Ev3 10-Q 2005
ý QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 3, 2005
o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number: 0-51348
(Exact name of registrant as specified in its charter)
4600 Nathan Lane North
(Address of principal executive offices)
(Registrants telephone number including area code)
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 o NO ý*
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý
As of August 1, 2005, there were 49,116,454 shares of common stock, par value $0.01 per share, of the registrant outstanding.
* The registrant has not been subject to the
filing requirements for the past 90 days as the registration statement in
connection with its initial public offering became effective on June 16,
2005. The registrant has filed all
reports required to be filed by Section 13 or
For the Quarterly Period Ended July 3, 2005
TABLE OF CONTENTS
In this report, references to ev3, the company, we, our or us, unless the context otherwise requires, refer to ev3 Inc. and its subsidiaries.
All trademarks or trade names referred to in this report are the property of their respective owners.
The accompanying notes are an integral part of these consolidated financial statements.
(b) Net loss per common share attributable to common stockholders and the weighted average common shares outstanding reflect the June 21, 2005 1-for-6 reverse stock split for all periods presented.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
1. Description of Business
ev3 Inc. (the Company) is a global medical device company focused on catheter-based, or endovascular, technologies for the minimally invasive treatment of vascular diseases and disorders. The Company develops, manufactures and markets a wide range of products that includes stents, embolic protection devices, thrombectomy devices, balloon angioplasty catheters, foreign object retrieval devices, guidewires, embolic coils, liquid embolics, microcatheters, and occlusion balloon systems. The Company markets its products in the United States, Europe, Canada, and Japan through a direct sales force, and through distributors in certain other international markets.
The Company holds ownership interests directly in two companies: ev3 Endovascular, Inc. (ev3 Endovascular) and Micro Investment, LLC (MII), a holding company that owns a controlling interest in Micro Therapeutics, Inc. (MTI), a publicly traded operating company. The Companys majority equity holder, Warburg, Pincus Equity Partners, L.P. and certain of its affiliates (collectively Warburg Pincus), owns a majority, controlling interest in ev3 Inc. The Company is organized in two business segments: cardio peripheral and neurovascular. The Company manages its business and reports its operations internally and externally on this basis. The Companys cardio peripheral segment contains products that are used in both cardiovascular and peripheral vascular procedures by cardiologists, radiologists, vascular surgeons and other endovascular specialists. The Companys neurovascular segment contains products that are used primarily by neuro-radiologists and neurosurgeons for neurovascular procedures.
2. Basis of Presentation
The accompanying unaudited financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (U.S.) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results for the three and six months ended July 3, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005, or for any future period. These financial statements and notes should be read in conjunction with the audited financial statements and the notes thereto included in the Companys registration statement on Form S-1, initially filed with the Securities and Exchange Commission on April 5, 2005 (File No. 333-123851), as subsequently amended (the Registration Statement).
The consolidated financial statements of ev3 Inc. include the financial results of MTI, which ev3 Inc. consolidates for accounting purposes but is not wholly owned. On May 26, 2005, Warburg Pincus and The Vertical Group L.P. and certain of its affiliates (collectively Vertical) contributed all of the shares of MTIs common stock directly owned by them to ev3 LLC in exchange for common membership units. These common membership units were subsequently converted into shares of ev3 Inc. common stock in connection with a subsequent merger of ev3 LLC with and into ev3 Inc. on June 21, 2005. As a result of this merger, ev3 Inc. became the holding company of ev3 LLCs subsidiaries. The merger of ev3 LLC with and into ev3 Inc. was accounted for as a combination under common control with the result that the financial statements for all periods presented were such that the historical financial statements of the group were carried forward without adjustment.
As the controlling shareholder of the Company, the contribution of the shares by Warburg Pincus, representing a 15.7% interest in MTI as of May 26, 2005, was accounted for as a transfer of assets between entities under common control resulting in the retention of historical based accounting. These consolidated financial statements give effect to the contribution of MTI shares owned by Warburg Pincus as though such contribution occurred in 2003 and 2004 when Warburg Pincus acquired its interest in MTI. The contribution of the MTI shares owned by Vertical, representing a 4.3% interest in MTI as of May 26, 2005, was accounted for under the purchase method of
accounting on the contribution date (see Note 6). As of July 3, 2005, ev3 Inc. owned 70.3% of the outstanding shares of common stock of MTI. The consolidation of MTI for accounting purposes results in all of MTIs assets and liabilities being included in the Companys consolidated balance sheets. Although all of MTIs assets are included in the Companys consolidated balance sheets, not all of these assets would be available to the Company for distribution to its stockholders in the event of MTIs liquidation.
Prior to the consummation of the Companys initial public offering on June 21, 2005, the Company amended and restated its certificate of incorporation to authorize 100,000,000 shares of common stock, par value $0.01 per share, and 100,000,000 shares of preferred stock, par value $0.01 per share. On June 21, 2005, immediately prior to the Companys initial public offering, the Company completed a one-for-six reverse stock split of its outstanding common stock. All share and per share amounts for all periods presented in these consolidated financial statements reflect this split.
The Company operates on a manufacturing calendar with its fiscal year always ending on December 31. Each quarter is 13 weeks, consisting of one five-week and two four-week periods. Accordingly, the first three fiscal quarters in 2004 ended on April 4, July 4 and October 3. The corresponding fiscal quarters in 2005 ended or end on April 3, July 3 and October 2.
3. Stock Based Compensation
The Company accounts for its stock based compensation plans under the fair value recognition provisions of SFAS 123, Accounting for Stock Based Compensation. Under the fair value method, compensation expense is measured at the grant date based on the estimated fair value of the award. The fair value is estimated using the Black-Scholes option pricing model and is recognized over the service period, which is typically the vesting period. The Company recognized compensation expense related to stock options of $915 thousand and $1.7 million for the three and six months ended July 3, 2005, respectively, as compared to the compensation expense related to stock options of $435 thousand and $1.9 million for the three and six months ended July 4, 2004, respectively.
The Company used the Black-Scholes option pricing model, with a minimum value pricing method, for measuring the fair value of its options granted for the year ended December 31, 2004 and for the three-month period ended April 3, 2005. The minimum value pricing method does not take into consideration volatility. In accordance with SFAS 123, subsequent to April 5, 2005, the date of the Companys initial filing of the registration statement relating to its initial public offering with the Securities and Exchange Commission, the Company used the Black-Scholes model, including a volatility assumption, to estimate the fair value of all option grants. Forfeitures and cancellations are recognized as they occur. Expense previously recognized related to options that are cancelled or forfeited prior to vesting is reversed in the period of the cancellation or forfeiture.
The fair value of options was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions by plan:
In accordance with the provisions of SFAS 123 and Emerging Issues Task Force Issue 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, the Company accounts for non-employee equity based awards, in which goods or services are the consideration received for the equity instruments issued, at their fair value. The assumptions used to determine fair value under the Black-Scholes pricing model are as disclosed above for ev3 Inc. and MTI as appropriate.
4. New Accounting Pronouncements
In November 2004, the FASB issued SFAS 151, Inventory Costs, An Amendment of Accounting Research Bulletin No. 43, Chapter 4, which adopts wording from the International Accounting Standards Boards (IASB) IAS 2 Inventories in an effort to improve the comparability of cross-border financial reporting. The new standard indicates that abnormal freight, handling costs, and wasted materials (spoilage) are required to be treated as current period charges rather than as a portion of inventory cost. Additionally, the standard clarifies that fixed production overhead should be allocated based on the normal capacity of a production facility. The statement is effective for the Company beginning in 2006. Adoption is not expected to have a material impact on the Companys consolidated earnings, financial position or cash flows.
On December 16, 2004, the FASB issued SFAS 123(R), Share-Based Payment, which is a revision of SFAS 123 and supersedes APB Opinion 25. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period and is effective for the Company on January 1, 2006. The Company has not yet determined the impact of the provisions of SFAS 123(R) on its consolidated earnings, financial position or cash flows.
5. Liquidity and Capital Resources
On June 21, 2005, the Company completed an initial public offering in which it sold 11,765,000 shares of common stock at $14.00 per share for net cash proceeds of $152.7 million, net of underwriting discounts and other offering costs. Immediately prior to the consummation of the offering, ev3 LLC merged with and into ev3 Inc. and 24,040,718 Class A preferred membership units, 41,077,336 Class B preferred membership units, and 18,799,962 common membership units of ev3 LLC were converted into 83,918,016 shares of common stock of ev3 Inc. (on a pre-split basis). Immediately thereafter, the Company completed a one for six reverse stock split whereby the 83,918,016 shares of common stock were converted into 13,986,350 shares of common stock. Prior to the consummation of the offering, and subsequent to the reverse stock split, the Company also issued 21,964,815 and 1,194,489 shares of common stock to Warburg Pincus and Vertical, respectively, in exchange for their contribution of $324.2 million aggregate principal amount of demand notes and accrued and unpaid interest thereon. The remaining balance of the accrued and unpaid interest on the demand notes, totaling $36.5 million, was repaid using proceeds from the offering.
The following summarizes the changes in stockholders equity (deficit) since December 31, 2004:
(in thousands, except unit and share amounts)
Comprehensive loss consists of net loss, gains on changes of interest related to ownership changes in MTI, and the effects of foreign currency translation. The components of comprehensive loss resulted in a decrease to our net loss of $792 thousand and $1.6 million for the three and six months ended July 3, 2005, respectively, and a decrease to our net loss of $47 thousand and $742 thousand for the three and six months ended July 4, 2004, respectively.
The Companys future liquidity and capital requirements will be influenced by numerous factors, including clinical research and product development programs, receipt of and time required to obtain regulatory clearances and approvals, sales and marketing programs and continuing acceptance of the Companys products in the marketplace. The Company believes that the resources generated through its initial public offering are sufficient to meet the Companys liquidity requirements through the end of fiscal 2006; however, if the Company requires additional working capital, but is not able to raise additional funds, it may be required to significantly curtail or cease ongoing operations.
6. MTI Step Acquisitions
The Company, through its wholly owned subsidiary, MII, has acquired a controlling interest in MTI in various step investments. MTI is a publicly held Delaware corporation that develops, manufactures and markets minimally invasive medical devices for diagnosis and treatment primarily of neurovascular diseases. The investments were accounted for using the step acquisition method prescribed by ARB 51, Consolidated Financial Statements. Step acquisition accounting requires the allocation of the excess purchase price to the fair value of net assets acquired. The excess purchase price is determined as the difference between the cash paid and the historical book value of the interest in net assets acquired.
On May 26, 2005, the shares of MTIs common stock directly held by Warburg Pincus and Vertical were contributed to ev3 LLC in exchange for 10,804,500 and 3,004,332 common membership units, respectively. These common membership units were subsequently converted into shares of ev3 Inc. common stock in connection with the subsequent merger of ev3 LLC with and into ev3 Inc. on June 21, 2005. MTI shares contributed by Warburg Pincus, representing a 15.7% interest in MTI, have been accounted for as a transfer of assets between entities under common control and the consolidated financial statements give effect to the contribution by Warburg Pincus as though such contributions occurred in 2003 and 2004 when Warburg Pincus acquired its interest in MTI. Shares of MTI contributed by Vertical, representing a 4.3% interest, have been accounted for under the purchase method of accounting at the date of the contribution by Vertical. As a result, the Company held an approximate interest in MTI of 70.3% and 66.0% at July 3, 2005 and December 31, 2004, respectively.
The number of membership units of ev3 LLC issued in exchange for the MTI shares directly held by Warburg Pincus and Vertical was determined based on fair value. Fair value of the MTI shares contributed was measured as the average closing price per share of MTIs common stock on the NASDAQ National Market System for the twenty trading days from and including the date the Companys Registration Statement with respect to the Companys initial public offering was first filed by the Company with the Securities and Exchange Commission. Fair value of
ev3 LLCs equity issued in exchange for the MTI shares was based on the midpoint of the range of estimated initial public offering prices per share, after consideration of the reverse stock split (See Note 2).
The following summarizes the allocation of the excess purchase price over historical book values arising from the May 26, 2005 contribution of MTI shares by Vertical (in thousands):
The acquired in-process research and development charge was estimated considering an appraisal and represents the estimated fair value of the in-process projects at the date of contribution of the MTI shares. As of the acquisition date, the in-process projects had not yet reached technological feasibility and had no alternative use. The primary basis for determining technological feasibility of these projects is obtaining regulatory approval to market the products. Accordingly, the value attributable to these projects, which had yet to obtain regulatory approval, was expensed in conjunction with the acquisition. If the projects are not successful, or completed in a timely manner, the Company may not realize the financial benefits expected from these projects.
To the extent that investments in MTI by third party investors reduced the Companys ownership interest, the difference between the carrying value of the interest indirectly sold by the Company, and the consideration paid by the third party investor is considered a change in interest transaction. The Company has adopted an accounting policy of recording change of interest gains or losses within equity as permitted by Staff Accounting Bulletin (SAB) 5H. Change of interest gains recorded in equity were $149 thousand and $149 thousand for the three and six months ended July 3, 2005, respectively, as compared with $71 thousand and $731 thousand for the three months and six months ended July 4, 2004, respectively.
8. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill by operating segment for the three and six months ended July 3, 2005 were as follows (in thousands):
Other intangible assets consist of the following (in thousands):
Intangible assets are amortized using methods which approximate the benefit provided by the utilization of the assets. Patents and licenses, developed technology and trademarks and tradenames are amortized on a straight line basis. Customer relationships are amortized using the double declining balance method. The Company continually evaluates the amortization period and carrying basis of intangible assets to determine whether later events and circumstances warrant a revised estimated useful life or reduction in value.
Total amortization of intangibles was $2.5 million and $5.2 million for the three and six months ended July 3, 2005, respectively, as compared to $2.4 million and $5.0 million for the three and six months ended July 4, 2004. The estimated amortization expense (inclusive of amortization expense already recorded for the six months ended July 3, 2005) for the five years ending December 31 is as follows (in thousands):
MTI had a licensing agreement and an approximate 14% interest in Genyx Medical, Inc. (Genyx). The carrying value of MTIs investment in Genyx was $0 as of December 31, 2004, and MTI had no obligation to fund Genyxs operations. In January 2005, MTI sold its interest in Genyx and recorded a gain of $3.7 million.
In connection with the 2002 sale of its investment in Enteric Medical Technologies, Inc., MTI has a right to receive certain contingent consideration. In the three months ended July 3, 2005 and July 4, 2004, MTI received $878 thousand and $1.7 million, respectively, based upon the achievement of certain milestones. These receipts were recognized as additional gain on sale of investment when received by MTI.
10. Accrued Liabilities
At June 21, 2005, the closing date of the Companys initial public offering, ev3 Endovascular had outstanding $316.0 million aggregate principal amount of demand notes plus $44.7 million of accrued and unpaid interest thereon. These notes were payable to Warburg Pincus, our majority stockholder, and Vertical, our second largest stockholder. Immediately prior to the Companys initial public offering, the Company issued 21,964,815 and 1,194,489 shares of common stock to Warburg Pincus and Vertical, respectively, in exchange for their contribution of $324.2 million principal amount of the demand notes and a portion of the accrued and unpaid interest thereon. Upon successful consummation of the initial public offering, the Company utilized $36.5 million of the net proceeds to repay the remaining accrued and unpaid interest, reducing the Companys debt balance to zero at June 21, 2005.
On May 6, 2005, MTI entered into a Loan and Security Agreement with Silicon Valley Bank (SVB), which will expire on May 6, 2007. Pursuant to the terms of the Agreement, MTI may borrow up to the lesser of (i) $3.0 million or (ii) the sum of (a) 80% of MTIs eligible accounts receivable, which exclude among other things accounts receivable relating to international sales, and (b) the lesser of (1) 30% of MTIs eligible inventory, which excludes among other things inventory located outside of the United States, (2) 50% of outstanding loans under (a) above or (3) $750 thousand. All outstanding amounts under the Agreement bear interest at a variable rate equal to SVBs prime rate plus 2%. The Agreement also contains customary covenants regarding operations of MTIs business and financial covenants relating to minimum tangible net worth. As of July 3, 2005, MTI had no borrowings under the Agreement.
12. Redeemable Convertible Preferred Membership Units
In connection with the merger of ev3 LLC with and into ev3 Inc., 24,040,718 Class A preferred membership units of ev3 LLC with a carrying value of $98.7 million and 41,077,336 Class B preferred membership units of ev3 LLC with a carrying value of $167.4 million were converted into common membership units of ev3 LLC, and
subsequently into shares of the Companys common stock, on a 1:1 basis. The newly converted shares were then subject to a 1-for-6 reverse stock split (See Note 2).
Pursuant to the terms of the preferred membership units, prior to conversion they were being accreted to a redemption value and that accretion for the three and six months ended July 3, 2005 was $5.6 million and $12.1 million, respectively. Accretion for the three and six months ended July 4, 2004 was $5.9 million and $11.8 million, respectively. Accretion was discontinued at the time of conversion.
13. Equity Based Compensation Plans
Upon consummation of the Companys initial public offering, the ev3 LLC 2003 Incentive Plan was terminated with respect to options available for grant that were not granted prior to the offering and the ev3 Inc. 2005 Incentive Stock Plan became effective. Subject to adjustment as provided in the plan, 2,000,000 shares of the Companys common stock are available for issuance under the plan. Under the plan, the Companys eligible employees, outside directors and consultants may be awarded options, stock grants, stock units or stock appreciation rights. The terms and conditions of an option, stock grant, stock unit or stock appreciation right (including any vesting or forfeiture conditions) are set forth in the certificate evidencing the grant. During the three months ended July 3, 2005, options to purchase 56,859 shares of ev3 LLC common membership units were granted under the ev3 LLC 2003 Incentive Plan. In connection with the merger of ev3 LLC with and into ev3 Inc., these options were converted into options to purchase an equivalent number of shares of the Companys common stock. During the three months ended July 3, 2005, options to purchase 1,491,619 shares of the Companys common stock were granted under the ev3 Inc. 2005 Incentive Stock Plan.
14. Commitments and Contingencies
Letters of Credit
As of July 3, 2005, the Company had $2.4 million of outstanding letters of credit. These outstanding commitments are fully collateralized by restricted cash.
The Companys acquisition agreements relating to the purchase of MitraLife, Appriva Medical, Inc. and Dendron GmbH require the Company to make additional payments to the sellers of these businesses if certain milestones related to regulatory steps in the product commercialization process are achieved. The potential milestone payments total $25.0 million, $175.0 million and $15.0 million with respect to the MitraLife, Appriva and Dendron acquisitions, respectively, during the period of 2003 to 2009. On September 29, 2004, the Company sold substantially all of the assets constituting the MitraLife business to Edwards Lifesciences and is no longer pursuing commercialization of the product line acquired in the MitraLife transaction. As of the date that the Company sold these assets to Edwards Lifesciences, none of the milestones set forth in the Companys agreement with the sellers of MitraLife had been met. The Company has determined that it has no current obligations in respect of these milestone payments, and the Company does not believe that it is likely that it will have obligations with respect to these milestones in the future. The Company has determined that the first milestone with respect to the Appriva agreement was not achieved by the January 1, 2005 milestone date and that the first milestone is not payable. It is possible that the Company will meet one or more of the remaining milestones with respect to the Appriva acquisition and could become obligated to make the corresponding milestone payments totaling $125.0 million in periods subsequent to 2005. Under the terms of the stock purchase agreement the Company entered into in connection with its acquisition of Dendron, the Company may be required to make additional payments which are contingent upon Dendron products achieving certain revenue targets between 2003 and 2008. In 2003, the $4.0 million revenue target for sales of Dendron products during 2003 was met. Accordingly, an additional payment to the former Dendron stockholders of $3.75 million was made in 2004. In 2004, the $5.0 million revenue target for sales of Dendron products during 2004 was met. Accordingly, a payment to the former Dendron stockholders of $3.75 million was accrued in 2004 and was paid during the second quarter of 2005. The Company may be required to make a final payment of $7.5 million, which is contingent upon Dendron products achieving annual revenues of
$25 million in any year during the period between 2003 and 2008. Any such final payment would be due in the year following the year of target achievement.
The Company is from time to time subject to, and is presently involved in, litigation or other legal proceedings.
In September 2000, Dendron, which was acquired by MTI in 2002, was named as the defendant in three patent infringement lawsuits brought by the Regents of the University of California, as the plaintiff, in the District Court (Landgericht) in Dusseldorf, Germany. The complaints requested a judgment that Dendrons EDC I coil device infringed three European patents held by the plaintiff and asked for relief in the form of an injunction that would prevent Dendron from producing and selling the devices within Germany and selling from Germany to customers abroad, as well as an award of damages caused by Dendrons alleged infringement, and other costs, disbursements and attorneys fees. In August 2001, the court issued a written decision that the EDC I coil devices did infringe the plaintiffs patents, enjoined Dendron from selling the devices within Germany and from Germany to customers abroad, and requested that Dendron disclose the individual products costs as the basis for awarding damages. In September 2001, Dendron appealed the decision. In addition, Dendron instituted challenges to the validity of each of these patents by filing opposition proceedings with the European Patent Office, or EPO, against one of the patents (MTI joined Dendron in this action in connection with its acquisition of Dendron), and by filing, with MTI, nullity proceedings with the German Federal Patents Court against the German component of the other two patents. The opposition proceedings with the EPO on the one patent are complete, and the EPO has rejected the opposition and has upheld the validity of the one patent.
On July 4, 2001, the University of California filed another suit against Dendron alleging that the EDC I coil device infringed another European patent held by the plaintiff. The complaint was filed in the District Court of Dusseldorf, Germany seeking additional monetary and injunctive relief. In April 2002, the Court found that EDC I coil devices did infringe the plaintiffs patent. The patent involved is the same patent that was involved in the case before the English Patents Court (see below) and that was ruled by a Dutch court to be invalid (see below). The opposition proceedings on the patent are complete, and the EPO has rejected the opposition and has upheld the validity of the patent. The case is under appeal and an oral hearing is scheduled to be held in the Dusseldorf Court of Appeal on March 9, 2006.
An accrual for the matters discussed above was included in the balance sheet of Dendron as of the date of its acquisition by MTI. As of July 3, 2005, approximately $800 thousand was recorded in accrued liabilities in our consolidated balance sheet. Dendron ceased all activities with respect to the EDC I coil device prior to MTIs October 2002 acquisition of Dendron.
Concurrent with its acquisition of Dendron, MTI initiated a series of legal actions related to its Sapphire coils in the Netherlands and the United Kingdom, which included a cross-border action that was heard by a Dutch court, as further described below. The primary purpose of these actions was to assert both invalidity and non-infringement by MTI of certain patents held by others. The range of patents at issue are held by the Regents of the University of California, with Boston Scientific Corporation subsidiaries named as exclusive licensees, collectively referred to as the patent holders, related to detachable coils and certain delivery catheters.
In October 2003, the Dutch court ruled that the three patents at issue related to detachable coils are valid and that MTIs Sapphire coils do infringe such patents. The Dutch court also ruled that the patent holders patent at issue related to the delivery catheter was invalid. Under the courts ruling, MTI has been enjoined from engaging in infringing activities related to the Sapphire coils in most countries within the European Union, and may be liable for then-unspecified monetary damages for activities engaged in by MTI since September 27, 2002. In February 2005, MTI received an initial claim from the patent holders with respect to monetary damages, amounting to 3.6 million, or approximately $4.3 million as of July 3, 2005, with which MTI disagrees. Court hearings will be held regarding these claims. MTI has filed an appeal with the Dutch court, and believes that since the date of injunction in each separate country it is in compliance with the Dutch courts injunction and MTI intends to continue such compliance. Because the Company believes that MTI has valid legal grounds for appeal, it has determined that a loss is not probable at this time as defined by SFAS 5, Accounting for Contingencies. However, there can be no assurance that the ultimate resolution of this matter will not result in a material adverse effect on the Companys business, financial condition or results of operations.
In January 2003, MTI initiated a legal action in the English Patents Court seeking a declaration that a patent held by the patent holders related to delivery catheters was invalid, and that MTIs products did not infringe this patent. The patent in question was the U.K. designation of the same patent that was found by the Dutch court in October 2003 to be invalid, as discussed above. The patent holders counterclaimed for alleged infringement by MTI. In February 2005, the court approved an interim settlement between the parties under which the patent holders are required to surrender such patent to the U.K. Comptroller of Patents, and to pay MTIs costs associated with the legal action, including interest. As a result, MTI received interim payments from the patent holders aggregating £500 thousand (equivalent to approximately $950 thousand based on the dates of receipt), which MTI recorded as a reduction of litigation expense upon receipt of such funds in February and March 2005. The parties intend to continue discussions regarding payment by the patent holders of the remaining costs incurred by MTI in such litigation. As a result of the interim settlement, MTI anticipates that it will no longer be involved in litigation in the United Kingdom, although no assurance can be given that no other litigation involving MTI may arise in the United Kingdom.
In the United States, concurrent with the FDAs marketing clearance of the Sapphire line of embolic coils received in July 2003, MTI initiated a declaratory judgment action against the patent holders in the United States District Court for the Western District of Wisconsin. The action included assertions of non-infringement by MTI and invalidity of a range of patents held by the patent holders related to detachable coils and certain delivery catheters. In October 2003, the court dismissed MTIs actions for procedural reasons without prejudice and without decision as to the merits of the parties positions. In December 2003, the University of California filed an action against MTI in the United States District Court for the Northern District of California alleging infringement by MTI with respect to a range of patents held by the University of California related to detachable coils and certain delivery systems. MTI has filed a counterclaim against the University of California asserting non-infringement by MTI, invalidity of the patents and inequitable conduct in the procurement of certain patents. In addition, MTI filed a claim against the University of California and Boston Scientific Corporation for violation of federal antitrust laws, with the result that the court has subsequently decided to add Boston Scientific as a party to the litigation. A trial date has not been set. Because these matters are in early stages, the Company cannot estimate the possible loss or range of loss, if any, associated with their resolution. However, there can be no assurance that the ultimate resolution of these matters will not result in a material adverse effect on the Companys business, financial condition or results of operations.
In March 2005, Medtronic, Inc. contacted the Company to express its view that the Companys Protégé stents infringe on one or more of Medtronics patents. The Company informed Medtronic that it disagrees with Medtronics assertions, and has since had several discussions with Medtronic. No lawsuit with respect to this matter has been filed. The Company also received notice from an individual claiming that he believes that the Companys PLAATO device infringes on two of his patents. The Company has informed this individual that it does not believe that its PLAATO device infringes on these patents. On March 30, 2005, the Company was served with a complaint by Boston Scientific Corporation and one of its affiliates which claims that some of the Companys products, including its SpideRX Embolic Protection Device, infringe certain of Boston Scientifics patents. This action was brought in the United States District Court for the District of Minnesota. The Company has answered the complaint and intends to vigorously defend this action. Because these matters are in early stages, the Company cannot estimate the possible loss or range of loss, if any, associated with their resolution. However, there can be no assurance that the ultimate resolution of these matters will not result in a material adverse effect on the Companys business, financial condition or results of operations.
During 2002, the Company acquired Appriva Medical, Inc., a developer of a technology to reduce stroke in patients with atrial fibrillation which provided the platform for the Companys current PLAATO device. The acquisition agreement relating to the Companys acquisition of Appriva contains four milestones to which payments relate. The first milestone was required by its terms to be achieved by January 1, 2005 in order to trigger a payment equal to $50 million. The Company has determined that the first milestone was not achieved by January 1, 2005 and that the first milestone is not payable. On May 20, 2005, Michael Lesh, as an individual seller of Appriva stock and purporting to represent certain other sellers of Appriva stock, filed a complaint in the Superior Court of the State of Delaware with individually specified damages aggregating $70 million and other unspecified damages for several allegations, including that the Company, along with other defendants, breached the acquisition agreement and an implied covenant of good faith and fair dealing by willfully failing to take the steps necessary to meet the first milestone under the agreement, and thereby also failing to meet certain other milestones, and further that one
milestone was actually met. The complaint also alleges fraud, negligent misrepresentation and violation of state securities laws in connection with the negotiation of the acquisition agreement. The Company believes these allegations are without merit and intends to vigorously defend this action. On August 5, 2005, the Companys attorneys received a letter from attorneys representing certain other sellers of Appriva stock (who are not purported to be represented in the action filed by Lesh), asking the Companys attorneys to enter into a dialogue regarding their assertions that certain milestones should have been paid. The Company believes their assertions are without merit. Failure to reach agreement with these new claimants on a resolution of the parties differences, could lead to additional litigation on this matter. Because these matters are in early stages, the Company cannot estimate the possible loss or range of loss, if any, associated with their resolution. However, there can be no assurance that the ultimate resolution of these matters will not result in a material adverse effect on the Companys business, financial condition or results of operations.
15. Segment and Geographic Information
The following is segment and geographic information (in thousands):
(1) Gross profit for internal measurement purposes is defined as net sales less cost of goods sold excluding the amortization of intangible assets.
16. Earnings Per Share
The following outstanding convertible preferred units of ev3 LLC, convertible demand notes, and options of the Company and ev3 LLC were excluded from the computation of diluted earnings per share as they had an antidilutive effect. In connection with the merger of ev3 LLC with and into ev3 Inc. immediately prior to the Companys initial public offering, each preferred membership unit of ev3 LLC was converted into a share of our common stock and each option to purchase common membership units of ev3 LLC was converted into an option to purchase an equivalent number of shares of the Companys common stock (see Note 13).
17. Subsequent Events
On July 20, 2005, subsequent to the end of the fiscal quarter, the Company sold 205,800 shares of common stock pursuant to the over-allotment option granted to the underwriters in connection with its initial public offering. Net proceeds to the Company from this sale totaled $2.5 million, after deducting underwriting discounts and commissions and offering expenses, and increased the Companys outstanding shares to 49,116,454.
The following managements discussion and analysis of financial condition and results of operations describes the principal factors affecting the results of our operations, financial condition and changes in financial condition for the three and six months ended July 3, 2005. You should read this discussion together with the accompanying unaudited consolidated financial statements, related notes and other financial information included herein. As discussed under the heading Forward-Looking Statements below, the following discussion and other portions of this report may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under the heading Risk Factors below and elsewhere in this report. These risks could cause our actual results to differ materially from any future performance suggested in such forward-looking statements.
We are a global medical device company focused on catheter-based, or endovascular, technologies for the minimally invasive treatment of vascular diseases and disorders. Our broad product portfolio is focused on applications in each of the three sub-markets of the endovascular device market: peripheral vascular, cardiovascular and neurovascular. We sell over 100 products consisting of over 1,000 SKUs in these markets. From 2000 to 2002, our investor group acquired certain of the assets in our cardio peripheral division to build the foundation of our current peripheral and cardiovascular product portfolios. During this period, our investor group also purchased certain neurovascular assets to expand our neurovascular product portfolio and, through a series of investments, obtained our indirect controlling investment in Micro Therapeutics, Inc., or MTI. Beginning in 2002, we entered into long-term, exclusive agreements to market or distribute MTIs full product portfolio in Europe, Japan, Canada and the major markets of Asia Pacific and Latin America. Since our last acquisition in 2002, we have dedicated significant capital and management effort to advance the acquired technologies and broaden our product lines in order to execute our strategies.
We have corporate infrastructure and direct sales capabilities in the United States, Canada, Europe and Japan and have established distribution relationships in other large international markets. Our corporate headquarters is located in Plymouth, Minnesota and contains our manufacturing, research and development, and U.S. sales operations for our peripheral vascular and cardiovascular product lines. MTI is headquartered in Irvine, California, which contains our manufacturing, research and development, and U.S. sales operations for our neurovascular product lines. Outside of the United States, our primary offices are in Paris, France and Tokyo, Japan. During the three and six months ended July 3, 2005, approximately 49.5% and 49.2% of our net sales, respectively, were generated outside of the United States, as a result of which we are sensitive to risks related to fluctuation in exchange rates, which could affect our business results in the future.
Since our inception, we have focused on building our U.S. and international direct sales and marketing infrastructure that now includes a sales force of 199 direct sales representatives as of August 1, 2005 in the United States, Canada, Europe and Japan. Our direct sales representatives accounted for approximately 87% and 88% of our net sales during the three and the six months ended July 3, 2005, respectively, with the balance generated by independent distributors. In 2004, we increased our U.S. direct sales force from 44 to 82 and our Japan sales force from four to eleven. In order to drive sales growth, we have invested heavily throughout our history in new product development, clinical trials to obtain regulatory approvals and the expansion of our global distribution system. As a result, our costs and expenses have significantly exceeded our net sales, resulting in an accumulated deficit of $520.2 million at July 3, 2005. Consequently, we have financed our operations through debt and equity offerings. We expect to continue to generate operating losses for at least the next 18 months.
Our cash, cash equivalents and short-term investments available to fund current operations were $128.4 million and $20.1 million at July 3, 2005 and December 31, 2004, respectively. We completed an initial public offering of our common stock on June 21, 2005 in which we sold 11,765,000 shares of our common stock at $14.00 per share, resulting in net proceeds to us of approximately $152.8 million, after deducting underwriting discounts and commissions and offering expenses. We used $36.5 million of these net proceeds to repay a portion of the accrued and unpaid interest on certain demand notes held by Warburg, Pincus Equity Partners, L.P. and certain of its
affiliates, which we refer to collectively as Warburg Pincus, and The Vertical Group L.P. and certain of its affiliates, which we refer to collectively as Vertical. In addition, on July 20, 2005, we sold 205,800 shares of common stock pursuant to an over-allotment option granted to the underwriters which resulted in net proceeds to us of $2.5 million, after deducting underwriting discounts and commissions and offering expenses. We invested the remaining portion of the net proceeds in short-term, investment-grade, interest bearing securities. We expect to use these funds for general corporate purposes, which may include funding the operations of MTI. We expect our cash balance to decrease as we continue to use cash to fund our operations. We do not have any debt for borrowed money. We believe our cash, cash equivalents and short-term investments will be sufficient to meet our liquidity requirements through the end of fiscal 2006. There can be no assurance, however, that we will be able to achieve such positive cash flow or that we will not need additional financing to fund our operations.
We believe the overall market for endovascular devices will grow as the demand for minimally invasive treatment of vascular diseases and disorders continues to increase. Our broad product portfolio is focused on applications that we estimate represented an addressable worldwide endovascular market opportunity of approximately $1.6 billion in 2004. We intend to capitalize on this market opportunity by the continued introduction of new products. We intend to originate these new products primarily through our internal research and development and clinical efforts, but we may supplement them with acquisitions or other external collaborations. Additionally, our growth has been, and will continue to be, impacted by our expansion into new geographic markets and the expansion of our direct sales organization in existing geographic markets
We report and manage our operations in two reportable business segments based on similarities in the products sold, customer base and distribution system. Our cardio peripheral segment contains products that are used in both cardiovascular and peripheral vascular procedures by cardiologists, radiologists and vascular surgeons. Our neurovascular segment contains products that are used primarily by neuro-radiologists and neurosurgeons. Our sales activities and operations are aligned closely with our business segments. We generally have dedicated cardio peripheral sales teams in the United States and Europe that target customers who often perform procedures in both anatomic areas (cardiovascular and peripheral vascular). We generally have separate, dedicated neurovascular sales teams in the United States and Europe that are specifically focused on this customer base.
MTI, our public operating subsidiary, is focused on the neurovascular market. However, a small portion of MTIs sales relate to products sold into the cardio peripheral market, which we classify as cardio peripheral sales in our reporting. In addition, some of MTIs sales are generated at a transfer price to our international sales entities where they are resold by our sales organization. For consolidated reporting, these intercompany sales are eliminated. As a result, the neurovascular sales we report will be different from the sales that MTI reports publically. Based on MTIs public financial statements, approximately 41.5% of our net sales and 6.2% of our net losses during the three months ended July 3, 2005 and 41.3% of our net sales and 3.3% of our net losses during the six months ended July 3, 2005 were attributable to MTI.
On January 28, 2005, we were formed as a subsidiary of ev3 LLC. Immediately prior to the closing of our initial public offering on June 21, 2005, ev3 LLC merged with and into us, and we became the holding company for all of ev3 LLCs subsidiaries. Warburg Pincus and Vertical directly owned an aggregate of 9,704,819 shares of MTIs common stock, or 20.0% of the outstanding shares of MTIs common stock as of May 1, 2005. On May 26, 2005, pursuant to a contribution and exchange agreement dated as of April 4, 2005, Warburg Pincus and Vertical contributed these shares of MTIs common stock to ev3 LLC in exchange for 10,804,500 and 3,004,332 common membership units of ev3 LLC, respectively. As a result of the merger described above, as of July 3, 2005, we owned 34,041,578 shares of MTIs common stock, or 70.3% of the outstanding shares of MTIs common stock.
As the controlling stockholder, the contribution of the MTI shares by Warburg Pincus, representing a 15.7% interest in MTI as of May 26, 2005, was accounted for as a transfer of assets between entities under common control resulting in the retention of historical based accounting. The consolidated financial statements included in this report give effect to the contribution of MTI shares owned by Warburg Pincus as though such contribution occurred in 2003 and 2004 when Warburg Pincus acquired its interest in MTI. The contribution of the MTI shares owned by Vertical was accounted for under the purchase method of accounting on the contribution date. As of July 3, 2005 and December 31, 2004, we owned 70.3% and 66.0% of the outstanding shares of common stock of MTI, respectively. The following results of operations data include the financial results of MTI, which we consolidate for
accounting purposes but is not wholly owned. The consolidation of MTI for accounting purposes results in all of MTIs assets and liabilities being included in our consolidated balance sheets. Although all of MTIs assets are included in our consolidated balance sheets, not all of these assets would be available to us for distribution to our stockholders in the event of MTIs liquidation.
Immediately prior to the consummation of our initial public offering, we completed a one-for-six reverse stock split of our outstanding common stock. All share and per share amounts for all periods presented in this report reflect this split.
Sales and Expense Components
The following is a description of the primary components of our net sales and expenses:
Net sales. We derive our net sales from the sale of endovascular devices in two primary business segments: cardio peripheral and neurovascular devices. Most of our sales are generated by our global, direct sales force and are shipped and billed to hospitals or clinics throughout the world. In countries where we do not have a direct sales force, sales are generated by shipments to distributors who, in turn, sell to hospitals and clinics. In cases where our products are held in consignment at a customers location, we generate sales at the time the product is used in surgery rather than at shipment. We charge our customers for shipping and record shipping income as part of net sales.
Cost of goods sold. We manufacture a substantial majority of the products that we sell. Our cost of goods sold consists primarily of direct labor, allocated manufacturing overhead, raw materials and components and excludes amortization of intangible assets, which is presented as a separate component of operating expenses.
Sales, general and administrative expenses. Our selling and marketing expenses consist primarily of sales commissions and support costs for our global, direct distribution system, royalty and consulting expenses associated with our medical advisors, marketing costs and facility costs, including any costs related to closing facilities. General and administrative expenses consist primarily of salaries and benefits, compliance systems, accounting, finance, legal, information technology, human resources and freight expense that we pay to ship products to customers.
Research and development. Research and development expense includes costs associated with the design, development, testing, deployment, enhancement and regulatory approval of our products. It also includes costs associated with design and execution of clinical trials and regulatory submissions.
Amortization of intangible assets. Intangible assets, such as purchased completed technology, distribution channels, intellectual property, including trademarks and patents, are amortized over their estimated useful life. We amortize intangible assets over periods ranging from 5 to 8 years.
(Gain) loss on sale of assets, net. (Gain) loss on sale of assets, net includes the difference between the proceeds received from the sale of an operating asset and its carrying value.
Acquired in-process research and development. Acquired in-process research and development is related to value assigned to those projects acquired in business combinations or in the acquisition of assets for which the related products have not received regulatory approval and have no alternative future use.
Gain on sale of investments, net. Gain on sale of investments, net includes the difference between the proceeds received from the sale of an investment and its carrying value. In addition, this caption includes losses from other than temporary declines in investments accounted for on a cost basis.
Interest expense, net. Interest expense, net consists primarily of interest associated with loans from our principal investors, Warburg Pincus and Vertical.
Minority interest in loss of subsidiary. Minority interest in loss of subsidiary is the portion of MTIs net losses allocated to minority stockholders.
Other expense, net. Other expense, net primarily includes foreign exchange losses net of certain other expenses.
Income tax benefit. Income tax benefit is generated in certain of our European subsidiaries. Due to our history of operating losses, we have not recorded a provision for U.S. income taxes through 2004 and the six months ended July 3, 2005.
Accretion of preferred membership units to redemption value. Accretion of preferred membership units to redemption value represents the increase in carrying value of preferred membership units of ev3 LLC prior to ev3 LLCs merger with and into us on June 21, 2005. The increase in carrying value was based on the rights to which the preferred membership units were entitled related to a liquidation, dissolution or winding up of ev3 LLC. Accretion was recorded as a reduction to members equity and increased the loss attributable to common unit holders. Accretion was discontinued upon conversion of the preferred units to common membership units, and subsequently into shares of our common stock, on June 21, 2005, in connection with the merger.
Results of Operations
The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts (in thousands), and the changes between the specified periods expressed as percent increases or decreases: