 40 medical systems and monitor manufacturers worldwide. Revenue related to the critical care ventilator product line, the CliniVision product line and the small Holter monitoring and international portable ventilator product lines decreased 1 percent from fiscal 1994. The decrease is primarily the result of the Company's decision to withdraw from the United States portable ventilator market. Home care product sales increased 14 percent to $228.2 million in fiscal 1995 from $200.6 million in fiscal 1994. Home care product line revenue increased due primarily to higher unit sales of sleep and respiratory support systems products. Sleep and respiratory support systems products include the Assurance 2000 and 3000 heart and respiration monitors, the EdenTrace II and II Plus multichannel recording systems and related products, the GoodKnight 314 and 318 nasal CPAP (continuous positive airway pressure) systems used to treat sleep apnea, and the KnightStar 320 bilevel device and 335 respiratory support system for patients with apnea or respiratory insufficiency. The therapeutic products also include a variety of masks and accessories such as the innovative ADAM nasal pillow interface. During the fourth quarter of fiscal 1995, the Company acquired Pierre Medical, a privately held French manufacturer of respiratory products used in the home. Pierre Medical markets the O'Nyx noninvasive ventilation system, the Omega(TM) oxygen concentrator and the Morphee(TM) and Morphee Plus(TM) sleep apnea therapy systems in Western Europe, primarily in France. Revenue from the above mentioned home health care products increased significantly during fiscal 1995 primarily due to higher sales of the EdenTrace II Plus and the Assurance 3000, as well as sales from Pierre Medical included in the Company's results subsequent to its May 3, 1995 acquisition. In addition, the Company had a full year of revenue from SEFAM S.A., a European supplier of diagnostic and therapeutic sleep disorder products, which was acquired in January 1994. 26 International revenue increased 33 percent to $183.9 million in fiscal 1995 from $138.3 million in fiscal 1994. International revenue increased significantly across all markets principally due to higher unit sales of oximetry sensors, the N-3000 pulse oximeter, OEM oximetry modules, the acquisition of SEFAM S.A., and the favorable effect of foreign currency exchange rates. Gross margin | Gross margin improved to 51 percent of net revenue in fiscal 1996 from 50 percent in fiscal 1995 due primarily to improved manufacturing efficiencies, the favorable effect which foreign currency exchange rates had upon revenue, and savings associated with producing certain ventilator components internally. Gross margin at 50 percent of net revenue in fiscal 1995 was comparable to the prior year, as pricing pressures across a number of hospital and home care product lines were offset by improved sleep product margins and the favorable effect which foreign currency exchange rates had upon revenue. Research and development expenses | In fiscal 1996, research and development expenses as a percentage of net revenue remained constant from fiscal 1995 at 8 percent but increased in absolute dollars by $5.1 million due primarily to higher spending on ventilator product development and costs associated with perinatal product clinical studies. Research and development expenses decreased to 8 percent of net revenue during fiscal 1995 from 9 percent for fiscal 1994 and decreased in absolute dollars from fiscal 1994. The decrease was due to the elimination of the intra-arterial blood gas monitoring product line during fiscal 1994, partially offset by higher spending on the development of additional modules of the Nellcor Symphony monitoring system, and increased sleep product development costs. Selling, general and administrative expenses | Selling, general and administrative expenses in fiscal 1996 decreased to 28 percent of net revenue from 30 percent of net revenue in fiscal 1995. Selling, general and administrative expenses increased in absolute dollars due primarily to operating expenses associated with the Company's recently acquired Pierre Medical and Melville subsidiaries, and the unfavorable effect foreign currency exchange rates had upon international operating expenses. Selling, general and administrative expenses in fiscal 1995 decreased to 30 percent of net revenue from 31 percent of net revenue in fiscal 1994. Selling, general and administrative expenses increased in absolute dollars due primarily to the unfavorable effect foreign currency exchange rates had upon international operating expenses, the inclusion of operating expenses from Pierre Medical and SEFAM S.A. subsequent to their acquisition, and increased costs related to the Company's profit sharing and bonus plans, partially offset by lower patent litigation expenses. Net income | The Company reported a net loss for fiscal 1996 of $9.4 million or ($0.16) per share compared to net income of $48.1 million, $0.82 per share, for fiscal 1995. Excluding the effect of merger and related costs of $108.9 million, fiscal 1996 net income of $75.0 million, $1.27 per share, increased 39 percent over net income of $53.8 million, $0.92 per share for fiscal 1995, exclusive of the restructuring and unsolicited takeover charges discussed below. The Company's net income for fiscal 1995 was $48.1 million, $0.82 per share, compared to a net loss of $8.7 million, ($0.15) per share, for fiscal 1994. Excluding the effect of the restructuring and unsolicited takeover attempt charges, fiscal 1995 net income of $53.8 million, $0.92 per share, increased 6 percent over net income of $50.9 million, $0.89 per share for fiscal 1994, exclusive of the restructuring charges and litigation settlements discussed below. UNUSUAL AND/OR NONRECURRING ITEMS Restructuring charges | During fiscal 1995, Puritan-Bennett recorded a $2.7 million restructuring charge associated with a workforce reduction. During fiscal 1994, Puritan-Bennett restructured the hospital ventilator and portable ventilator portions of its business, consolidated its aviation facilities and substantially reduced a division's operations to improve profitability. In connection with the restructuring, during fiscal 1994 Puritan-Bennett recorded restructuring charges of $43.2 million. Included in these changes were provisions for personnel-related charges ($7.7 million), non-cash asset write-downs ($29.7 million), consolidations of manufacturing and marketing facilities ($1.3 million), and other restructuring related costs ($4.5 million). During the third quarter of fiscal 1995, Puritan-Bennett completed the shutdown of the division. During fiscal 1994, Nellcor recorded a restructuring charge of $0.5 million associated with the consolidation of two of Nellcor's divisions. 27 Merger and related costs | The Company's results for fiscal 1996 reflect merger and related costs of $108.9 million associated with the Company's first quarter and fourth quarter acquisitions of Puritan-Bennett ($92.6 million in merger and related costs) and Infrasonics ($16.3 million in merger and related costs), respectively. For additional information on the costs included in this charge, see the separate discussion on mergers and acquisitions below. Litigation settlements, net | In the third quarter of fiscal 1994, the Company agreed to settle trade secrets and patent litigation with BOC Health Care, Inc., and its Ohmeda, Inc. subsidiary, and Square One Technology. Under the terms of the agreement, the patent in issue was assigned to the Company. The Company also received a $2.0 million pretax payment and receives ongoing royalties. The $2.0 million payment was recorded as non-operating income. In the fourth quarter of fiscal 1994, the Company agreed to settle its patent litigation with Camino Laboratories, Inc., ("Camino") of San Diego, CA. Under the terms of the settlement, Camino agreed not to sue the Company or its current or future customers relating to the use or sale of the Company's sensors and monitors intended for use with such sensors. A cash payment of $15.0 million was made by the Company to Camino and was recorded as a non-operating expense. This settlement neither recognizes the validity nor acknowledges infringement of the Camino patent at issue. Costs associated with an unsolicited offer | During fiscal 1995, $5.0 million of costs were incurred associated with an unsolicited offer to acquire Puritan-Bennett. These costs included investment banking fees, public relations expenses and legal fees, of which $0.9 million was paid during fiscal 1995 and the remaining $4.1 million was paid during fiscal 1996. BUSINESS CONSIDERATIONS Mergers and acquisitions | The Company has either merged with or acquired four companies during fiscal 1995 and 1996. Each acquisition was intended to broaden the Company's product offerings and expand sales into hospital and emerging markets, such as home health care. The Company intends to continue pursuing acquisition opportunities in the future. Puritan-Bennett. On August 25, 1995 the merger of Nellcor and Puritan-Bennett was consummated. The issuance of Company common stock in connection with the Agreement and Plan of Merger was approved by shareholders at special shareholder meetings held by both companies on August 24, 1995. Under the terms of the agreement, shareholders of Puritan-Bennett received 0.88 of a share of the Company's common stock for each Puritan-Bennett share. These financial statements and Management's Discussion and Analysis reflect the consummation of this transaction as a pooling-of-interests, resulting in the combining of the two company's balance sheets and income statements for all periods presented. Upon consummation of the merger, the Company recorded one-time merger and related costs of $92.6 million during the first quarter of fiscal 1996. Included in this charge were provisions for merger transaction costs ($13.7 million), costs to combine and integrate operations ($53.8 million), certain intangible asset write-downs ($19.6 million), and other merger-related costs ($5.5 million). The merger transaction costs included expenses for investment banker and professional fees, and other costs associated with completing the transaction. The costs to combine and integrate operations included provisions for severance and severance-related costs, facilities consolidations and other integration costs. The write-down of certain intangible assets, primarily goodwill associated with prior acquisitions made by both companies, results from the effect that certain integration decisions have had upon the future realization of these assets. Nellcor Puritan Bennett is headquartered in Pleasanton, California, site of Nellcor's headquarters. Infrasonics. On June 27, 1996 the Company acquired Infrasonics in a stock-for-stock merger. The issuance of Company common stock in connection with the Agreement and Plan of Merger was approved by shareholders at special shareholder meetings held by both companies on June 27, 1996. Under the terms of the agreement, shareholders of Infrasonics received .12 of a share of Company common stock for each Infrasonics share. These financial statements and management's discussion and analysis reflect the consummation of this transaction as a pooling-of-interests, resulting in the combining of the two companies' balance sheets and income statements for all periods presented. Infrasonics is a respiratory equipment manufacturer of neonatal, pediatric and adult ventilators and accessories. Upon consummation of the merger, the Company recorded one-time merger and related costs of $16.3 million during the fourth quarter of fiscal 1996. Included in this charge were provisions for merger transaction costs ($2.5 million), costs to combine and integrate operations ($11.8 million), and certain intangible asset write-downs ($2.0 million). The merger transaction 28 costs include expenses for investment banker and professional fees, and other costs associated with completing the transaction. The costs to combine and integrate operations include provisions for severance and severance-related costs, facilities consolidations, and other integration costs. The write-down of certain intangible assets, primarily intangibles associated with prior acquisitions by Infrasonics, results from the effect that certain integration decisions have had upon the future realization of these assets. Melville. During the first quarter of fiscal 1996, the Company acquired Melville Software Ltd. (Melville), a privately held Canadian company that manufactures and markets sleep diagnostic products used primarily in sleep labs for $4.9 million in cash. In the event that certain profitability levels are achieved over the next three fiscal years, additional compensation totaling $1.0 million would be payable to the former principal stockholders of Melville who continue to manage the company. Such amounts will be expensed when, and if, earned. The acquisition of Melville was accounted for under the purchase method and its results are included since the date of acquisition. Pierre Medical. During the fourth quarter of fiscal 1995, the Company acquired Pierre Medical, a privately held French manufacturer of respiratory products used in the home, for $21.5 million in cash. In the event that certain profitability targets are achieved or certain of Pierre Medical's products receive FDA approval for marketing in the United States subsequent to the acquisition, additional compensation totaling 30 million French Francs ($5.8 million as of July 7, 1996), would be payable to the former principal stockholders of Pierre Medical who will continue to manage the company. During fiscal 1996, $3.8 million of this additional compensation was accrued as a merger and related cost to reflect the effect that integration decisions associated with the Company's merger with Puritan-Bennett would have upon the achievement of certain of the performance milestones. Pierre Medical manufactures and markets noninvasive ventilators, sleep apnea therapy systems, oxygen concentrators, and related respiratory products in Western Europe, primarily France. The acquisition of Pierre Medical was accounted for under the purchase method and its results are included since the date of acquisition. International markets | During fiscal 1996 and 1995, sales of the Company's products into international markets accounted for 32 and 30 percent, respectively, of the Company's consolidated revenue. International revenue grew 22 percent to $225.0 million in fiscal 1996 from $183.9 million in fiscal 1995. Although the Company experienced sales growth in all its international markets during fiscal 1996, the strongest growth occurred in Europe. The Company continues to expand sales, service and distribution operations in this market, and has broadened its product offerings through recent acquisitions. The Company continues to devote significant resources to the development of its other international markets, particularly Asia Pacific, and believes that growth in international revenue and market shares will be key factors in the Company's overall long-term performance. Timing of orders and shipments | Historically, orders in the first quarter have been lower than in the second, third and fourth quarters. Of the orders received by the Company in any quarter, a disproportionately large percentage have typically been received and shipped toward the end of the quarter. Accordingly, backlog has historically been modest and not an accurate predictor of future revenues, and results for a given quarter can be adversely affected if there is a substantial order shortfall in that quarter. Accounting changes | In March 1995, The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which requires the Company to review for impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In certain situations, an impairment loss would be recognized. SFAS 121 is effective for the Company's 1997 fiscal year. The Company is evaluating the impact of the new standard on its financial position, results of operations, and cash flows and expects the effect to be immaterial. In October 1995, the FASB issued SFAS 123 "Accounting for Stock-Based Compensation" which also will be effective for the Company's 1997 fiscal year. The Company does not expect SFAS 123 to have a material impact on its financial position, results of operations, and cash flows. SFAS 123 allows companies which have stock-based compensation arrangements with employees to adopt a new fair-value basis of accounting for stock options and other equity instruments, or to continue to apply the existing accounting rules under APB Opinion 25 "Accounting for Stock Issued to Employees" but with additional 29 financial statement disclosure. The company expects to continue to account for stock-based compensation arrangements under APB Opinion 25 and will include additional footnote disclosure in its fiscal 1997 annual report. Other business considerations | The Company is a United States Food and Drug Administration (FDA) regulated business operating in the rapidly changing health care industry. From time to time the Company may report, through its press releases and/or Securities and Exchange Commission filings, certain matters that would be characterized as forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Certain of these risks and uncertainties are beyond management's control. Such risks and uncertainties may include, among other things, the following items. Integration of Acquired Businesses. Since the acquisition of Puritan-Bennett, the Company has dedicated, and will continue to dedicate, substantial management resources in order to achieve the anticipated operating efficiencies from integrating the two companies. While the Company has achieved certain operating cost savings to date, difficulties encountered in integrating the two companies' operations could adversely impact the business, results of operations or financial condition of the Company. Also, the Company intends to pursue additional acquisition opportunities in the future. The integration of any business that the Company might acquire could require substantial management resources. There can be no assurance that any such integration will be accomplished without having a short or potentially long-term adverse impact on the business, results of operations or financial condition of the Company or that the benefits expected from any such integration will be fully realized. Managed Care and Other Health Care Provider Organizations. Managed care and other health care provider organizations have grown substantially in terms of the percentage of the population in the United States that receives medical benefits through such organizations and in terms of the influence and control that they are able to exert over an increasingly large portion of the health care industry. These organizations are continuing to consolidate and grow, which may increase the ability of these organizations to influence the practices and pricing involved in the purchase of medical devices, including the products sold by the Company. Health Care Reform/Pricing Pressure. The health care industry in the United States is experiencing a period of extensive change. Health care reform proposals have been formulated by the current administration and by members of Congress. In addition, state legislatures periodically consider various health care reform proposals. Federal, state and local government representatives will, in all likelihood, continue to review and assess alternative health care delivery systems and payment methodologies, and ongoing public debate of these issues can be expected. Cost containment initiatives, market pressures and proposed changes in applicable laws and regulations may have a dramatic effect on pricing or potential demand for medical devices, the relative costs associated with doing business and the amount of reimbursement by both government and third-party payors. In particular, the industry is experiencing market-driven reforms from forces within the industry that are exerting pressure on health care companies to reduce health care costs. These market-driven reforms are resulting in industry-wide consolidation that is expected to increase the downward pressure on health care product margins, as larger buyer and supplier groups exert pricing pressure on providers of medical devices and other health care products. Both short-term and long-term cost containment pressures, as well as the possibility of regulatory reform, may have an adverse impact on the Company's results of operations. Government Regulation; Consent Decree. There has been a trend in recent years, both in the United States and abroad, toward more stringent regulation of, and enforcement of requirements applicable to, medical device manufacturers. The continuing trend of more stringent regulatory oversight in product clearance and enforcement activities has caused medical device manufacturers to experience longer approval cycles, more uncertainty, greater risk and higher expenses. At the present time, there are no meaningful indications that this trend will be discontinued in the near-term or the long-term either in the United States or abroad. Puritan-Bennett has been subject to significant FDA enforcement activity with respect to its operations in recent years. In January 1994, Puritan-Bennett entered into a consent decree with the FDA pursuant to which Puritan-Bennett agreed to maintain systems and procedures complying with the FDA's good manufacturing practices regulation and medical device reporting regulation in all of its device manufacturing facilities. Puritan-Bennett has experienced and will continue to experience incremental operating costs due to ongoing compliance requirements and quality assurance programs initiated in part as a result of the FDA consent decree. Puritan-Bennett expects to continue to incur additional operating expenses associated with its ongoing regulatory compliance program, but the amount of these incremental costs cannot be completely predicted and will depend upon a variety of factors, including future changes in statutes and regulations governing medical device manufacturers and the manner in which the FDA continues to enforce and interpret the requirements of the consent decree. There can be no assurance that such compliance requirements and quality assurance programs will not have an adverse impact on the business, results of operations or financial condition of the Company or that the Company will not experience problems associated with FDA regulatory compliance, including increased general costs of ongoing regulatory compliance and specific costs associated with the Puritan-Bennett consent decree. 30 Intellectual Property Rights. From time to time, the Company has received, and in the future may receive, notices of claims with respect to possible infringement of the intellectual property rights of others or notices of challenges to its intellectual property rights. In some instances such notices have given rise to, or may give rise to, litigation. Any litigation involving the intellectual property rights of the Company may be resolved by means of a negotiated settlement or by contesting the claim through the judicial process. There can be no assurance that the business, results of operations or the financial condition of the Company will not suffer an adverse impact as a result of intellectual property claims that may be commenced against the Company in the future. Competition. The medical device industry is characterized by rapidly evolving technology and increased competition. There are a number of companies that currently offer, or are in the process of developing, products that compete with products offered by the Company. Some of these competitors may have substantially greater capital resources, research and development staffs and experience in the medical device industry, including with respect to regulatory compliance in the development, manufacturing and sale of medical products similar to those offered by the Company. These competitors may succeed in developing technologies and products that are more effective than those currently used or produced by the Company or that would render some products offered by the Company obsolete or noncompetitive. Competition based on price is expected to become an increasingly important factor in customer purchasing patterns as a result of cost containment pressures on, and consolidation in, the health care industry. Such competition has exerted, and is likely to continue to exert, downward pressure on the prices the Company is able to charge for its products. The Company may not be able to offset such downward price pressure through corresponding cost reductions. Any failure to offset such pressure could have an adverse impact on the business, results of operations or financial condition of the Company. New Product Introductions. As the Company's existing products become more mature and its existing markets more saturated, the importance of developing or acquiring new products will increase. The development of any such products will entail considerable time and expense, including research and development costs and the time and expense required to obtain necessary regulatory approvals, which could adversely affect the business, results of operations or financial condition of the Company. There can be no assurance that such development activities will yield products that can be commercialized profitably, or that any product acquisitions can be consummated on commercially reasonable terms or at all. Any failure to acquire or develop new products to supplement more mature products could have an adverse impact on the business, results of operations or financial condition of the Company. Product Liability Exposure. Because its products are intended to be used in health care settings on patients who are physiologically unstable and may also be seriously or critically ill, the Company is exposed to potential product liability claims. From time to time, patients using the Company's products have suffered serious injury or death, which has led to product liability claims against the Company. The Company does not believe that any of these claims, individually or in the aggregate, will have a material adverse impact on its business, results of operations or financial condition. However, the Company may, in the future, be subject to product liability claims that could have such an adverse impact. The Company maintains product liability insurance coverage in amounts that it deems sufficient for its business. However, there can be no assurance that such coverage will ultimately prove to be adequate, or that such coverage will continue to remain available on acceptable terms or at all. Impact of Currency Fluctuations; Importance of Foreign Sales. Because sales of products by the Company outside the United States typically are denominated in local currencies and such sales are growing at a rate that is generally faster than domestic sales, the results of operations of the Company are expected to continue to be affected by changes in exchange rates between certain foreign currencies and the United States Dollar. Although the Company currently engages in some hedging activities, there can be no assurance that the Company will not experience currency fluctuation effects in future periods, which could have an adverse impact on its business, results of operation or financial condition. The operations and financial results of the Company also may be significantly affected by other international factors, including changes in governmental regulations or import and export restrictions, and foreign economic and political conditions generally. Possible Volatility of Stock Price. The market price of the Company's stock is, and is expected to continue to be, subject to significant fluctuations in response to variations in quarterly operating results, trends in the health care industry in general and the medical device industry in particular, and certain other factors beyond the control of the Company. In addition, broad market fluctuations, as well as general economic or political conditions and initiatives such as health care reform, may adversely impact the market price of the Company's stock, regardless of the Company's operating performance. LIQUIDITY AND CAPITAL RESOURCES At July 7, 1996, the Company had cash, cash equivalents, and marketable securities of approximately $74.4 million compared to $149.2 million at the end of fiscal 1995. The Company's fiscal 1996 operating activities provided positive cash flows of $61.2 million, exclusive of merger-related cash outlays. Depreciation and amortization were significant non-cash operating activities for all years presented. Of the $108.9 million in merger and related charges which were recorded during the first and fourth quarters of fiscal 1996, approximately $45.4 million resulted in a cash outlay and $31.0 million was utilized for non-cash charges during the year. Approximately $31 million of the remaining merger and related costs are expected to result in cash outlays during fiscal 1997. 31 Sales and maturities of marketable securities were significant investing activities during fiscal 1996. Capital expenditures were approximately $29.7 million in fiscal 1996, primarily reflecting additional investments in business computer systems and production machinery and equipment. The Company expects that capital expenditures will be slightly higher in fiscal 1997, principally due to the construction of a new distribution facility and leasehold improvements as part of the consolidation of certain manufacturing and distribution operations into the Company's Carlsbad location. Shares of Company common stock issued under the Company's stock option plans were significant sources of cash from financing activities in fiscal 1996. Additionally, the Company retired approximately $75.4 million in notes payable and debt that it assumed as part of its merger with Puritan-Bennett. To initially consolidate a portion of this debt, during fiscal 1996 the Company borrowed $40 million against a $50 million credit facility that it has in place with a group of four banks. This borrowing was subsequently repaid during the third quarter of fiscal 1996, and the Company was in compliance with all credit facility covenants at July 7, 1996. The Company's inventories have increased to $128.1 million at July 7, 1996, from $95.3 million at July 2, 1995. Much of the increase in inventory occurred from February 1, 1995 and is comprised primarily of an increase in Puritan-Bennett inventory. The increase in Puritan-Bennett inventory was due primarily to production levels across several product lines which exceeded customer demands, and in part resulted from inventory build-ups associated with several new product introductions within the Global Sleep Solutions Group. Additionally, inventory levels across several hospital and home care product lines were increased in line with higher sales demands. The Company anticipates that current capital resources combined with cash to be generated from operating activities will be sufficient to meets its liquidity and capital expenditure requirements at least through the end of fiscal 1997. The Company may use debt to fund certain capital and other strategic opportunities when deemed necessary and financially advantageous. 32 NELLCOR PURITAN BENNETT INCORPORATED Report of Independent Accountants To the Board of Directors of Nellcor Puritan Bennett Incorporated In our opinion, based upon our audits and the reports of other auditors, the accompanying consolidated balance sheet and the related consolidated statements of operations, of stockholders' equity, and of cash flows present fairly, in all material respects, the financial position of Nellcor Puritan Bennett Incorporated and its subsidiaries at July 7, 1996 and July 2, 1995, and the results of their operations and their cash flows for each of the three years in the period ended July 7, 1996 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the consolidated financial statements of Puritan-Bennett Corporation and its subsidiaries, which statements reflect total assets of $273,135,000 at January 31, 1995, and total revenues of $336,026,000, and $309,255,000 for each of the two years in the period ended January 31, 1995, respectively, or Infrasonics, which statements reflect total assets of $26,954,000 at June 30, 1995, and total revenues of $23,000,000 and $19,906,000 for each of the two years in the period ended June 30, 1995, respectively. Those statements were audited by other auditors whose reports thereon have been furnished to us, and our opinion expressed herein, insofar as it relates to the amounts included for Puritan-Bennett Corporation and its subsidiaries and Infrasonics, is based solely on the reports of the other auditors. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for the opinion expressed above. /s/ Price Waterhouse LLP San Francisco, California July 31, 1996 33 SELECTED QUARTERLY DATA
Year ended July 7, 1996 -------------------------------------------------------- Unaudited (in thousands except per share amounts) 1st quarter 2nd quarter 3rd quarter 4th quarter - --------------------------------------------------------------------------------------------------------------------- Net revenue $162,506 $168,481 $175,638 $199,506 Gross profit 81,669 86,519 90,898 101,025 Income (loss) from operations (70,356)(1) 26,832 28,201 15,276(2) Net income (loss) (58,999)(1) 18,626 19,778 11,235(2) Net income (loss) per share (.97)(1) .30 .32 .19(2) -------------------------------------------------------- Year ended July 2, 1995 -------------------------------------------------------- Unaudited (in thousands except per share amounts) 1st quarter 2nd quarter 3rd quarter 4th quarter - --------------------------------------------------------------------------------------------------------------------- Net revenue $140,714 $153,661 $159,873 $168,818 Gross profit 68,835 76,643 79,463 85,155 Income from operations 13,405 17,569 20,960 21,470 Net income 9,588 11,648 10,994 15,882 Net income per share .16 .20 .19 .27 - ---------------------------------------------------------------------------------------------------------------------
(1) Includes pretax merger and related charges of $92.6 million, $74.0 million after-tax, or ($1.26) per share. (2) Includes pretax merger and related charges of $16.3 million, $10.3 million after-tax, or ($0.17) per share. 34 (ii) Following are the Nellcor Puritan Bennett Incorporated consolidated balance sheets as of July 7, 1996 and April 6, 1997, consolidated statements of operations for the three months and nine months ended March 31, 1996 and April 6, 1997 and consolidated statements of cash flows for the nine months ended March 31, 1996 and April 6, 1997. 35 NELLCOR PURITAN BENNETT INCORPORATED CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT SHARE AMOUNT, UNAUDITED)
ASSETS April 6, 1997 July 7, 1996 ------------- ------------ Current assets: Cash and cash equivalents $54,077 $71,692 Marketable securities 3,501 5,825 Accounts receivable 192,521 158,023 Inventories 155,671 132,378 Deferred income taxes 32,279 32,375 Other current assets, net 16,572 14,589 ------------- ------------ Total current assets 454,621 414,882 Property, plant and equipment, net 144,815 132,956 Intangible and other assets, net 46,779 49,983 Deferred income taxes 13,242 13,101 ------------- ------------ $659,457 $610,922 ============= ============ LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $46,654 $40,269 Employee compensation and related costs 26,358 32,072 Merger and related costs 27,481 32,452 Other accrued expenses 39,716 35,133 Current maturities of long-term debt 22,744 530 Income taxes payable 15,279 20,444 ------------- ------------ Total current liabilities 178,232 160,900 Long-term debt, less current maturities 5,970 8,394 Deferred compensation and pensions 9,581 9,522 Deferred revenue 7,857 10,039 ------------- ------------ Total liabilities 201,640 188,855 ------------- ------------ Stockholders' equity: Common stock, par value 67 63 Additional paid-in-capital 245,545 236,461 Retained earnings 270,501 242,687 Accumulated translation adjustment 81 304 Notes receivable from stockholders (5) (5) Net unrealized gain on available-for-sale securities 445 1,374 Treasury stock, at cost (3,224,020 shares) (58,817) (58,817) ------------- ------------ Total stockholders' equity 457,817 422,067 ------------- ------------ $659,457 $610,922 ============= ============
See accompanying note 36 NELLCOR PURITAN BENNETT INCORPORATED CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, UNAUDITED)
For the Three Months Ended For the Nine Months Ended ------------------------------- -------------------------------- April 6, March 31, April 6, March 31, 1997 1996 1997 1996 ---------- ---------- ---------- ---------- Net revenue $ 209,054 $ 184,750 $ 566,267 $ 535,008 Cost of goods sold 111,229 88,785 298,938 260,287 ---------- ---------- ---------- ---------- Gross profit 97,825 95,965 267,329 274,721 ---------- ---------- ---------- ---------- Operating expenses: Research and development 14,545 14,854 40,720 41,815 Selling, general and administrative 58,189 52,360 162,721 152,844 Merger and related costs --- --- 21,689 92,618 ---------- ---------- ---------- ---------- 72,734 67,214 225,130 287,277 ---------- ---------- ---------- ---------- Income (loss) from operations 25,091 28,751 42,199 (12,556) Interest income 710 1,304 2,055 4,797 Interest expense (489) (331) (1,110) (3,082) Other (expense), net (1,267) (170) (1,506) (386) ---------- ---------- ---------- ---------- Income (loss) before income taxes 24,045 29,554 41,638 (11,227) Provision for income taxes 7,454 9,406 14,550 7,560 ---------- ---------- ---------- ---------- Net income (loss) $ 16,591 $ 20,148 $ 27,088 $ (18,787) ========== ========== ========== ========== Net income (loss) per common and common equivalent share $ 0.26 $ 0.31 $ 0.42 $ (0.30) ========== ========== ========== ========== Weighted average common and common equivalent shares 64,014 64,452 63,888 63,612 ========== ========== ========== ==========
See accompanying note 37 NELLCOR PURITAN BENNETT INCORPORATED CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS, UNAUDITED)
For the Nine Months Ended ----------------------------------- April 6, 1997 March 31, 1996 ----------------------------------- Cash flows from operating activities: Net income (loss) $27,088 ($18,787) Adjustments to reconcile net income (loss) to cash provided by (used for) operating activities: Depreciation and amortization 24,419 24,124 Deferred income taxes --- (200) Merger and related charges 21,689 92,618 Deferred compensation and pensions --- (11,954) Other 55 762 Increases (decreases) in cash flows, net of effect of purchased companies, as a result of changes in: Accounts receivable (32,891) (14,779) Inventories (18,217) (13,617) Other current assets (3,506) (9,941) Intangible and other assets (1,545) 584 Accounts payable 5,726 2,973 Merger and related costs (22,822) (36,470) Employee compensation and other accrued expenses 280 3,598 Income taxes payable (6,050) 1,187 Deferred revenue (939) (545) ------------ ---------- Cash provided by (used for) operating activities (6,713) 19,553 ------------ ---------- Cash flows from investing activities: Aequitron net cash provided during the period from 5/1/96 - 7/7/96 46 --- Capital expenditures (33,822) (18,354) Purchase of available-for-sale securities (1,800) --- Proceeds from maturities of securities held-to-maturity --- 61,842 Proceeds from the sale of available-for-sale securities 3,057 --- Acquisitions, net of cash acquired (5,268) (9,713) Other investing activities 1,417 713 ------------ ---------- Cash provided by (used for) investing activities (36,370) 34,488 ------------ ---------- Cash flows from financing activities: Issuance of common stock under the Company's stock plans and related tax benefits, net 9,073 24,533 Additions to long-term debt 29,049 2,500 Repayment of long-term debt (11,854) (70,473) Purchase of treasury shares --- (12,103) ------------ ---------- Cash provided by (used for) financing activities 26,268 (55,543) ------------ ---------- Effect of exchange rate changes on cash (800) (40) ------------ ---------- Decrease in cash and cash equivalents (17,615) (1,542) Cash and cash equivalents at the beginning of the period 71,692 84,552 ------------ ---------- Cash and cash equivalents at the end of the period $54,077 $83,010 ============ ==========
See accompanying note 38 NELLCOR PURITAN BENNETT INCORPORATED NOTE TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) GENERAL. The consolidated financial statements reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position and results of operations of Nellcor Puritan Bennett Incorporated (the Company) as of the end of and for the periods indicated. The accompanying interim consolidated financial statements should be read in conjunction with the financial statements and related notes included in the Company's 1996 Annual Report to Stockholders. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the Securities and Exchange Commission rules and regulations. The Company believes the information included in the report on Form 10-Q, when read in conjunction with the consolidated financial statements and related notes thereto included in the Company's 1996 Annual Report to Stockholders, is not misleading. The results of operations for the three and nine months ended April 6, 1997 are not necessarily indicative of operating results for the full fiscal year. COMBINED FINANCIAL RESULTS. The Company acquired Infrasonics Incorporated (Infrasonics) on June 27, 1996, and Aequitron Medical, Inc. (Aequitron) on December 5, 1996, in stock for stock mergers. Both mergers were intended to qualify as tax-free reorganizations and were accounted for as poolings of interests. Accordingly, the consolidated financial statements present, for all periods, the combined financial results of the Company, Infrasonics, and Aequitron. The Company's consolidated statements of operations and cash flows for the three and nine month periods ended March 31, 1996 combine the results of the Company's third quarter and first nine months of fiscal 1996, the period ended March 31, 1996, with Infrasonics' third quarter and first nine months of fiscal 1996, the period ended March 31, 1996, and Aequitron's third quarter and first nine months of fiscal 1996, the period ended January 31, 1996, respectively. Adjustments made to conform the accounting policies of the Company, Infrasonics, and Aequitron were immaterial. Separate results for each of the Company's, Infrasonics' and Aequitron's third quarter of fiscal 1996, and combined results for the three and nine months ended March 31, 1996, were as follows (in thousands):
Nellcor Puritan Bennett Infrasonics Aequitron Combined Three months ended: March 31, 1996 March 31, 1996 January 31, 1996 March 31, 1996 - ------------------- ----------------- --------------- ---------------- -------------- Revenue $ 168,490 $ 7,148 $ 9,112 $ 184,750 - -------------------------------------------------------------------------------------------------------------------- Net income $ 19,178 $ 600 $ 370 $ 20,148 - -------------------------------------------------------------------------------------------------------------------- Nellcor Puritan Bennett Infrasonics Aequitron Combined Nine months ended: March 31, 1996 March 31, 1996 January 31, 1996 March 31, 1996 - ------------------ ----------------- -------------- ---------------- -------------- Revenue $ 487,354 $ 19,271 $ 28,383 $ 535,008 - -------------------------------------------------------------------------------------------------------------------- Net income (loss) $(21,901) $ 1,306 $ 1,808 $(18,787) - --------------------------------------------------------------------------------------------------------------------
39 INVENTORIES. Inventories are stated at the lower of cost (first-in, first-out) or market. Allowances are made for slow-moving, obsolete, unsalable, or unused inventories. Interim fiscal 1997 and year-end fiscal 1996 inventory balances for the Company were as follows (in thousands):
APRIL 6, 1997 JULY 7, 1996 ---------------- ---------------- Raw materials $67,711 $66,805 Work-in-process 16,981 16,538 Finished goods 70,979 49,035 ---------------- ---------------- $155,671 $132,378 ================ ================
STATEMENT OF CASH FLOWS. The Company paid income taxes of approximately $19.7 million in the first nine months of fiscal 1997 ended April 6, 1997, and $13.4 million in the first nine months of fiscal 1996 ended March 31, 1996. PROPERTY AND EQUIPMENT. Depreciation expense was approximately $21.2 million in the first nine months of fiscal 1997 and $18.0 million in the first nine months of fiscal 1996. MARKETABLE SECURITIES. At April 6, 1997, the Company held available-for-sale marketable securities with a fair market value of $3.5 million. The Company's marketable securities, generally, are in high quality government, municipal, and corporate obligations with original maturities of up to two years. The Company has established guidelines relative to investment quality, diversification and maturities to maintain appropriate levels of safety and liquidity. Realized gains and losses resulting from the sale of available-for-sale marketable securities during the periods presented were not material. The difference between the cost and market value of the Company's marketable securities at April 6, 1997, an unrealized gain of approximately $.4 million, is carried in stockholders' equity as a "net unrealized gain on available-for-sale securities". ACCOUNTING CHANGES. In February 1997, the Financial Accounting Standards Board issued Statement of Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). SFAS 128 supercedes Accounting Principles Board Opinion No. 15, "Earnings Per Share" and is effective for financial statements for both interim and annual periods ending after December 15, 1997. SFAS 128 requires dual presentation of basic and diluted earnings per share (EPS) on the face of the income statement for entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to Opinion 15. Under SFAS 128, the pro forma net income per share for the three month period ended April 6, 1997 was $0.26 for both basic and diluted earnings per share. ACQUISITION OF AEQUITRON. On December 5, 1996, the Company acquired Aequitron in a stock-for-stock merger. Under the terms of the Amended and Restated Agreement and Plan of Merger, shareholders of Aequitron received .467 of a share of the Company's common stock for each Aequitron share, resulting in the Company issuing approximately 2,322,000 shares, valued at approximately $52.5 million based on the closing price of the Company's common stock on December 5, 1996. Additionally, outstanding options to acquire Aequitron's common stock were assumed by the Company and converted into options to acquire approximately 545,000 shares of the Company's common stock. Aequitron, headquartered in Minneapolis, Minnesota, is a respiratory equipment manufacturer of portable compact ventilators, infant apnea products, and sleep disorder diagnostic devices. In addition, through its Crow River Industries, Inc. subsidiary, the company also manufactures wheelchair lifts and automobile hand controls to assist individuals who have mobility limitations. For the fiscal year ended April 30, 1996, Aequitron reported revenue of $38.5 million. ACQUISITION OF NELLCOR-CMI, INC. On September 30, 1996, the Company acquired from Century Medical, Inc. the remaining 50 percent ownership interest in Nellcor-CMI, Inc. (NCI) for $5.4 million in cash. The acquisition of NCI has been accounted for as a purchase and, accordingly, the results from the Company's new wholly-owned subsidiary, Nellcor Puritan Bennett Japan, are included in the Company's financial statements subsequent to the acquisition date. 40 MERGER AND RELATED COSTS. In connection with the acquisition of Aequitron, the Company recorded merger and related costs during the second quarter of fiscal 1997 of $21.7 million. Included in this charge were provisions for merger transaction costs ($3.4 million), certain intangible asset write downs ($3.0 million), costs to combine and integrate operations ($14.5 million), and other merger related costs ($0.8 million). During fiscal 1996, one-time merger and related costs of $108.9 million were recorded associated with the Company's acquisitions of Puritan-Bennett and Infrasonics. Of the $130.6 million in merger and related costs accrued during fiscal 1996 and fiscal 1997, as of April 6, 1997, approximately $103.1 million had been utilized, primarily associated with the write-down (non-cash charge) of certain assets to their net realizable value ($24.3 million), the payment of merger transaction costs ($17.6 million), initial costs incurred to combine and integrate operations ($57.4 million, of which $17.2 million was associated with employee severance and benefits termination costs) and other merger related costs ($3.8 million). The remaining merger and related costs accrued at April 6, 1997 of $27.5 million, approximately $25.5 million of which is expected to result in a cash outlay, should be substantially utilized by the end of fiscal 1998. Employee severance and benefit termination costs included in the merger and related costs accrual were associated with the elimination of approximately 320 positions from the Company's total workforce. The positions to be eliminated are primarily associated with corporate administrative groups, field sales and customer service organizations, and the consolidation of manufacturing sites. As of April 6, 1997, approximately 306 positions contemplated by this workforce reduction had been eliminated. The Company expects the remainder of these positions to be eliminated during fiscal 1997. SUBSEQUENT EVENT. On May 7, 1997, the Company announced that it will consolidate home care product line activities spread across six existing U.S. sites into three sites. The Company is undertaking this action as part of its operations improvement plan focused on increasing productivity, reducing cost and improving the effectiveness of product development activities. Overall, the Company expects to eliminate approximately 80-85 positions in the sleep products divisions and 30-50 positions in the oxygen therapy products divisions. In addition, the portion of the Company's critical care ventilator research and development operations located in Ireland will be absorbed into the R&D operations in Carlsbad, California. The Company expects to record one-time restructuring charges of $15-20 million in the fiscal 1997 fourth quarter associated with these consolidations. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. RESULTS OF OPERATIONS - YEAR-TO-DATE PERIOD AND THIRD QUARTER ENDED APRIL 6, 1997, COMPARED WITH THE YEAR-TO-DATE PERIOD AND THIRD QUARTER ENDED MARCH 31, 1996. The Company reported net income for the third quarter of fiscal 1997 of $16.6 million, or $0.26 per share, compared to net income of $20.1 million, $0.31 per share, for the same period a year ago. For the first nine months of fiscal 1997, the Company reported net income of $27.1 million, or $0.42 per share, including one-time merger and related charges of $21.7 million, ($0.26) per share, associated with the acquisition of Aequitron. The Company's results for the first nine months of fiscal 1996, a net loss of $18.8 million, or ($0.30) per share, reflect one-time merger and related charges of $92.6 million, ($1.17) per share, associated with the first quarter fiscal 1996 acquisition of Puritan-Bennett. Excluding the effect of these nonrecurring charges, net income for the first nine months of fiscal 1997 was $43.6 million, $0.68 per share, compared to net income of $55.2 million, $0.86 per share, for the first nine months of fiscal 1996. 41 The Company's net revenue for the third quarter of fiscal 1997 was $209.1 million, a 13 percent increase over net revenue of $184.8 million for the same period a year ago. Net revenue for the first nine months of fiscal 1997 increased 6 percent to $566.3 million from $535.0 million in the same period last year. Hospital product line sales increased 7 percent to $123.6 million for the third quarter of fiscal 1997 from $115.7 million for the same period last year as higher oximetry revenue was partially offset by slightly lower sales of the Company's critical care ventilators. Oximetry product line sales increased due to higher sales of the Company's sensors and sales of the NPB-4000 multiparameter monitor, a product which has been well received in international markets since its introduction in the first quarter of fiscal 1997. Sales of the Company's critical care ventilators were lower due primarily to reduced sales of the ADULT STAR series ventilator. Home care product line sales increased 24 percent to $73.9 million from $59.6 million for the same period last year. The increase in home care product line sales was due primarily to higher sales across the company's oxygen therapy, sleep therapy and portable ventilator product lines. Growth in national account business contributed to higher U.S. home care sales levels. In addition, international home care revenue was strong, primarily the result of higher European sales of sleep therapy devices. Aero business sales increased 23 percent to $11.6 million for the third quarter of fiscal 1997 compared to $9.4 million for the same period last year. Separately, international revenue of $61.8 million represents an increase of 13 percent over international revenue of $54.6 million for the third quarter of fiscal 1996. International sales growth was strongest in Asia where the Company benefited from strong sales within its newly established Japanese subsidiary. Foreign currency exchange rates unfavorably impacted international revenue growth by 5 percentage points during the third quarter. Gross profit as a percentage of net revenue for the third quarter of fiscal 1997 was 47 percent compared to 52 percent for the same period last year. This decline was due primarily to unfavorable product mix and lower average selling prices within certain home care and hospital product lines and the unfavorable effect that foreign currency exchange rates had upon international sales. The Company's gross margins are expected to improve slightly in the fourth quarter of this fiscal year. Operating expenses for the third quarter of fiscal 1997 were 35 percent of net revenue versus 36 percent for the third quarter of fiscal 1996. Operating expenses for the first nine months of 1997 and 1996 were comparable at 36 percent of net revenue, exclusive of the effect of one-time merger and related charges. Research and development expenses were 7 percent of net revenue in the third quarter of fiscal 1997 compared to 8 percent for the third quarter of fiscal 1996. The slight decrease in research and development expenses is due primarily to synergies resulting from the consolidation of certain hospital product development activities. Selling, general and administrative expenses for the third quarter of fiscal 1997 and fiscal 1996 were comparable at 28 percent of net revenue. Selling, general and administrative expenses increased in absolute dollars due primarily to the inclusion of expenses from the Company's newly established NPB Japan subsidiary, selling expenses increasing in line with the revenue growth rates and higher information systems conversion costs. Operating expenses for the first nine months of fiscal 1997 reflect the effect of one-time merger and related costs of $21.7 million associated with the Company's acquisition of Aequitron. Included in this charge were provisions for merger transaction costs ($3.4 million), certain intangible asset write-downs ($3.0 million), costs to combine and integrate operations ($14.5 million), and other merger related costs ($0.8 million). 42 Operating expenses for the first nine months of fiscal 1996 reflect the effect of one-time merger and related costs of $92.6 million associated with the merger of Nellcor and Puritan-Bennett. Included in this charge were provisions for merger transaction costs ($13.7 million), costs to combine and integrate operations ($53.8 million), certain intangible asset write-downs ($19.6 million), and other merger related costs ($5.5 million). Other expense for the third quarter of fiscal 1997 was $1.3 million compared to $.2 million reported in the prior year. Other expense increased due primarily to the recording of higher bad debt reserve provisions associated with continued sales growth in emerging markets. LIQUIDITY AND CAPITAL RESOURCES At April 6, 1997, the Company had cash, cash equivalents and marketable securities of approximately $57.6 million compared to $77.5 million at the end of fiscal 1996. Cash provided by operating activities was approximately $16.1 million during the first nine months of fiscal 1997, exclusive of $22.8 million in merger related cash outlays. Accounts receivable and inventory growth and income tax payments during the year were major contributors to the net use of cash for operating activities. The Company's accounts receivable increased to $192.5 million at April 6,1997, from $158.0 million at July 7, 1996, due primarily to the assumption of accounts receivable from NCI subsequent to its acquisition and a trend towards extended credit terms. The Company's inventories increased to $155.7 million at April 6, 1997 from $132.4 million at July 7, 1996 due primarily to lower than planned sales levels, inventory buildups in advance of product line relocations and the consolidation of Southern California hospital business manufacturing sites, and certain new product introductions. The Company is actively working to reduce inventory levels over the remainder of 1997. In part to fund incremental working capital requirements, net of repayments of $11.9 million, the Company increased borrowings by $17.2 million during the first nine months of fiscal 1997. On September 30, 1996, the Company acquired the remaining 50 percent ownership interest in NCI for $5.4 million in cash. Debt of $8 million was assumed as part of this acquisition. On December 5, 1996, the Company acquired Aequitron in a stock-for-stock merger. Under the terms of the Amended and Restated Agreement and Plan of Merger, shareholders of Aequitron received .467 a share of the Company's common stock for each Aequitron share, resulting in the Company issuing approximately 2,322,000 shares, valued at approximately $52.5 million based on the closing price of the Company's common stock on December 5, 1996. Additionally, outstanding options to acquire Aequitron's common stock were assumed by the Company and converted into options to acquire approximately 545,000 shares of the Company's common stock. Aequitron, headquartered in Minneapolis, Minnesota, is a respiratory equipment manufacturer of portable compact ventilators, infant apnea products, and sleep disorder diagnostic devices. In addition, through its Crow River Industries, Inc. subsidiary, the company also manufactures wheelchair lifts and automobile hand controls to assist individuals who have mobility limitations. For the year ended April 30, 1996, Aequitron reported revenue of $38.5 million. On May 7, 1997, the Company announced that it will consolidate home care product line activities spread across six existing U.S. sites into three sites. The Company is undertaking this action as part of its operations improvement plan focused on increasing productivity, reducing cost and improving the effectiveness of product development activities. Overall, the Company expects to eliminate approximately 80-85 positions in sleep products and 30-50 positions in oxygen therapy products. In addition, the portion of the Company's critical care ventilator research and development operations located in Ireland will be absorbed into the R&D operations in Carlsbad, California. The Company expects to record one-time restructuring charges of $15-20 million in the fiscal 1997 fourth quarter associated with these consolidations. 43 On January 15, 1997 the Company rescinded the general stock repurchase program, which had originally been implemented on December 8, 1993. The Company anticipates that current working capital resources, combined with cash to be generated from operating activities, will be sufficient to meet its liquidity and capital expenditure requirements at least through the end of fiscal 1997. The Company may continue to use debt to fund certain working capital and other strategic opportunities when deemed necessary and financially advantageous. BUSINESS CONSIDERATIONS The Company is a United States Food and Drug Administration (FDA) regulated business operating in the rapidly changing healthcare industry. From time to time the Company may report, through its press releases and/or Securities and Exchange Commission filings, certain matters that would be characterized as forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Certain of these risks and uncertainties are beyond management's control. Such risks and uncertainties include, among other things, the following items. INTEGRATION OF ACQUIRED BUSINESSES. The Company has dedicated and will continue to dedicate, substantial management resources in order to achieve the anticipated operating efficiencies from integrating Puritan-Bennett, Infrasonics, and Aequitron. While the Company has achieved certain operating cost savings to date, difficulties encountered in integrating the companies' operations could adversely impact the business, results of operations or financial condition of the Company. Also, the Company intends to pursue acquisition opportunities in the future. The integration of any businesses that the Company might acquire could require substantial management resources. There can be no assurance that any such integration will be accomplished without having a short or potentially long-term adverse impact on the business, results of operations or financial condition of the Company or that the benefits expected from any such integration will be fully realized. MANAGED CARE AND OTHER HEALTHCARE PROVIDER ORGANIZATIONS. Managed care and other large healthcare provider organizations have grown substantially in terms of the percentage of the population in the United States that receives medical benefits through such organizations and in terms of the influence and control that they are able to exert over an increasingly large portion of the health care industry. These organizations are continuing to consolidate and grow, which may increase the ability of these organizations to influence the practices and pricing involved in the purchase of medical devices, including the products sold by the Company. HEALTH CARE REFORM/PRICING PRESSURE. The health care industry in the United States is experiencing a period of extensive change. Health care reform proposals have been formulated by the current administration and by members of Congress. In addition, state legislatures periodically consider various health care reform proposals. Federal, state and local government representatives will, in all likelihood, continue to review and assess alternative health care delivery systems and payment methodologies, and ongoing public debate of these issues can be expected. Cost containment initiatives, market pressures and proposed changes in applicable laws and regulations may have a dramatic effect on pricing for medical devices, the relative costs associated with doing business and the amount of reimbursement by both government and third-party payors. In particular, the industry is experiencing market-driven reforms from forces within the industry that are exerting pressure on health care companies to reduce health care costs. These market-driven reforms are resulting in industry-wide consolidation that is expected to increase the downward pressure on health care product margins, as larger buyer and supplier groups exert pricing pressure on providers of medical devices and other health care products. Both short-term and long-term cost containment pressures, as well as the possibility of regulatory reform, may have an adverse impact on the Company's results of operations. Page 10 44 GOVERNMENT REGULATION; CONSENT DECREE. Both in the United States and outside the United States, there has been a trend toward more stringent regulation of, and enforcement of requirements applicable to, medical device manufacturers. The continuing trend of more stringent regulatory oversight in product clearance and enforcement activities has caused medical device manufacturers to experience longer approval cycles, more uncertainty, greater risk and higher expenses. At the present time, there are no meaningful indications that this trend will be discontinued in the near-term or the long-term either in the United States or abroad. Puritan-Bennett has been subject to significant FDA enforcement activity with respect to its operations. In January 1994, Puritan-Bennett entered into a consent decree with the FDA pursuant to which Puritan-Bennett agreed to maintain systems and procedures complying with the FDA's good manufacturing practices regulation and medical device reporting regulation in all of its device manufacturing facilities. Puritan-Bennett has experienced and will continue to experience incremental operating costs due to ongoing compliance requirements and quality assurance programs initiated in part as a result of the FDA consent decree. Puritan-Bennett expects to continue to incur additional operating expenses associated with its ongoing regulatory compliance program, but the amount of these incremental costs cannot be completely predicted and will depend upon a variety of factors, including future changes in statutes and regulations governing medical device manufacturers and the manner in which the FDA continues to enforce and interpret the requirements of the consent decree. There can be no assurance that such compliance requirements and quality assurance programs will not have a material adverse effect on the business, results of operations or financial condition of the Company or that the Company will not experience problems associated with FDA regulatory compliance, including increased general costs of ongoing regulatory compliance and specific costs associated with the Puritan-Bennett consent decree. INTELLECTUAL PROPERTY RIGHTS. From time to time, the Company has received, and in the future may receive, notices of claims with respect to possible infringement of the intellectual property rights of others or notices of challenges to its intellectual property rights. In some instances such notices have given rise to, or may give rise to, litigation. Any litigation involving the intellectual property rights of the Company may be resolved by means of a negotiated settlement or by contesting the claim through the judicial process. There can be no assurance that the business, results of operations or the financial condition of the Company will not suffer a material adverse effect as a result of intellectual property claims that may be commenced against the Company in the future. 45 COMPETITION. The medical device industry is characterized by rapidly evolving technology and increased competition. There are a number of companies that currently offer, or are in the process of developing, products that compete with products offered by the Company. Some of these competitors may have substantially greater capital resources, research and development staffs and experience in the medical device industry, including with respect to regulatory compliance in the development, manufacturing and sale of medical products similar to those offered by the Company. These competitors may succeed in developing technologies and products that are more effective than those currently used or produced by the Company or that would render some products offered by the Company obsolete or non-competitive. Moreover, competition based on price has become and is expected to continue to be an increasingly important factor in customer purchasing patterns as a result of cost containment pressures on, and consolidation in, the health care industry. Such competition has exerted, and is likely to continue to exert, downward pressure on the prices the Company is able to charge for its products. The Company may not be able to offset such downward price pressure through corresponding cost reductions. Any failure to offset such pressure could have an adverse impact on the business, results of operations or financial condition of the Company. NEW PRODUCT INTRODUCTIONS. As the existing products of the Company become more mature and its existing markets more saturated, the importance of developing or acquiring new products will increase. The development of any such products will entail considerable time and expense, including research and development costs and the time and expense required to obtain necessary regulatory approvals, which could adversely affect the business, results of operations or financial condition of the Company. There can be no assurance that such development activities will yield products that can be commercialized profitably, or that any product acquisitions can be consummated on commercially reasonable terms or at all. Any failure to acquire or develop new products to supplement more mature products could have an adverse impact on the business, results of operations or financial condition of the Company. PRODUCT LIABILITY EXPOSURE. Because its products are intended to be used in health care settings on patients who are physiologically unstable and may also be seriously or critically ill, the Company is exposed to potential product liability claims. From time to time, patients using the Company's products have suffered serious injury or death, which has led to product liability claims against the Company. The Company does not believe that any of these claims, individually or in the aggregate, will have a material adverse effect on its business, results of operations or financial condition. However, the Company may, in the future, be subject to product liability claims that could have such an adverse impact. The Company maintains product liability insurance coverage in amounts that it deems sufficient for its business. However, there can be no assurance that such coverage will ultimately prove to be adequate, or that such coverage will continue to remain available on acceptable terms or at all. IMPACT OF CURRENCY FLUCTUATIONS; IMPORTANCE OF FOREIGN SALES. Because sales of products by the Company outside the United States typically are denominated in local currencies and such sales are growing at a rate that is generally faster than domestic sales, the results of operations of the Company are expected to continue to be affected by changes in exchange rates between certain foreign currencies and the United States Dollar. Although the Company currently engages in some hedging activities, there can be no assurance that the Company will not experience currency fluctuation effects in future periods, which could have an adverse impact on its business, results of operation or financial condition. The operations and financial results of the Company also may be significantly affected by other international factors, including changes in governmental regulations or import and export restrictions, and foreign economic and political conditions generally. POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Company's stock is, and is expected to continue to be, subject to significant fluctuations in response to variations in quarterly operating results, trends in the health care industry in general and the medical device industry in particular, and certain other factors beyond the control of the Company. In addition, broad market fluctuations, as well as general economic or political conditions and initiatives such as health care reform, may adversely affect the market price of the Company's stock, regardless of the Company's operating performance. 46
Filed with Incorporated Herein by Electronic Exhibit Description Reference to Submission - ------- ----------- ---------------------- ----------- 23.1 Consent of Price Waterhouse LLP X
### Mallinckrodt Inc. ROGER A. KELLER Vice President, Secretary and General Counsel DATE: March 4, 1998 EX-23.1 2 CONSENT OF PRICE WATERHOUSE LLP 1 Exhibit 23.1 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 333-42325) and in the Registration Statements on Form S-8 (Nos. 2-65727, 2-80553, 2-90910, 2-94151, 33-10381, 33-32109, 33-40246, 33-43925, 333-34489, 333-38291 and 333-38293) of Mallinckrodt Inc., of our report dated July 31, 1996 relating to the consolidated financial statements of Nellcor Puritan Bennett Incorporated, which appears in the Current Report of Form 8-K/A of Mallinckrodt Inc. dated March 4, 1998. PRICE WATERHOUSE LLP San Francisco, California March 4, 1998 -----END PRIVACY-ENHANCED MESSAGE-----