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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 0-19711

96 Talamine Court
Colorado Springs, Colorado 80907
(719) 633-8333
(Address of principal executive offices and telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes     X     No_____

     As of August 9, 2002, there were 23,877,744 outstanding shares of Common Stock.

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Part I—FINANCIAL INFORMATION

Item 1. Financial Statements

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
(In Thousands, Except Share and Per Share Amounts)

See accompanying unaudited notes to consolidated financial statements.

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Item 1. Financial Statements (cont’d)

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited)
(In Thousands, Except Percentages, Share and Per Share Amounts)

See accompanying unaudited notes to consolidated financial statements.

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Item 1. Financial Statements (cont’d)

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)

     See accompanying unaudited notes to consolidated financial statements.

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Item 1. Notes to Financial Statements

(1) General

     The information included in the accompanying condensed consolidated interim financial statements is unaudited and should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s latest Annual Report on Form 10-K. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the assets, liabilities and results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.

(2) Current Developments

     In August 2002, the Company identified a single revenue transaction originally recorded in March 2002 that did not meet the revenue recognition criteria established by the Company under generally accepted accounting principles. The transaction related to the sale of a laser system to an international distributor. The Company shipped the laser to the distributor based on a purchase order, but did not receive complete documentation necessary to meet our revenue recognition criteria prior to March 31, 2002. The Company believes that its revenue recognition criteria will be met prior to December 31, 2002; however, no assurance can be given that this will occur. The transaction is not considered to be material; however, the Company has determined that, a correcting adjustment is appropriate. The adjustment is reflected in the condensed consolidated statement of operations for the six months ended June 30, 2002 and the condensed consolidated balance sheet as of June 30, 2002.

     The impact of the correcting adjustment on the statement of operations for the three months ended March 31, 2002 and the six months ended June 30, 2002 is $160,000 reduction of revenue. Net income for the three months ended March 31, 2002 is reduced by $75,000 and net loss for the six months ended June 30, 2002 is increased by $75,000. Within the balance sheet at March 31, 2002 and June 30, 2002, accounts receivable have been reduced by $160,000, inventories have been increased by $61,000, accrued liabilities have been reduced by $24,000 and shareholders’ equity has been reduced by $75,000. No other accounts were affected by the correcting adjustment. The changes to the financial statements for the three months ended March 31, 2002 are further summarized below:

(3) Net Income (Loss) Per Share

     The Company calculates net income (loss) per share under the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). Under SFAS 128, basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were outstanding. Diluted earnings per share is computed in a manner consistent with that of basic earnings per share while giving effect to all potentially dilutive common shares that were outstanding during the period using the treasury stock method.

     Diluted net loss per share is the same as basic loss per share for the three months ended June 30, 2002 and the six months ended June 30, 2002 and 2001, as potential common stock instruments are anti-dilutive. For the three months ended June 30, 2002 and 2001, 4,699,636 and 4,555,609, stock options, respectively, were excluded from the computation of diluted earnings per share due to their antidilutive effect. For the six months ended June 30, 2002 and 2001, 4,699,636 and 4,995,053, stock options, respectively, were excluded from the computation of diluted earnings per share due to their antidilutive effect. A summary of the net income (loss) per share calculation is shown below (in thousands except per share amounts):

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(4) Inventories

     Components of inventories are as follows (in thousands):

(5) Deferred Revenue

     Deferred revenue — current in the amounts of $985,000 and $963,000 at June 30, 2002, and December 31, 2001, respectively, relates to payments in advance for various product maintenance contracts, where revenue is initially deferred and amortized over the life of the contract, which is generally one year.

(6) Segment and Geographic Reporting

     An operating segment is a component of an enterprise whose operating results are regularly reviewed by the enterprise’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance. The primary performance measure used by management is net income or loss. The Company operates in one distinct line of business consisting of developing, manufacturing, marketing and distributing a proprietary excimer laser system for the treatment of certain coronary and vascular conditions. The Company has identified two reportable geographic segments within this line of business: (1) U.S. Medical and (2) Europe Medical. U.S. Medical and Europe Medical offer the same products and services but operate in different geographic regions and have different distribution networks. Additional information regarding each reportable segment is shown below.

U. S. Medical

     Products offered by this reportable segment include an excimer laser unit (“equipment”), fiber-optic delivery devices (“disposables”), and service of the excimer laser unit (“service”). The Company is subject to product approvals from the Food and Drug Administration (“FDA”). At June 30, 2002, FDA-approved products were used in conjunction with coronary angioplasty as well as the removal of non-functioning leads from pacemakers and cardiac defibrillators. This segment’s customers are primarily located in the United States; however, the geographic areas served by this segment also include Canada, Mexico, South America, the Pacific Rim and Australia.

     U.S. Medical is also corporate headquarters for the Company. Accordingly, research and development as well as corporate administrative functions are performed within this reportable segment. As of June 30, 2002 and 2001, cost allocations of these functions to Europe Medical have not been performed.

     Generally, all manufacturing activities are performed within the U.S. Medical Segment. Revenue associated with intersegment product transfers to Europe Medical was $322,000 and $212,000 for the three months ended June 30, 2002 and 2001, respectively, and $620,000 and $567,000 for the six months ended June 30, 2002 and 2001, respectively. Revenue is based upon transfer prices, which provide for intersegment profit that is eliminated upon consolidation. For each of the three and six months ended

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June 30, 2002 and 2001, intersegment revenue and intercompany profits have been eliminated in the segment information in the tables later in this section.

Europe Medical

     The Europe Medical segment is a marketing and sales subsidiary located in the Netherlands that serves all of Europe as well as the Middle East. Products offered by this reportable segment are generally the same as U.S. Medical products. The Company has received CE mark approval for products that relate to four applications of excimer laser technology — coronary angioplasty, in-stent restenosis, lead removal, and peripheral angioplasty to clear blockages in leg arteries.

     Summary financial information relating to reportable segment operations is shown below. Intersegment transfers as well as intercompany assets and liabilities are excluded from the information provided (in thousands):

(7) Litigation Settlement

     In October 2000, the Company entered into a settlement and release agreement with Baxter Healthcare Corporation (and its spin-off company, Edwards LifeSciences LLC) (collectively, Baxter) related to a patent infringement lawsuit filed by Baxter in August 1999. The agreement provides that the Company and Baxter each release all claims and counterclaims against each other, and Spectranetics enters into a license agreement for use of certain patents in the United States and abroad until the expiration of the last patent on November 15, 2005.

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     The Company is required to pay a royalty through the life of the patents. In addition, the Company recorded a net charge of $3,654,000 during the year ended December 31, 2000, to reflect the cost of past and current-year royalties to the agreement date, and legal fees related to this lawsuit, offset by the release of the Company’s prior obligation to provide defined medical devices to USSC, which had transferred certain assets to Baxter in July 1999. In addition, Baxter returned to the Company 15 laser systems for resale. The payments for past royalties were to be made in three annual installments, which began in November 2000; accrued liabilities as of June 30, 2002 included $1,595,000 for past royalties that will be paid in November 2002.

(8) Reorganization Costs

     During the three months ended December 31, 2000, reorganization costs primarily associated with the elimination of the direct sales organization in Germany totaled $1,200,000. A rollforward of these costs is summarized below.

     Additional costs of $140,000 relate primarily to a provision for bad debt expense associated with the restructuring as of December 31, 2000. At June 30, 2002, this provision had a balance of $15,000.

     The termination and severance costs primarily relate to eight employees within the sales organization in Germany. Effective January 1, 2001, a direct sales organization was no longer used in Germany; instead, a distributor has been contracted to continue selling the Company’s products in Germany. Substantially all of the remaining reorganization costs accrued at June 30, 2002, are expected to be paid in 2002.

     The change from a direct sales organization resulted in reduced revenue associated with reduced selling prices to our distributor. The reduced revenue was more than offset by increased unit volumes within our disposable products combined with reduced marketing and sales expenses of approximately $1,800,000. As a result, Spectranetics International, B.V. has been profitable in each quarter subsequent to the change to a distributor-based sales model in Germany.

(9) Proxy Contest and Settlement Obligations

     On April 26, 2002, a stockholder of the Company, Steven W. Sweet, filed a preliminary proxy statement with the Securities and Exchange Commission (the “SEC”) in which he nominated two directors for election at the Company’s 2002 Annual Meeting, then scheduled to take place on June 4, 2002. On May 3, 2002, all of the executive officers of the Company signed a letter addressed to Mr. Sweet agreeing to vote in favor of Mr. Sweet’s director nominees. On May 13, 2002, Mr. Sweet, together with Joseph A. Largey, the former President and Chief Executive Officer of the Company, Paul C. Samek, the former Vice President, Finance and Chief Financial Officer of the Company, Lawrence R. McKinley, Sharon L. Sweet, a sibling of Steven W. Sweet (collectively, the “Sweet Group”) and the other executive

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officers of the Company filed a Schedule 13D with the SEC indicating that they were acting as a group (the “13D Group”) in connection with Mr. Sweet’s proxy solicitation. On May 14, 2002, all of the executive officers of the Company, other than Messrs. Largey and Samek, signed a letter addressed to Mr. Sweet withdrawing from the 13D Group and from Mr. Sweet’s proxy solicitation group and stating their neutrality with respect to any proposals submitted to the stockholders by the Company or the Sweet Group. Subsequently, Mr. Sweet filed additional proxy materials adding four proposals for consideration at the June 4, 2002 Annual Meeting. On May 15, 2002, the Company announced that it had deferred its 2002 Annual Meeting in order to give the Company’s stockholders more time to fully consider recent developments. On May 23, 2002, the Company filed an action in the United States District Court for the District of Delaware against the members of the Sweet Group for violation of federal securities laws.

     On June 6, 2002, the Company reached a definitive agreement that resolved disputes among the Company and the members of the Sweet Group. As part of the settlement, the parties agreed to the following:

	•		The withdrawal by the Sweet Group of its director nominees as well as the other matters it had proposed for the Annual Meeting and agreed to vote at the Annual Meeting for the election of Messrs. Geisenheimer and Schulte, who are current members of the Board of Directors, and the Company dismissed with prejudice the lawsuits filed against the Sweet Group.
	•		The appointment to the Board of two new directors who are unaffiliated with, and independent of, any of the Company’s current directors and the Sweet Group and who are approved in good faith by the Board and Mr. Sweet, which approval shall not by unreasonably withheld. One of the new directors will fill a vacancy on the Board created by the resignation of Mr. Largey, which became effective on June 18, 2002, and the other new director will replace a current member of the Board, who will retire from the Board upon the appointment of a replacement director. Heidrick & Struggles, a nationally recognized executive recruiting firm, has been retained by the Company to assist in identifying the new directors.
	•		The retention by the Company of a nationally recognized consultant to recommend a program for equity incentives, including stock options, for outside directors and to submit the program recommended by the independent consultant to a vote of the stockholders at the Annual Meeting.

     The resolution also settled all claims between the Company and Messrs. Largey and Samek and Ms. Sweet, each of whom has separated from the Company.

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     Costs associated with the proxy contest and settlement obligations are shown below (in thousands):

     Additional costs of $56,000 relate primarily to costs associated with accelerating the vesting of stock options of the three terminated executives. These costs were recorded as additional paid in capital.

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

Forward-Looking Statements

     This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based on current assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially. For a description of such risks and uncertainties, which could cause the actual results, performance or achievements of the Company to be materially different from any anticipated results, performance or achievements, please see the risk factors below. Spectranetics disclaims any intention or obligation to update or revise any financial projections or forward-looking statements due to new information or other events.

Corporate Overview

     We develop, manufacture, market and service an excimer laser unit and fiber optic delivery system for minimally invasive surgical procedures within the cardiovascular system. Our CVX-300® excimer laser is the only system approved by the FDA for multiple cardiovascular procedures, including coronary angioplasty and removal of faulty pacemaker and defibrillator leads. Our laser system competes against alternative technologies including balloon catheters, cardiovascular stents and mechanical atherectomy and thrombectomy devices.

     Our strategy is to develop additional applications for our excimer laser system, increase utilization of our FDA-approved products, and expand our installed base of laser systems. In 1997, we secured FDA approval to use our excimer laser system for removal of pacemaker and defibrillator leads, and we secured FDA approval in 2001 to market certain products for use in restenosed (clogged) stents (thin steel mesh tubes used to support the walls of coronary arteries) as a pretreatment prior to brachytherapy (radiation therapy).

     We are currently conducting two FDA-approved clinical trials evaluating the use of our excimer laser system to treat blocked arteries in the upper and lower leg. We completed enrollment in April 2002 in our LACI (Laser Angioplasty for Critical Limb Ischemia) trial, which deals with blockages in the

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

lower leg. We are currently in the patient follow-up phase of the LACI trial, and we anticipate making a submission to the FDA for pre-market approval in early 2003. We completed enrollment in December 2001 in our PELA (Peripheral Excimer Laser Angioplasty) trial, which deals with blockages in the upper leg. We are currently in the patient follow-up phase of the PELA trial. These trials are on schedule to result in additional FDA-approved applications in the United States during late 2003 or early 2004, if successful.

Results of Operations

     The following table summarizes key supplemental financial information for the last 5 quarters.

*		Represents lasers sold, rented, or placed for evaluation at a new customer location.
**		Cash flow generated (used) is a result of the net change in cash, cash equivalents, and investment securities available for sale (current and long-term) during the periods presented.

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

Three Months Ended June 30, 2002 Compared with Three Months Ended June 30, 2001

     Revenue in the second quarter of 2002 was $6,463,000, down $940,000, or 13 percent, from the second quarter of 2001. The decrease is due to a 38 percent decrease in equipment revenue and a 10 percent decrease in disposable revenue, partially offset by a four percent increase in service revenue.

     Equipment revenue decreased 38 percent primarily as a result of lower selling prices realized from the $90,000 special price promotion in the 2002 period, combined with lower than expected laser placements. The $90,000 promotional price compares with a list price of $249,000, and we anticipate the termination of this special promotion on September 30, 2002. The Company sold (either an outright sale from inventory or a sale conversion from evaluation or rental programs) five laser units in the second quarter of 2002, which represents no change from the five units sold in the second quarter of 2001. For the three months ended June 30, 2002, we had net placements (sold, rented or placed for evaluation) of four excimer laser systems compared with three in 2001 bringing the installed base up to 341 excimer laser systems (243 in the United States).

     The 10 percent decrease in disposable products revenue, which consists of single-use catheter products, is attributable to a 14 percent decrease in atherectomy catheters and a five percent decrease in lead removal products.

     Service revenue increased four percent in the second quarter of 2002 due to the larger installed base of the Company’s excimer laser systems. At June 30, 2002, the installed base included 341 excimer laser systems compared with 318 at June 30, 2001.

     Gross margin increased to 69 percent during the three months ended June 30, 2002, from 68 percent for the second quarter of 2001. This increase was primarily due to a higher product mix of disposable products revenue compared with 2001. Disposable products revenue generates higher gross margins than equipment revenue.

     Operating expenses, excluding proxy contest charges and settlement obligations of $1,837,000, were $4,958,000 in the second quarter of 2002, consistent with $4,932,000 in the second quarter of 2001.

     Selling, general and administrative expenses increased four percent to $3,716,000 for the three months ended June 30, 2002 from $3,561,000 in the second quarter of 2001. The increase is due to:

•

Selling expenses increased approximately $400,000 in the quarter compared with last year as a result of the following:

		•		Approximately $300,000 relates to personnel-related expenses associated with our field sales force.
		•		Approximately $100,000 related to marketing materials associated with the support of our coronary and lead removal applications.

•

General and administrative expenses decreased approximately $250,000 in the quarter compared with last year as a result of the following:

		•		Approximately $150,000 relates to reduced legal expenses as a result of the settlement of litigation with Cook Vascular, Inc. in the prior year. No costs of this nature were incurred within general and administrative expenses during the quarter ended June 30, 2002.
		•		Approximately $100,000 relates to reduced personnel-related costs as a result of the termination of the Company’s President and Chief Executive Officer, Chief Financial Officer, and Vice President, Corporate Relations during the quarter.

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

     Research, development and other technology expenses decreased nine percent to $1,242,000 for the second quarter of 2002 from $1,371,000 in the second quarter of 2001. Costs included within research, development and other technology expenses are research and development costs, clinical studies costs and royalty costs associated with various license agreements with third-party licensors. The decrease from prior year amounts is primarily due to decreased royalties as a result of decreased royalty-bearing revenue, partially offset by increased research and development expenses associated with the second generation laser sheath used for our lead removal application.

     Proxy contest charges and settlement obligations totaled $1,837,000. See further discussion of these costs contained in footnote (9) to our financial statements.

     Interest income increased to $142,000 during the quarter ended June 30, 2002, from $121,000 in 2001, due to higher average cash and investment balances offset by lower investment yield within our investment portfolio, which consists of short-term government and corporate bonds.

     Net loss for the three months ended June 30, 2002, was $2,259,000 compared with a net income of $182,000 in 2001. The net loss was primarily due to proxy contest charges and settlement obligations of $1,837,000 and decreased revenue discussed above.

     The functional currency of Spectranetics International B.V. is the euro. All revenue and expenses are translated to U.S. dollars in the consolidated statements of operations using weighted average exchange rates during the period. Fluctuation in euro currency rates during the three months ended June 30, 2002, as compared with the three months ended June 30, 2001, caused a decrease in consolidated revenue and operating expenses of less than one percent.

Six Months Ended June 30, 2002 Compared with Six Months Ended June 30, 2001

     Revenue for the six months ended June 30, 2002 was $13,522,000, an increase of one percent from the six months ended June 30, 2001. The increase is due to a six percent increase in equipment revenue and a three percent increase in service revenue, partially offset by a two percent decrease in disposable revenue.

     For the six months ended June 30, 2002, we placed 14 new excimer laser systems compared with six during the six months ended June 30, 2001. The increase in equipment placement activity is part of an emphasis in 2002 on equipment placements. The equipment revenue increase is primarily due to revenue from sales conversions of rental and evaluation units during the first quarter of 2002, which was driven by the $90,000 special price promotion on laser equipment.

     The decrease in disposable products revenue, which consists of single-use catheter products, is attributable to a one percent decrease in sales of atherectomy catheters and a three percent decrease in sales of lead removal products.

     Service revenue increased three percent in the six months ended June 30, 2002 due to the larger installed base of the Company’s excimer laser systems. At June 30, 2002, the installed base included 341 excimer laser systems, compared with 318 at June 30, 2001.

     Gross margin decreased to 68 percent during the six months ended June 30, 2002, from 69 percent for the six months ended June 30, 2001. This decrease was due to a shift in product mix to a higher proportion of excimer laser systems, which generate lower margins than disposable products.

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

     Operating expenses, excluding proxy contest charges and settlement obligations of $1,837,000, increased slightly in the six months ended June 30, 2002 to $9,852,000, compared with $9,818,000 for the six months ended June 30, 2001.

     Selling, general and administrative expenses increased two percent to $7,417,000 for the six months ended June 30, 2002 from $7,261,000 in the six months ended June 30, 2001. This increase is due to:

•

Selling expenses increased approximately $400,000 compared with last year as a result of the following:

		•		Approximately $300,000 relates to personnel-related expenses associated with our field sales force.
		•		Approximately $100,000 related to marketing materials associated with the support of our coronary and lead removal applications.

•

General and administrative expenses decreased approximately $250,000 compared with last year as a result of the following:

		•		Approximately $150,000 relates to reduced legal expenses as a result of the settlement of litigation with Cook Vascular, Inc. in the prior year. No costs of this nature were incurred within general and administrative expenses during the six months ended June 30, 2002.
		•		Approximately $100,000 relates to reduced personnel-related costs as a result of the termination of the Company’s President and Chief Executive Officer, Chief Financial Officer, and Vice President, Corporate Relations during the six months ended June 30, 2002.

     Research, development and other technology expenses of $2,435,000 for the six months ended June 30, 2002 represent a decrease of five percent from $2,557,000 for the six months ended June 30, 2001. Costs included within research, development and other technology expenses are research and development costs, clinical studies costs and royalty costs associated with various license agreements with third-party licensors. The decrease from prior year amounts is primarily due to decreased royalties as a result of decreased royalty-bearing revenue, partially offset by increased research and development expenses associated with the second generation laser sheath used for our lead removal application.

     Proxy contest charges and settlement obligations totaled $1,837,000. See further discussion of these costs contained in footnote (9) to our financial statements.

     Interest income decreased in 2002 to $246,000 from $270,000 in 2001 due to lower investment yields within our investment portfolio, which consists of short-term government and corporate bonds.

     Net loss for the six months ended June 30, 2002, was $2,276,000, compared with a net loss of $374,000 in 2001. Net loss, excluding proxy contest charges and settlement obligations, was $439,000.

     The functional currency of Spectranetics International B.V. is the euro. All revenue and expenses are translated to U.S. dollars in the consolidated statements of operations using weighted average exchange rates during the period. Fluctuation in euro currency rates during the six months ended June 30, 2002, as compared with the six months ended June 30, 2001, caused a decrease in consolidated revenue and operating expenses of less than one percent.

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

Liquidity and Capital Resources

     As of June 30, 2002, we had cash, cash equivalents and investment securities of $13,658,000, an increase of $774,000 from $12,884,000 at December 31, 2001.

     Cash provided by operations during the six months ended June 30, 2002, totaled $477,000, consisting of $574,000 of cash provided by a decrease in accounts receivable, $1,408,000 provided by an increase in accounts payable and accrued liabilities, increased deferred revenues of $150,000 and $68,000 from a decrease in other assets and equipment held for rental or loan. This was partially offset by cash loss (net loss plus depreciation and amortization) of $1,341,000, increased inventories of $209,000 and an increase of $173,000 in prepaid expenses and other current assets.

     The table below presents the change in receivables and inventory in relative terms, through the presentation of financial ratios. Days sales outstanding is calculated by dividing the ending net accounts receivable balance by the average daily sales for the period. Inventory turns are calculated by dividing annualized cost of sales for the period by ending inventory.

     Cash provided by investing activities of $901,000 for the six months ended June 30, 2002, was due primarily to the maturity of $1,015,000 of investment securities, partially offset by capital expenditures of $114,000.

     Cash provided by financing activities was $371,000, and is comprised of $500,000 of proceeds from the sale of common stock to employees through stock option exercises and the employee stock purchase plan, offset by $129,000 of principal payments on debt and capital lease obligations. At June 30, 2002, total debt, including capital lease obligations was $107,000.

     At June 30, 2002, and December 31, 2001, we had placed a number of laser systems on rental and loan programs. A total of $4,804,000 and $5,089,000 was recorded as equipment held for rental or loan at June 30, 2002, and December 31, 2001, respectively, and is being depreciated over three to five years.

     We currently use two placement programs in addition to the sale of laser systems:

(1)

Evergreen rental program — This rental program was introduced in July 1999. Rental revenue under this program varies on a sliding scale depending on the customer’s catheter purchases each month. Rental revenue is invoiced on a monthly basis and revenue is recognized upon invoicing. The laser unit is transferred to the equipment held for rental or loan account upon shipment, and depreciation expense is recorded within cost of revenue based upon a three- to five-year expected life of the unit. As of June 30, 2002, 52 laser units were in place under the evergreen rental program.

(2)

Evaluation programs — We “loan” a laser system to an institution for use over a short period of time, usually three to six months. The loan of the equipment is to create awareness of our products and their capabilities, and no revenue is earned or recognized in connection with the placement of a loaned laser (although sales of disposable products result from the laser placement). The laser unit is transferred to the equipment held for

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

rental or loan account upon shipment, and depreciation expense is recorded within selling, general and administrative expense based on a three- to five-year expected life of the unit. As of June 30, 2002, 23 laser units were in place under the evaluation program.

     During the six months ended June 30, 2002, we implemented a price promotion in which we are offering lasers for sale at $90,000, compared with a list price of $249,000, and have arranged for a third-party leasing company to provide financing for our customers, if necessary. In addition, we anticipate that some customers currently on the Evergreen rental program may decide to purchase their lasers at the $90,000 price. We anticipate continuation of this price promotion through September 30, 2002.

     We believe our liquidity and capitalization as of June 30, 2002 are sufficient to meet our operating and capital requirements through at least the next twelve months. In the event we need additional financing for the operation of our business, we will consider additional public or private financing. Factors influencing the availability of additional financing include our progress in our current clinical trials, investor perception of our prospects and the general condition of the financial markets. We cannot assure you that our existing cash and cash equivalents will be adequate or that additional financing will be available when needed or that, if available, this financing will be obtained on terms favorable to us or our stockholders.

CONVERSION TO THE EURO

     On January 1, 2002, Spectranetics International B.V. adopted the euro as its functional currency. The conversion to the euro did not have and is not expected to have a material effect on our consolidated financial results of operations.

NEW ACCOUNTING PRONOUNCEMENTS

     On June 30, 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 141, Business Combinations, and SFAS 142, Goodwill and Intangible Assets. Major provisions of these Statements are as follows: All business combinations initiated after June 30, 2001, must use the purchase method of accounting; the pooling of interest method of accounting is prohibited, except for transactions initiated before July 1, 2001; intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; goodwill and intangible assets with indefinite lives are not amortized but are tested for impairment annually, except in certain circumstances, and whenever there is an impairment indicator; all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting; and effective January 1, 2002, goodwill will no longer be subject to amortization. The adoption of this standard did not have a material impact on our consolidated financial position, results of operations, or cash flows.

     No goodwill amortization was recorded during the three and six months ended June 30, 2002 or 2001, respectively.

RISK FACTORS

     We Have a History of Losses and May Not Be Able to Maintain Profitability. We incurred net losses from operations since our inception in June 1984 until the second quarter of 2001, and we incurred a net loss in the second quarter of 2002. At June 30, 2002, we had accumulated $78 million in net

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

losses since inception. We expect that our research, development and clinical trial activities and regulatory approvals, together with future selling, general and administrative activities and the costs associated with launching our products for additional indications will result in significant expenses for the foreseeable future. No assurance can be given that we will be able to achieve or maintain profitability in the future.

     We May be Unable to Recruit a Qualified Chief Executive Officer. Although we have retained an executive recruiting firm to identify potential candidates for the position of Chief Executive Officer, no assurance can be given that a qualified candidate will be identified or, if one is identified, available for hire at terms that are agreeable to us.

     Our Small Sales and Marketing Team May Be Unable To Compete With Our Larger Competitors or To Reach All Potential Customers. Many of our competitors have larger sales and marketing operations than we do. This allows those competitors to spend more time with potential customers and to focus on a larger number of potential customers, which gives them a significant advantage over our team in making sales.

     Our Products May Not Be Accepted in Their Markets. Excimer laser technology competes with more established therapies for restoring circulation to clogged or obstructed arteries such as balloon angioplasty and stent implantation. Market acceptance of the excimer laser system depends on our ability to provide adequate clinical and economic data that shows the clinical efficacy and cost effectiveness of, and patient benefits from, excimer laser atherectomy and lead removal.

     We May Be Unable To Compete Successfully With Bigger Companies in Our Highly Competitive Industry. Our primary competitors are manufacturers of products used in competing therapies, such as:

	•		balloon angioplasty, which uses a balloon to push obstructions out of the way;
	•		stent implantation;
	•		open chest bypass surgery; and
	•		atherectomy and thrombectomy, using mechanical methods to remove arterial blockages.

     We also compete with companies marketing lead extraction devices or removal methods, such as mechanical sheaths. In the lead removal market, we compete worldwide with lead removal devices manufactured by Cook Vascular Inc. and we compete in Europe with devices manufactured by VascoMed.

     Almost all of our competitors have substantially greater financial, manufacturing, marketing and technical resources than we do. Larger competitors have a broader product line, which enables them to offer customers bundled purchase contracts and quantity discounts. We expect competition to intensify.

     We believe that the primary competitive factors in the interventional cardiovascular market are:

	•		the ability to treat a variety of lesions safely and effectively;
	•		the impact of managed care practices, related reimbursement to the health care provider, and procedure costs;
	•		ease of use;

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Item 2. Management's Discussion and Analysis of
             Results of Operations and Financial Condition (cont'd)

	•		size and effectiveness of sales forces; and
	•		research and development capabilities.

     We estimate that approximately 80 percent of coronary interventions involve the placement of a stent. The leading stent providers in the United States are SCIMED Life Systems, Inc. (a subsidiary of Boston Scientific Corporation); Cordis Corporation (a subsidiary of Johnson & Johnson Interventional Systems); Guidant Corporation; Medtronic, Inc.; and JOMED N.V. The leading balloon angioplasty manufacturers are SCIMED, Cordis, Guidant and Medtronic. Manufacturers of atherectomy or thrombectomy devices include SCIMED, Guidant and Possis Medical, Inc.

     Laser placement is a barrier to accessing patient cases for which our disposable products may be suited. Many competing products do not require an up-front investment in the form of a capital equipment purchase, lease, or rental.

     Failure of Third Parties To Reimburse Medical Providers for Our Products May Reduce Our Sales. We sell our CVX-300 laser unit primarily to hospitals, which then bill third-party payers, such as government programs and private insurance plans, for the services the hospitals provide using the CVX-300 laser unit. Unlike balloon angioplasty, laser atherectomy requires the purchase or lease of expensive capital equipment. In some circumstances, the amount reimbursed to a hospital for procedures involving our products may not be adequate to cover a hospital’s costs. We do not believe that reimbursement has materially adversely affected our business to date, but continued cost containment measures by third-party payers could hurt our business in the future.

     In addition, the FDA has required that the label for the CVX-300 laser unit state that adjunctive balloon angioplasty was performed together with laser atherectomy in most of the procedures we submitted to the FDA for pre-market approval. Adjunctive balloon angioplasty requires the purchase of a balloon catheter in addition to the laser catheter. While all approved procedures using the excimer laser system are reimbursable, some third-party payers attempt to deny reimbursement for procedures they believe are duplicative, such as adjunctive balloon angioplasty performed together with laser atherectomy. Third-party payers may also attempt to deny reimbursement if they determine that a device used in a procedure was experimental, was used for a non-approved indication, or was not used in accordance with established pay protocols regarding cost-effective treatment methods. Hospitals that have experienced reimbursement problems or expect to experience reimbursement problems may not purchase our excimer laser systems.

     Technological Change May Result in Our Products Becoming Obsolete. We derive substantially all of our revenue from the sale or lease of the CVX-300 laser unit, related disposable devices and service. Technological progress or new developments in our industry could adversely affect sales of our products. Many companies, some of which have substantially greater resources than we do, are engaged in research and development for the treatment and prevention of coronary artery disease. These include pharmaceutical approaches as well as development of new or improved angioplasty, atherectomy, thrombectomy or other devices. Our products could be rendered obsolete as a result of future innovations in the treatment of vascular disease.

     Regulatory Compliance Is Expensive and Can Often Be Denied or Significantly Delayed. The industry in which we compete is subject to extensive regulation by the FDA and comparable state and foreign agencies. Complying with these regulations is costly and time consuming. International regulatory approval processes may take longer than the FDA approval process. If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspensions or revocations of approvals, seizures or recalls of products, operating restrictions, criminal prosecutions and other penalties. We may

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