-----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, LiN/aUapEr6ENG4X+ywS/SrRHfdPhnSVslaMJmGDs3NCq7YXqkD13zwLbx9tJR2G BAHfhASkv68vCHCTugV6Og== 0000891618-98-001490.txt : 19980402 0000891618-98-001490.hdr.sgml : 19980402 ACCESSION NUMBER: 0000891618-98-001490 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ENDOSONICS CORP CENTRAL INDEX KEY: 0000883420 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 680028500 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-19880 FILM NUMBER: 98584359 BUSINESS ADDRESS: STREET 1: 6616 OWENS DRIVE CITY: PLEASANTON STATE: CA ZIP: 94508 BUSINESS PHONE: 9166388008 MAIL ADDRESS: STREET 1: 6616 OWENS DR CITY: PLEASANTON STATE: CA ZIP: 94508 10-K 1 FORM 10-K FOR THE PERIOD ENDING DECEMBER 31, 1997 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM --------------- TO --------------- . COMMISSION FILE NUMBER: 0-19880 ENDOSONICS CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 68-0028500 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
2870 Kilgore Road, Rancho Cordova, California 95670 (Address of principal executive offices, including zip code) Registrant's telephone number, including area code: (916) 638-8008 Securities Registered Pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.001 PAR VALUE. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicated by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the Registrant, as of March 20, 1998, was approximately $100,254,962 (based upon the closing price for shares of the Registrant's Common Stock as reported by the Nasdaq National Market for the last trading date prior to that date). Shares of Common Stock held by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. On March 20, 1998, approximately 16,177,183 shares of the Registrant's Common Stock, $.001 par value, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE. Portions of the Registrant's Proxy Statement for the 1998 Annual Meeting of Stockholders to be held on or about June 4, 1998 are incorporated by reference into Part III. Form 8-K for EndoSonics Corporation filed on August 7, 1997. ================================================================================ 2 PART I ITEM 1. BUSINESS EndoSonics Corporation ("EndoSonics" or the "Company") develops, manufactures and markets intravascular ultrasound ("IVUS") imaging systems and percutaneous transluminal coronary angioplasty ("balloon angioplasty") catheters to assist in the diagnosis and treatment of cardiovascular and peripheral vascular disease. The Company's IVUS imaging products enhance the effectiveness of the diagnosis and treatment of coronary artery and other vascular diseases by providing important diagnostic information not available from conventional x-ray angiography. This information includes the location, amount and composition of atherosclerotic plaque and enables physicians to identify lesion characteristics, select an optimum course of treatment, position therapeutic devices, treat disease sites with drugs or other therapies and promptly assess the results of treatment. In 1993, the Company commenced the Pinnacle Development Project to further enhance the image quality of its IVUS imaging products. This project resulted in the Five-64 catheter line and an enhancement to the Company's Oracle Imaging System. The Company has received United States Food and Drug Administration ("FDA") clearance for its Five-64 diagnostic catheters, which were commercially available in the first quarter of 1996. The Company believes that it offers the only FDA approved combined coronary balloon angioplasty/IVUS imaging catheters, devices that can reduce the time and cost of interventional procedures by providing both diagnostic and therapeutic functions on the same catheter. The Company's products are based on two core proprietary technologies: digital, all-electronic IVUS imaging and specialized balloon catheter material technology. The Company's IVUS imaging system and catheters use high-speed, computer-based electronics and proprietary integrated circuit technologies to produce ultrasound images. The combination of these technologies and the Company's manufacturing expertise enables its catheters to provide high-quality ultrasound images while maintaining the small size, flexibility and trackability necessary to access, diagnose and treat a wide range of coronary and peripheral vessels. See "Risk Factors." As of December 31, 1997, the Company held approximately 24% of the outstanding shares of the Common Stock of CardioVascular Dynamics, Inc. ("CVD"). CVD designs, develops, manufactures and markets catheters used to treat certain vascular diseases. CVD's catheters are used in conjunction with angioplasty and other interventional procedures such as vascular stenting and drug delivery. CVD's proprietary FOCAL and Multiple Microporous Membrane ("M(3)") technologies enable physicians to deliver therapeutic radial force, stents, drugs or contrast media accurately and effectively to the treatment site in addition to allowing the perfusion of blood during an interventional procedure. CVD's catheters are designed to address three principal challenges facing cardiologists: restenosis of a treated vessel, chronic total occlusions and acute reclosure of a vessel during or soon after a procedure. CVD was formerly a 84%-owned subsidiary of the Company's until CVD completed its initial public offering in June of 1996. BUSINESS ACQUISITION On July 23, 1997, the Company acquired all of the outstanding shares of Cardiometrics, Inc. ("Cardiometrics") for approximately $73.4 million in Common Stock of the Company, Common Stock of CVD and cash. The financial results of Cardiometrics' operations have been combined with those of the Company since the date of acquisition. The acquisition was accounted for using the purchase method of accounting. Purchased in-process research and development in the amount of $43 million was valued by an independent appraiser. As such in-process research and development had not reached technological feasibility and had no probable alternative future uses, it was charged to operations upon acquisition. Goodwill and other intangible assets are being amortized over three-to-eight years. In addition, the Company recognized a gain of $3.7 million related to the excess of the fair value over the book value of CVD common stock used as part of the purchase price consideration. The results of operations for the twelve months ended December 31, 1997 include one-time charges of $43 million related to the write-off of acquired in-process research and development, and $5.0 million related to restructuring and integration of the two companies. 1 3 Cardiometrics develops, manufactures and markets intravascular medical devices to measure blood flow impairment caused by coronary artery disease. Cardiometrics' principal products, the FloWire(R)Doppler guide wire and FloMap(R) ultrasound instrument, represent an advance in functional testing of blood flow impairment, enabling cardiologists to evaluate the appropriateness of angioplasty interventions and assess post-procedural results directly in the cardiac catheterization laboratory. Clinical experience demonstrates that the measurement of blood flow impairment downstream from (distal to) an obstruction, which Cardiometrics calls functional angiometry, provides information to improve the quality of patient care and procedure outcomes in the diagnosis and treatment of cardiovascular disease. The FloWire/FloMap system has received clearance from the U.S. Food and Drug Administration and many corresponding European and Pacific Rim regulatory agencies. As of December 1997, more than 88,000 FloWire guide wires have been sold and cumulative FloMap shipments were approximately 623. FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-K, including, without limitation, statements containing the words "believes," "anticipates," "estimates," "expects" and words of similar import, constitute "forward-looking statements" within the meaning of Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. The Company disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained or incorporated by reference herein to reflect any events or developments. PRODUCTS EndoSonics develops and markets IVUS imaging systems and catheters and combination balloon angioplasty/IVUS imaging catheters. IVUS Imaging Products The Company's IVUS imaging products capture imaging data in a digital format, providing a platform for further enhancements of image quality and increased design flexibility in the development of new application catheters such as the Company's Five-64 catheter line. Advanced features include the following: In-Vision(TM), an enhanced Windows-like user interface, ChromaFLO(TM) imaging technology, which provides images of blood flow and 3D Resolve(TM) option, which offers a three-dimensional reconstruction of a specific region of interest in the artery. The Company believes that the In-Vision(TM)option, ChromaFLO(TM) imaging and 3D Resolve(TM) will enable easier image interpretation for purposes such as lesion differentiation and characterization. Similarly, the Company is developing various balloon versions of its five-64 catheters. ChromaFlo(TM) and 3D Resolve(TM) are currently undergoing clinical evaluation by the Company. The images produced by the Company's IVUS imaging systems are displayed on a high resolution video screen located on the digital processor, and can be permanently stored on video tape and CD-R. The systems' software can also provide immediate measurements of lumen diameter, cross-sectional area and vessel wall thickness. The systems' fluoroscopic windowing feature lets the user simultaneously display both angiography and ultrasound images on the physician interface module's video screen. The Company believes this feature gives the physician the ability to analyze and compare ultrasound and angiographic images of the same disease site, thereby facilitating a determination of the therapeutic procedure and a review of the results. 2 4 The following table lists the Company's key IVUS systems and catheters:
U.S. REGULATORY FIRST COMMERCIAL PRODUCT PRINCIPAL APPLICATION STATUS SALE ------- ------------------------ ------------------------ ---------------------- IVUS IMAGING SYSTEMS Oracle Imaging System Processes and display 510(k) Approved Q4 1995 IVUS images (U.S. and Int'l) In-Vision Enhanced user interface 510(k) Approved Q2 1996 (US and Int'l) ChromaFLO Images of blood flow 510(k) Approved Q2 1997(Int'l) Q3 1997 (U.S.) 3D Resolve Three dimensional 510(k) Applied For Q2 1997 (Int'l) representation of Expected 1998 artery IVUS IMAGING CATHETERS Diagnostic/Therapeutic Five-64 Therapeutic PTCA/IVUS imaging PMA Supplement Submitted Expected 1998 Oracle-Micro Plus PTCA/IVUS imaging PMA Supplement Approved Q3 1994 (Int'l) Q3 1995 (U.S.) Oracle-Micro/FX PTCA/IVUS Imaging Only sold outside the Q2 1995 (Int'l) U.S. Oracle Focus F/X PTCA/IVUS imaging Only sold outside the Q4 1995 (Int'l) U.S Oracle Megasonics F/X High Pressure PTCA/ IVUS Only sold outside the Q1 1996 (Int'l) imaging U.S. Oracle Megasonics High pressure PTCA/ PMA Supplement Approved Q4 1996 (U.S.) IVUS imaging Diagnostic Visions Five-64 F/X IVUS imaging 510(k) Approved Q1 1996 (U.S. and Int'l) Visions IVUS imaging 510(k) Approved Q2 1991 (US. and Int'l) Visions F/X IVUS imaging 510(k) Approved Q4 1992 (Int'l) Q1 1993 (U.S.) - --------------------------------- ------------------------ ------------------------ --------------------
PRODUCT DEVELOPMENT The Company has conducted developmental programs to refine its proprietary integrated circuit and transducer technology towards smaller and more advanced integrated circuits and transducers in order to enhance image quality. The Company has also developed IVUS-based color blood flow imaging technology ("ChromaFlo(TM)"), as well as integrated sagittal view products. The Company has also focused the advancement of its catheter technology on the expansion of the diagnostic applications of its products and the combination of its core IVUS imaging technologies with its therapeutic catheter technologies. The combination of these technologies resulted in the Oracle-Micro family of catheters for combined balloon angioplasty/ IVUS imaging in coronary arteries. The Company is continuing to develop combination diagnostic/ therapeutic catheters as well as multiple therapeutic catheters such as balloon angioplasty/site-specific drug delivery, balloon angioplasty/perfusion catheters and IVUS/radiation delivery catheters. In February 1996, the Company and Cordis Corporation entered into an Imaging/Therapeutic Combination Devices Development Agreement (the "Development Agreement") pursuant to which the parties agreed to cooperate in the development and marketing of advanced, cost effective imaging/therapeutic combination devices. The Development Agreement provides, among other things, that the parties shall jointly agree upon the specifications of the products to be developed, the budget, and the schedule for completion. Pursuant to the Development Agreement, the parties have developed an enhanced version of the Oracle(R) Megasonics(TM) catheter which combines the IVUS technology and Cordis' high-pressure Titan balloon. Cordis agreed to provide technical and manufacturing support for the development efforts and to provide certain funding payable over a period not to exceed thirty months. The Development Agreement expires upon the earlier of thirty months from the date of the Development Agreement or the completion of the products that the parties agree to develop under such agreement. EndoSonics agreed, during the term of the Development Agreement, not to enter into an agreement with any other party for the development, manufacture, or sale of a product for 3 5 use in the intracoronary ultrasound market that is similar to the products developed, if any, during the term of the Development Agreement. Substantially all of the Company's product development activities are performed by the Company's team of research scientists, engineers, technicians and consultants, who have extensive experience in ultrasound signal processing, semiconductor design, acoustics and catheter development. The Company's research, development and clinical expenditures approximated $7.1 million, $5.7 million and $6.3 million in 1995, 1996, and 1997 respectively, excluding acquired in-process research and development. The Company intends to continue to make significant investments in research and development. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Dependence on New Products; Rapid Technological Change." MANUFACTURING The Company fabricates certain proprietary components, then assembles, inspects, tests and packages all components into finished products. By designing and assembling its systems and catheter products, the Company believes it is better able to control quality and costs, limit third-party access to its proprietary technology, and manage manufacturing process enhancements and new product introductions. In addition, the Company purchases many standard and custom built components from independent suppliers, and contracts with third-parties for certain specialized electronic component manufacturing processes. Most of these purchased components and processes are available from more than one vendor. However, the manufacturing of the Five-64 integrated circuit microchips is currently performed by a single vendor. Any supply interruption from this single source vendor would have a material adverse effect on the Company's ability to manufacture its products until a new source of supply were qualified and, as a result, could have an adverse effect on the Company's business, financial condition and results of operations. Although the Company is in the process of identifying alternative vendors, the qualification of additional or replacement vendors for certain components or services is a lengthy process. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Future Operating Results -- Suppliers." The Company provides a one-year limited warranty on its imaging systems sold in the United States. System repairs are made at the customer site by a Company service technician. In addition to the one-year warranty, the customer may purchase additional warranty coverage under the Company's extended warranty program. Service on the Company's systems sold outside the United States is provided either by the Company's European service engineer or by the international distributor responsible for the customer. The Company provides its international distributors with a one-year limited warranty covering service and parts. The Company's success will depend in part on its ability to manufacture its products in compliance with GMP regulations, ISO 9000 and other regulatory requirements, in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs. In addition, the Company intends to establish an automated manufacturing process for its Visions Five-64 catheter line in Rancho Cordova, California. Manufacturers often encounter difficulties in scaling up production of new products and integrating automation equipment, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel. The Company's failure to fully integrate automation into the manufacturing process for the Visions Five-64 catheter line in a timely manner, or to timely increase production volumes of the Visions Five-64 catheter line, would materially adversely affect the Company's business, financial condition and results of operations. The Company instituted two voluntary product recalls in 1994 due to manufacturing defects in its Vision catheter line. There can be no assurance that defects will not occur in the Company's products in the future. Failure to increase production volumes in a timely or cost-effective manner or to maintain compliance with GMP, ISO 9000 and other regulatory requirements could have a material adverse effect on the Company's sales and the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Limited Manufacturing Experience." 4 6 BACKLOG The Company had a backlog of customer purchase orders for products representing approximately $0.8 million and $0.6 million as of December 31, 1996 and 1997, respectively. The Company expects that substantially all of the backlog as of December 31, 1997 will be filled within three months. Orders in backlog may be cancelled or rescheduled by customers without penalty. The Company further believes that its backlog is not necessarily indicative of Company sales for any future period. As is common in this industry, the Company's backlog is typically not significant, and a substantial majority of the product shipments in any given period relate to orders received within that period. In addition, actual product shipment depends on production capacity, manufacturing yields, and component availability, among other factors. MARKETING AND SALES The Company's products are sold in the United States, Canada and other international markets, principally Europe and Japan. The Company's strategy has been to leverage its technology by entering into distribution agreements with strategic partners, supplemented by a small direct sales force. The Company is currently a party to five such agreements. In February 1996, EndoSonics and Cordis, now a subsidiary of Johnson and Johnson, entered into an agreement pursuant to which Cordis was granted the exclusive right to distribute EndoSonics' IVUS imaging products for coronary applications in North America, Europe, Africa and the Middle East (the "Exclusive Distribution Agreement"). The Exclusive Distribution Agreement supersedes and replaces a prior distribution agreement between Cordis and EndoSonics and a prior distribution agreement between EndoSonics Nederland B.V., a wholly owned subsidiary of EndoSonics, and Cordis S.A. Cordis is obligated during each year of the Exclusive Distribution Agreement to use reasonable efforts to purchase certain minimum annual amounts of products from EndoSonics. Subject to certain exceptions, Cordis' failure to meet the minimum annual purchase amount during any year of the Exclusive Distribution Agreement shall constitute a material breach of such agreement. Cordis is also obligated during the term of the Exclusive Distribution Agreement to undertake certain efforts to market, promote, distribute and sell EndoSonics' IVUS imaging products, including the provision of adequate personnel and facilities, the maintenance of sufficient inventory for demonstration purposes and the appointment of a United States and European intracoronary ultrasound marketing manager to interface with EndoSonics' United States and European clinical and support staff. The Exclusive Distribution Agreement also contains standard representations and warranties of each party and standard provisions regarding indemnification, service and maintenance and confidentiality. Under the terms of the Exclusive Distribution Agreement, Cordis shall purchase IVUS imaging products from EndoSonics at agreed upon prices set forth in such agreement, which prices shall be jointly reviewed by EndoSonics and Cordis every six months. The Exclusive Distribution Agreement initially expires on December 31, 1998, but may be extended by the parties for successive one year periods. The Company currently believes that Cordis is unlikely to meet the minimum purchase amounts required under the Exclusive Distribution Agreement for fiscal 1998 and has engaged Cordis in discussions that would lead to amendment or termination of the Exclusive Distribution Agreement, although neither option can be assured. The failure of Cordis to meet minimum contractual purchase requirements in 1998 would have a material adverse effect on the Company's 1998 operation results in 1997, the Company entered into similar agreements with affiliates of Cordis covering Japan and certain South American countries. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Dependence on Strategic Relationships; Reliance on Cordis." Fukuda and the Company entered into a Distribution Agreement in February 1990 pursuant to which Fukuda was granted an exclusive distributorship in Japan for the Company's Oracle Imaging Systems and certain related IVUS imaging catheter products. The Distribution Agreement expired in February 1997, and Fukuda did not exercise their option to extend the Agreement for an additional term of three years. In March 1997, the company and Fukuda entered into a Distribution Transition Agreement which grants Fukuda limited distributorship rights through February 1999 on a non-exclusive basis. In March 1990, Fukuda and certain other Japanese entities acquired approximately $3.7 million of preferred stock of the Company. 5 7 In light of the Company's exclusive distribution relationship with Cordis, the Company's revenue from sales of IVUS imaging products will depend substantially on the distribution capabilities of Cordis. Further, in recent years there has been significant consolidation among medical device suppliers as the major suppliers have attempted to broaden their product lines in order to focus on product configurations that address a given procedure or treatment and in order to respond to cost pressures from health care providers. This consolidation has made it increasingly difficult for smaller suppliers, such as the Company, to effectively distribute their products without a major relationship with one of the major suppliers. There can be no assurance that the Company will be able to maintain its relationship with Cordis or replace Cordis in the event the Company's relationship with Cordis would be terminated. In the event of such a termination, the Company's ability to distribute its IVUS imaging products would be materially adversely affected, which would have a material adverse effect on the Company's business, financial condition and results of operations. The Company is in final discussions to expand the Cordis distribution to include Japan, and a number of companies in the Latin America, Asia-Pacific markets. In 1995, 1996 and 1997, total export sales were $9.9 million, $16.9 million, and $21.9 million respectively, or approximately 61%, 72%, and 66% respectively, of total product sales. In 1995, 1996 and 1997, sales to Europe accounted for $7.0 million, $9.8 million, and $11.5 million respectively, and sales to Asia represented $2.9 million, $6.7 million, and $9.3 million respectively. A significant portion of the Company's revenues, therefore, will continue to be subject to the risks associated with international sales, including economic or political instability, shipping delays, fluctuations in foreign currency exchange rates and various trade restrictions, all of which could have a significant impact on the Company's ability to deliver products on a competitive and timely basis. Future imposition of, or significant increases in the level of, customs duties, export quotas or other trade restrictions, could have an adverse effect on the Company's business, financial condition and results of operation. The regulation of medical devices, particularly in the European Community, continues to expand and there can be no assurance that new laws or regulations will not have an adverse effect on the Company. STRATEGIC RELATIONSHIPS The Company entered into a license agreement with CardioVascular Dynamics, Inc. ("CVD"), dated December 22, 1995 (the "CardioVascular Agreement"), pursuant to which CVD granted to EndoSonics a non-exclusive, royalty-free right to CVD's FOCAL technology for the development and sale of a combined FOCAL/Ultrasound product. In exchange, CVD received a non-exclusive, royalty-free right to submit PMA supplemental applications utilizing an EndoSonics PMA as a reference and to manufacture and distribute CVD products as a supplement to the EndoSonics PMA. The CardioVascular Agreement may be terminated in the event of breach upon 60 days notice by the non-breaching party, subject to the breaching party's right to cure. In the event of termination, the CVD would be prohibited from submitting new PMA supplements referencing the EndoSonics PMA and would be required to seek independent FDA approval for such products, which would have a material adverse effect on the CVD's business, financial condition and results of operations. The Company entered into a separate license agreement with CVD on February 6, 1996, pursuant to which EndoSonics granted to CVD a non-exclusive, royalty-free right and license to use and reference the EndoSonics PMA to enable CVD to file for and obtain PMA approval for coronary balloon dilatation catheters from the FDA. The remaining terms of the February 6, 1996 agreement are substantially identical to the terms of the Cardiovascular Agreement described above. COMPETITION The Company believes that the primary competitive factors in the market for IVUS imaging devices are: image quality, catheter size, flexibility and trackability, ease of use, reliability and price. In addition, a company's distribution capability and the time in which products can be developed and receive regulatory approval are important competitive factors. Certain of the Company's competitors have developed IVUS imaging products with high quality images. Therefore, the Company believes that its competitive position is dependent upon its ability to establish its reputation as a producer of high quality imaging products. The 6 8 Company's IVUS catheters compete with mechanical ultrasound devices manufactured by Cardiovascular Imaging Systems, a subsidiary of Boston Scientific Corporation ("CVIS"), and the Hewlett-Packard Company ("Hewlett-Packard"). Both CVIS and Hewlett-Packard are significantly larger than the Company, have significantly greater financial, marketing and technical resources available. Although the Company believes that these companies are not currently marketing or clinically testing combined coronary balloon angioplasty/IVUS imaging catheters, there can be no assurance that they will not attempt to develop and market catheters in the future that would compete with the Company's combination products. Moreover, companies currently engaged in the manufacture and marketing of non-imaging balloon angioplasty catheters could attempt to expand their product lines to include combination balloon angioplasty/IVUS imaging products. Other companies could also attempt to enter the market with competitive devices. Many of the Company's competitors and potential competitors have substantially greater financial, manufacturing, marketing, distribution and technical resources. Competition in the market for devices used in the treatment of cardiovascular and peripheral vascular disease is intense, and is expected to increase. The interventional cardiology market is characterized by rapid technological innovation and change, and the Company's products could be rendered obsolete as a result of future innovations. The Company's non-imaging catheters and combination balloon angioplasty/IVUS imaging catheters compete with non-imaging balloon angioplasty catheters marketed by a number of manufacturers, including ACS, a subsidiary of Guidant Corporation, SciMed Life Systems, Inc., a subsidiary of Boston Scientific Corporation ("SciMed"), Cordis, Medtronic, and Schneider. Such companies have established market positions, substantial resources, and significantly larger sales and marketing organizations. In addition, the Company faces competition from manufacturers of atherectomy devices, vascular stents and pharmaceutical products intended to treat cardiovascular disease. THIRD-PARTY REIMBURSEMENT In the United States, the Company's products are purchased primarily by medical institutions, which then bill various third-party payors, such as Medicare, Medicaid, and other government programs and private insurance plans, for the health care services provided to patients. Government agencies, private insurers and other payors determine whether to provide coverage for a particular procedure and reimburse hospitals for medical treatment at a fixed rate based on the diagnosis-related group ("DRG") established by the U.S. Health Care Financing Administration ("HCFA"). The fixed rate of reimbursement is based on the procedure performed, and is unrelated to the specific type or number of devices used in a procedure. If a procedure is not covered by a DRG, payors may deny reimbursement. In addition, some payors may deny reimbursement if they determine that the device used in a treatment was unnecessary, inappropriate or not cost-effective, experimental or used for a non-approved indication. Currently, there are no established DRGs specifically covering IVUS imaging procedures. Reimbursement for the equipment and hospital expense of an angioplasty procedure is covered under a DRG, but because the amount of reimbursement is fixed, the amount of potential profit relating to the procedure is reduced to the extent the physician performs additional procedures such as IVUS Imaging or uses a more expensive product which combines ultrasound imaging with therapeutic capabilities. Beginning in January 1997, HCFA implemented a policy in which the physician will receive payment for the additional effort required to obtain ultrasound images and interpret those images when imaging is performed in conjunction with a therapeutic intervention. The level of payment for this physician fee component may be less than the incremental cost of the IVUS imaging and, therefore, physicians must determine that the clinical benefits of intravascular ultrasound imaging justify the additional cost. On April 1, 1996, the Japanese Ministry of Health approved reimbursement for IVUS-based procedures. The reimbursements cover both the cost of the physician and the cost of the devices. The market for the Company's products could be adversely affected by changes in governmental and private third-party payors' policies. Capital costs for medical equipment purchased by hospitals are currently reimbursed separately from DRG payments. Federal legislation reduced capital cost reimbursements under the Medicare capital cost pass-through system. The legislation requires that the aggregate amount of 7 9 reimbursements in fiscal years 1992 through 1995 be reduced by approximately 10% per year. Such reductions have had an adverse impact on reimbursements to hospitals for the capital cost of equipment such as the Oracle Imaging System. Although the Company believes that less invasive procedures generally provide less costly overall therapies as compared to alternative surgical procedures, there can be no assurance that reimbursement for procedures using the Company's products will be available or, if currently available, will continue to be available, or that future reimbursement policies of payors will not adversely affect the Company's ability to sell its products on a profitable basis. Failure by hospitals and other users of the Company's products to obtain reimbursement from third-party payors, or changes in government and private third-party payors' policies toward reimbursement for procedures employing the Company's products, would have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, the Company is unable to predict what additional legislation or regulation, if any, relating to the health care industry or third-party coverage and reimbursement may be enacted in the future, or what effect such legislation or regulation would have on the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Limitations on Third-Party Reimbursement." GOVERNMENT REGULATION United States. The manufacturing and marketing of the Company's products are subject to extensive and rigorous government regulation in the United States. The process of obtaining and maintaining required regulatory approvals is lengthy, expensive and uncertain. The Company believes that its success will be significantly dependent upon commercial sales of improved versions of its imaging systems and catheter products. The Company will not be able to market these new products in the United States unless and until the Company obtains approval from the FDA. If a medical device manufacturer can establish that a newly developed device is "substantially equivalent" to a device that was legally marketed prior to May 1976, or to a device that the FDA has found to be substantially equivalent to a legally marketed pre-1976 device, the manufacturer may seek clearance from the FDA to market the device by filing a premarket notification with the FDA under Section 510(k). A 510(k) premarket notification must be supported by appropriate data establishing the claim of substantial equivalence to the satisfaction of the FDA. Clearance under 510(k) normally takes at least three months and may require submission of clinical safety and efficacy data to the FDA. There can be no assurance that 510(k) clearance for any future product or modification of an existing product will be granted or that the process will not be unduly lengthy. In the future, the FDA will require manufacturers of certain medical devices introduced prior to 1976 to present additional safety and effectiveness data or face restrictions on the sale of these products, including the possible withdrawal of such devices from the market. All of the 510(k) clearances received for the Company's products were based on substantial equivalence to legally marketed pre-1976 devices. Review of the substantially equivalent pre-1976 devices on which the 510(k) clearances for the Company's catheters were based and any resulting restrictions on the Company or requirements imposed to present additional data could have a material adverse effect on the Company's business, financial condition and results of operations. If substantial equivalence cannot be established, or if the FDA determines that the device or the particular application for the device requires a more rigorous review, the FDA will require that the manufacturer submit a pre-market approval ("PMA") application that must be reviewed and approved by the FDA prior to sales and marketing of the device in the United States. The PMA process is significantly more complex, expensive and time consuming than the 510(k) clearance process and frequently requires submission of clinical data. It is expected that certain of the Company's combination balloon angioplasty/IVUS imaging products under development will be subject to this PMA process. There can be no assurance that PMA approval for any future product or modification of an existing product will be granted or that the process will not be unduly lengthy. Failure to comply with applicable regulatory requirements can, among other consequences, result in fines, injunctions, civil penalties, suspensions or loss of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution. In addition, governmental regulations may be established that could prevent or delay regulatory approval of the Company's products. 8 10 Delays in receipt of approvals, failure to receive approvals or the loss of previously received approvals would have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also required to register as a medical device manufacturer with the FDA and certain state agencies, such as the Food and Drug Branch of the California Department of Health Services ("CDHS"). As such, the Company is inspected on a routine basis by both the FDA and the CDHS for compliance with the FDA's Good Manufacturing Practices ("GMP") regulations. These regulations require that the Company manufacture its products and maintain related documentation in a prescribed manner with respect to manufacturing, testing and control activities. Further, the Company is required to comply with various FDA requirements for labeling. The Medical Device Reporting regulation requires that the Company provide information to the FDA on deaths or serious injuries alleged to have been associated with the use of its devices, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. In addition, the FDA prohibits an approved device from being marketed for unapproved applications. Specifically, the Company's FOCAL balloon catheters are approved in certain European countries, where the Company believes these catheters are being used principally for deployment of coronary stents and balloon angioplasty. In October 1995, EndoSonics received FDA approval to market CVD's line of FACT catheters, which utilize the FOCAL technology, for coronary balloon angioplasty. These catheters may not be marketed by the Company in the United States for stent deployment without further FDA approval. If the FDA believes that a company is not in compliance with the law, it can institute proceedings to detain or seize products, issue a recall, prohibit marketing and sales of the company's products and assess civil and criminal penalties against the company, its officers or its employees. The Company is also subject to other federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices. The extent of government regulation that might result from any future legislation or administrative action cannot be accurately predicted. Failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Products." International. International sales of the Company's products are subject to the regulatory agency product registration requirements of each country. The regulatory review process varies from country to country and may in some cases require the submission of clinical data. The Company typically relies on its distributors in such foreign countries to obtain the requisite regulatory approvals. Distributors have obtained regulatory approval for certain products in certain European countries and Japan and have applied for additional approvals. There can be no assurance, however, that such approvals will be obtained on a timely basis or at all. The Company is in the process of implementing policies and procedures which are intended to allow the Company to receive ISO 9001 qualification of its processes and CE mark certifications. The ISO 9000 series of standards for quality operations has been developed to ensure that companies know the standards of quality to which they must adhere to receive certification. The European Union has promulgated rules which require that medical products receive, by mid-1998, the right to affix the CE mark, an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. ISO 9000 certification is one of the CE mark certification requirements. Failure to receive the right to affix the CE mark will prohibit the Company from selling its products in member countries of the European Union. In Europe, the Company has obtained ISO 9002 as of January 1997. The Company has received ISO 9001 certification of its facilities in the United States for manufacture and development at their facility in Rancho Cordova. There can be no assurance that the Company will be successful in meeting ongoing certification requirements. PATENTS AND PROPRIETARY INFORMATION The Company's policy is to protect its proprietary position by, among other methods, filing U.S. and foreign patent applications to protect technology, inventions and improvements that are important to the development of its business. The Company holds 34 U.S. and 11 foreign issued patents; 12 are EndoSonics, three are Du-MED, and 30 are Cardiometrics. The Company has other U.S. and foreign patent applications 9 11 pending covering various aspects of its technology. The first issued U.S. patent covers IVUS imaging catheters, including IVUS balloon catheters, in which multiple transducer elements are electronically controlled by integrated circuits or other means mounted near the transducer elements in the catheter. This patent expires in April 2007. Two patents cover aspects of catheter design technology used by the Company in its Oracle-Micro catheters. A fourth patent covers improvements to the IVUS imaging system which enables it to obtain images closer to the transducer surface. The fifth patent covers modifications to the catheter tip transducer technology. The sixth patent covers a method and apparatus for imaging blood flow using an ultrasound catheter. Eleven additional patent applications have been submitted to the U.S. Patent Office and additional patent applications have been submitted to international agencies for review. The basic patent for the Du-MED micromotor technology was issued by the U.S. Patent Office in January 1993. Additional patents covering this technology were subsequently issued in August 1993 and December 1994. Additional U.S. and foreign patent applications have been filed. No assurance can be given that pending patent applications will be approved, or that any issued patents will provide competitive advantages for the Company's products, or that they will not be challenged or circumvented by competitors. The Company is currently involved in litigation with Intravascular Research Limited ("IRL") regarding certain of the Company's technology. (See "Legal Proceedings.") The Company relies upon trade secrets, technical know-how and continuing technological innovation to develop and maintain its competitive position. The Company typically requires its employees, consultants and advisors to execute appropriate confidentiality and assignment of inventions agreements in connection with their employment, consulting or advisory relationships with the Company. There can be no assurance, however, that these agreements will not be breached, or that the Company will have adequate remedies for any breach. Furthermore, no assurance can be given that competitors will not independently develop substantially equivalent proprietary information and techniques, or otherwise gain access to the Company's proprietary technology, or that the Company can meaningfully protect its unpatented proprietary technology. The interventional cardiology market in general and the market for balloon angioplasty catheters in particular, has been characterized by substantial litigation regarding patent and other intellectual property rights. In the event that any relevant claims of third-party patents are upheld as valid and enforceable, the Company could be prevented from utilizing the subject matter claimed in such patents, or would be required to obtain licenses from the patent owners of any such patents, or redesign its products or processes to avoid infringement. There can be no assurance that such licenses would be available or, if available, would be so on terms acceptable to the Company, or that the Company would be successful in any attempt to redesign its products or processes to avoid infringement. Additional litigation may be necessary to defend against claims of infringement, to enforce patents issued to the Company, or to protect trade secrets, and could result in substantial cost to, and diversion of effort by, the Company. PRODUCT LIABILITY AND INSURANCE Medical device companies are subject to a risk of product liability and other liability claims in the event that the use of their products results in personal injury claims. Although the Company has not experienced any product liability claims to date, any such claims could have an adverse impact on the Company. The Company maintains liability insurance with coverage of $1.0 million per occurrence and an annual aggregate maximum of $5.0 million. There can be no assurance that product liability or other claims will not exceed such insurance coverage limits, or that such insurance will continue to be available on commercially acceptable terms, or at all. EMPLOYEES As of December 31, 1997, the Company had 300 employees, including 196 in manufacturing, 51 in research, development and regulatory affairs, 31 in sales and marketing, and 22 in administration. The Company believes that the success of its business will depend, in part, on its ability to attract and retain qualified personnel. 10 12 ITEM 2. PROPERTIES Currently, the Company leases approximately 59,000 square feet in Rancho Cordova, California, which is leased through the year 2006. The Company also leases approximately 4,100 square feet in The Netherlands for its European operations, which lease expires at the end of the year 2001. In connection with the acquisition of Cardiometrics, the Company obtained 16,000 square feet in Mountain View, California, which is leased through March 1998. Upon expiration of the Mountain View lease the Company's domestic operations will be consolidated at the Rancho Cordova facility. In April 1997, the Company closed its Pleasanton, California facility and consolidated the manufacturing operations conducted there at its Rancho Cordova facility. ITEM 3. LEGAL PROCEEDINGS In August 1997, the Company sued Intravascular Research Limited ("IRL") in the Superior Court of the State of California for the County of Sacramento for misappropriation of trade secrets. The Company's complaint alleged that IRL had misappropriated certain confidential information received from the Company, and sought a court order requiring IRL to assign to the Company all rights in all IRL patent applications and issued patents worldwide based on the misappropriated technology. In March 1998, the Company dismissed the Complaint without prejudice. In September 1997, IRL sued the Company in the United States District Court, District of Delaware, accusing the Company of infringing one of IRL's imaging patents, seeking a declaration of invalidity and non-infringement with respect to one of the Company's patents, and requesting a declaratory judgment that it has not misappropriated the Company's trade secrets. In February 1998, the Court dismissed IRL's declaratory relief cause of action. In March 1998, the Company counterclaimed and accused IRL of infringing two of its imaging patents. The Company also sought a declaration of invalidity and non-infringement with respect to the patent IRL had accused the Company of infringing, as well as to correct IRL's claim of inventorship relating to this patent. In late-March, IRL counterclaimed and accused the company of infringing an additional two of its imaging patents, and sought a declaration of invalidity and non-infringement with respect to the second patent the Company had asserted. IRL further sought to reinstitute its declaratory relief cause of action relating to trade secret misappropriation. The Company anticipates seeking a declaration of invalidity and non-infringement with respect to the additional two patents asserted by IRL, and moving to dismiss IRL's non-misappropriation declaratory relief cause of action for lack of subject matter jurisdiction. The Company is also subject to various other legal actions and claims arising in the ordinary course of business. Management believes the outcomes of these matters will have no material adverse effect on the Company's financial position, results of operations or cash flows. 11 13 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company, their ages as of February 28, 1998, and their positions are as follows:
NAME AGE POSITION ---- --- -------- Roger Salquist...... 56 Chairman of the Board Reinhard J. 49 President, Chief Executive Officer and Director Warnking.......... Thomas E. Black..... 42 Vice President, Systems and Wire Manufacturing Dr. Hans P. de 51 Senior Vice President, European Operations Weerd............. Michael J. Eberle... 41 Senior Vice President, Engineering and Chief Technical Officer Richard L. 56 Vice President, Finance and Chief Financial Officer Fischer........... Donald V. Fraley.... 41 Vice President, Sales and Marketing Adam D. Savakus..... 41 Vice President, Quality Assurance, Clinical and Regulatory Affairs Michael J. Sorna.... 55 Vice President, Sales and Marketing, European Operations Clifford R. 47 Vice President, Catheter Manufacturing and Development Varney............ Oti M. Wooster...... 45 Vice President, Human Resources and Administration
BACKGROUND The principal occupations of each executive officer and key employee of the Company for at least the last five years are as follows: ROGER SALQUIST. Mr. Salquist was appointed Chairman of the Board in November of 1996. Since March 1997, Mr. Salquist has been a partner in Bay City Capital, a life sciences merchant banking firm. Mr. Salquist served as Chairman and Chief Executive Officer of Calgene, Inc., a Davis, California-based agribusiness biotechnology company, from 1984 through August 1996. He also served on the Board of Directors of Collagen Corporation from 1988 through October 1997 and on the Board of Celtrix Pharmaceuticals, Inc. from 1990 through 1996, serving as its Chairman from 1993 through 1995. Mr. Salquist serves on the Advisory Council of the Stanford University Graduate School of Business and is a member of the Board of Trustees of the University of San Francisco. REINHARD J. WARNKING. Mr. Warnking joined EndoSonics in 1993 as a director, President and Chief Operating Officer. Mr. Warnking was appointed Chief Executive Officer on February 1, 1995. He was the President and Chief Executive Officer of Acoustic Imaging Technology Corporation, a manufacturer of ultrasound and transducer systems, from August 1991 to March 1993. From February 1989 to September 1990, he founded and operated Warnking Medizintechnik GmbH, which was acquired by Dornier Medizintechnik GmbH in September 1990. After the acquisition, Mr. Warnking founded and managed the ultrasound division of Dornier Medizintechnik. From August 1985 to February 1989, he held positions as Technical Director, General Manager and Vice President International for Squibb Medical Systems and Advanced Technology Laboratories (ATL). THOMAS E. BLACK. Mr. Black joined the Company as Test Engineering Manager in August 1988. In 1989 he became Manager of Systems Manufacturing and was promoted to Director of Systems Manufacturing in 1993. In January 1996, he was appointed Vice President of Systems Manufacturing, with primary responsibility of managing the Company's ultrasound system related departments. Prior to joining EndoSonics Mr. Black held technical positions within the ultrasound division of General Electric Medical Systems. DR. HANS P. DE WEERD. Dr. de Weerd became Senior Vice President and Managing Director of European Operations effective September 1994. Previously, he was the Managing Director of Du-MED BV, a Dutch company which the Company acquired, from June 1993 to August 1994. Prior to joining Du-MED, he 12 14 was the Managing Director of EME GmbH, a transcranial Doppler ultrasound company which he acquired for Nicolet Instrument Corporation in July 1992. From April 1983 until July 1992, Dr. De Weerd was with Nicolet Instrument Corporation, a division of Thermo Electron Corporation, in a variety of research and development, new business and general management positions. MICHAEL J. EBERLE. Mr. Eberle joined the Company as Director of Engineering in January 1985. In December 1985, he became a Vice President and Director of Research, with primary responsibility for the development of the Company's products. In 1992, Mr. Eberle became Senior Vice President, Engineering and Chief Technical Officer. Prior to joining EndoSonics, Mr. Eberle served as an independent consultant, Manager of Electronic Research and Development at Second Foundation, an ultrasound imaging company, and as a scientist at GEC Hirst Research Center in the United Kingdom. RICHARD L. FISCHER. Mr. Fischer joined the Company in November 1997 as Vice President, Finance, and Chief Financial Officer. From August 1996 to August 1997 he was Vice President and Chief Financial Officer of Calydon, Inc., an emerging biopharmaceutical company developing therapeutics for the treatment of prostate cancer. From October 1989 to August 1996, Mr. Fischer was Vice President and Chief Financial Officer of Microgenics Corporation, a manufacturer of immunoassays for medical diagnostics. Prior to joining Microgenics, he was Vice President, Finance and Chief Financial Officer for Verilink Corporation, a manufacturer of telecommunications equipment. DONALD V. FRALEY. Mr. Fraley joined the Company in February 1995, and was appointed Vice President of Sales and Marketing in March 1995. Previously he was the Executive Director of Marketing of Karl Storz Endoscopy America, a company which manufactures and markets endoscopic products, joining them in August 1992. From June 1983 to July 1992, he held various marketing and sales positions with Baxter Healthcare Corporation. ADAM D. SAVAKUS. Mr. Savakus was appointed Vice President, Clinical and Regulatory Affairs and Quality Assurance in January 1996. Previously, Mr. Savakus was Director of Clinical and Regulatory Affairs since January 1990. Mr. Savakus was a founding member of EndoSonics and joined the company as a Research Scientist. Between 1984 and 1990, Mr. Savakus served as Manager of Technical Affairs and as Manager of Project Development. Prior to joining EndoSonics, Mr. Savakus was a research scientist at Second Foundation, an ultrasound imaging company. MICHAEL J. SORNA. Mr. Sorna joined the Company in July 1997 as Vice President, Sales and Marketing, Europe. Previously, he was Vice President of International Sales and Operations for Cardiometrics, Inc. (January 1994 -- July 1997), Vice President of Sales and Marketing (June 1991 -- January 1994), and was responsible for the worldwide launch of the Doppler FloWire. Mr. Sorna was Director of Sales for CVIS, Inc. from March 1989 to June 1991 and was responsible for the worldwide launch of their Intravascular Ultrasound Imaging System. Mr. Sorna comes to us with over 25 years experience in the cardiovascular market at senior management and sales/marketing management levels. CLIFFORD R. VARNEY. Mr. Varney became Vice President of Catheter Development and Manufacturing in March 1994. He joined the Company in October 1990 as Director of Catheter Manufacturing. Prior to joining the Company, Mr. Varney was the Vice President, Manufacturing of BSW Technologies, a private automated equipment manufacturing and consulting company from September 1984 to October 1990. OTI M. WOOSTER. Ms. Wooster joined the Company in April 1997 as Vice President, Human Resources and Administration. She is responsible for directing the Company's human resources, facilities and administration activities. From 1994 to 1997, Ms. Wooster was Director, Human Resources and Operations for U.S. West Cellular, a multinational telecommunications company. From 1987 to 1994, she was Vice President, Human Resources and Administration for Government Technology Services, Inc., the world's largest seller of computer products and services to the federal government. Prior to 1987, Ms. Wooster was a member of the Executive Staff, and Cabinet member at Northern Telecom. She held various line, human resources and administration management positions in both domestic and international levels there and at General Electric Corporation. 13 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock has been traded on the Nasdaq National Market under the symbol "ESON" since the Company's initial public offering in March 1992. The following table sets forth the high and low sales prices for the Common Stock for the periods indicated, as reported on the Nasdaq National Market.
HIGH LOW ------ ------ 1996 First Quarter.............................................. $18.63 $12.50 Second Quarter............................................. 19.50 14.50 Third Quarter.............................................. 17.75 11.88 Fourth Quarter............................................. 15.31 9.56 1997 First Quarter.............................................. $15.38 $ 9.25 Second Quarter............................................. 12.25 8.00 Third Quarter.............................................. 15.88 10.50 Fourth Quarter............................................. 15.13 8.50
On March 20, 1998, the last reported sale price of the Common Stock as reported on the Nasdaq National Market was $10.06 per share. As of March 20, 1998, there were approximately 187 holders of record of the Company's Common Stock. DIVIDEND POLICY The Company declared a dividend for all shareholders of record on September 5, 1997 of .04 shares of Common Stock of CardioVascular Dynamics, Inc. (CCVD) for each outstanding EndoSonics share. The dividend was distributed on September 26, 1997. The Company has never declared or paid any cash dividends on its capital stock. The Company currently intends to retain any earnings to finance future growth and does not anticipate paying any cash dividends in the foreseeable future. 14 16 ITEM 6. SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, --------------------------------------------------- 1993 1994 1995 1996 1997 -------- -------- -------- ------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF OPERATIONS REVENUES: Product sales.............................. $ 4,165 $ 6,665 $ 16,175 $23,542 $ 33,141 License fee................................ -- 1,000 -- -- -- Contract revenue........................... 500 353 962 831 856 -------- -------- -------- ------- -------- Total revenue.............................. 4,665 8,018 17,137 24,373 33,997 Cost of sales................................ 4,058 4,716 11,270 15,688 17,962 -------- -------- -------- ------- -------- Gross margin............................... 607 3,302 5,867 8,685 16,035 -------- -------- -------- ------- -------- OPERATING EXPENSES: Acquired in-process research, development and clinical............................ 2,000 2,315 488 -- 43,000 Other research, development and clinical... 3,938 8,445 7,127 5,746 6,309 Marketing and sales........................ 2,961 4,056 5,096 5,411 6,068 General and administrative................. 2,432 2,854 4,516 4,821 5,840 Restructuring.............................. -- -- -- 518 4,956 Amortization of intangibles................ -- -- -- -- 475 -------- -------- -------- ------- -------- Total operating expenses..................... 11,331 17,670 17,227 16,496 66,648 -------- -------- -------- ------- -------- Loss from operations......................... (10,724) (14,368) (11,360) (7,811) (50,613) Equity in net loss of CardioVascular Dynamics, Inc.............................. -- -- -- (1,621) (2,358) Other income (expense): Interest income............................ 1,669 1,124 888 2,269 1,881 Gain realized on equity investment in CardioVascular Dynamics, Inc............ -- -- -- -- 4,021 -------- -------- -------- ------- -------- Total other income, net...................... 1,669 1,124 888 2,269 5,902 -------- -------- -------- ------- -------- Net loss before provision for income taxes... (9,055) (13,244) (10,472) (7,163) (47,069) Provision for income taxes................... -- -- -- -- 175 -------- -------- -------- ------- -------- Net loss..................................... $ (9,055) $(13,244) $(10,472) $(7,163) $(47,244) -------- -------- -------- ------- -------- Basic net loss per share..................... $ (0.99) $ (1.38) $ (1.01) $ (0.53) $ (3.22) -------- -------- -------- ------- -------- Shares used in computing basic net loss per share...................................... 9,166 9,584 10,387 13,395 14,670
AS OF DECEMBER 31, --------------------------------------------------- 1993 1994 1995 1996 1997 -------- -------- -------- ------- -------- BALANCE SHEET DATA: Cash, cash equivalents and short-term investments................................ $ 30,997 $ 20,410 $ 44,395 $40,192 $ 23,009 Working capital.............................. 32,047 23,517 49,872 44,676 30,146 Convertible obligation....................... -- -- 750 -- -- Total assets................................. 35,280 28,295 56,953 72,039 62,807 Total stockholders' equity................... 33,155 22,268 48,155 66,067 49,254
In 1997 the Company adopted Statement of Financial Accounting Standard No. 128, Earnings per Share (SFAS No. 128). SFAS No. 128 requires that reported earnings per share amounts prior to 1997 be restated to comply with SFAS No. 128. The adoption of SFAS No. 128 did not have a material impact on the Company's loss per share in any of the years presented. For further discussion of earnings per share and the impact of SFAS No. 128, see the Notes to the consolidated financial statements. 15 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Annual Report on Form 10-K contains forward looking statements which involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors" beginning on page [20]. INTRODUCTION Since its inception in 1984, EndoSonics has been engaged primarily in the research and development of products for the diagnosis and treatment of cardiovascular disease. Since 1991, a majority of the Company's net revenue has been derived from sales of its IVUS imaging systems and catheters. The Company markets and distributes its IVUS imaging products in the United States, Europe and Japan through relationships with strategic partners, certain other distributors and, to a lesser extent, through a direct sales force. In February 1996, EndoSonics and Cordis entered into the Exclusive Distribution Agreement pursuant to which Cordis was granted the exclusive right to distribute EndoSonics' IVUS imaging products for coronary applications in North America, Europe, Africa and the Middle East. Cordis is obligated during each year of the Exclusive Distribution Agreement to use reasonable efforts to purchase certain minimum annual amounts of products from EndoSonics. Subject to certain exceptions, Cordis' failure to meet the minimum annual purchase amount during any year of the Exclusive Distribution Agreement shall constitute a material breach of such agreement. Cordis is also obligated during the term of the Exclusive Distribution Agreement to undertake certain efforts to market, promote, distribute and sell EndoSonics' IVUS imaging products, including the provision of adequate personnel and facilities, the maintenance of sufficient inventory for demonstration purposes and the appointment of a United States and European intracoronary ultrasound marketing manager to interface with EndoSonics' United States and European clinical and support staff. The Exclusive Distribution Agreement also contains standard representations and warranties of each party and standard provisions regarding indemnification, service and maintenance and confidentiality. Under the terms of the Exclusive Distribution Agreement, Cordis shall purchase IVUS imaging products from EndoSonics at agreed upon prices set forth in such agreement, which prices shall be jointly reviewed by EndoSonics and Cordis every six months. The Exclusive Distribution Agreement initially expires on December 31, 1998, but may be extended by the parties for successive one-year periods. The Company currently believes that Cordis is unlikely to meet the minimum purchase amounts required under the Exclusive Distribution Agreement for fiscal 1998 and has engaged Cordis in discussions that would lead to amendment or termination of the Exclusive Distribution Agreement, although neither option can be assured. The failure of Cordis to meet minimum contractual purchase requirements in 1998 would have a material adverse effect on the Company's 1998 operation results. The failure of Cordis to meet minimum contractual purchase requirements in 1998 would have a material adverse effect on the Company's 1998 operating results. In connection with the execution of the Exclusive Distribution Agreement, the Company issued 350,877 shares of its Common Stock to Cordis in a private placement transaction for an aggregate purchase price of approximately $5,000,000. The Company has since registered the shares of Common Stock issued to Cordis. In 1997, the Company entered into similar agreements with affiliates of Cordis covering Japan and certain South American countries. CardioVascular Dynamics, Inc., ("CVD") formerly an 84%-owned subsidiary of the Company, designs, develops, manufactures and markets catheters used to treat certain vascular diseases. CVD's catheters are used in conjunction with angioplasty and other interventional procedures such as vascular stenting and drug delivery. CVD completed its initial public offering in June of 1996 and, as a result, its assets, liabilities and results of operations are no longer included in the Company's consolidated financial statements. At December 31, 1997, the Company held approximately 24% of the outstanding shares of the Common Stock of CVD and accounted for its investment on the equity method. The Company's business strategy includes acquiring related businesses, products or technologies. In January 1997, the Company entered into an agreement to acquire Cardiometrics, Inc. (Cardiometrics) 16 18 through the merger of a wholly-owned subsidiary of the Company with and into Cardiometrics, with Cardiometrics surviving as a wholly-owned subsidiary of the Company. Cardiometrics develops, manufactures, and markets intravascular medical devices to measure blood flow impairment caused by coronary artery disease. Cardiometrics' primary products, the FloWire(R) Doppler guide wire and FloMap ultrasound intsrument, represent an advance in functional testing of blood flow impairment, enabling cardiologists to evaluate the appropriateness of angioplasty interventions and assess post-procedural results directly in the cardiac catherization laboratory. Clinical experience demonstrates that the measurement of blood flow impairment downstream from (distal to) an obstruction, which Cardiometrics calls functional angiometry, provides information to improve the quality of patient care and procedure outcomes in the diagnosis and treatment of cardiovascular disease. The FloWire(R)/FloMap system has received clearance from the FDA and many corresponding European and Pacific Rim regulatory agencies. Cardiometrics has also developed the WaveWire(TM)/WaveMap intracoronary blood pressure measurement system, which was first used in a clinical case in Europe in December 1996. Cardiometrics received a 510(k) approval in August 1997 and expects the product will be available for sale as early as the first quarter of 1998. The Acquisition of Cardiometrics, which was finalized on July 23, 1997, was accounted for under the purchase method of accounting. The Company incurred a $43 million dollar in-process research and development charge as a result of the acquisition and $8.6 million in restructuring, integration and other non-merger charges in connection with plans to reduce overhead of the combined companies. The Company expects that it may pursue additional acquisitions in the future. Any future acquisitions may result in potentially dilutive issuances of equity securities, the write-off of in-process research and development, the incurrence of debt and contingent liabilities and amortization expenses related to intangible assets acquired, any of which could materially adversely affect the Company's business financial condition and results of operations. In particular, if the Company is unable to use the "pooling of interests" method of accounting, the Company will be required to amortize any intangible assets acquired in connection with any additional acquisitions and the amortization periods for such costs will be over the useful lives of such assets, which range from three years to eight years. Additionally, unanticipated expenses may be incurred relating to the integration of technologies and research and development, and administrative functions. Any acquisition will involve numerous risks, including difficulties in the assimilation of the acquired company's employees, operations and products, uncertainties associated with operating in new markets and working with new customers, the potential loss of the acquired company's key employees as well as the costs associated with completing the acquisition and integrating the acquired company. In 1993, the Company introduced both its Oracle Imaging System, a platform upgrade from its previous system, and enhanced imaging catheters. The Company also commenced the Pinnacle Development Project, which involved the development of new IVUS technology and resulted in the Five-64 catheter line and an enhanced Oracle Imaging System. The Company began commercial sales of the enhanced Oracle Imaging System in the fourth quarter of 1995 and began commercial sales of the Five-64 catheter line in the first quarter of 1996. See "Business -- Manufacturing". The Company's financial results will be affected in the future by certain factors, including the scaling up of manufacturing for the Company's Five-64 catheter line, market acceptance of the Company's new products and the revenue mix between sales of imaging systems and catheters and changes in government regulation regarding third-party reimbursement applicable to the Company's System and Products. See "Management's Discussion and Analysis of Financial Condition and Results of Operation." 17 19 RESULTS OF OPERATIONS Comparison of the Year Ended December 31, 1997 with the Year Ended December 31, 1996 CardioVascular Dynamics' results of operations were consolidated in the Company's results through June 19, 1996, and accounted for on the equity method thereafter. Cardiometrics' results of operations were consolidated in the Company's results of operations beginning July 24, 1997. (See Notes 3 and 4 to Consolidated Financial Statements.)
1997 1996 ------- ------- Revenue EndoSonics............................. $27,207 $20,539 CardioVascular Dynamics................ -- 3,834 Cardiometrics.......................... 6,790 -- ------- ------- Total.......................... $33,997 $24,373 ======= =======
Total Revenue. Total revenue in 1997 increased by 39% to approximately $34.0 million from $24.4 million in 1996. The increase is a result of the Cardiometrics acquisition, which resulted in an additional $6.8 million in revenue. In addition, IVUS revenue increased $6.6 million, primarily in Europe and Japan. Sales of the Company's digital all-electronic IVUS imaging system and catheters accounted for approximately 78% of total revenue and a 32% increase over 1996 results. The increase is due both to the growth of the overall market for IVUS imaging products and increased sales under the Company's distribution agreements with Cordis and Fukuda. Total revenue from Cardiometrics was approximately $6.8 million for the period from the acquisition, July 23, 1997 through December 31, 1997. Total CardioVascular Dynamics revenue was approximately $3.8 million in 1996. There was no CVD revenue included in 1997. Currently, a majority of the Company's sales of IVUS products consists of sales of IVUS imaging systems. The sales of IVUS imaging catheters as a percentage of total IVUS sales has increased from 30% in 1996 to 42% in 1997 due to the increase in the Company's installed base. In 1997, export sales as a percentage of total revenue decreased to 64% as compared to 69% in 1996, as domestic sales increased at a greater rate than export sales. The Company currently anticipates that export sales will continue to represent a substantial portion of the Company's total revenue in future periods. Cost of Product Sales. Cost of product sales as a percentage of product sales decreased to approximately 52% from approximately 63% in 1996. Cost of sales as a percentage of product sales in 1997 was reduced principally by volume increases and improved manufacturing efficiencies, as well as favorable margins on Cardiometrics products. Gross profit margins on product sales improved to 48% in 1997 as compared to 37% in 1996. Due to the uncertainty associated with continued improvements in efficiency of the Company's manufacturing process and the impact of increasingly competitive pricing, there can be no assurance that the Company's gross profit margin will be maintained or continue to improve in future periods. Acquired In-Process Research and Development Write-Off. In connection with the Company's acquisition of Cardiometrics, the Company engaged an independent appraiser to provide the Company with a recommendation of value for certain assets acquired. Based on this valuation analysis, $43 million of the purchase price has been assigned to in-process research and development. Because the technological feasibility of the acquired in-process research and development has not been established and has no alternative uses, it was expensed in the third quarter of 1997. Although the Company is in the process of evaluating its research and development projects, it is expected that future expenditures of over $5 million will be necessary to develop the acquired technology into commercial products. Other Research, Development and Clinical. Other research, development and clinical expenses increased 10% to $6.3 million in 1997 from approximately $5.7 million in 1996. Cardiometrics portion of research, development and clinical expense for 1997 was approximately $1.9 million. 18 20 Marketing and Sales. Marketing and sales expenses increased 12% to approximately $6.1 million from $5.4 million in 1996, primarily due to increased staffing and marketing programs related to the acquisition of Cardiometrics. After adjusting for $0.5 million in integration charges in 1997, marketing and sales remained constant. As a percentage of total revenue, marketing and sales expenses decreased to 18% as compared to 22% in 1996. The Company expects marketing and sales expenses to increase in anticipation of the expiration of the Cordis Agreements at the end of 1998. General and Administrative. General and administrative expenses increased by 21% to approximately $5.8 million in 1997 from approximately $4.8 million in 1996. After adjusting for integration charges of $1.4 million in 1997 and $0.3 million in 1996, general and administrative expenses increased $0.1 million. The increase is attributable to an overall increase in the Company's level of operations; however, general and administrative expenses decreased to 17% of total revenue in 1997 as compared to 20% of total revenue in 1996. Restructuring. Concurrent with the purchase of Cardiometrics, the Company recorded restructuring charges of $5.0 million related to corporate reorganization costs and plans to reduce overhead of the combined companies. The charges primarily consist of cash expenditures anticipated in 1998 related to termination of certain agreements and relocation and consolidation of facilities. The Company believes that its existing cash resources will be sufficient to fund these expenditures. Other Income, Net. Other income increased to approximately $5.9 million in 1997 from approximately $2.3 million in 1996. The increase is due to the result of gains realized on the shares of CVD common stock used to acquire Cardiometrics, distributions to the Company's shareholders and option holders, and the sale of CVD stock, offset in part by a reduction in interest income of $0.4 million due to reduced cash balances. Net Loss. Net loss was $47.3 million, or $3.22 per share for 1997, as compared to a net loss of approximately $7.2 million, or $0.53 per share in 1996. Comparison of the Year Ended December 31, 1996 with the Year Ended December 31, 1995 Total Revenue. Total revenue in 1996 increased by 42% to approximately $24.4 million from approximately $17.1 million in 1995. This increase was principally the result of an increase in IVUS sales in the United States and Europe. Sales of the Company's digital all-electronic IVUS imaging system and catheters accounted for approximately 83% of the total revenue. Sales of the Oracle Imaging System and catheters were approximately $20.4 million in 1996 as compared to approximately $12.7 million in 1995, an increase of 58%. The increase is due both to the growth of the overall market for IVUS imaging products and increased sales under the Company's distribution agreements with Cordis and, to a lesser extent, with Fukuda. Total revenue from CVD was approximately $3.8 million for the period from January 1, 1996, to the date of the CVD Initial Public Offering (see Notes 3 and 4 to the Consolidated Financial Statements), as compared to approximately $4.1 million for all of 1995. Currently, a majority of the Company's sales of IVUS products consists of sales of the Company's IVUS imaging systems. The Company currently anticipates that sales of IVUS imaging catheters will increase as a percentage of total sales of IVUS products in future periods as the Company's installed base grows. In 1996, export sales as a percentage of total revenue increased to 69% as compared to 58% in 1995. The Company currently anticipates that export sales will continue to represent a substantial portion of the CompanyIs total revenue in future periods. Cost of Product Sales. Cost of product sales as a percentage of product sales decreased to approximately 67% in 1996 from 70% in 1995. Cost of sales as a percentage of product sales in 1996 were reduced principally by improved manufacturing efficiencies. Gross profit margins on product sales improved to 33% in 1996 as compared to 30% in 1995. Acquired In-process Research, Development and Clinical. The Company recorded no acquired in-process research, development and clinical expenses in 1996 compared to $488,000 in 1995. In June 1995, 19 21 EndoSonics recorded a non-cash charge of $488,000, reflecting the final payment in connection with the 1993 acquisition of CVD. Other Research, Development and Clinical. Other research, development and clinical expenses decreased by 19% to approximately $5.7 million in 1996 from approximately $7.1 million in 1995 due to a decrease in expenses related to the Pinnacle Development Project and reimbursement from Cordis Corporation for joint Research and Development projects, offset by continued investment in CVDIs infrastructure to launch and produce its new products until its initial public offering in June of 1996. As a percentage of total revenue, these expenses decreased to 29% for 1996 from 42% in 1995. These expenses decreased by 20% from $5.4 million to $4.3 million for the IVUS business. Marketing and Sales. Marketing and sales expenses increased by 6% to approximately $5.4 million in 1996 as compared to approximately $5.1 million in 1995, primarily due to higher costs associated with increased staffing and marketing programs in Europe and the United States to support higher sales levels. As a percentage of total revenue, marketing and sales expenses decreased to 22% in 1996 as compared to 30% in 1995 due to increased revenues. Marketing and sales expenses for the IVUS business increased 20% from $3.5 million in 1995 to $4.2 million in 1996. General and Administrative. General and administrative expenses increased by 7% to approximately $4.8 million in 1996 from approximately $4.5 million in 1995. This increase is attributable to an overall increase in the Company's level of operations; however, general and administrative expenses decreased to 20% of total revenue in 1996 from 26% of total revenue in 1995. These expenses for the IVUS business were $4.1 million for 1996 compared with $3.2 million in 1995, a 28% increase. Other Income, Net. Other income increased to approximately $2.3 million in 1996 from approximately $.9 million in 1995, primarily due to a higher level of interest income. Net Loss. Net loss decreased to approximately $7.2 million, or $0.53 per share, in 1996 as compared to a net loss of approximately $10.5 million, or $1.01 per share, in 1995. For the IVUS business, net loss decreased 25% from $8.1 million to $6.1, $0.78 per share versus $0.45 per share. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1997, the Company had cash, cash equivalents and short-term investments of $23 million and no borrowings or credit facilities. Net cash used in operations was $7.9 million in 1997, as compared to $4.1 million in 1996. Working capital decreased to $30.1 million in 1997, as compared to $44.7 million in 1996. The decrease is primarily due to the use of cash in the acquisition of Cardiometrics and the increase in accrued restructuring, integration and other charges. Net cash used in investing activities was $17.9 million, as compared to $5.2 million in 1996. On July 23, 1997, the Company acquired all of the outstanding shares of Cardiometrics, Inc. As a result, Cardiometrics' assets, liabilities and results of operations since the acquisition date are included in the Company's consolidated statements of cash flows. Net cash used in the acquisition was $13.3 million. Net cash provided by financing activities was $0.6 million as compared to $7.4 million in 1996. In 1997, the Company received $0.6 million from the issuance of common stock, primarily related to the exercise of common stock options. In 1996 proceeds from the issuance of common stock was $7.4 million, which includes $5.0 million issued to a customer. The Company anticipates using cash resources primarily for capital expenditures, product development, sales and marketing efforts and working capital purposes prior to achieving positive cash flow from operations. The Company believes that its existing cash, cash equivalents and short-term investments as of December 31, 1997 will be sufficient to meet the Company's operating expenses and capital requirements through 1998. However, there can be no assurance that the Company will not be required to seek other financing or that such financing, if required, will be available on terms satisfactory to the Company. See "Future Operating Results -- History of Operating Losses; Anticipated Future Losses."* 20 22 SUBSEQUENT EVENTS During February 1998, the Company, in separate transactions, sold a total of 470,000 shares of CVD common stock valued at $1.8 million, resulting in a gain of $0.3 million. Also in February 1998, the Company's Board of Directors authorized a stock repurchase program whereby the Company may repurchase up to $5 million of its common stock. IMPACT OF YEAR 2000 The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions to operations, including a temporary inability to process transactions, send invoices, or engage in similar normal business activities. The Company has completed an assessment and will have to modify or replace certain portions of its software in order for its computer systems to function properly with respect to dates in the year 2000 and thereafter. Because the Company's computer programs are primarily packaged software for which there is a Year 2000 compliant update available, and the Company believes that it can make the necessary modifications primarily using the Company's personnel, the cost of the Year 2000 project is not expected to be material. It is anticipated that the Year 2000 project will be completed not later than December 31, 1998, which is prior to any anticipated impact on its operating systems. The Company believes that with modifications to the existing software, the Year 2000 Issue will not pose a significant operational problem. However, if such modifications are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company. The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which assume certain future events, including the continued availability of certain resources. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the effectiveness of the updates received from the Company's software vendors at addressing the Year 2000 Issue and similar uncertainties. TAX MATTERS As of December 31, 1997, the Company had federal and state net operating loss carryforwards of approximately $49.5 million and $8.5 million, respectively. The Company also had federal research and development and other tax credit carryforwards for federal and state income tax purposes, of approximately $1.786 million and $0.8 million respectively. The net operating loss and credit carryforwards began expiring and will continue to expire at various dates beginning in 1997 through 2012 if not utilized. Utilization of the net operating losses and credits may be subject to a substantial annual limitation due to the "change of ownership" rules provided by the Internal Revenue Code and similar state tax provisions. As a result of the annual limitation, a portion of these carryforwards may expire before ultimately becoming available to reduce future income tax liabilities. RISK FACTORS History of Operating Losses; Anticipated Future Losses. The Company was founded in 1984 and has experienced annual operating losses since its inception. The Company's accumulated deficit at December 31, 1997 was approximately $108 million. There can be no assurance that the Company will be able to sustain profitability in the future. Although the Company believes that its existing cash, cash equivalents and short-term investments will be sufficient to meet its liquidity requirements through 1998, there can be no assurance that the Company will not require additional financing or that such financing, if required, will be available on satisfactory terms, if at all. 21 23 Acquisitions. On July 23, 1997 the Company acquired all of the outstanding shares of Cardiometrics, Inc. for approximately $73.4 million in common stock of the Company, common stock of CVD, and cash. The results of Cardiometrics' operations have been combined with those of the Company since the date of acquisition. The acquisition was accounted for using the purchase method of accounting. Purchased in-process research and development in the amount of $43 million was valued by an independent appraiser. As it had not reached technological feasibility, and had no probable alternative future uses, it was charged to operations upon acquisition. Goodwill and other intangible assets are being amortized over three-to-eight years. In addition, the Company recognized a gain of $3.7 million related to the excess of the fair value over the book value of CVD common stock used as part of the purchase price consideration. The results of operations for the twelve months ended December 31, 1997 include one-time charges of $43 million related to the write-off of acquired in-process research and development, and $5.0 million related to restructuring and integration of the two companies. The Company expects that it may pursue additional acquisitions in the future. Any future acquisitions may result in potentially dilutive issuances of equity securities, the write-off of in process research and development, the incurrence of debt and contingent liabilities and amortization expenses related to intangible assets acquired, any of which could materially adversely affect the Company's business, financial condition and results of operations. In particular, if the Company is unable to use the "pooling of interests" method of accounting, the Company will be required to amortize any intangible assets acquired in connection with any additional acquisitions and the amortization periods for such costs will be over the useful lives of such assets, which range from two years to eight years. Additionally, unanticipated expenses may be incurred relating to the integration of technologies and research and development and administrative functions. Any acquisition will involve numerous risks, including difficulties in the assimilation of the acquired company's employees, operations and products, uncertainties associated with operating in new markets and working with new customers, the potential loss of the acquired company's key employees as well as the costs associated with completing the acquisition and integrating the acquired company. Uncertainty of Market Acceptance. Although external ultrasound imaging and balloon angioplasty are widely used technologies, the use of IVUS imaging in connection with interventional cardiology is relatively new. The commercial success of the Company's products will depend upon their acceptance by the medical community as a useful, cost-effective component of interventional cardiovascular and peripheral vascular procedures. IVUS imaging is used in conjunction with angioplasty and other intravascular procedures such as vascular stenting. Accordingly, the medical community must determine that the information obtained from the use of the Company's ultrasound products will increase the safety or effectiveness or lower the overall cost of the care being provided and that the value of such information justifies the incremental expense of obtaining IVUS imaging. In addition, market acceptance of the Company's combination balloon angioplasty/IVUS imaging catheters will depend, among other things, on a determination by the medical community that the efficacy of the therapeutic component of the Company's combination catheters is at least comparable to that of competing non-imaging angioplasty catheters and other types of therapy. Although IVUS imaging devices have been available for over ten years, the market for such products has remained relatively small. Although the Company believes the benefits of IVUS imaging can be demonstrated, there can be no assurance that the benefits will be considered sufficient by the medical community to enable the Company's products to achieve widespread market acceptance. Failure of the Company's products to achieve market acceptance would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Products." Dependence on Strategic Relationships; Reliance on Cordis. In February 1996, EndoSonics and Cordis entered into the Exclusive Distribution Agreement pursuant to which Cordis was granted the exclusive right to distribute EndoSonics' IVUS imaging products for coronary applications in North America, Europe, Africa and the Middle East. The Exclusive Distribution Agreement supersedes and replaces a prior distribution agreement between Cordis and EndoSonics and a prior distribution agreement between EndoSonics Nederland B.V., a wholly owned subsidiary of EndoSonics, and Cordis S.A. Cordis is obligated during each year of the Exclusive Distribution Agreement to use reasonable efforts to purchase certain minimum annual amounts of products from EndoSonics. Subject to certain exceptions, Cordis' failure to meet the minimum annual 22 24 purchase amount during any year of the Exclusive Distribution Agreement shall constitute a material breach of such agreement. Cordis is also obligated during the term of the Exclusive Distribution Agreement to undertake certain efforts to market, promote, distribute and sell EndoSonics' IVUS imaging products, including the provision of adequate personnel and facilities, the maintenance of sufficient inventory for demonstration purposes and the appointment of a United States and European intracoronary ultrasound marketing manager to interface with EndoSonics' United States and European clinical and support staff. The Exclusive Distribution Agreement also contains standard representations and warranties of each party and standard provisions regarding indemnification, service and maintenance and confidentiality. Under the terms of the Exclusive Distribution Agreement, Cordis shall purchase IVUS imaging products from EndoSonics at agreed upon prices set forth in such agreement, which prices shall be jointly reviewed by EndoSonics and Cordis every six months. The Exclusive Distribution Agreement initially expires on December 31, 1998, but may be extended by the parties for successive one year periods. The Company currently believes that Cordis is unlikely to meet the minimum purchase amounts required under the Exclusive Distribution Agreement for fiscal 1998 and has engaged Cordis in discussions that would lead to amendment or termination of the Exclusive Distribution Agreement, although neither option can be assured. The failure of Cordis to meet minimum contractural purchase requirements in 1998 would have a material adverse effect on the Company's 1998 operation results. In 1997, the Company entered into similar agreements with affiliates of Cordis covering Japan and certain South American countries. In light of the Company's exclusive distribution relationship with Cordis, the Company's revenue from sales of IVUS imaging products will depend substantially on the distribution capabilities of Cordis. Further, in recent years there has been significant consolidation among medical device suppliers as the major suppliers have attempted to broaden their product lines in order to focus on product configurations that address a given procedure or treatment and in order to respond to cost pressures from health care providers. This consolidation has made it increasingly difficult for smaller suppliers, such as the Company, to effectively distribute their products without a major relationship with one of the major suppliers. There can be no assurance that the Company will be able to maintain its relationship with Cordis or replace Cordis in the event the Company's relationship with Cordis would be terminated. In the event of such a termination, the Company's ability to distribute its IVUS imaging products would be materially adversely affected, which would have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on New Products; Rapid Technological Change. The medical device industry generally, and the IVUS imaging device market in particular, are characterized by rapid technological change, changing customer needs, and frequent new product introductions. The Company's future success will depend upon its ability to develop and introduce new products that address the increasingly sophisticated needs of its customers. There can be no assurance that the Company will be successful in developing and marketing new products that achieve market acceptance or that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of new products. In October 1995, the Company announced the receipt of approval from the FDA to market its Five-64 diagnostic catheters, which are designed to enhance image quality and reduce manufacturing cost relative to the Company's Oracle-Micro(TM) catheter line. The Company introduced the Five-64 diagnostic catheters in November 1995 and commenced commercial shipments of these catheters in the first quarter of 1996. There can be no assurance that the Company's competitors will not succeed in developing or marketing technologies and products that are more effective or commercially attractive than any that are being developed by the Company, or that such competitors will not succeed in obtaining regulatory approval for introducing or commercializing any such products prior to the Company. Furthermore, there can be no assurance that the Company's products will not be rendered obsolete as a result of future innovations. See "Business -- Products." Dependence on International Sales. The Company derives, and expects to continue to derive, a significant portion of its revenue from international sales. In 1995, 1996, and 1997, the Company's international sales were $9.9 million, $16.9 million, and $21.9 million respectively, or 58%, 69% and 64% respectively of total revenue. Therefore, a significant portion of the Company's revenues will continue to be subject to the risks associated with international sales, including economic or political instability, shipping 23 25 delays, changes in applicable regulatory policies, fluctuations in foreign currency exchange rates and various trade restrictions, all of which could have a significant impact on the Company's ability to deliver products on a competitive and timely basis. Future imposition of, or significant increases in the level of, customs duties, import quotas or other trade restrictions, could have an adverse effect on the Company's business, financial condition and results of operation. The regulation of medical devices, particularly in the European Community, continues to expand and there can be no assurance that new laws or regulations will not have an adverse effect on the Company. Suppliers. The Company purchases many standard and custom built components from independent suppliers, and contracts with third parties for certain specialized electronic component manufacturing processes. Most of these purchased components and processes are available from more than one vendor. However, the manufacturing of the integrated circuit microchips, used in the Five 64 catheter line is currently performed by a single vendor. Although the Company is in the process of identifying alternative vendors, the qualification of additional or replacement vendors for certain components or services is a lengthy process. Any supply interruption from this single source vendor would have a material adverse effect on the Company's ability to manufacture its products until a new source of supply was qualified and, as a result, could have an adverse effect on the Company's business, financial condition and results of operations. See "Business -- Manufacturing" and "-- Government Regulation." Limitations on Third-Party Reimbursement. In the United States, the Company's products are purchased primarily by medical institutions, which then bill various third-party payors, such as Medicare, Medicaid, and other government programs and private insurance plans, for the health care services provided to patients. Government agencies, private insurers and other payors determine whether to provide coverage for a particular procedure and reimburse hospitals for medical treatment at a fixed rate based on the DRG established by the U.S. HCFA. The fixed rate of reimbursement is based on the procedure performed, and is unrelated to the specific devices used in that procedure. If a procedure is not covered by a DRG, payors may deny reimbursement. In addition, some payors may deny reimbursement if they determine that the device used in a treatment was unnecessary, inappropriate or not cost-effective, experimental or used for a non-approved indication. Currently, there are no established DRGs covering diagnostic IVUS imaging procedures. Reimbursement of balloon angioplasty procedures is covered under a DRG, but because the amount of reimbursement is fixed, the amount of potential profit relating to the procedure is reduced to the extent the physician performs additional procedures such as IVUS imaging or uses a more expensive product which combines IVUS imaging with therapeutic capabilities. Accordingly, physicians must determine that the clinical benefits of IVUS imaging justify the additional cost. Although the Company believes that less invasive procedures generally provide less costly overall therapies as compared to alternative surgical procedures, there can be no assurance that reimbursement for such less invasive procedures will continue to be available, or that future reimbursement policies of payors will not adversely affect the Company's ability to sell its products on a profitable basis. Failure by hospitals and other users of the Company's products to obtain reimbursement from third-party payors, or changes in government and private third-party payors' policies toward reimbursement for procedures employing the Company's products, would have a material adverse effect on the Company's business, financial condition and results of operations. Competition. Competition in the market for devices used in the diagnosis and treatment of cardiovascular and peripheral vascular disease is intense, and is expected to increase. The interventional cardiology market is characterized by rapid technological innovation and change, and the Company's products could be rendered obsolete as a result of future innovations. The Company's digital, all-electronic IVUS imaging catheters compete with mechanical ultrasound devices manufactured by CVIS and Hewlett-Packard. Both CVIS and Hewlett-Packard are significantly larger than the Company, and have significantly greater financial, sales and marketing and technical resources available. These competitors have also developed IVUS imaging products with high quality images and the Company believes that its competitive position is dependent upon its ability to establish its reputation as a producer of high quality IVUS imaging products. There can be no assurance that these companies are not currently developing, or will not attempt to develop, combination balloon angioplasty/IVUS imaging catheters that would compete with the Company's combination balloon angioplasty/IVUS imaging products. Moreover, companies currently engaged in the manufacture and marketing 24 26 of non-imaging angioplasty catheters could attempt to expand their product lines to include combination balloon angioplasty/IVUS imaging products. The Company's combination balloon angioplasty/IVUS imaging catheters compete or will compete with therapeutic catheters marketed by a number of manufacturers, including ACS, SciMed, Cordis, Medtronic, Inc. and Schneider USA, a subsidiary of Pfizer, Inc. ("Schneider"). Such companies have substantial resources, established market positions, and significantly larger sales and marketing organizations. In addition, the Company faces competition from manufacturers of atherectomy devices, vascular stents and pharmaceutical products intended to treat cardiovascular disease. See "Business -- Competition." Reliance on Patents and Proprietary Technology; Risk of Patent Infringement. The Company holds six issued United States patents and has other United States and several foreign patent applications pending covering various aspects of its IVUS imaging technology. No assurance can be given, however, that the Company's patent applications will issue as patents or that any issued patents will provide competitive advantages for the Company's products or will not be successfully challenged or circumvented by its competitors. Although the Company attempts to ensure that its products do not infringe other party's patents and proprietary rights, there can be no assurance that its products do not infringe such patents or rights. The interventional cardiovascular market has been characterized by substantial litigation regarding patent and other intellectual property rights. The Company is currently involved in litigation with Intravasular Research Limited ("IRL") regarding certain of the Company's technology. In the event that any relevant claims of IRL or other third-party patents are upheld as valid and enforceable, the Company could be prevented from practicing the subject matter claimed in such patents, or would be required to obtain licenses from the owners of any such patents or redesign its products or processes to avoid infringement. There can be no assurance that such licenses would be available or, if available, would be so on terms acceptable to the Company or that the Company would be successful in any attempt to redesign its products or processes to avoid infringement. The Company also relies on trade secrets and proprietary technology and enters into confidentiality and non- disclosure agreements with its employees and consultants. There can be no assurance that the confidentiality of such trade secrets or proprietary information will be maintained by employees, consultants, advisors or others, or that the Company's trade secrets or proprietary technology will not otherwise become known or be independently developed by competitors in such a manner that the Company has no practical recourse. Additional litigation may be necessary to defend against claims of infringement or invalidity, to enforce patents issued to the Company or to protect trade secrets and could result in substantial cost to, and diversion of effort by, the Company. See "Business -- Patents and Proprietary Technology" and "Legal Proceedings." Government Regulation. The manufacturing and marketing of the Company's products are subject to extensive and rigorous government regulation in the United States and in other countries. The Company believes that its success will be significantly dependent upon commercial sales of improved versions of its imaging systems and catheter products. The Company will not be able to market these new products in the United States unless and until the Company obtains approval from the FDA. If a medical device manufacturer can establish that a newly developed device is "substantially equivalent" to a device that was legally marketed prior to May 1976, or to a device that the FDA has found to be substantially equivalent to a legally marketed pre-1976 device, the manufacturer may seek clearance from the FDA to market the device by filing a premarket notification with the FDA under Section 510(k) of the Federal Food, Drug, and Cosmetic Act ("510(k)"). There can be no assurance that 510(k) clearance for any future product or modification of an existing product will be granted or that the process will not be unduly lengthy. All of the 510(k) clearances received for the Company's catheters were based on substantial equivalence to legally marketed pre-1976 devices. Review of the substantially equivalent pre-1976 devices on which the 510(k) clearances for the Company's catheters were based and any resulting restrictions on the Company or requirements imposed to present additional data could have a material adverse effect on the Company's business, financial condition and results of operations. If substantial equivalence cannot be established, or if the FDA determines that the device or the particular application for the device requires a more rigorous review, the FDA will require that the manufacturer submit a PMA application that must be reviewed and approved by the FDA prior to sales and 25 27 marketing of the device in the United States. The PMA process is significantly more complex, expensive and time consuming than the 510(k) clearance process and frequently requires the submission of clinical data. It is expected that certain of the Company's combination angioplasty/IVUS imaging products under development will be subject to this PMA process. Failure to comply with applicable regulatory requirements can, among other consequences, result in fines, injunctions, civil penalties, suspensions or loss of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution. In addition, governmental regulations may be established that could prevent or delay regulatory approval of the Company's products. Delays in receipt of approvals, failure to receive approvals or the loss of previously received approvals would have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also required to register as a medical device manufacturer with the FDA and certain state agencies, such as the Food and Drug Branch of CDHS. As such, the Company is inspected on a routine basis by both the FDA and the CDHS for compliance with the GMP regulations. These regulations require that the Company manufacture its products and maintain related documentation in a prescribed manner with respect to manufacturing, testing and control activities. Further, the Company is required to comply with various FDA requirements for labeling. The Medical Device Reporting regulation requires that the Company provide information to the FDA on deaths or serious injuries alleged to have been associated with the use of its devices, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. In addition, the FDA prohibits an approved device from being marketed for unapproved applications. Specifically, the Company's FOCAL balloon catheters are approved in certain European countries. The Company believes that these catheters are being used in those countries principally for deployment of coronary stents and balloon angioplasty. In October 1995, EndoSonics received FDA approval to market CVD's line of FACT catheters, which utilize the FOCAL technology, for coronary balloon angioplasty. Without specific FDA approval for use in stent deployment, these catheters may not be marketed by the Company in the United States for such use. If the FDA believes that a company is not in compliance with applicable laws and regulations, it can institute proceedings to detain or seize products, issue a recall, prohibit marketing and sales of the company's products and assess civil and criminal penalties against the company, its officers or its employees. The Company is also subject to other federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices. The extent of government regulation that might result from any future legislation or administrative action cannot be accurately predicted. Failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Products" and " Government Regulation." International sales of the Company's products are subject to the regulatory agency product registration requirements of each country. The regulatory review process varies from country to country and may in some cases require the submission of clinical data. The Company typically relies on its distributors in such foreign countries to obtain the requisite regulatory approvals. There can be no assurance, however, that such approvals will be obtained on a timely basis or at all. The Company is in the process of implementing policies and procedures which are intended to allow the Company to receive ISO 9001 qualification of its processes. The ISO 9000 series of standards for quality operations has been developed to ensure that companies know the standards of quality to which they must adhere to receive certification. The European Union has promulgated rules which require that medical products receive by mid-1998 the right to affix the CE mark, an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. ISO 9001 certification is one of the CE mark certification requirements. Failure to receive the right to affix the CE mark will prohibit the Company from selling its products in member countries of the European Union. In Europe, the Company has obtained ISO 9002 as of January 1997. There can be no assurance that the Company will be successful in meeting certification requirements. Potential Product Liability; Limited Insurance. The Company faces the risk of financial exposure to product liability claims. The Company's products are often used in situations in which there is a high risk of 26 28 serious injury or death. Such risks will exist even with respect to those products that have received, or in the future may receive, regulatory approval for commercial sale. The Company maintains product liability insurance with coverage limits of $1.0 million per occurrence and $5.0 million per year in the aggregate. There can be no assurance that the Company's product liability insurance is adequate or that such insurance coverage will remain available at acceptable costs. There can be no assurance that the Company will not incur significant product liability claims in the future. A successful claim brought against the Company in excess of its insurance coverage could have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, adverse product liability actions could negatively affect the reputation and sales of the Company's products as well as the Company's ability to obtain and maintain regulatory approval for its products. See "Business -- Product Liability and Insurance." Volatility of Stock Price. The Company's Common Stock has experienced and can be expected to continue to experience substantial price volatility in response to actual or anticipated quarterly variations in operating results, announcements of technological innovations or new products by the Company or its competitors, developments related to patents or other intellectual property rights, developments in the Company's relationships with its customers, distributors or suppliers, acquisitions or divestitures of other companies in the health care industry, and other events or factors. In addition, any shortfall or changes in revenue, gross margins, earnings, or other financial results from analysts' expectations could cause the price of the Company's Common Stock to fluctuate significantly. In recent years, the stock market in general has experienced extreme price and volume fluctuations, which have particularly affected the market price of many technology and health care companies and which have often been unrelated to the operating performance of those companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. See "Market for Registrant's Common Equity and Related Stockholder Matters." ITEM 8. FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors Financial Statements Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The financial statement schedule listed under Part IV, Item 14, is filed as part of this Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT The information concerning the Company's directors required by this item is incorporated by reference from the Company's Proxy Statement, to be mailed to stockholders for the Annual Meeting to be held on or about June 4, 1998. The information concerning the Company's executive officers required by this item is incorporated by reference to the section of Part I hereof entitled "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the Company's Proxy Statement, to be mailed to stockholders for the Annual Meeting to be held on or about June 4, 1998. 27 29 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the Company's Proxy Statement, to be mailed to stockholders for the Annual Meeting to be held on or about June 4, 1998. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the Company's Proxy Statement, to be mailed to stockholders for the Annual Meeting to be held on or about June 4, 1998. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS ANNUAL REPORT ON FORM 10-K: 1. Financial Statements of the Company. Report of Ernst & Young LLP, Independent Auditors Consolidated Balance Sheets -- December 31, 1996 and 1997 Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997 Notes to Consolidated Financial Statements for the years ended December 31, 1995, 1996 and 1997 2. Financial Statement Schedule. II -- Valuation and Qualifying Accounts Schedules not listed above have been omitted because they are not applicable or are not required to be set forth herein as such information is included in the Consolidated Financial Statements or the notes thereto. 3. Exhibits. Reference is made to Item 14(c) of this Annual Report on Form 10-K. (b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the last quarter of the fiscal year covered by this Annual Report on Form 10-K. (c) EXHIBITS.
EXHIBIT NUMBER DESCRIPTION ------- ----------- 2.1(1) Agreement and Plan of Reorganization dated as of June 9, 1993 among the Company, EndoSonics Acquisition Corporation and CardioVascular Dynamics, Inc. ("CVD"). 2.2(1) First Amendment dated as of June 30, 1993 to the Agreement and Plan of Reorganization among the Company, EndoSonics Acquisition Corporation and CVD. 2.3(8) Agreement and Plan of Reorganization between EndoSonics and Cardiometrics, Inc. 3.1(2) Certificate of Incorporation. 3.2(4) Amended Bylaws. 4.1(2) Specimen Certificate of Common Stock. 4.2(3) Loan and Warrant Purchase Agreement dated May 19, 1988. 10.1(3) Series F Preferred Stock Purchase Agreement dated February 1, 1991 between the Company and Esaote Biomedica S.p.A. ("Esaote") and Registration Rights and Right of First Offer Agreement.
28 30
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.2(3) Distribution Agreement dated February 28, 1990 between the Company and Fukuda Denshi Co., Ltd. 10.3(3) Distribution Agreement dated as of January 31, 1991 between the Company and Esaote. 10.4(3) Line of Credit Agreement between the Company and Wells Fargo Bank, N.A. dated November 19, 1990. 10.5(3) Lease dated October 31, 1991 between the Company and Olympia Investments, Inc. for the Pleasanton facilities. 10.6(3) Lease dated May 1, 1990 between the Company and Commonwealth Growth Fund I and the Rancho Cordova facilities and Amendment to Lease dated January 9, 1992. 10.7(3) 1988 Stock Option Plan and forms of a Stock Option Agreement and a Stock Purchase Agreement. 10.8(3) 1984 Restricted Stock Purchase Plan and form of a Stock Purchase Agreement. 10.9(3) Form of Indemnification Agreement between the Company and directors of the Company. 10.10(5) Form of Domestic Distribution Agreement. 10.11(4) Supplemental Stock Purchase Agreement dated June 5, 1992, by and between the Company and CVD. 10.12(4) Stock Purchase Agreement dated June 5, 1992, by and between the Company and CVD. 10.13(4) Product Development Agreement dated June 5, 1992, by and between the Company and CVD. 10.14(6) Distribution Agreement dated May 28, 1993 between CVD and Fukuda Denshi Co., Ltd. 10.15(6) Micro Motor Catheter and Instrument Development Agreement, Funding and Option Agreement, Escrow and License agreement, and Distribution Agreement dated October 1993 between the Company and Du-MED. 10.16(9) Stock Purchase and Technology License Agreement dated September 10, 1994 by and among EndoSonics, CVD and SCIMED Life Systems, Inc. 10.17(9) Exclusive Distribution Agreement dated November 1, 1994 between Cordis S.A. and EndoSonics, as amended on December 20, 1994. 10.18(7) Imaging/Therapeutic Combination Devices Development Agreement dated as of February 2, 1996 by and between Cordis Corporation ("Cordis") and the Company. 10.19(7) Exclusive Distribution Agreement dated February 2, 1996 by and between Cordis and the Company. 10.20(10) Shareholder Agreement dated June 19, 1996 between EndoSonics and CVD. 10.21(10) License Agreement dated February 6, 1997 between EndoSonics and CVD. 10.22 Form of Change of Control Agreement by and between the Company and each exective officer of the Company. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 23.2 Consent of Ernst & Young LLP, Independent Auditors. 23.3 Consent of Ernst & Young LLP, Independent Auditors. 24.1 Power of Attorney. (Reference is made to page 30 of this Report on Form 10-K/A.) 27.1 Financial Data Schedule.
- --------------- * Confidential Treatment Granted. (1) Filed as an exhibit to the Company's Current Report on Form 8-K (File No. 0-19880) filed with the Commission on July 14, 1993. 29 31 (2) Filed as an exhibit to the Company's Registration Statement on Form 8-B filed with the Securities and Exchange Commission (the "Commission") on September 25, 1992 and incorporated by reference herein. (3) Filed as an exhibit to the Company's Registration Statement on Form S-1 (File No. 33-45280) filed with the Securities and Exchange Commission on January 24, 1992 (the "Registration Statement") and incorporated by reference herein. (4) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 31, 1993. (5) Filed as Exhibit 10.13 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 33-45280) filed with the Commission on February 25, 1992 and incorporated herein by reference. (6) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 24, 1994. (7) Filed as an exhibit to the Company's Annual Report on Form 10-K/A (File No. 0-19880) filed with the Commission on July 29, 1996. (8) Filed as an exhibit to the Company's Form 8-K (File No. 0-19880) filed with the Commission on February 10, 1997 and incorporated herein by reference. (9) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 21, 1995. (10) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 19, 1997. (d) 1. Financial Statements of Cardiovascular Dynamics, Inc. Report of Ernst & Young LLP, Independent Auditors Consolidated Balance Sheets -- December 31, 1996 and 1997 Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997 Notes to Consolidated Financial Statements for the years ended December 31, 1995, 1996 and 1997 2. Financial Statement Schedule. II -- Valuation and Qualifying Accounts 30 32 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. ENDOSONICS CORPORATION Date: March 30, 1998 By: /s/ REINHARD J. WARNKING ------------------------------------ Reinhard J. Warnking Chief Executive Officer (Principal Executive Officer) By: /s/ RICHARD L. FISCHER ------------------------------------ Richard L. Fischer Vice President, Finance (Principal Financial and Accounting Officer) POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints, jointly and severally, Reinhard J. Warnking and Richard L. Fischer, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ REINHARD J. WARNKING President, Chief Executive March 30, 1998 - -------------------------------------------------------- Officer and Director Reinhard J. Warnking (Principal Executive Officer) /s/ RICHARD L. FISCHER Vice President, Finance March 30, 1998 - -------------------------------------------------------- (Principal Financial and Richard L. Fischer Accounting Officer) /s/ ROGER SALQUIST Chairman of the Board of March 30, 1998 - -------------------------------------------------------- Directors Roger Salquist /s/ THOMAS J. CABLE Director March 30, 1998 - -------------------------------------------------------- Thomas J. Cable /s/ WILLIAM G. DAVIS Director March 30, 1998 - -------------------------------------------------------- William G. Davis
31 33
SIGNATURE TITLE DATE --------- ----- ---- /s/ MICHAEL R. HENSON Director March 30, 1998 - -------------------------------------------------------- Michael R. Henson /s/ EDWARD M. LEONARD Director March 30, 1998 - -------------------------------------------------------- Edward M. Leonard /s/ MENAHEM NASSI, PH.D. Director March 30, 1998 - -------------------------------------------------------- Menahem Nassi, Ph.D. /s/ W. MICHAEL WRIGHT Director March 30, 1998 - -------------------------------------------------------- W. Michael Wright
32 34 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Ernst & Young LLP, Independent Auditors........... F-1 Consolidated Balance Sheets................................. F-2 Consolidated Statements of Operations....................... F-3 Consolidated Statements of Stockholders' Equity............. F-4 Consolidated Statements of Cash Flows....................... F-5 Notes to Consolidated Financial Statements.................. F-6
35 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders EndoSonics Corporation We have audited the accompanying consolidated balance sheets of EndoSonics Corporation as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14.(a).2. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of EndoSonics Corporation at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Sacramento, California February 13, 1998 F-1 36 ENDOSONICS CORPORATION CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, --------------------------- 1997 1996 ---- ---- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) Current assets: Cash and cash equivalents................................. $ 13,889 $ 34,943 Short-term investments.................................... 9,120 5,249 Trade accounts receivable, net of allowance for doubtful accounts of $562 and $646 at December 31, 1997 and 1996, respectively..................................... 13,351 5,682 Inventories............................................... 6,915 3,572 Accrued interest receivable and other current assets...... 424 1,202 --------- -------- Total current assets.............................. 43,699 50,648 Property and equipment, net................................. 3,408 1,947 Investment in CardioVascular Dynamics, Inc. (CVD)........... 8,478 19,444 Intangible assets, net...................................... 7,222 -- --------- -------- $ 62,807 $ 72,039 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses..................... $ 7,536 $ 5,040 Accrued restructuring and integration expenses............ 6,017 932 --------- -------- Total current liabilities................................... 13,553 5,972 ========= ======== Stockholders' equity: Convertible-preferred stock, $.001 par value; 5,000,000 shares authorized, no shares issued and outstanding....................... -- -- Common stock, $.001 par value; 25,000,000 shares authorized, 16,153,113 and 13,522,572 shares issued and outstanding as of December 31, 1997 and 1996, respectively........................................... 16 14 Additional paid-in capital................................ 157,588 124,024 Accumulated deficit....................................... (108,263) (58,000) Unrealized gain on available-for-sale securities.......... 1 1 Foreign currency translation.............................. (88) 28 --------- -------- Total stockholders' equity.................................. 49,254 66,067 --------- -------- $ 62,807 $ 72,039 ========= ========
See accompanying notes F-2 37 ENDOSONICS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, ---------------------------------------------------- 1997 1996 1995 ---- ---- ---- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) REVENUES: Product sales...................................... $ 33,141 $ 23,542 $ 16,175 Contract revenue................................... 856 831 962 Total revenue........................................ 33,997 24,373 17,137 Cost of sales........................................ 17,962 15,688 11,270 ---------- ---------- ---------- Gross margin....................................... 16,035 8,685 5,867 ---------- ---------- ---------- OPERATING EXPENSES: Acquired in-process research, development and clinical........................................ 43,000 -- 488 Other research, development and clinical........... 6,309 5,746 7,127 Marketing and sales................................ 6,068 5,411 5,096 General and administrative......................... 5,840 4,821 4,516 Restructuring...................................... 4,956 518 -- Amortization of intangibles........................ 475 -- -- ---------- ---------- ---------- Total operating expenses............................. 66,648 16,496 17,227 ---------- ---------- ---------- Loss from operations................................. (50,613) (7,811) (11,360) Equity in net loss of CardioVascular Dynamics, Inc................................................ (2,358) (1,621) -- OTHER INCOME (EXPENSE): Interest income.................................... 1,881 2,269 888 Gain realized on equity investment in CardioVascular Dynamics, Inc.................... 4,021 -- -- ---------- ---------- ---------- Total other income, net.............................. 5,902 2,269 888 ---------- ---------- ---------- Net loss before provision for income taxes........... (47,069) (7,163) (10,472) ---------- ---------- ---------- Provision for income taxes........................... 175 -- -- ---------- ---------- ---------- Net loss............................................. $ (47,244) $ (7,163) $ (10,472) ========== ========== ========== Basic net loss per share............................. $ (3.22) $ (0.53) $ (1.01) ========== ========== ========== Shares used in computing basic net loss per share.... 14,669,975 13,394,728 10,386,549 ========== ========== ==========
See accompanying notes F-3 38 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS)
CONVERTIBLE PREFERRED STOCK COMMON STOCK ADDITIONAL --------------- ------------------- PAID-IN ACCUMULATED SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT ------ ------ ---------- ------ ---------- ----------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Balance at December 31, 1994.................. -- $-- 9,983,031 $10 $ 63,070 $ (40,365) Issuance of common stock to complete CardioVascular Dynamics, Inc. acquisition......... -- -- 50,000 -- 488 -- Issuance of common stock in follow -- on offering, net of issuance costs of $2,806.............. -- -- 2,645,000 3 34,882 -- Exercise of common stock options....... -- -- 153,481 -- 549 -- Change in unrealized loss on available -- for-sale securities.......... -- -- -- -- -- -- Foreign currency translation......... -- -- -- -- -- -- Net loss.............. -- -- -- -- -- (10,472) -- -- ---------- --- -------- --------- Balance at December 31, 1995.................. -- -- 12,831,512 13 98,989 (50,837) Increase in carrying value from CardioVascular Dynamics, Inc. initial public offering............ -- -- -- -- 17,605 -- Sale of common stock to Cordis Corporation......... -- -- 350,877 1 5,000 -- Exercise of common stock options....... -- -- 340,183 -- 2,429 -- Change in unrealized loss on available--for-sale securities.......... -- -- -- -- -- -- Foreign currency translation......... -- -- -- -- -- -- Net loss.............. -- -- -- -- -- (7,163) -- -- ---------- --- -------- --------- Balance at December 31, 1996.................. -- -- 13,522,572 14 124,024 (58,000) Issuance of common stock to complete Cardiometrics acquisition......... -- -- 2,502,500 2 33,137 -- Issuance of CardioVascular Dynamics, Inc. stock dividend............ -- -- -- -- -- (3,019) Decrease in carrying value of CardioVascular Dynamics, Inc....... -- -- -- -- (193) -- Exercise of common stock options....... -- -- 128,041 -- 620 -- Change in unrealized loss on available--for-sale securities.......... -- -- -- -- -- -- Foreign currency translation......... -- -- -- -- -- -- Net loss.............. -- -- -- -- -- (47,244) -- -- ---------- --- -------- --------- Balance at December 31, 1997.................. -- $-- 16,153,113 $16 $157,588 $(108,263) == == ========== === ======== ========= UNREALIZED GAIN (LOSS) OR FOREIGN TOTAL AVAILABLE-FOR- CURRENCY STOCKHOLDERS' SALE SECURITIES TRANSLATION EQUITY --------------- ----------- ------------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Balance at December 31, 1994.................. $(451) $ 4 $ 22,268 Issuance of common stock to complete CardioVascular Dynamics, Inc. acquisition......... -- -- 488 Issuance of common stock in follow -- on offering, net of issuance costs of $2,806.............. -- -- 34,885 Exercise of common stock options....... -- -- 549 Change in unrealized loss on available -- for-sale securities.......... 444 -- 444 Foreign currency translation......... -- (7) (7) Net loss.............. -- -- (10,472) ----- ----- -------- Balance at December 31, 1995.................. (7) (3) 48,155 Increase in carrying value from CardioVascular Dynamics, Inc. initial public offering............ -- -- 17,606 Sale of common stock to Cordis Corporation......... -- -- 5,001 Exercise of common stock options....... -- -- 2,429 Change in unrealized loss on available--for-sale securities.......... 8 -- 8 Foreign currency translation......... -- 31 31 Net loss.............. -- -- (7,163) ----- ----- -------- Balance at December 31, 1996.................. 1 28 66,067 Issuance of common stock to complete Cardiometrics acquisition......... -- -- 33,139 Issuance of CardioVascular Dynamics, Inc. stock dividend............ -- -- (3,019) Decrease in carrying value of CardioVascular Dynamics, Inc....... -- -- (193) Exercise of common stock options....... -- -- 620 Change in unrealized loss on available--for-sale securities.......... -- -- -- Foreign currency translation......... -- (116) (116) Net loss.............. -- -- (47,244) ----- ----- -------- Balance at December 31, 1997.................. $ 1 $ (88) $(49,254) ===== ===== ========
See accompanying notes F-4 39 ENDOSONICS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 ---- ---- ---- OPERATING ACTIVITIES Net loss.................................................... $(47,244) $(7,163) $(10,472) Adjustments to reconcile net loss to net cash used in operating activities: Acquired in-process research and development........... 43,000 -- 488 Depreciation........................................... 580 618 415 Amortization........................................... 549 -- -- Gain on investment in CVD.............................. (4,021) -- -- Operating expense paid with CVD common stock (Note 11).................................................. 542 -- -- Equity in net loss of CVD.............................. 2,358 1,621 -- Changes in operating assets and liabilities net of effects from purchase of Cardiometrics: Trade accounts receivable, net....................... (2,711) 170 (2,409) Inventories.......................................... (419) 474 (2,135) Accrued interest receivable and other current assets............................................ 1,232 (229) (106) Accounts payable and accrued expenses................ (2,580) 424 2,021 Accrued restructuring and integration expenses....... 5,084 -- -- -------- ------- -------- Net cash used in operating activities....................... (3,630) (4,085) (12,198) ======== ======= ======== INVESTING ACTIVITIES Purchase of short-term investments.......................... (9,090) (4,000) -- Proceeds from sale of CVD common stock...................... 528 289 6,815 Maturities of short-term investments........................ 5,219 6,108 1,539 Capital expenditures for property and equipment............. (1,299) (1,164) (438) Effect of CVD initial public offering....................... -- (6,423) -- Business acquisition, net of cash and cash equivalents acquired.................................................. (13,286) -- -- -------- ------- -------- Net cash provided by (used in) investing activities......... (17,928) (5,190) 7,916 ======== ======= ======== FINANCING ACTIVITIES Proceeds from common stock issuance to Cordis Corporation... -- 5,001 -- Proceeds from issuance of common stock...................... 620 2,429 35,434 Proceeds from convertible obligation........................ -- -- 750 -------- ------- -------- Net cash provided by financing activities................... 620 7,430 36,184 -------- ------- -------- Effect of exchange rate changes on cash and cash equivalents............................................... (116) 31 (7) -------- ------- -------- Net increase (decrease) in cash and equivalents............. (21,054) (1,814) 31,895 Cash and equivalents, beginning of year..................... 34,943 36,757 4,862 -------- ------- -------- Cash and equivalents, end of year........................... $ 13,889 $34,943 $ 36,757 ======== ======= ======== Non-cash financing and investing activities: Acquisition of business (Note 3) Fair value of assets acquired.................................................. $ 73,418 $ -- $ -- Cash paid................................................. (22,281) -- -- EndoSonics common stock issued............................ (33,139) -- -- CVD common stock transferred.............................. (8,484) -- -- Other consideration....................................... (4,674) -- -- -------- ------- -------- Liabilities assumed....................................... 4,840 -- -- -------- ------- -------- Capital expenditures for property and equipment........... -- 292 -- Effect of CardioVascular Dynamics, Inc., initial public offering............................................... $ -- $17,606 $ -- ======== ======= ========
See accompanying notes F-5 40 ENDOSONICS CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1997, 1996, 1995 (IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------- -------- ---------------------------------- -------- ------------- ADDITIONS BALANCE AT ---------------------------------- BEGINNING OF CHARGES TO CHARGED TO BALANCE AT DESCRIPTION PERIOD COST AND EXPENSES OTHER ACCOUNTS END OF PERIOD ----------- ------------ ----------------- -------------- ------------- YEAR ENDED DECEMBER 31, 1997 Allowance for doubtful accounts................. $646 $ 81 $ -- $ 165(2)(4) $ 562 Accrued warranty expenses... $295 $440 $640 $ -- $ 95 ---- ---- ---- ----- ----- YEAR ENDED DECEMBER 31, 1996 Allowance for doubtful accounts................. $360 $497 $ -- $(211)(2) $ 646 Accrued warranty expenses... $280 $350 $ -- $(335)(1)(3) $ 295 ---- ---- ---- ----- ----- YEAR ENDED DECEMBER 31, 1995 Allowance for doubtful accounts................. $365 $365 $ 85 $ 445(2) $ 360 Accrued warranty expenses... $321 $257 $ -- $ 298(1) $ 280 ==== ==== ==== ===== =====
- --------------- (1) Deductions represent actual warranty expenses charged against the accrual. (2) Deductions represent accounts written off. (3) Deductions represent impact of CVD initial public offering. (4) Deductions represent impact of Cardiometrics acquisition. F-6 41 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 1. ORGANIZATION, BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Business EndoSonics Corporation (EndoSonics), a Delaware corporation, develops, manufactures and markets intravascular ultrasound imaging systems, diagnostic imaging and doppler catheters, combined angioplasty imaging catheters and medical devices for the diagnosis and treatment of coronary and peripheral vascular disease. Consolidation The accompanying consolidated financial statements include the accounts of EndoSonics and its subsidiaries (EndoSonics and its subsidiaries are collectively referred to hereinafter as the "Company"). All significant inter-company accounts and transactions have been eliminated in consolidation. Investments in unconsolidated subsidiaries, and other investments in which the Company has a 20% to 50% interest or otherwise has the ability to exercise significant influence, are accounted for under the equity method (see Notes 3 and 4). 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 amounts reported in the financial statements and in the accompanying notes. Actual results could differ from those estimates. Foreign Currency Translation The local currency is the functional currency of the Company's foreign subsidiary. Exchange gains or losses resulting from foreign currency translation are included as a component of stockholders' equity. Transaction exchange gains or losses are included in general and administrative expense in the consolidated statement of operations, and have not been significant in any year presented. Cash Equivalents and Short-Term Investments The Company invests its excess cash in various investment grade, interest-bearing securities. As of December 31, 1997 and 1996, cash equivalents and short-term investments consisted of money market mutual funds, U.S. Treasury Notes and obligations of other U.S. government agencies and corporate debt securities. With the exception of the U.S. government and its agencies, by policy, the amount of credit exposure to any one issuer is limited. The Company has not experienced any significant losses on such investments. Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. At December 31, 1997 and 1996, the Company's entire portfolio of investments is classified as available-for-sale. These securities are stated at fair market value, determined based on quoted market prices, with the unrealized gains and losses reported in a separate component of stockholders' equity. The amortized cost of debt securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, over the estimated life of the security. Such amortization is included in interest income. Realized gains and losses, which were not significant in any year presented, and declines in value judged to be other-than-temporary are included in general and administrative expense. The cost of securities sold is based on the specific identification method. F-7 42 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) For purposes of reporting cash flows, the Company considers highly liquid investments with original maturities of three months or less as cash equivalents. INVENTORIES Inventories are stated at the lower of cost, determined on a first-in, first-out (FIFO) basis, or market value. PROPERTY AND EQUIPMENT Property and equipment are stated at cost and depreciated or amortized on a straight-line basis over the lesser of the estimated useful lives of the assets or the lease term. The estimated useful lives range from three to five years. INTANGIBLE ASSETS Intangible assets consist of goodwill, assembled workforce, and developed technology arising from business acquisitions. The value assigned to intangible assets is based on independent appraisals and is being amortized on a straight-line basis over periods of three to eight years. Concentrations of Credit Risk, Significant Customers, Export Sales and Suppliers The Company sells its products primarily to medical institutions and distributors worldwide (see Note 5). The Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral from customers. Management believes that an adequate allowance for doubtful accounts has been provided. Accounts receivable from two of the Company's customers represented 60% and 13% of net trade accounts receivable, respectively, at December 31, 1997 (75% and 7%, respectively, at December 31, 1996). During 1997, sales to two of the Company's customers comprised 58% and 19% of the Company's total product sales, respectively. During 1996, sales to these two customers comprised 62% and 9% of the Company's total product sales, respectively. During 1995, sales to these two customers comprised 53% and 16% of the Company's total product sales. The Company had sales to customers outside the United States as follows:
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 ------- ------- ------ Europe......................................... $11,528 $ 9,820 $6,996 Asia........................................... 9,312 6,689 2,891 Other.......................................... 1,027 359 14 ------- ------- ------ $21,867 $16,868 $9,901 ======= ======= ======
The manufacturing of the Company's Five-64 integrated circuit microchips, an important component of its imaging catheters, is currently performed by a single vendor. Although management believes that other vendors could provide similar microchips on comparable terms, a change in suppliers can be a lengthy process. Consequently, any supply interruption from this single source could delay production and have a material adverse effect on the Company's business, financial condition and results of operations. F-8 43 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) Revenue Recognition and Warranties The Company recognizes revenue from the sale of its products when the goods are shipped to its customers, including distributors. Contract revenue is recognized upon the completion of specified milestones. For ultrasound imaging systems sold in the United States, the Company provides a 12-month limited warranty covering materials and workmanship. For ultrasound imaging systems sold to its international distributors, the Company provides various warranty periods up to 12 months covering replacement parts. A provision for anticipated warranty expenses is accrued at the time of shipment. Customers may purchase extended warranty coverage for additional one-year periods. Revenue from sales of extended warranties is deferred and recognized as revenue on a straight-line basis over the term of the extended warranty. Stock Compensation In accordance with the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") which the Company adopted in 1996, the Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock option plans. Under APB 25, if the exercise price of the Company's employee stock options equals or exceeds the fair value of the underlying stock on the date of grant as determined by the Company's Board of Directors, no compensation expense is recognized. See Note 11 for pro forma disclosures required by SFAS 123. Net Loss Per Share Net loss per share is computed using the weighted average number of shares of common stock outstanding. Common equivalent shares from stock options and warrants are excluded from the computation because their effect is antidilutive. At December 31, 1995, 1996 and 1997 the Company had outstanding options to purchase 2,045,389, 2,315,366 and 2,993,638 shares of common stock, respectively (with exercise prices ranging from $0.32 to $16.50), and outstanding warrants to purchase 12,304 shares of common stock (with exercise prices from $11.76 to $12.55). If exercised, these options could potentially dilute basic earnings per share in future periods. These options have not been included in the computation of net loss per share, because to do so would have been antidilutive for the periods presented. In February 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share, (SFAS No. 128) which was adopted by the Company. SFAS No. 128 requires presentation of basic and diluted earnings per share. Under the new requirements for calculating basic earnings per share, the dilutive effect of stock options are excluded. Stock options are included in the calculation of diluted earnings per share if the effect is dilutive. The adoption of SFAS No. 128 did not have a material impact on the financial statements. New Accounting Pronouncements In February 1997, the FASB issued Statement No. 129, Disclosure of Information about Capital Structure, which is effective for financial statements for periods ending after December 15, 1997. This statement establishes standards for disclosing information about an entity's capital structure. Adoption of Statement 129 will have no impact on the Company's existing disclosures. In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income. Statement 130 establishes standards for reporting and disclosure of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. Statement 130, which is effective for fiscal years beginning after December 15, 1997, requires reclassification of financial statements for F-9 44 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) earlier periods to be provided for comparative purposes. The Company anticipates that implementing the provisions of Statement 130 will not have a significant impact on the Company's existing disclosures. In June 1997, the FASB issued Statement No. 131, Disclosure about Segments of an Enterprise and Related Information. Statement 131 establishes standards for the way that public business enterprises report information about operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Statement 131 is effective for fiscal years beginning after December 15, 1997. In the initial year of application, comparative information for earlier years must be restated. The Company anticipates that implementing the provisions of Statement 131 will not have a significant impact on the Company's existing disclosures. Reclassifications Certain reclassifications have been made to the 1996 Consolidated Financial Statements to conform to the 1997 presentation. 2. SHORT-TERM INVESTMENTS The following is a summary of available-for-sale securities at December 31, 1997 and 1996:
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- DECEMBER 31, 1997 U.S. Treasury notes and obligations of other U.S government agencies........ $ 3,499 $1 $-- $ 3,500 Corporate debt securities.............. 10,045 -- -- 10,045 ------- -- --- ------- $13,544 $1 $-- $13,545 ======= == === ======= DECEMBER 31, 1996 U.S. Treasury notes and obligations of other U.S government agencies........ $18,946 $2 $-- $18,948 Corporate debt securities.............. 17,164 -- (1) 17,163 ------- -- --- ------- $36,110 $2 $(1) $36,111 ======= == === =======
Included in the above table are securities with fair values totaling $4,425 and $30,862 at December 31, 1997 and 1996, respectively, which are classified as cash equivalents in the accompanying balance sheet. The amortized cost and estimated fair value of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because the issuers of the securities may have the rights to prepay obligations without prepayment penalties.
ESTIMATED AMORTIZED FAIR MARKET COST VALUE --------- ----------- Due in one year or less................................. $12,053 $12,054 Due after one year...................................... 1,491 1,491 ------- ------- $13,544 $13,545 ======= =======
3. BUSINESS ACQUISITIONS Pursuant to an Agreement and Plan of Reorganization between EndoSonics and CardioVascular Dynamics, Inc., in June 1993 EndoSonics acquired all of the preferred and common shares of CVD held by F-10 45 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) others in exchange for $335 in cash and 250,000 shares of EndoSonics' common stock with an aggregate market value of $1,563. EndoSonics also incurred direct acquisition costs of approximately $236 in conjunction with this transaction which have been included as part of the purchase price. EndoSonics accounted for the acquisition of the interest in CVD under the purchase method of accounting. In connection with the acquisition, $2,000 was charged to acquired in-process research, development and clinical expense related to CVD products which had not received regulatory approval and did not have identified alternative uses. Pursuant to the terms of the Agreement and Plan of Reorganization, in June 1995 the Company became obligated to issue 50,000 shares of its common stock to the former shareholders of CVD because the market price of the Company's common stock did not exceed a specified price for a specified period during the two year period following the acquisition. The fair market value of such shares of $488 has been charged to acquired in-process research, development and clinical expenses. In March 1996, the Company purchased 400,000 shares of CVD Series B Preferred Stock at $20.00 per share for an aggregate purchase price of $8,000. The Company converted their shares to common shares upon the consummation of CVD's initial public offering. On July 23, 1997, the Company acquired all of the outstanding shares of Cardiometrics, Inc. (Cardiometrics) for approximately $73,400. The results of Cardiometrics' operations have been combined with those of the Company since the date of acquisition. The acquisition was accounted for using the purchase method of accounting. Consideration for this transaction consisted of the following (in thousands): Cash........................................................ $22,281 EndoSonics common stock..................................... 33,139 CardioVascular Dynamics, Inc. common stock.................. 8,484 Cancellation of the Company's pre-merger investment in Cardiometrics............................................. 2,317 Liabilities assumed (including Cardiometrics termination benefits of $1,900)....................................... 4,840 Transaction costs........................................... 2,357 ------- $73,418 =======
A summary of the purchase price allocation is as follows: Tangible assets acquired.................................... $22,721 In-process research and development......................... 43,000 Developed technology........................................ 5,200 Other intangibles........................................... 700 Goodwill.................................................... 1,797 ------- $73,418 =======
The purchased in-process research and development was valued by an independent appraiser. As it had not reached technological feasibility, and had no probable alternative future uses, it was charged to operations upon acquisition. Goodwill and other intangible assets are being amortized over three-to-eight years. Amortization expense and accumulated amortization were $475 at December 31, 1997. In addition, the Company recognized a gain of $3,700 related to the excess of the fair value over the book value of CVD common stock used as part of the purchase price consideration. The purchase price includes $1,900 in severance and relocation liabilities assumed by the Company related to plans to relocate certain Cardiometrics employees to Rancho Cordova, and to terminate others. Approximately $1,000 was paid in 1997. The Company expects that the remainder of this cash outlay will be completed by April 1998. F-11 46 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) Unaudited proforma combined results of operations for the twelve month periods ending December 31, 1997 and 1996, giving effect to certain adjustments, including the acquisition restructuring, as if the Cardiometrics acquisition had occurred at the beginning of each period, are displayed in the following table:
TWELVE MONTHS ENDED DECEMBER 31, ---------------------- 1997 1996 --------- --------- (IN THOUSANDS EXCEPT PER SHARE DATA) Total revenue............................................ $41,057 $38,376 Net loss................................................. (53,049) (59,206) Loss per share........................................... $ (3.66) $ (3.79)
The unaudited proforma results of operations for the twelve months ended December 31, 1997 and 1996 include one-time charges of $43,000 related to the write-off of acquired in-process research and development, and $5,000 related to restructuring and integration of the two companies. 4. CHANGE IN OWNERSHIP PERCENTAGE OF CARDIOVASCULAR DYNAMICS, INC. On June 19, 1996, EndoSonics' 84% owned subsidiary, CVD (see Note 3), successfully completed an Initial Public Offering (IPO) of 3,400,000 shares of common stock at $12.00 per share, followed by an additional 510,000 shares issued in July 1996 (over-allotment option granted to CVD's underwriters). As a result of this transaction, CVD's results of operations for 1996 have been consolidated through June 19, 1996, and accounted for on the equity method thereafter. In June 1996, the Company recorded an increase to additional paid-in capital of approximately $17,600 representing the Company's proportionate share of CVD's net assets following the IPO. For the year ended December 31, 1997 and for the period from June 20, 1996 to December 31, 1996, the Company recorded ($2,358) and ($1,621) respectively, representing its proportionate share of CVD's net losses for the period. As of December 31, 1997 and 1996, EndoSonics owned 24% and 45% respectively of the outstanding shares of CVD. Condensed financial information for CVD is shown below:
DECEMBER 31, DECEMBER 31, 1997 1996 BALANCE SHEET ------------ ------------ Current assets..................................... $37,316 $48,574 Property and equipment, net........................ 1,550 1,182 Other assets....................................... 2,495 328 ------- ------- Total assets............................. $41,361 $50,084 ------- ------- Current liabilities................................ $ 3,488 $ 2,432 Deferred distributorship fee revenue............... -- 29 Stockholders' equity............................... 37,873 47,623 ------- ------- Total liabilities and stockholders' equity................................. $41,361 $50,084 ------- ------- EndoSonics' share of CVD's net assets.............. $ 8,478 $19,444 ======= =======
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1997 1996 1995 STATEMENT OF OPERATIONS ------------ ------------ ------------ Total revenue......................... $11,332 $ 8,734 $ 4,103 Cost of sales......................... 6,418 4,111 2,051 ------- ------- ------- Gross profit.......................... 4,914 4,623 2,052 Total operating expenses.............. 15,911 10,621 5,028 Other income.......................... 2,225 1,374 102 ------- ------- ------- Net loss.............................. ($8,772) ($4,624) ($2,874) ======= ======= =======
F-12 47 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) CardioVascular Dynamics, Inc.'s stock is quoted on the Nasdaq Stock Market. The closing price of CVD's stock at December 31, 1997 and 1996 was $5.50 and $13.00 respectively, per share. The Company held 2,194,016 and 4,040,000 shares of CVD's common stock at December 31, 1997 and 1996 respectively. 5. DISTRIBUTION AGREEMENTS During 1994, the Company entered into agreements with Cordis for the exclusive distribution by Cordis of certain of EndoSonics intracoronary ultrasound systems and catheters worldwide, excluding Japan, Canada and certain European countries. These agreements expired in 1995. In February 1996, the Company and Cordis entered into a new agreement which provides for the exclusive distribution of EndoSonics' products in North America, Europe, Africa and the Middle East through 1998. The Company and Cordis also entered into an agreement for the development of certain catheters. Under the terms of this agreement, the Company may receive payments from Cordis as contract milestones are achieved. During 1997 and 1996, the Company received payments totaling $637 and $705 respectively. In connection with the above agreements, in February 1996, Cordis purchased 350,877 shares of the Company's common stock at $14.25 per share. The Company has executed distribution agreements with Fukuda, a common shareholder of EndoSonics. The agreements provide Fukuda with exclusive distribution rights relative to certain of the Company's products in Japan for periods extending through May 1999, which may be extended at the option of the parties. Distribution fees received from Fukuda are being recognized as revenue over the initial periods covered by the respective agreement. There are no purchase commitments between Fukuda and the Company. In July 1995, CVD amended its distribution agreement with Fukuda to include additional products. Under the terms of the amendment, Fukuda made a $750 payment which is convertible into equity securities of CVD upon the occurrence of certain events. Upon the CVD initial public offering, the $750 convertible obligation was converted to equity securities of CVD. 6. RESTRUCTURING AND OTHER CHARGES Concurrent with the purchase of Cardiometrics, Inc., (Note 3), the Company recorded restructuring and integration charges of approximately $9,500 related to plans to reduce overhead of the combined companies and increase operating efficiency in future periods. The restructuring and integration charges include approximately $7,500 of corporate reorganization costs and approximately $2,000 related to relocation of certain product lines and overall integration of the Company's operations. Due to changes in conditions subsequent to the initial recording of the restructuring and integration charges, the Company reduced the provision for these charges to $8,600 during the fourth quarter of 1997. These charges are included in the accompanying Consolidated Statements of Operations, as follows:
1997 -------------- (IN THOUSANDS) Cost of sales.......................................... $1,251 Research and development............................... 200 Marketing and sales.................................... 542 General and administrative............................. 1,361 Restructuring.......................................... 4,956 Other.................................................. 296 ------ Total charges................................ $8,606 ======
F-13 48 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) During the year ended December 31, 1997, adjustments to the initial accrual for restructuring and integration charges were as follows:
ACCRUAL AS OF PROVISION ADJUSTMENTS COST INCURRED DECEMBER 31, 1997 --------- ----------- ------------- ----------------- (IN THOUSANDS) Corporate reorganization.............. $7,491 ($375) ($2,062) $5,054 Consolidation of facilities........... 1,965 (475) (834) 656 ------ ----- ------- ------ $9,456 ($850) ($2,896) $5,710 ====== ===== ======= ======
In June 1996, the Company recorded restructuring and integration charges of approximately $3,066 in connection with the consolidation of the Company's IVUS manufacturing operations and with the start-up production of the new Five-64 imaging devices. The elements of the 1996 restructuring accrual as of December 31, 1997, were as follows:
ACCRUAL AS OF COST DECEMBER 31, PROVISION INCURRED 1997 --------- -------- ------------ Consolidation of Facilities.......................... $ 994 $ (777) $217 Conversion to new technology......................... 1,849 (1,849) -- Corporate reorganization............................. 223 (133) 90 ------ ------- ---- $3,066 $(2,759) $307 ====== ======= ====
The charges included in the accompanying Consolidated Statements of Operations for the year ended December 31, 1996 are as follows:
1996 ------ Cost of sales............................................... $ 794 Other research, development and clinical.................... 475 Marketing and sales......................................... 480 General and administrative.................................. 799 Restructuring............................................... 518 ------ Total charges..................................... $3,066 ======
The accrual for restructuring and integration charges was approximately $6,017 and $932 as of December 31, 1997 and December 31, 1996 respectively. 7. INVENTORIES Inventories consisted of the following as of December 31:
1997 1996 ------ ------ Raw materials............................................... $2,817 $ 798 Work-in-process............................................. 1,842 1,181 Finished goods.............................................. 2,256 1,593 ------ ------ $6,915 $3,572 ====== ======
F-14 49 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 8. PROPERTY AND EQUIPMENT Property and equipment consisted of the following as of December 31:
1997 1996 ------ ------ Furniture, fixtures and equipment........................... $7,745 $5,459 Leasehold improvements...................................... 161 332 ------ ------ 7,906 5,791 Less accumulated depreciation and amortization.............. (4,498) (3,844) ------ ------ $3,408 $1,947 ====== ======
9. CURRENT LIABILITIES Current liabilities consisted of the following as of December 31:
1997 1996 ------- ------ Accrued restructuring and integration..................... $ 6,017 $ 932 Accounts payable.......................................... 1,954 1,625 Accrued payroll and related expenses...................... 2,058 1,647 Accrued product transition costs.......................... -- 312 Deferred revenue.......................................... 377 -- Accrued royalties......................................... 96 3 Accrued warranty.......................................... 95 295 Other accrued expenses.................................... 2,956 1,158 ------- ------ $13,553 $5,972 ======= ======
10. OPERATING LEASES The Company leases its administrative, research and manufacturing facilities and certain equipment under long-term non-cancelable lease agreements that have been accounted for as operating leases. Certain of these leases include scheduled rent increases and renewal options as prescribed by the agreements. Future minimum payments by year under long-term non-cancelable operating leases are as follows: 1998................................................ $ 839 1999................................................ 811 2000................................................ 790 2001................................................ 736 2002................................................ 731 Thereafter.......................................... 2,753 ------ $6,660 ======
Rental expense charged to operations for all operating leases during 1997, 1996 and 1995 was approximately $742, $630, and $576 respectively. F-15 50 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 11. EQUITY Common Stock In 1995, the Company completed a second public offering of 2,645,000 shares of its common stock. The Company received net proceeds of approximately $35,000. On September 26, 1997, the Company distributed to shareholders and common stock option holders of record as of September 5, 1997, .04 shares of CVD common stock for each share of the Company's common stock outstanding or subject to options. The Company recorded approximately $1,000 in compensation expense, related to the distribution to stock option holders, which consisted of $540 in CVD common stock and $460 in cash. The compensation expense was based on the closing price of $8.75 per share of CVD common stock on September 25, 1997. The book value of the CVD common stock distributed to shareholders totaled $3,019, and was charged to accumulated deficit. Stock Options In March 1988, EndoSonics established a stock option plan (the "1988 Plan") under which key employees, directors, officers and consultants may participate. Either incentive stock options or nonstatutory stock options may be granted under the 1988 Plan. Option prices are established by the Board of Directors and cannot be less than 85% of the fair market value of a share of common stock on the date of the option grant in the case of nonstatutory options, or 100% of the fair market value in the case of incentive stock options (110% in the case of any options granted to a person who owns more than 10% of the total combined voting power of all classes of stock of the Company). Options generally vest over periods ranging from one to four years (principally four years) and are exercisable upon vesting over five or ten year terms as specified in the option grants. Certain options granted in 1995 and 1996 have accelerated vesting provisions. As of December 31, 1997, 4,100,000 common shares were reserved for issuance, 1,488,072 shares were fully exercisable (998,334 at December 31, 1996) and 279,089 shares were available for future grant (391,958 at December 31, 1996). The following is a summary of the activity, including the range of per share option prices, in the 1988 Plan during each of the three years in the period ended December 31, 1997:
SHARES WEIGHTED UNDER OPTION PRICE AVG. OPTION PER SHARE EXERCISE PRICE --------- --------------- -------------- Balance at December 31, 1994........................... 1,406,025 $ .32 - $16.50 $ 6.57 Granted.............................................. 852,850 7.75 - 13.88 10.34 Canceled............................................. (86,941) 5.25 - 10.00 6.20 Exercised............................................ (126,545) .32 - 7.75 5.59 Balance at December 31, 1995........................... 2,045,389 .32 - 16.50 8.24 Granted.............................................. 668,685 11.88 - 16.00 12.18 Canceled............................................. (61,324) 3.75 - 13.88 10.92 Exercised............................................ (337,384) .32 - 9.75 7.28 Balance at December 31, 1996........................... 2,315,366 .32 - 16.50 7.90 Granted.............................................. 1,057,490 8.93 - 13.38 10.59 Canceled............................................. (294,621) 3.75 - 13.88 11.32 Exercised............................................ (84,597) .32 - 13.88 4.84 Balance at December 31, 1997........................... 2,993,638 $ .32 - $16.50 $ 8.71
No shares purchased under the option plan are subject to repurchase at December 31, 1997. F-16 51 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) As part of the CVD acquisition, the Company agreed to the assumption of all of the outstanding stock options previously granted by CVD and that such option holders may upon exercise of their options purchase up to 39,820 shares of EndoSonics common stock at exercise prices ranging from $.167 to $.334 per share. Through December 31, 1997, 31,683 of these options have been exercised. As part of the Cardiometrics acquisition, the Company agreed to the assumption of all of the outstanding stock options previously granted by Cardiometrics and that such option holders may upon exercise of their options purchase up to 128,467 shares of EndoSonics common stock at exercise prices ranging from $0.47 to $13.23 per share. Through December 31, 1997, 43,444 of these options have been exercised. The options outstanding at December 31, 1997 have been segregated into ranges for additional disclosure as follows:
OPTIONS OUTSTANDING - ---------------------------------------------------------------------------------- OPTIONS WEIGHTED-AVERAGE RANGE OF OUTSTANDING AT REMAINING CONTRACTUAL LIFE WEIGHTED-AVERAGE EXERCISE PRICES DECEMBER 31, 1997 (IN YEARS) EXERCISE PRICE - --------------- ----------------- -------------------------- ---------------- $ 0.00 - $ 2.50 58,672 2.5 $ 0.95 2.50 - 5.00 185,214 4.4 $ 4.33 5.00 - 7.50 404,272 5.8 $ 6.78 7.50 - 10.00 1,180,443 8.0 $ 8.89 10.00 - 12.50 467,432 9.1 $11.58 12.50 - 15.00 652,605 8.1 $13.30 $15.00 - $20.00.. 45,000 6.5 $16.22 --------- --- ------ 2,993,638 7.6 $ 9.76 ========= === ======
OPTIONS EXERCISABLE - ------------------------------------------------------------ OPTIONS RANGE OF CURRENTLY EXERCISABLE AT WEIGHTED-AVERAGE EXERCISE PRICES DECEMBER 31, 1997 EXERCISE PRICE - --------------- ------------------------ ---------------- $ 0.00 - $ 2.50.. 58,672 $ 0.95 2.50 - 5.00.. 167,366 $ 4.39 5.00 - 7.50.. 368,713 $ 6.80 7.50 - 10.00.. 435,660 $ 8.58 10.00 - 12.50.. 182,099 $11.63 12.50 - 15.00.. 245,667 $13.39 $15.00 - $20.00.. 29,895 $16.35 --------- ------ 1,488,072 $ 8.69 ========= ======
Pro forma information regarding net loss and loss per share is required by Statement 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
1997 1996 1995 --------- --------- --------- Risk Free Interest Rates................... 5.5 - 5.5% 6.1 - 6.7% 6.1 - 6.7% Expected Volatility........................ 101% 109% 109% Expected Dividend Yield.................... -- -- -- Expected Life (in years)................... 7 to 10 5 to 8.25 5 to 8.25
The weighted-average fair value on the date of grant for options granted during 1997, 1996 and 1995 was $9.25, $10.90 and $9.28 respectively. F-17 52 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share information):
1997 1996 1995 -------- -------- -------- Pro forma net loss......................... $(49,096) $(10,642) $(12,315) Pro forma loss per share................... $ 3.35 $ (0.80) $ (1.19)
Because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully realized until 1997. 12. INCOME TAXES The provision for income taxes for the year ended December 31, 1997.
1997 1996 1995 ---- ---- ---- Federal Current................................................... $137 $-- $-- Deferred.................................................. -- -- -- ---- -- -- Total federal..................................... $137 $-- $-- ---- -- -- State Current................................................... $ 38 $-- $-- Deferred.................................................. -- -- -- ---- -- -- Total state....................................... $ 38 $-- $-- ---- -- -- Provision for Income Taxes.................................. $175 $-- $-- ==== == ==
The income tax provisions differ from the amount computed by applying the federal statutory rate (35% used in each year presented) to income (loss) before income taxes. A reconciliation to the statutory federal income tax rate is as follows:
1997 1996 1995 -------- ------- ------- (IN THOUSANDS) Statutory federal income tax......................... $(16,474) $(2,507) $(3,665) State income taxes, net of federal benefit 25 $ -- $ -- Write-off of in-process research and development..... 15,050 -- -- Distributions of appreciated property................ 993 -- -- Net operating loss utilization....................... (2,042) -- -- Valuation allowance increases........................ 2,571 2,507 3,665 Other................................................ 520 -- -- -------- ------- ------- Provision for income taxes........................... $ 175 $ -- $ -- ======== ======= =======
F-18 53 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) Significant components of the Company's deferred tax assets are as follows at December 31, 1997:
1997 1996 -------- -------- Deferred tax assets: Net operating loss carryforwards.......................... $ 17,850 $ 13,828 Research and development and other tax credit carryforwards.......................................... 2,293 1,411 Other..................................................... 7,322 2,374 -------- -------- Total deferred tax assets......................... $ 27,405 $ 17,613 -------- -------- Deferred tax liabilities: Intangible assets......................................... $ (2,264) $ -- Investment basis differences.............................. (3,173) -- -------- -------- Total deferred tax liabilities.................... ($ 5,437) -- ======== ======== Net deferred tax assets..................................... 22,028 17,613 Valuation allowance......................................... (22,028) (17,613) -------- -------- Deferred tax asset.......................................... $ -- $ -- ======== ========
Income tax payments were $93 in 1997 and $0 in 1996 and 1995. The valuation allowance decreased by $275 in 1996, and increased by $3,891 in 1995. At December 31, 1997, the Company has net operating loss carryforwards for federal and state income tax purposes of approximately $49,500 and $8,500, respectively, which expire in the years 1997 through 2012. At December 31, 1997, the Company has research and development and other tax credit carryforwards for federal and state income tax purposes of approximately $1,786 and $779, respectively, which expire in the years 2005 through 2011. As a result of the "change of ownership" provision of the Tax Reform Act of 1986, the utilization of the federal net operating loss and the deduction equivalent of federal tax credit carryforwards of approximately $3,900 included in the above amounts are subject to a cumulative annual limitation of approximately $1,375 per year pursuant to certain stock ownership changes of Cardiometrics prior to July 24, 1997. Due to the acquisition of Cardiometrics by EndoSonics in 1997, a second annual limitation of approximately $4,000 per year applies to approximately $15,500 of federal net operating loss, $630 of federal research and development credits, $4,500 of state net operating loss and $360 of state tax credit carryforwards included in the above amounts. Future "changes in ownership" may further limit the ability of the Company to utilize its net operating loss and tax credit carryforwards prior to their expiration. 13. CONTINGENCIES In August 1997, the Company sued Intravascular Research Limited ("IRL") in the Superior Court of the State of California for the County of Sacramento for misappropriation of trade secrets. The Company's complaint alleged that IRL had misappropriated certain confidential information received from the Company, and sought a court order requiring IRL to assign to the Company all rights in all IRL patent applications and issued patents worldwide based on the misappropriated technology. In March 1998, the Company dismissed the Complaint without prejudice. In September 1997, IRL sued the Company in the United States District Court, District of Delaware, accusing the Company of infringing one of IRL's imaging patents, seeking a declaration of invalidity and non-infringement with respect to one of the Company's patents, and requesting a declaratory judgment that it has not misappropriated the Company's trade secrets. In February 1998, the Court dismissed IRL's declaratory F-19 54 ENDOSONICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) relief cause of action. In March 1998, the Company counterclaimed and accused IRL of infringing two of its imaging patents. The Company also sought a declaration of invalidity and non-infringement with respect to the patent IRL had accused the Company of infringing, as well as to correct IRL's claim of inventorship relating to this patent. In late March, IRL counterclaimed and accused the company of infringing an additional two of its imaging patents, and sought a declaration of invalidity and non-infringement with respect to the second patent the Company had asserted. IRL further sought to reinstitute its declaratory relief cause of action relating to trade secret misappropriation. The Company anticipates seeking a declaration of invalidity and non-infringement with respect to the additional two patents asserted by IRL, and moving to dismiss IRL's non-misappropriation declaratory relief cause of action for lack of subject matter jurisdiction. The Company is subject to various other legal actions and claims arising in the ordinary course of business. Management believes the outcomes of these matters will have no material adverse effect on the Company's financial position, results of operations or cash flows. 14. SUBSEQUENT EVENTS On February 17, 1998, the Company announced that its Board of Directors authorized a stock repurchase program whereby the Company may, from time to time, repurchase up to $5,000 of its common stock. Also in February 1998, the Company, in separate transactions, sold a total of 470,000 shares of CVD common stock valued at $1,800, resulting in a gain of approximately $300. F-20 55 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Ernst & Young LLP, Independent Auditors........... F-21 Consolidated Balance Sheets................................. F-22 Consolidated Statements of Operations....................... F-23 Consolidated Statements of Stockholders' Equity (Net Capital Deficiency)............................................... F-24 Consolidated Statements of Cash Flows....................... F-25 Notes to Consolidated Financial Statements.................. F-26
56 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders CardioVascular Dynamics, Inc. We have audited the accompanying consolidated balance sheets of CardioVascular Dynamics, Inc. and subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, stockholders' equity (net capital deficiency) and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CardioVascular Dynamics, Inc. and subsidiaries at December 31, 1996 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Orange County, California January 29, 1998 F-21 57 CARDIOVASCULAR DYNAMICS, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share amounts)
December 31 -------------------------- 1996 1997 ---------- ---------- ASSETS Current Assets: Cash and cash equivalents ........................................... $ 17,192 $ 6,141 Marketable securities available-for-sale ............................ 25,733 24,773 Accounts receivable, net of allowance for doubtful accounts of $377 and $500, respectively ............................................ 2,268 2,752 Other accounts receivable ........................................... 320 282 Inventories ......................................................... 2,899 3,205 Other current assets ................................................ 162 163 ---------- ---------- Total current assets .......................................... 48,574 37,316 Property and Equipment: Furniture and equipment ............................................. 1,161 1,871 Leasehold improvements .............................................. 310 322 ---------- ---------- 1,471 2,193 Less accumulated depreciation and amortization ...................... (289) (643) ---------- ---------- Net property and equipment ........................................ 1,182 1,550 Goodwill, net of amortization of $78 ................................ -- 1,809 Notes receivable from officers ...................................... 325 273 Other assets ........................................................ 3 413 ---------- ---------- Total assets ...................................................... $ 50,084 $ 41,361 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses ............................... $ 2,382 $ 3,488 Deferred distributorship fee revenue, current portion ............... 50 -- ---------- ---------- Total current liabilities ........................................... 2,432 3,488 Deferred distributorship fee revenue .................................... 29 -- Commitments (Note 10) Stockholders' equity Convertible Preferred Stock, $.001 par value; 7,560,000 shares authorized, 2,000,000 and no shares issued and outstanding....... -- -- Common Stock, $.001 par value; 30,000,000 shares authorized, 9,004,000 and 9,389,000 shares issued and outstanding at December 31, 1996 and 1997, respectively ................................. 9 9 Additional paid-in capital .......................................... 58,869 60,371 Deferred compensation ............................................... (376) (634) Accumulated deficit ................................................. (11,049) (19,821) Treasury stock, at cost, 345,000 common shares ...................... -- (2,205) Unrealized gain on available-for-sale securities .................... 170 176 Unrealized exchange rate loss ....................................... -- (23) ---------- ---------- Total stockholders' equity ...................................... 47,623 37,873 ---------- ---------- Total liabilities and stockholders' equity ...................... $ 50,084 $ 41,361 ========== ==========
See accompanying notes. F-22 58 CARDIOVASCULAR DYNAMICS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
YEAR ENDED DECEMBER 31, ------------------------------------------ Revenue: 1995 1996 1997 ---------- ---------- ---------- Sales .......................................................... $ 3,462 $ 8,384 $ 11,332 License fee and other from related party ....................... -- 150 -- Contract ....................................................... 641 200 -- ---------- ---------- ---------- Total revenue ................................................ 4,103 8,734 11,332 Operating costs and expenses: Cost of sales .................................................. 2,051 4,111 6,418 Charge for acquired in-process research and development ........ 488 2,133 -- Research and development ....................................... 1,683 3,582 7,041 Marketing and sales ............................................ 1,526 3,358 6,691 General and administrative (including $340 and $156 for the years ended December 31, 1995 and 1996, respectively, paid to EndoSonics) ............................................... 1,331 1,548 2,179 ---------- ---------- ---------- Total operating costs and expenses ........................... 7,079 14,732 22,329 ---------- ---------- ---------- Loss from operations ............................................ (2,976) (5,998) (10,997) Other Income: Interest income ................................................. 42 1,324 2,201 Distributorship fees and other income ........................... 60 50 24 ---------- ---------- ---------- Total other income ........................................... 102 1,374 2,225 ---------- ---------- ---------- Net Loss ........................................................ $ (2,874) $ (4,624) $ (8,772) ========== ========== ========== Basic and diluted net loss per share (pro forma through June 1996) ................................................... $ (0.71) $ (0.69) $ (0.96) ========== ========== ========== Shares used in computing basic and diluted net loss per share (pro forma through June 1996) ................................ 4,052 6,755 9,118 ========== ========== ==========
See accompanying notes. F-23 59 CARDIOVASCULAR DYNAMICS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) (In thousands, except share amounts)
Preferred Stock Common Stock Additional ------------------------ ------------------------ Paid-In Deferred Shares Amount Shares Amount Capital Compensation ---------- ---------- ---------- ---------- ---------- ------------ Balance at December 31, 1994 .......... -- $ -- 4,000,000 $ 4 $ 4,835 -- Additional effects of merger with EndoSonics Acquisition Corp. ... -- -- -- -- 488 -- Issuance of Preferred Stock in Exchange for Common Stock ...... 2,000,000 2 (4,000,000) (4) 2 -- Deferred compensation resulting From grant of options .......... -- -- -- -- 345 (345) Net Loss .............................. -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1995 .......... 2,000,000 2 -- -- 5,670 (345) Sale of Preferred Stock to EndoSonics . 400,000 -- -- -- 8,000 -- Conversion of Preferred Stock ......... (2,400,000) (2) 4,800,000 5 (3) -- Exercise of Common Stock Options ...... -- -- 139,000 -- 138 -- Initial Public Offering of Common Stock ................... -- -- 3,910,000 4 42,764 -- Deferred compensation resulting From grant of options .......... -- -- -- -- 150 (150) Amortization of deferred Compensation ................... -- -- -- -- -- 119 Acquisition of Intraluminal Devices, Inc. .................. -- -- 93,000 -- 1,400 -- Conversion of $750,000 debit by Fukuda Denshi .................. -- -- 62,000 -- 750 -- Net loss ............................. -- -- -- -- -- -- Unrealized gain on investments ........ -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Balance of December 31, 1996 .......... -- -- 9,004,000 9 58,869 (376) Exercise of common stock options ...... -- -- 208,000 -- 238 -- Employee stock purchase plan .......... -- -- 33,000 -- 266 -- SCIMED warrant exercise ............... -- -- 120,000 -- 377 -- Sale of common stock to Cathex ........ -- -- 25,000 -- 200 -- Expense repayment by Intraluminal Devices, Inc. by transfer and cancellation of common stock ... -- -- (1,000) -- (16) -- Deferred compensation resulting from grant of options ............... -- -- -- -- 437 (437) Amortization of deferred compensation ................... -- -- -- -- -- 179 Treasury Common Stock ................. -- -- -- -- -- -- Net Loss .............................. -- -- -- -- -- -- Unrealized gain on investments ........ -- -- -- -- -- -- Unrealized exchange rate loss ......... -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1997 .......... -- $ -- 9,389,000 $ 9 $ 60,371 $ (634) ========== ========== ========== ========== ========== ==========
Total Stockholders' Treasury Unrealized Unrealized Equity Accumulated ----------------------- Gain on Exchange (Net Capital Deficit Shares Amount Investments Rate Loss Deficiency) ----------- ---------- ---------- ----------- ---------- ---------- Balance at December 31, 1994 .......... $ (3,551) -- $ -- $ -- $ -- $ 1,288 Additional effects of merger with EndoSonics Acquisition Corp. ... -- -- -- -- -- 488 Issuance of Preferred Stock in Exchange for Common Stock ...... -- -- -- -- -- -- Deferred compensation resulting From grant of options .......... -- -- -- -- -- -- Net Loss .............................. (2,874) -- -- -- -- (2,874) ---------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1995 .......... (6,425) -- -- -- -- (1,098) Sale of Preferred Stock to EndoSonics . -- -- -- -- -- 8,000 Conversion of Preferred Stock ......... -- -- -- -- -- -- Exercise of Common Stock Options ...... -- -- -- -- -- 138 Initial Public Offering of Common Stock ................... -- -- -- -- -- 42,768 Deferred compensation resulting From grant of options .......... -- -- -- -- -- -- Amortization of deferred Compensation ................... -- -- -- -- -- 119 Acquisition of Intraluminal Devices, Inc. .................. -- -- -- -- -- 1,400 Conversion of $750,000 debit by Fukuda Denshi .................. -- -- -- -- -- 750 Net loss ............................. (4,624) -- -- -- -- (4,624) Unrealized gain on investments ........ -- -- -- 170 -- 170 ---------- ---------- ---------- ---------- ---------- ---------- Balance of December 31, 1996 .......... (11,049) -- -- 170 -- 47,623 Exercise of common stock options ...... -- -- -- -- -- 238 Employee stock purchase plan .......... -- -- -- -- -- 266 SCIMED warrant exercise ............... -- -- -- -- -- 377 Sale of common stock to Cathex ........ -- -- -- -- -- 200 Expense repayment by Intraluminal Devices, Inc. by transfer and cancellation of common stock ... -- -- -- -- -- (16) Deferred compensation resulting from grant of options ............... -- -- -- -- -- -- Amortization of deferred compensation ................... -- -- -- -- -- 179 Treasury Common Stock ................. -- 345 (2,205) -- -- (2,205) Net Loss .............................. (8,772) -- -- -- -- (8,772) Unrealized gain on investments ........ -- -- -- 6 -- 6 Unrealized exchange rate loss ......... -- -- -- -- (23) (23) ---------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1997 .......... $ (19,821) $ 345 $ (2,205) $ 176 $ (23) $ (37,873) ========== ========== ========== ========== ========== ==========
See accompanying notes F-24 60 CARDIOVASCULAR DYNAMICS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
YEAR END DECEMBER 31, ----------------------------------- 1995 1996 1997 -------- --------- -------- Operating activities Net loss ......................................................... $(2,874) $ (4,624) $ (8,772) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ................................... 74 182 432 Amortization of deferred compensation ........................... -- 119 179 Bad debt expense ................................................ 249 221 318 Charge for acquired in-process research and development ......... 488 1,400 -- Net changes in: Trade accounts receivable, net .................................. (639) (1,372) (2,767) Receivable from related parties ................................. 125 -- -- Inventories ..................................................... (704) (2,145) 10 Other assets .................................................... (135) (671) 37 Accounts payable and accrued expenses ........................... 1,369 698 836 Deferred distributor fee revenue ................................ (54) (50) (79) ------- -------- -------- Net cash used in operating activities .............................. (2,101) (6,242) (9,806) Investing activities: Purchase of available-for-sale securities ........................ -- (25,563) (43,208) Sales of available-for-sale securities ........................... -- -- 44,174 Capital expenditures for furniture, fixtures and equipment ....... (443) (940) (699) Purchase of Clintec, net of cash acquired ........................ -- -- (30) Change in other assets ........................................... -- -- (358) ------- -------- -------- Net cash used in investing activities .............................. (443) (26,503) (121) -------- Financing activities: Proceeds from issuance of convertible obligation ................. 750 -- -- Proceeds from sale of Common Stock ............................... -- 42,768 466 Proceeds from exercise of stock warrants ......................... -- -- 377 Proceeds from exercise of stock options .......................... -- 138 238 Proceeds from sale of Preferred Stock to EndoSonics .............. -- 8,000 -- Purchase of treasury common stock ................................ -- -- (2,205) Payable to EndoSonics, net ....................................... (17) (2,537) -- ------- -------- -------- Net cash provided by (used in) financing activities ................ 733 48,369 (1,124) ------- -------- -------- Net increase (decrease) in cash .................................... (1,811) 15,624 (11,051) Cash and cash equivalents, beginning of period ..................... 3,379 1,568 17,192 ------- -------- -------- Cash and cash equivalents, end of period ........................... $ 1,568 $ 17,192 $ 6,141 ======= ======== ======== Supplemental disclosure of non-cash financing activities: Common stock issued upon the acquisition of Intraluminal Devices, Inc., Note 1 ........................................... $ -- $ 1,400 $ -- Conversion of Debentures to Common Stock, Note 5 ................... -- 750 --
See accompanying notes. F-25 61 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) 1. BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business and Basis of Presentation CardioVascular Dynamics, Inc. (the "Predecessor") was incorporated on March 16, 1992 in the State of California. The Predecessor, and its successor corporation discussed below, develops, manufactures and markets proprietary therapeutic catheters used to treat certain vascular diseases. In June 1992, EndoSonics Corporation ("EndoSonics") acquired a 40% preferred interest in the Predecessor. EndoSonics, a Delaware corporation, develops, manufactures, and markets intravascular ultrasound imaging systems and diagnostic, therapeutic and imaging catheters for the treatment of coronary and peripheral vascular disease. In June 1993, EndoSonics acquired all of the remaining Preferred and Common Stock of the Predecessor. The acquisition was accomplished through a merger between the Predecessor and EndoSonics Acquisition Corp., a wholly owned subsidiary of EndoSonics (which then changed its name to CardioVascular Dynamics, Inc.) (hereinafter referred to as "CVD" or the "Company"). The acquisition by EndoSonics resulted in a new basis for the CVD assets and liabilities. Accordingly, the purchase price paid by EndoSonics has been allocated to the identifiable assets and liabilities, including in-process research and development, which was immediately expensed as no CVD products had received regulatory approval and the technology did not have identifiable alternative uses. The amount by which the purchase price exceeded the Predecessor's net book value has been reflected as paid-in capital in the accompanying financial statements. Pursuant to the terms of the original merger agreement, in June 1995 EndoSonics issued an additional 50,000 shares of its Common Stock to the former shareholders of the Predecessor. The fair market value of such shares of $488 has been reflected in the accompanying financial statements as an additional charge for acquired in-process technology. Subsequent to the acquisition, EndoSonics began performing certain services for CVD (see Note 4), including general management, accounting, cash management, and other administrative and engineering services. The amounts charged to CVD for such services have been determined based on proportional cost allocations and have been agreed to by the management of CVD and EndoSonics. In the opinion of CVD's management, the allocation methods used are reasonable. Such allocations, however, are not necessarily indicative of costs that would have been incurred had CVD continued to operate independent of EndoSonics. No formal agreement currently exists which specifies the nature of services to be provided by EndoSonics to CVD, or the charges for such services. Therefore, amounts are not necessarily indicative of the future charges to be incurred by CVD. In 1994 and 1996, the Board of Directors of CVD approved a 16,200-for-1 and a 2-for-1 Common Stock split, respectively, which has been reflected retroactively for all periods in the accompanying financial statements. On June 25, 1996, the Company closed its initial public offering (the "Offering") which consisted of 3,400,000 shares of Common Stock at $12.00 per share. On July 17, 1996, the Company's underwriters exercised their overallotment option to purchase an additional 510,000 shares of Common Stock at $12.00 per share. CVD received net offering proceeds from the sale of Common Stock of approximately $42.8 million after deducting underwriting discounts and commissions and other expenses of the Offering. F-26 62 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) In October 1996, CVD acquired 100% of the common stock of Intraluminal Device, Inc. ("IDI") in exchange for CVD common stock valued at $1.4 million. The acquisition was accomplished through the formation of IDI Acquisition, Inc., a wholly-owned subsidiary of CVD, and the merging of IDI into IDI Acquisition, Inc. (See Note 2). In July 1997, CVD the Company acquired all of the common stock of Clinitec GmbH ("Clinitec") its independent distributor in Germany and Switzerland, in exchange for the assumption of the assets and liabilities of Clinitec. The consolidated financial statements for December 31, 1996 and 1997 include the accounts of the Company and its subsidiaries. Intercompany transactions have been eliminated. 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents includes cash on hand, demand deposits, and short-term investments with original maturities of three months or less. Marketable Securities Available-For-Sale The Company accounts for its investments pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). The Company has classified its entire investment portfolio as available-for-sale. Available-for-sale securities are stated at fair value with unrealized gains and losses included in shareholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretions of discounts to maturity. Such amortization is included in interest income. Realized gains and losses are included in other income (expense). The cost of securities sold is based on the specific identification method. Inventories Inventories are comprised of raw materials, work-in-process and finished goods and are stated at the lower of cost, determined on an average cost basis, or market value. Property and Equipment Property and equipment are stated at cost and depreciated or amortized on a straight-line basis over the lesser of the estimated useful lives of the assets or the lease term. The estimated useful lives range from three to seven years. F-27 63 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Goodwill The excess of the purchase price over the net assets of the business acquired ("goodwill") is amortized on the straight-line method over the estimated recovery period. The goodwill stemming from the purchase of Clinitec is amortized over ten years (See Note 2). The carrying value of goodwill is reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the undiscounted cash flows of the entity acquired over the remaining amortization period, the carrying value of the goodwill is reduced to estimated fair value. Long-lived Assets The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. Concentrations of Credit Risk and Significant Customers The Company maintains its cash and cash equivalents in deposit accounts and in pooled investment accounts administered by a major financial institution. The Company sells its products primarily to medical institutions and distributors worldwide. The Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral from customers. Management believes that an adequate allowance for doubtful accounts has been provided. During 1995, 1996 and 1997 product sales to Fukuda Denshi Co., Ltd., ("Fukuda"), the Company's Japanese distributor (see Note 5), comprised 18%, 14% and 7% of total revenue, respectively. Accounts receivable from Fukuda represented 1% and 0% of net accounts receivable at December 31, 1996 and 1997, respectively. The Company terminated its Agreement with Fukuda in May 1997 and signed a five-year agreement with another Japan distributor, Cathex, LTD. ("Cathex"). During 1997, Product sales to Cathex comprised 13% of total revenues. Accounts receivable from Cathex represented 44% of net accounts receivable at December 31, 1997. Product sales to Medtronic, Inc. ("Medtronic") accounted for 21% and 13% of total revenues during 1996 and 1997, respectively. At December 31, 1996 and 1997, 27% and 0%, respectively, of net accounts receivable were due from Medtronic. In May of 1997, Medtronic advised the Company of its election to not make minimum purchases of product for the second year of the agreement. In June 1997, Medtronic informed CVD it would not fulfill its commitment for the first year of the agreement and it did not believe it was required to fulfill such commitment. One other customer comprised 12% of revenues for the year ended December 31, 1995 and 14% of accounts receivable at December 31, 1995. F-28 64 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Export Sales The Company had export sales by region as follows:
Year Ended December 31, ---------------------------------- 1995 1996 1997 -------- -------- -------- Europe ... $ 1,179 $ 1,614 $ 3,020 Japan .... 744 1,240 2,350 Latin America.. 131 243 253 Other .... -- 417 956 -------- -------- -------- $ 2,054 $ 3,514 $ 6,579 ======== ======== ========
Revenue Recognition and Warranty The Company recognizes revenue from the sale of its products when the goods are shipped to its customers. Reserves are provided for anticipated product returns and warranty expenses at the time of shipment. License fees are recognized on a contract with SCIMED Life Systems, Inc. ("SCIMED") when distribution rights to certain markets are made available to SCIMED for the sale of products based upon certain limited catheter technology. Contract revenues are recognized on contracts with SCIMED and Advanced CardioVascular Systems, Inc. ("ACS") for transferring certain limited catheter technology based upon the Company's completion of (1) technical Assistance to aid SCIMED in manufacturing the related products, and (2) research and development to develop the related products for ACS and SCIMED (See Note 3). Accounting for Stock-Based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net income and earnings per share is required by Statement 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. F-29 65 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) In calculating pro forma information regarding net income and net income per share the fair value was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the options on the Company's common stock: risk-free interest rate of 6.0 %, 6.0% and 5.5%; a dividend yield of 0%, 0% and 0%; volatility of the expected market price of the Company's common stock of 0.475, 0.475 and 0.692; and a weighted-average expected life of the options of 3.5, 3.5 and 5.0 years for 1995, 1996 and 1997, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information for the years ended December 31, 1995, 1996 and 1997 follows:
1995 1996 1997 ------------ ------------ ------------ Pro forma net loss ............. $ (2,905) $ (5,170) $ (9,320) Pro forma basic and diluted net loss per share ........... $ (0.72) $ (0.77) $ (1.02)
Because Statement 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1997. Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (Statement No. 130), which is effective for years beginning after December 15, 1997. Statement No. 130 establishes standards for reporting and displaying comprehensive income and its components with the same prominence as other financial statement information. Management has not completed its review of Statement No. 130, but does not anticipate that the adoption of this statement, other than required financial statement reclassifications, will have a significant effect on the Company's reported financial position. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (Statement No. 131), which is effective for years beginning after December 15, 1997. Statement No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. Statement No. 131 is effective for financial statements for fiscal years beginning after December 15, 1997, and therefore the Company will adopt the new requirements retroactively in 1998. The Company operates in one business segment. Accordingly, the Company does not anticipate that the adoption of this statement will have a significant effect on the Company's financial statements. In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of Computer Software Developed For or Obtained For Internal Use. The SOP is effective for companies beginning on January 1, 1999. The SOP will require the capitalization of certain costs incurred after the date of adoption in connection with developing or obtaining software for internal use. The Company currently expenses such costs. The Company has not yet assessed what the impact of the SOP will be on the Company's future earnings or financial position. Income Taxes From June 1993 until June 1996, the Company's results of operations have been included in consolidated tax returns filed by EndoSonics. There was no income tax provision for the consolidated tax group during the periods covered by these financial statements. All net operating loss and credit carryforwards and deferred tax assets and liabilities have been disclosed herein on a separate company basis for CVD. Net Loss Per Share In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share. Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented to conform with Statement No. 128. Net loss per common share after the Company's initial public offering is computed using the weighted average number of common shares outstanding during the periods presented. Options to purchase shares of the Company's common stock granted under the Company's stock option plan may have a dilutive effect on the Company's earnings per share in the future. Net loss per share prior to the Company's initial public offering is computed on a pro forma basis using the weighted average number of shares of Common Stock, convertible Preferred Stock (using the as-if-converted method) and Common Stock issuable upon conversion of the Convertible Obligation, outstanding. The following table sets forth the computation of basic and diluted net loss per share: F-30 66 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, --------------------------------------- 1995 1996 1997 --------- --------- --------- (In thousands) NUMERATOR: Net loss .............................................. $ (2,874) $ (4,624) $ (8,772) --------- --------- --------- Net loss used for basic and diluted loss per share-- loss attributable to common stockholders ............ $ (2,874) $ (4,624) $ (8,772) ========= ========= ========= DENOMINATOR: Denominator for basic and diluted loss per share-- weighted average common shares outstanding .......... 385 4,715 9,118 Assumed conversion of Preferred Stock from the date of issuance (Series A and B)......................... 3,667 2,040 -- --------- --------- --------- 4,052 6,755 9,118 ========= ========= ========= Basic and diluted net loss per share .................. $ (0.71) $ (0.69) $ (0.96) ========= ========= =========
2. ACQUISITIONS On October 16, 1996, the Company acquired all of the outstanding shares of Intraluminal Devices, Inc. ("IDI") in exchange for approximately 93,000 shares of CVD common stock valued at $1.4 million. The acquisition was accounted for using the purchase method of accounting. As the assets of IDI were patents for products still in their development stage, the purchase price and the associated costs of acquisition $0.7 million were expensed as acquired in-process research and development. On July 29, 1997, the Company acquired all of the common stock of its independent distributor in Germany and Switzerland, Clinitec GmbH ("Clinitec"). The aggregate purchase price of the acquisition was $1,636 and consisted of cash of $30 and the forgiveness of debt of $1,606. The transaction was accounted for by the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and the liabilities assumed based on their fair market values at the date of acquisition. In connection with the acquisition, the Company acquired assets and assumed liabilities with fair market values of $401 and $652, respectively. The excess of the purchase price over the fair value of the net assets acquired of $1,887 has been allocated to goodwill. The results of operations of Clinitec are included in the consolidated statement of operations subsequent to the date of acquisition. The following table reflects unaudited pro forma combined results of operations of the Company, IDI and Clinitec on the basis that the acquisitions had taken place and the related charge for IDI, noted above, was recorded at the beginning of 1996 for IDI and Clinitec, as IDI operations were not material to the Company's operations prior to 1996:
1996 1997 ------- ------- Revenues......................... $8,822 $11,633 Net Loss......................... (5,060) (9,484) Net Loss per common share........ (0.75) (1.04) Shares used in computation....... 6,755 9,118
F-31 67 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) In management's opinion, the unaudited pro forma combined results of operations are not indicative of the actual results that would have occurred had the acquisitions been consummated at the beginning of 1996 or 1997, respectively, or of future operations of the combined companies under the ownership and management of the Company. 3. SCIMED LIFE SYSTEMS, INC. In September 1994, CVD and EndoSonics entered into a Stock Purchase and Technology License Agreement with SCIMED Life Systems, Inc. ("SCIMED"). SCIMED acquired a 19% interest in CVD in exchange for $2,500 in cash. CVD also granted SCIMED an exclusive license to certain patents in the cardiovascular field of use, which allows SCIMED to manufacture the Transport PTCA infusion catheter (the "Transport") developed by CVD in exchange for a $1,000 license fee that was paid in 1994. SCIMED will pay royalties to CVD on sales of the Transport and other products which use this patented technology. CVD retains rights to this technology and the associated patents for use outside of the cardiovascular field. During June 1995, the Company issued a warrant to SCIMED to purchase up to 80,000 shares of Series A Preferred Stock at an exercise price of $3.29 per share in exchange for a waiver of SCIMED's anti-dilution right. During May 1996, the Company issued an additional warrant to SCIMED to purchase up to 40,000 shares of Series A Preferred Stock at an exercise price of $3.29 per share in exchange for a waiver of SCIMED's anti-dilution right related to the shares to be issued under the 1996 Plan. In August 1997, SCIMED exercised all 120,000 warrants, mentioned above. SCIMED also paid CVD $641, $200 and $0 in 1995, 1996 and 1997, respectively, on a cost reimbursement basis to fund continuing development of the technology and for other support. 4. RELATED PARTY TRANSACTIONS The following is a summary of significant transactions between CVD and EndoSonics: During a portion of 1995, EndoSonics manufactured certain of the Company's catheter products at cost plus a mark-up of 30%. Total purchases from EndoSonics during 1995 amount to $172. Prior to the Company's initial public offering in June 1996, certain EndoSonics corporate expenses, primarily related to executive management time, accounting, cash management, and other administrative and engineering services, have been allocated to the Company. Total expenses allocated were $340 and $156 for the years ended December 31, 1995 and 1996, respectively. No interest expense has been charged on the net payable due to EndoSonics. The following is an analysis of the payable to EndoSonics: F-32 68 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEAR-ENDED DECEMBER 31, ------------------------ 1995 1996 --------- --------- Beginning balance .................................................. $ 2,554 $ 2,537 Inventory purchases ................................................ 172 -- Corporate cost allocations ......................................... 340 156 Cash disbursements made by EndoSonicson behalf of CVD............... 312 -- Cash collections made by EndoSonics onbehalf of CVD................. (700) -- Cash payments to EndoSonics ........................................ -- (2,693) Cash disbursements made by CVD on behalf of EndoSonics and other ... (141) -- --------- --------- Ending balance ..................................................... $ 2,537 $ -- ========= ========= Average balance during period ...................................... $ 2,551 $ 1,974 ========= =========
In connection with the initial public offering, CVD and EndoSonics entered into a Tax Allocation Agreement that provides, among other things, for (i) the allocation of tax liabilities and adjustments thereto as between the business of the Company and other businesses conducted by EndoSonics and its affiliates related to periods in which the Company is includable in consolidated federal income tax returns filed by EndoSonics, (ii) the allocation of responsibility for filing tax returns and (iii) the conduct of and responsibility for taxes owed in connection with tax audits and various related matters. EndoSonics and CVD had entered into a Stockholder Agreement providing that all transactions between the Company and EndoSonics or any affiliate of EndoSonics must be approved by a special committee of CVD's Board of Directors comprised of two directors who are not officers, directors, employees or affiliates of EndoSonics. The provisions of this agreement became effective upon the consummation of the initial public offering and terminated in the fourth quarter of 1997 when EndoSonics beneficially owned less than 25% of CVD's Common Stock. See also Notes 5 and 11. 5. AGREEMENTS WITH FUKUDA AND CATHEX The Company had a distribution agreement with Fukuda which provided them with exclusive distribution rights relative to certain of the Company's products in Japan for periods extending through May 1999, which could be extended at the option of the parties. Distribution fee revenues received from Fukuda were deferred and were being recognized as revenue over the initial periods covered by the respective agreement. In July 1995 and May 1996, the distribution agreement with Fukuda was amended. In exchange for the exclusive distribution rights to additional CVD products, the Company received $750 which converted into the right to receive 62,500 shares of Common Stock upon the consummation of the initial public offering. In November, 1996, Fukuda exercised the conversion feature of said obligation. In May 1997, the Company terminated the existing distribution agreement and does not expect that any material obligations will arise as a result of such termination. The Company entered into a distribution agreement, dated May 1, 1997, with Cathex, Ltd. (The "Cathex Agreement"), whereby Cathex serves as CVD's exclusive distributor for certain of the Company's products in Japan. In exchange for this exclusive distributorship, Cathex shareholders agreed to purchase $200,000 in CVD F-33 69 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) common stock or approximately 25,000 shares, in addition to payments owing upon the purchase of the products. Cathex also agreed to undertake all necessary clinical trails to obtain approval from Japanese regulator authorities for the sale of the products in Japan. Cathex's purchases under the Cathex Agreement are subject to certain minimum requirements. The initial term of the Cathex Agreement expires on January 1, 2001, subject to a five-year extension. The Cathex Agreement may also be terminated in the event of breach upon 90 days notice by the non-breaching party, subject to cure within the notice period. 6. LICENSE AGREEMENTS In January 1995 the Company entered into a license agreement with Advanced CardioVascular Systems, Inc. ("ACS") under which the Company acquired the exclusive worldwide rights to ACS' SmartNeedle technology. The Company assumed responsibility for manufacturing the product in 1996, subject to the payment of royalties. ACS was granted an option, which was exercised in February 1996, to obtain exclusive worldwide rights to certain CVD perfusion technology. In exchange for the perfusion technology, ACS was obligated to make milestone and minimum royalty payments to CVD, and also has certain obligations to develop and market the perfusion technology. An initial milestone of $150 was earned in the year ended December 31, 1996. In February 1997, ACS elected to terminate the perfusion technology agreement. The Company entered into a license agreement with EndoSonics pursuant to which CVD granted EndoSonics the non-exclusive, royalty-free right to certain technology for use in the development and sale of certain products. In exchange, CVD received the non-exclusive, royalty-free right to utilize certain of EndoSonics' product regulatory filings to obtain regulatory approval of CVD products. 7. MARKETABLE SECURITIES AVAILABLE-FOR-SALE The Company's investments in debt securities are diversified among high credit quality securities in accordance with the Company's investment policy. The Company's investment portfolio is managed by a major financial institution. The following is a summary of investments in debt securities classified as current assets and available-for-sale at December 31, 1996 and 1997.
DECEMBER 31, 1996 DECEMBER 31, 1997 ----------------------------------- ---------------------------------- Gross Gross Unrealized Unrealized Holding Holding (Losses) Fair (Losses) Fair Costs Gains Value Cost Gains Value ---------- ---------- ---------- ---------- ---------- ---------- U.S. Treasury and other agencies debt securities .. $ 10,000 $ (19) $ 9,981 $ 4,976 $ 30 $ 5,006 Corporate debt securities ......................... 15,563 189 15,752 19,621 146 19,767 ---------- ---------- ---------- ---------- ---------- ---------- $ 25,563 $ 170 $ 25,733 $ 24,597 $ 176 $ 24,773 ========== ========== ========== ========== ========== ==========
All short-term investments at December 31, 1996 and December 31, 1997 were due within one year. 8. INVENTORIES Inventories are stated at the lower of cost, determined on an average cost basis, or market value. Inventories consisted of the following: F-34 70 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
DECEMBER 31, ------------------ 1996 1997 -------- -------- Raw materials $ 1,015 $ 1,285 Work in process 510 165 Finished goods 1,374 1,755 -------- -------- $ 2,899 $ 3,205 ======== ========
9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following:
DECEMBER 31, ------------------ 1996 1997 -------- -------- Accounts payable ....................... $ 750 $ 1,374 Accrued payroll and related expenses ... 1,040 1,317 Accrued clinical studies................ 290 548 Other accrued expenses ................. 302 249 -------- -------- $ 2,382 $ 3,488 ======== ========
10. COMMITMENTS Operating Leases The Company leases its administrative, research and manufacturing facilities and certain equipment under long-term, noncancelable lease agreements that have been accounted for as operating leases. Certain of these leases include scheduled rent increases and renewal options as prescribed by the agreements. Future minimum payments by year under long-term, noncancelable operating leases were as follows as of December 31: 1998.................. $ 429 1999.................. 213 2000................... 80 2001................... 8 ----- $ 730 =====
Rental expense charged to operations for all operating leases during the years ended December 31, 1995, 1996 and 1997, was approximately $171, $365 and $574, respectively. 11. SHAREHOLDERS EQUITY Preferred Stock In February 1995, every two shares of the Company's outstanding Common Stock was exchanged for one share of Series A Preferred Stock with a liquidation preference of $6.58 per share. In March 1996, the Company issued 400,000 shares of Series B Preferred Stock to EndoSonics at $20.00 per share for aggregate proceeds of $8,000. F-35 71 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The preferred stockholders converted their shares to common shares upon the consummation of the Company's initial public offering. Stock Option Plan In May 1996, the Company, adopted the 1996 Stock Option/Stock Issuance Plan (the "1996 Plan") which is the successor to the Company's 1995 Stock Option Plan. Under the terms of the 1996 Plan, eligible key employees, directors, and consultants can receive options to purchase shares of the Company's Common Stock at a price not less than 100% for incentive stock options and 85% for nonqualified stock options of the fair value on the date of grant, a determined by the Board of Directors. The Company has authorized 1,990,000 shares of Common Stock for issuance under the 1996 Plan. At December 31, 1997, the Company had 48,000 shares of Common Stock available for grant under the 1996 Plan. The options granted under the 1996 Plan are exercisable over a maximum term of ten years from the date of grant and generally vest over a four year period. Shares underlying the exercise of unvested options are subject to various restrictions as to resale and right of repurchase by the Company which lapses over the vesting period.
OPTION PRICE NUMBER PER SHARE OF SHARES ------------ --------- Balance at December 31, 1994 ......... $ 1.00 462,000 Granted .............................. $ 1.00 to $ 1.50 494,000 Exercised ............................ -- -- Forfeited ............................ -- -- Cancelled ............................ -- -- ------------------- --------- Balance at December 31, 1995 ......... $ 1.00 to $ 1.50 956,000 Granted .............................. $ 2.50 to $ 13.25 346,000 Exercised ............................ $ 1.00 to $ 1.50 (138,600) Forfeited ............................ $ 1.00 to $ 13.25 (18,875) Cancelled ............................ -- -- ------------------- --------- Balance at December 31, 1996 ......... $ 1.00 to $ 13.25 1,144,525 Granted .............................. $ 5.00 to $ 9.50 985,000 Exercised ............................ $ 1.00 to $ 2.50 (208,259) Forfeited ............................ $ 1.00 to $ 13.25 (196,479) Cancelled ............................ $ 6.87 (130,000) ------------------- --------- Balance at December 31, 1997 ......... $ 1.00 to $ 13.25 1,594,787 =================== =========
On April 21, 1997, the Board of Directors approved repricing of the options granted on August 5, 1996 at $13.25 per share and on November 4, 1996 at $12.50 per share. As a result of the repricing, the exercise price became $6.88 and the vesting period on the aforementioned options started anew. The following table summarizes information regarding stock options outstanding at December 31, 1997:
WEIGHTED- AVERAGE WEIGHTED- OPTIONS REMAINING WEIGHTED- OPTIONS AVERAGE RANGE OF OUTSTANDING CONTRACTUAL AVERAGE EXERCISABLE EXERCISE EXERCISE PRICES AT 12/31/97 LIFE EXERCISE PRICE AT 12/31/97 PRICE - --------------- ----------- ----------- -------------- ----------- --------- $ 1.00-$ 1.50 505,287 7.5 $ 1.25 242,912 $1.22 2.50- 13.25 1,089,500 9.4 7.23 25,292 6.96 --------- ------- 1.00- 13.25 1,594,787 8.8 5.33 268,204 1.76 ========= =======
As of December 31, 1996 and 1997, 253,525 and 268,204 options were exercisable, respectively. F-36 72 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The weighted-average grant-date fair value of options granted during 1995, 1996 and 1997, for options where the exercise price on the date of grant was equal to the stock price on that date, was $0.40, $5.12 and $4.50. The weighted-average grant-date fair value of options granted during 1995, 1996 and 1997, for options where the exercise price on the date of grant was less than the stock price on that date, was $1.44, $3.16 and $0. During 1996, the Company recorded deferred compensation of approximately $150 for financial reporting purposes to reflect the difference between the exercise price of certain options and the deemed fair value, for financial statement presentation purposes, of the Company's shares of Common Stock. An additional $437 of deferred compensation was recorded to recognize compensation for non-employee option grants during the year ended December 31, 1997. Deferred compensation is being amortized over the vesting period of the related options. $119 and $179 of deferred compensation was amortized in the year ended December 31, 1996 and 1997, respectively. Stock Purchase Plan Under the terms of the Company's 1996 Employee Stock Purchase Plan (the "Purchase Plan"), eligible employees can purchase Common Stock through payroll deductions at a price equal to the lower of 85% of the fair market value of the Company's Common Stock at the beginning or end of the applicable offering period. A total of 200,000 shares of Common Stock are reserved for issuance under the Purchase Plan. During 1997, a total of approximately 33,000 shares of common stock was purchased at an average price of $8.18 per share. 12. INCOME TAXES Significant components of the Company's deferred tax assets are as follows at December 31:
1996 1997 ---------------------- ---------------------- Federal State Federal State ---------- ---------- ---------- ---------- Net operating loss carryforward ....... $ 1,792 $ 44 $ 3,899 $ 60 Accrued expenses ...................... 456 78 346 59 Research and development credits ...... 256 144 521 291 Bad debt reserve ...................... 132 23 175 30 Depreciation .......................... 52 9 (48) (8) Inventory write-downs ................. 51 9 385 66 Capitalized research and development .. -- 276 -- 642 Deferred revenue ...................... 28 5 -- -- Other ................................. 47 57 163 28 ---------- ---------- ---------- ---------- Gross deferred tax assets ............. 2,814 645 5,441 1,168 Valuation allowance ................... (2,814) (645) (5,441) (1,168) Total deferred tax assets ............. -- -- -- -- ---------- ---------- ---------- ---------- Net deferred tax assets ............... $ -- $ -- $ -- $ -- ========== ========== ========== ==========
The valuation allowance increased by $3,150 and $1,569 in 1997 and 1996, respectively. The Company's effective tax rate differs from the statutory rate of 35% due to federal and state losses which were recorded without tax benefit. At December 31, 1997, the Company has net operating loss carryforwards for federal and state income tax purposes of approximately $11,000,000 and $1,000,000, respectively, which expire in the years 1998 through 2010. In addition, the Company has research and development tax credits for federal and state income tax purposes of approximately $520,000 and $320,000, respectively, which expire in the years 2008 through 2011. Because of the "change of ownership" provision of the Tax Reform Act of 1986, utilization of the Company's net operating loss and research credit carryforwards may be subject to an annual limitation against taxable income in future periods. As a result of the annual limitation, a portion of these carryforwards may expire before ultimately becoming available to reduce future income tax liabilities. F-37 73 CARDIOVASCULAR DYNAMICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 13. EMPLOYEE BENEFIT PLAN The Company provides a 401(k) Plan for all employees 21 years of age or older with over 3 months of service. Under the 401(k) Plan, eligible employees voluntarily contribute to the Plan up to 15% of their salary through payroll deductions. Employer contributions may be made by the Company at its discretion based upon matching employee contributions, within limits, and profit sharing provided for in the Plan. No employer contributions were made in 1996 and 1997. 14. FOURTH QUARTER ADJUSTMENTS Adjustments were made in the fourth quarter of 1997 to increase the reserve for excess and obsolete inventories by $955, increase the allowance for doubtful accounts by $270 and to accrue expenses of $780. F-38 74 CARDIOVASCULAR DYNAMICS, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 (IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------- -------- -------- -------- -------- ADDITIONS ----------------------- BALANCE AT CHARGES TO CHARGED BALANCE AT BEGINNING COSTS AND TO OTHER END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD ----------- ---------- ---------- ---------- ---------- ---------- Year ended December 31, 1997 Allowance for doubtful accounts ... $ 377 $ 318 $ -- $ (195) $ 500 Accrued warranty expenses ......... $ 29 $ -- $ -- $ (29) $ -- Reserve for excess and obsolete inventories...................... $ 145 $ 955 $ -- $ -- $ 1,100 Year ended December 31, 1996 Allowance for doubtful accounts ... $ 180 $ 221 $ -- $ (24) $ 377 Accrued warranty expenses ......... $ 113 $ -- $ -- $ (84) $ 29 Reserve for excess and obsolete inventories...................... $ 209 $ -- $ -- $ (64) $ 145 Year ended December 31, 1995 Allowance for doubtful accounts ... $ 85 $ 95 $ -- $ -- $ 180 Accrued warranty expenses ......... 20 $ 93 $ -- $ -- $ 113 Reserve for excess and obsolete inventories...................... $ -- $ 209 $ -- $ -- $ 209
75 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 2.1(1) Agreement and Plan of Reorganization dated as of June 9, 1993 among the Company, EndoSonics Acquisition Corporation and CardioVascular Dynamics, Inc. ("CVD"). 2.2(1) First Amendment dated as of June 30, 1993 to the Agreement and Plan of Reorganization among the Company, EndoSonics Acquisition Corporation and CVD. 2.3(8) Agreement and Plan of Reorganization between EndoSonics and Cardiometrics, Inc. 3.1(2) Certificate of Incorporation. 3.2(4) Amended Bylaws. 4.1(2) Specimen Certificate of Common Stock. 4.2(3) Loan and Warrant Purchase Agreement dated May 19, 1988. 10.1(3) Series F Preferred Stock Purchase Agreement dated February 1, 1991 between the Company and Esaote Biomedica S.p.A. ("Esaote") and Registration Rights and Right of First Offer Agreement. 10.2(3) Distribution Agreement dated February 28, 1990 between the Company and Fukuda Denshi Co., Ltd. 10.3(3) Distribution Agreement dated as of January 31, 1991 between the Company and Esaote. 10.4(3) Line of Credit Agreement between the Company and Wells Fargo Bank, N.A. dated November 19, 1990. 10.5(3) Lease dated October 31, 1991 between the Company and Olympia Investments, Inc. for the Pleasanton facilities. 10.6(3) Lease dated May 1, 1990 between the Company and Commonwealth Growth Fund I and the Rancho Cordova facilities and Amendment to Lease dated January 9, 1992. 10.7(3) 1988 Stock Option Plan and forms of a Stock Option Agreement and a Stock Purchase Agreement. 10.8(3) 1984 Restricted Stock Purchase Plan and form of a Stock Purchase Agreement. 10.9(3) Form of Indemnification Agreement between the Company and directors of the Company. 10.10(5) Form of Domestic Distribution Agreement. 10.11(4) Supplemental Stock Purchase Agreement dated June 5, 1992, by and between the Company and CVD. 10.12(4) Stock Purchase Agreement dated June 5, 1992, by and between the Company and CVD. 10.13(4) Product Development Agreement dated June 5, 1992, by and between the Company and CVD. 10.14(6) Distribution Agreement dated May 28, 1993 between CVD and Fukuda Denshi Co., Ltd. 10.15(6) Micro Motor Catheter and Instrument Development Agreement, Funding and Option Agreement, Escrow and License agreement, and Distribution Agreement dated October 1993 between the Company and Du-MED. 10.16(9) Stock Purchase and Technology License Agreement dated September 10, 1994 by and among EndoSonics, CVD and SCIMED Life Systems, Inc. 10.17(9) Exclusive Distribution Agreement dated November 1, 1994 between Cordis S.A. and EndoSonics, as amended on December 20, 1994. 10.18(7) Imaging/Therapeutic Combination Devices Development Agreement dated as of February 2, 1996 by and between Cordis Corporation ("Cordis") and the Company. 10.19(7) Exclusive Distribution Agreement dated February 2, 1996 by and between Cordis and the Company.
76
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.20(10) Shareholder Agreement dated June 19, 1996 between EndoSonics and CVD. 10.21(10) License Agreement dated February 6, 1997 between EndoSonics and CVD. 10.22 Form of Change of Control Agreement by and between the Company and each exective officer of the Company. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 23.2 Consent of Ernst & Young LLP, Independent Auditors. 23.3 Consent of Ernst & Young LLP, Independent Auditors. 24.1 Power of Attorney. (Reference is made to page 30 of this Report on Form 10-K/A.) 27.1 Financial Data Schedule.
- --------------- * Confidential Treatment Granted. (1) Filed as an exhibit to the Company's Current Report on Form 8-K (File No. 0-19880) filed with the Commission on July 14, 1993. (2) Filed as an exhibit to the Company's Registration Statement on Form 8-B filed with the Securities and Exchange Commission (the "Commission") on September 25, 1992 and incorporated by reference herein. (3) Filed as an exhibit to the Company's Registration Statement on Form S-1 (File No. 33-45280) filed with the Securities and Exchange Commission on January 24, 1992 (the "Registration Statement") and incorporated by reference herein. (4) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 31, 1993. (5) Filed as Exhibit 10.13 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 33-45280) filed with the Commission on February 25, 1992 and incorporated herein by reference. (6) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 24, 1994. (7) Filed as an exhibit to the Company's Annual Report on Form 10-K/A (File No. 0-19880) filed with the Commission on July 29, 1996. (8) Filed as an exhibit to the Company's Form 8-K (File No. 0-19880) filed with the Commission on February 10, 1997 and incorporated herein by reference. (9) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 21, 1995. (10) Filed as an exhibit to the Company's Annual Report on Form 10-K (File No. 0-19880) filed with the Commission on March 19, 1997. EX-10.22 2 FORM OF CHANGE OF CONTROL AGREEMENT 1 Exhibit 10.22 FORM OF CHANGE OF CONTROL AGREEMENT ENTERED INTO, OR TO BE ENTERED INTO BETWEEN THE COMPANY AND EACH EXECUTIVE OFFICER OF THE COMPANY [Date] [Name] [Position] ENDOSONICS CORPORATION 2870 Kilgore Road Rancho Cordova, CA 95670 Dear [Name]: We are pleased to inform you that the Board of Directors of EndoSonics Corporation (the "Company") has recently authorized and approved a special severance benefit program for you and other key executives. The purpose of this letter agreement is to set forth the terms and conditions of your benefit package and to explain the limitations which will govern the overall value of your benefits. Your severance benefits will become payable in the event your employment terminates within a specified time period following certain changes in ownership or control of the Company. To understand the full scope of your severance benefits, you should familiarize yourself with the definitional provisions of Part One of this letter agreement. The benefits comprising your severance package are detailed in Part Two, and the dollar limitations on the overall value of your benefit package are specified in Part Three. Part Four deals with ancillary matters affecting your severance arrangement. PART ONE -- DEFINITIONS For purposes of this letter agreement, the following definitions will be in effect: AVERAGE COMPENSATION means the average of your W-2 wages from the Company for the five (5) calendar years (or such fewer number of calendar years of employment with the Company) completed immediately prior to the calendar year in which the Change of Control is effected. Any W-2 wages for a partial year of employment will be annualized, in accordance with the frequency which such wages are paid during such partial year, before inclusion in your Average 2 Page 2 Compensation. If any of your compensation from the Company during such five (5)-year or shorter period was not included in your W-2 wages for U.S. income tax purposes, either because you were not a U.S. citizen or resident or because such compensation was excludible from income as foreign earned income under Code Section 911, then such compensation will nevertheless be included in your Average Compensation to the same extent as if it were part of your W-2 wages. 3 Page 3 BASE SALARY means the annual rate of base salary in effect for you immediately prior to the Change in Control or (if greater) the annual rate of base salary in effect at the time of your Involuntary Termination. BOARD means the Company's Board of Directors. CHANGE IN CONTROL means any of the following transaction effecting a change in ownership or control of the Company: (i) a merger or consolidation in which the company is not the surviving entity, except for a transaction the principal purpose of which is to change the State in which the Company is incorporated, (ii) the sale, transfer or other disposition of all or substantially all of the assets of the Company in complete liquidation or dissolution of the Company, (iii) any reverse merger in which the Company is the surviving entity but in which securities possessing fifty percent (50%) or more of the total combined voting power of the Company's outstanding securities are transferred to person or persons different from the persons holding those securities immediately prior to such merger, or (iv) a Hostile Take-Over CODE means the Internal Revenue Code of 1986, as amended. COMMON STOCK means the Company's common stock. FAIR MARKET VALUE means, with respect to any shares of Common Stock subject to any of your Options, the closing selling price per share of Common Stock on the date in question, as reported on the Nasdaq National Market. If there is no reported sale of Common Stock on such date, then the closing selling price on the Nasdaq National Market on the next preceding day for which there does exists such quotation will be determinative of Fair Market Value. HEALTH CARE COVERAGE means the continued health care coverage to which you and your eligible dependents may become entitled under Part Two of this letter agreement upon the Involuntary Termination of your employment. 4 Page 4 HOSTILE TAKE-OVER means any of the following transactions: (i) the successful acquisition by a person or a group of related persons, other than the Company or a person controlling, controlled by or under common control with the Company, of beneficial ownership (as determined pursuant to the provisions of Rule 13d-3 under the Securities Exchange Act of 1934, as amended) of securities possessing more than twenty-five percent (25%) of the total combined voting power of the Company's outstanding securities pursuant to a transaction or series of related transactions which the Board does not at any time recommend the Company's shareholders to accept or approve, or (ii) a change in the composition of the Board over a period of twenty-four (24) consecutive months or less such that a majority of the Board ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (I) have been members of the Board continuously since the beginning of such period or (II) have been elected or nominated for election as Board members during such period by at least a two-thirds majority of the Board members described in clause (I) who were still in office at the time such election or nomination was approved by the Board, INVOLUNTARY TERMINATION means the termination of your employment with the Company: - involuntarily upon your discharge or dismissal (other than a Termination for Cause), or - voluntarily upon your resignation following (I) a change in your position with the Company which reduces your duties or level of responsibility or which otherwise changes the level of management to which you report, (II) a reduction in your level of compensation (including base salary, fringe benefits and target bonus under any incentive performance plan) or (III) a change in your place of employment which is more than twenty five (25) miles from your place of employment prior to the Change in Control, provided and only if such change or reduction is effected without your written concurrence. In no event shall an Involuntary Termination be deemed to occur should your employment terminate by reason of your death or disability. OPTION means any option granted to you under the Plan which is outstanding at the time of the Change in Control or upon your subsequent Involuntary Termination. Your Options will be divided into two (2) separate categories as follows: 5 Page 5 Acquisition-Accelerated Options: any outstanding Option (or installment thereof) which automatically accelerates, pursuant to the acceleration provisions of the agreement evidencing that Option, upon a change in control or ownership of the Company under certain specified circumstances. Severance-Accelerated Options: any outstanding Option (or installment thereof) which accelerates upon your Involuntary Termination pursuant to Part Two of this letter agreement. OPTION PARACHUTE PAYMENT means, with respect to any Acquisition-Accelerated Option or any Severance-Accelerated Option, the portion of that Option deemed to be a parachute payment under Code Section 280G and the Treasury Regulations issued thereunder. The portion of such Option which is categorized as an Option Parachute Payment will be calculated in accordance with the valuation provisions established under Code Section 280G and the applicable Treasury Regulations and will include an appropriate dollar adjustment to reflect the lapse of your obligation to remain in the Company's employ as a condition to the vesting of the accelerated installment. In no event, however, will the Option Parachute Payment attributable to any Acquisition-Accelerated Option or Severance-Accelerated Option (or accelerated installment) exceed the spread (the excess of the Fair Market Value of the accelerated option shares over the option exercise price payable for those shares) existing at the time of acceleration. OTHER PARACHUTE PAYMENT means any payment in the nature of compensation (other than the benefits to which you become entitled under Part Two of this letter agreement) which are made to you in connection with the Change in Control and which accordingly qualify as parachute payments within the meaning of Code Section 280G(b)(2) and the Treasury Regulations issued thereunder. Your Other Parachute Payments will include (without limitation) the Present Value, measured as of the Change in Control, of the aggregate Option Parachute Payment attributable to your Acquisition-Accelerated Options (if any). PLAN means (i) the Company's 1988 Stock Option Plan, as amended or restated from time to time, and (ii) any successor stock incentive plan subsequently implemented by the Company. PRESENT VALUE means the value, determined as of the date of the Change in Control, of any payment in the nature of compensation to which you become entitled in connection with the Change in Control or the subsequent Involuntary Termination of your employment, including (without limitation) the Option Parachute Payment attributable to your Severance-Acceleration Options, your Severance Payments under Part Two of this letter agreement and the Option Parachute Payment attributable to your Acquisition-Accelerated Options. The Present Value of each such payment shall be determined in accordance with the provisions of Code Section 280G(d)(4), utilizing a discount rate equal to one hundred twenty percent (120%) of the applicable Federal rate in effect at the time of such determination, compounded semi-annually to the effective 6 Page 6 date of the Change in Control. SEVERANCE PAYMENTS mean the severance payments to which you may become entitled under Part Two in the event of your Involuntary Termination following a Change in Control, subject, however, to the dollar limitations of Part Three. TERMINATION FOR CAUSE means an Involuntary Termination of your employment occasion by reason of your having engaged in fraud or in any other intentional misconduct adversely affecting the business reputation of the Company in a material manner. PART TWO -- CHANGE IN CONTROL BENEFITS Upon the Involuntary Termination of your employment within eighteen (18) months following a Change in Control, you will become entitled to receive the special severance benefits provided in this Part Two. 1. SEVERANCE PAYMENTS. If your Involuntary Termination occurs within the first twelve (12) months after the Change in Control, then you will be entitled to Severance Payments in an aggregate amount equal to (i) one and one-half (1.5) times your Base Salary plus (ii) the bonus you accrue for each fiscal period of the Company within the twelve (12) month period. If your Involuntary Termination occurs more than twelve (12) months, but within eighteen (18) months, after the Change in Control, then you will be entitled to Severance Payments in an aggregate amount equal to one (1) times your Base Salary plus (ii) any bonus you accrue for each fiscal period of the Company within that additional period. In the absence of a Hostile Take-Over, your Severance Payments will be made at bi-weekly intervals following your Involuntary Termination. However, these payments will immediately terminate in the event you cease to remain available for the consulting services required under Paragraph 4 of this Part Two or in the event you fail to abide by the restrictive covenants set forth in Paragraph 5 of this Part Two. Should your Involuntary Termination occur in connection with a Hostile Take-Over, the Severance Payments will be made to you in a lump sum payment within thirty (30) days after your Involuntary Termination, and the provisions of Paragraphs 4 and 5 of this Part Two will not apply. All Severance Payments will be subject to the Company's collection of applicable 7 Page 7 federal and state income and employment withholding taxes. In the event your employment terminates by reason of your death or disability or your Termination for Cause, you will not be entitled to receive any Severance Payments or other benefits under this letter agreement. 2. OPTION ACCELERATION. Each of your outstanding Options will (to the extent not then otherwise fully exercisable) automatically accelerate so that each such Option will become fully vested and immediately exercisable for the total number of shares of Common Stock at the time subject to that Option. Each such accelerated Option, together with all your other vested Options, will remain exercisable for fully-vested shares until the earlier of (i) the expiration date of the ten (10) year option term or (ii) the end of the three (3)-month period measured from the date of your Involuntary Termination. 3. ADDITIONAL BENEFITS. (a) HEALTH CARE COVERAGE The Company will, at its expense, provide you and your eligible dependents with continued health care coverage under the Company's medical/dental plan until the earlier of (i) eighteen (18) months after the date of the Change in Control or (ii) the first date that you are covered under another employer's health benefit program which provides substantially the same level of benefits without exclusion for pre-existing medical conditions. The coverage so provided you and your eligible dependents will be in full and complete satisfaction of the continued health care coverage to which you or your eligible dependents would otherwise, at your own expense, be entitled under Code Section 4980B by reason of your termination of employment, and neither you nor your eligible dependents will accordingly be entitled to any additional period of health care coverage under Code Section 4980B as a result of your termination of employment. 8 Page 8 (b) RELOCATION REIMBURSEMENT If at the Company's request, you moved during the 1995, 1996 or 1997 calendar year to (i) the Sacramento, California area in connection with the consolidation of the Company's operations in Rancho Cordova or (ii) Europe in connection with the Company's acquisition of Cardiometrics, Inc., then the Company will reimburse you for the relocation expenses you incur in your move back to the San Francisco Bay Area from the Sacramento area, or from Europe back to the United States, following your Involuntary Termination, provided such Involuntary Termination occurs within (i) twenty-four (24) months after your initial move to the Sacramento area or (ii) within twelve (12) months after a Change in Control if you are moving back from Europe. However, the maximum dollar amount of such reimbursement will be limited to thirty-five percent (35%) of the annual rate of Base Salary in effect for you at the time of your Involuntary Termination. In no event will you be entitled to reimbursement for such relocation expenses unless you provide the Company with appropriate documentation of those expenses. (c) UNPAID BENEFITS You will receive an immediate lump sum payment of all unpaid vacation days which you have accrued through the date of your Involuntary Termination. 4. CONSULTING SERVICES. Unless your Involuntary Termination occurs in connection with a Hostile Take-Over, you will make yourself available to render up to ten (10) hours of consulting services per month during the period of your Severance Payments on such projects within your area of expertise as may be assigned to you by the Company's Chief Executive Officer or the Board. You will not be entitled to any cash compensation for the first ten (10) hours of consulting services you render each month, but the Company will compensate you for any additional hours you render at an hourly rate to be negotiated with you at the time. You will also be reimbursed for all reasonable out-of-pocket expenses incurred in rendering your consulting services upon your submission of appropriate documentation for those expenses. 5. RESTRICTIVE COVENANTS. During the period of your Severance Payments, you will not: (i) directly or indirectly, whether for your own account or as an employee, director, consultant or advisor, provide services to any business enterprise which is at the time in competition with any of the Company's then-existing or formally planned product lines and which is located geographically in an area where 9 Page 9 the Company maintains substantial business activities, or (ii) directly or indirectly encourage or solicit any individual to leave the Company's employ for any reason or interfere in any other manner with the employment relationships at the time existing between the Company and its current or prospective employees, or (iii) induce or attempt to induce any customer, supplier, distributor, licensee or other business affiliate of the Company to cease doing business with the Company or in any way interfere with the existing business relationship between any such customer, supplier, distributor, licensee or other business affiliate and the Company. You acknowledge that monetary damages may not be sufficient to compensate the Company for any economic loss which may be incurred by reason of your breach of the foregoing restrictive covenants. Accordingly, in the event of any such breach, the Company will, in addition to the Company's cessation of the Severance Payments provided under this letter agreement and any remedies available to the Company at law, be entitled to obtain equitable relief in the form of an injunction precluding you from continuing to engage in such breach. None of the foregoing restrictive covenants will be applicable in the event your Involuntary Termination occurs in connection with a Hostile Take-Over. PART THREE -- LIMITATION ON BENEFITS 1. PARACHUTE LIMIT Except the limited extent (if any) provided under Paragraph 4(a) below, the aggregate Present Value (measured as of the Change in Control) of the benefits to which you become entitled under Part Two at the time of your Involuntary Termination (namely the Severance Payments, the Option Parachute Payment attributable to your Severance-Accelerated Options and your Health Care Continuation) will in no event exceed in amount the difference between (i) 2.99 times your Average Compensation and (ii) the Present Value, measured as of the Change in Control, of all Other Parachute Payments to which you are entitled. Accordingly, except as otherwise provided under Paragraph 4(a) below, your Options will not accelerate and no Severance Payments will be made to you pursuant to this letter agreement, to the extent the Present Value as of the Change in Control of (I) the aggregate Option Parachute Payment attributable to your Severance-Accelerated Options plus (II) your Severance Payments plus (III) your Health Care Continuation would, when added to the Present Value of your Other Parachute Payments, exceed 2.99 times your Average Compensation (the "Parachute Limit"). 10 Page 10 2. RESOLUTION PROCEDURE For purposes of the foregoing Parachute Limit, the following provisions will be in effect: (a) In the event there is any disagreement between you and the Company as to whether one or more payments to which you become entitled in connection with either the Change in Control or your subsequent Involuntary Termination constitute Option Parachute Payments or Other Parachute Payments or as to the determination of the Present Value thereof, such dispute will be resolved as follows: (i) In the event temporary, proposed or final Treasury Regulations in effect at the time under Code Section 280G (or applicable judicial decisions) specifically address the status of any such payment or the method of valuation therefor, the characterization afforded to such payment by the Regulations (or such decisions) will, together with the applicable valuation methodology, be controlling. (ii) In the event Treasury Regulations (or applicable judicial decisions) do not address the status of any payment in dispute, the matter will be submitted for resolution to independent counsel mutually acceptable to you and the Company ("Independent Counsel"). The resolution reached by Independent Counsel will be final and controlling; provided, however, that if in the judgment of Independent Counsel the status of the payment in dispute can be resolved through the obtainment of a private letter ruling from the Internal Revenue Service, a formal and proper request for such ruling will be prepared and submitted by Independent Counsel, and the determination made by the Internal Revenue Service in the issued ruling will be controlling. All expenses incurred in connection with the retention of Independent Counsel and (if applicable) the preparation and submission of the ruling request will be paid by the Company. (iii) In the event Treasury Regulations (or applicable judicial decisions) do not address the appropriate valuation methodology for any payment in dispute, the Present Value thereof will, at the Independent Counsel's election, be determined through an independent third-party appraisal, and the expenses incurred in obtaining such appraisal will be paid by the Company. 3. STATUS OF BENEFITS (a) No Severance Payments will be made to you under Part Two of this letter 11 Page 11 agreement until the Present Value of the Option Parachute Payment attributable to both your Severance-Accelerated Options and your Acquisition-Accelerated Options has been determined and the status of any payments in dispute under Paragraph 2 above has been resolved in accordance therewith. However, you will be permitted to exercise your Severance-Accelerated Options at any time during the three (3)-month (or shorter) period immediately following your Involuntary Termination, provided any and all shares of Common Stock purchased under your Severance-Accelerated Options will, together with the exercise price paid for those shares, be held in escrow by the Company. To the extent your purchased shares are held in escrow, you will have the right to (i) direct the sale of such shares, provided the sale proceeds are immediately deposited in escrow, (ii) exercise all voting rights with respect to such shares and (iii) receive dividends declared on such shares, provided such dividends are immediately deposited in escrow. (b) Once the requisite determinations under Paragraph 2 have been made, then to the extent the aggregate Present Value, measured as of the Change in Control, of (1) the Option Parachute Payment attributable to your Severance-Accelerated Options (or installments thereof) plus (2) your Severance Payments would, when added to the Present Value of all your Other Parachute Payments (including the Option Parachute Payment attributable to your Acquisition-Accelerated Options), exceed the Parachute Limit, the following reductions to the benefits otherwise payable to you hereunder will be made: First, your Severance Payments will be reduced. Then, any outstanding Severance-Accelerated Options will immediately terminate and cease to be exercisable. If there is more than one such Option outstanding, then the Severance-Accelerated Options with the lowest option spread will be the first to terminate. Finally, to the extent one or more of your outstanding Severance-Accelerated Options (or installments thereof) have been exercised following your Involuntary Termination, those exercises will be rescinded (with the Severance-Accelerated Options with the lowest option spread to be the first rescinded) by refunding to you the exercise price paid for the purchased shares and returning those shares (plus any cash dividends paid thereon) to the Company. To the extent the shares purchased under such accelerated Options (or accelerated installments thereof) have been sold while held in escrow, the sale proceeds attributable to those shares will be allocated as follows: first an amount not to exceed the exercise price you paid for such shares will be refunded to you, and then the balance of the proceeds (together with any cash dividends paid on those shares) will be returned to the Company. (c) To the extent any shares or cash proceeds remain in the escrow account under subparagraph (a) above after the reductions specified in subparagraph (b) have been made, 12 Page 12 those shares or proceeds will be promptly distributed to you. 4. OVERRIDING LIMITATIONS (a) Notwithstanding any provision to the contrary set forth in the preceding provisions of this Part Three, the aggregate Present Value of your Severance Payments and the Option Parachute Payment attributable to your Severance-Accelerated Options will not be reduced below that amount (if any) which, when added to the Present Value of all the Other Parachute Payments to which you are entitled, would nevertheless qualify as reasonable compensation for past services within the standards established under Code Section 280G(b)(4)(B) or as reasonable compensation under Code Section 280G(b)(4)(A) for the consulting arrangement and restrictive covenants to be in effect under Paragraphs 4 and 5 of Part Two following your Involuntary Termination. (b) The limitations of this Part Three will in all events be interpreted in such manner as to avoid the imposition of excise taxes under Code Section 4999, and the disallowance of deductions under Code Section 280G(a), with respect to any of the benefits paid pursuant to Part Two of this letter agreement. PART FOUR -- MISCELLANEOUS PROVISIONS 1. TERMINATION FOR CAUSE. Should your Involuntary Termination constitute a Termination for Cause, then the Company will only be required to pay you (i) any unpaid compensation earned for services previously rendered through the date of such termination and (ii) any accrued but unpaid vacation benefits or sick days, and no benefits will be payable to you under Part Two of this letter agreement. 2. DEATH. Should you die before receipt of one or more Severance Payments to which you become entitled under Part Two of this letter agreement, then those payment or payments will be made to the executors or administrators of your estate. Should you die before you exercise all you outstanding Options, then such Options may be exercised, within twelve (12) months after your death, by the executors or administrators of your estate or by persons to whom the Options are transferred pursuant to your will or in accordance within the laws of inheritance. In no event, however, may any such Option be exercised after the specified expiration date of the option term. 13 Page 13 3. GENERAL CREDITOR STATUS. The payments and benefits to which you become entitled hereunder will be paid, when due, from the general assets of the Company, and no trust fund, escrow arrangement or other segregated account will be established as a funding vehicle for such payment. Accordingly, your right (or the right of the personal representatives or beneficiaries of your estate) to receive any payments or benefits hereunder will at all times be that of a general creditor of the Company and will have no priority over the claims of other general creditors. 5. INDEMNIFICATION. The indemnification provisions for Officers and Directors under the Company By-Laws will (to the maximum extent permitted by law) be extended to you, during the period following your Involuntary Termination, with respect to any and all matters, events or transactions occurring or effected during your employment with the Company. 6. MISCELLANEOUS. This letter agreement will be binding upon the Company, its successors and assigns (including, without limitation, the surviving entity in any Change in Control) and is to be construed and interpreted under the laws of the State of California. This letter agreement supersedes all prior agreements between you and the Company relating to the subject of severance benefits payable upon a change in control or ownership of the Company and may only be amended by written instrument signed by you and an authorized officer of the Company. If any provision of this letter agreement as applied to you or the Company or to any circumstance should be adjudged by a court of competent jurisdiction to be void or unenforceable for any reason, the invalidity of that provision will in no way affect (to the maximum extent permissible by law) the application of such provision under circumstances different from those adjudicated by the court, the application of any other provision of this letter agreement, or the enforceability or invalidity of this letter agreement as a whole. Should any provision of this letter agreement become or be deemed invalid, illegal or unenforceable in any jurisdiction by reason of the scope, extent or duration of its coverage, then such provision will be deemed amended to the extent necessary to conform to applicable law so as to be valid and enforceable or, if such provision cannot be so amended without materially altering the intention of the parties, then such provision will be stricken and the remainder of this letter agreement will continue in full force and effect. 7. NO EMPLOYMENT OR SERVICE CONTRACT. Nothing in this letter agreement is intended to provide you with any right to continue in the employ of the Company (or any subsidiary) for any period of specific duration or interfere with or otherwise restrict in any way your rights or the rights of the Company (or any subsidiary), 14 Page 14 which rights are hereby expressly reserved by each, to terminate your employment at any time for any reason whatsoever, with or without cause. 8. ATTORNEY FEES. In the event legal proceeding should be initiated by you or by the Company with respect to any controversy, claim or dispute relating to the interpretation or application of the provisions of this letter agreement or any benefits payable hereunder, the prevailing party in such proceedings will be entitled to recover from the losing party reasonable attorney fees and costs incurred in connection with such proceedings or in the enforcement or collection of any judgment or award rendered in such proceedings. For purposes of this provision, the prevailing party means the party determined by the court to have most nearly prevailed in the proceedings, even if that party does not prevail in all matters, and does not necessarily mean the party in whose favor the judgment is actually rendered. If the Company materially breaches any of its obligations under this letter agreement and fails to cure that breach within thirty (30) days after written notice from you, you will then be entitled to reimbursement from the Company for any reasonable expenses and attorney fees you incur in having the Company subsequently cure that breach, whether or not legal proceedings are actually commenced in connection with such breach. Please indicate your acceptance of the foregoing provisions of this employment agreement by signing the enclosed copy of this agreement and returning it to the Company. ENDOSONICS CORPORATION BY: ----------------------------------------- TITLE: -------------------------------------- ACCEPTANCE I hereby agree to all the terms and provisions of the foregoing letter agreement governing the special benefits to which I may become entitled in connection with certain changes in control or ownership of ENDOSONICS CORPORATION. Signature: --------------------------------- Dated: ------------------------------------- EX-23.1 3 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-32273, 33-93330, 33-48208, 33-80880 and 33-67734) pertaining to the Restated 1988 Stock Option Plan, Certain Option Grant to Mr. Salquist pursuant to a written Compensation Agreement and the CardioMetrics, Inc. 1995 Stock Incentive Plan and in the Registration Statements (Form S-3, Nos. 33-98084 and 333-1058, and related Prospectuses of EndoSonics Corporation, of our report dated February 13, 1998, with respect to the consolidated financial statements and schedule of EndoSonics Corporation included in this Annual Report (Form 10-K) for the year ended December 31, 1997. ERNST & YOUNG LLP Sacramento, California March 30, 1998 EX-23.2 4 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.2 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Annual Report (Form 10-K of EndoSonics Corporation of our report dated February 17, 1997, except as to Note 10, as which the date is May 20, 1997 with respect to the 1996 financial statements of CardioMetrics, Inc. incorporated by reference in the Current Report of Form 8-K of EndoSonics Corporation dated July 23, 1997, filed with the Securities and Exchange Commission. We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-32273, 33-93330, 33-48208, 33-80880 and 33-67734) pertaining to the Restated 1998 Stock Option Plan, certain Option Grant to Mr. Salquist pursuant to a written Compensation Agreement and the CardioMetrics, Inc. 1995 Stock Incentive Plan in the Registration Statements (Form S-3, Nos. 33-98084 and 333-1058, and related Prospectuses of EndoSonics Corporation of our report dated February 17, 1997, except as to Note 10, at which the date is May 20, 1997, with respect to the financial statements of CardioMetrics, Inc. incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 1997. ERNST & YOUNG LLP Palo Alto, California March 27, 1998 EX-23.3 5 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.3 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-32273, 33-93330, 33-48208, 33-80880 and 33-67734) pertaining to the Restated 1998 Stock Option Plan, certain Option Grants to Mr. Salquist pursuant to a written Compensation Agreement and the CardioMetrics, Inc. 1995 Stock Incentive Plan and in the Registration Statements (Form S-3, Nos. 33-98084 and 333-1058, and Form S-4, No. 0-26748) and related Prospectuses of EndoSonics Corporation, of our report dated January 29, 1998, with respect to the consolidated financial statements and schedule of CardioVascular Dynamics, Inc. and subsidiaries included in this Annual Report (Form 10-K) for the year ended December 31, 1997. ERNST & YOUNG LLP Orange County, California March 30, 1998 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 13,899 9,120 13,351 562 6,915 43,699 3,408 0 62,807 13,553 0 0 0 16 49,238 0 33,997 33,997 17,962 66,648 (3,544) 0 0 (47,069) (47,244) 0 0 0 0 (47,244) (3.22) (3.22)
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