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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
-------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________________ to ________________________
Commission file number 0-27588
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VITALCOM INC.
(Exact name of registrant as specified in its charter)
DELAWARE 3662 33-0538926
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
15222 DEL AMO AVENUE
TUSTIN, CALIFORNIA 92780
(714) 546-0147
(Address and telephone number of principal executive offices)
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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of May 10, 1998, there were 8,205,682 shares outstanding of the issuer's
common stock.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VITALCOM INC.
BALANCE SHEETS
-------------------------------
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
(UNAUDITED) (AUDITED)
ASSETS
Current assets
Cash and cash equivalents $ 17,699,871 $ 12,157,160
Short-term investments 6,000,000
Accounts receivable, 3,364,874 3,853,066
net
Inventories 1,719,825 1,812,499
Prepaid expenses 382,438 269,462
------------ ------------
Total current assets 23,167,008 24,092,187
Property
Machinery and equipment 1,498,223 1,464,903
Office furniture and computer equipment 2,097,074 2,044,083
Leasehold improvements 87,351 87,351
------------ ------------
3,682,648 3,596,337
Less accumulated amortization and depreciation (1,818,367) (1,659,939)
------------ ------------
Property, net 1,864,281 1,936,398
Other assets 202,265 51,935
Goodwill, net 617,055 627,549
------------ ------------
Total assets $ 25,850,609 $ 26,708,069
============ ============
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VITALCOM INC.
BALANCE SHEETS - (CONTINUED)
-------------------------------
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
(UNAUDITED) (AUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 962,276 $ 585,744
Accrued payroll and related costs 742,251 1,198,055
Accrued warranty costs 960,043 968,245
Other accrued liabilities 1,179,414 1,353,675
Current portion of capital lease obligations 21,120 21,120
------------ ------------
Total current liabilities 3,865,104 4,126,839
Capital lease obligations, less current portion 54,326 60,296
Redeemable preferred stock, 5,000,000 shares authorized,
$.001 par value; no shares issued and outstanding at
December 31, 1997 and March 31, 1998, respectively
Stockholders' equity (deficit):
Common stock, including paid-in capital, $0.0001 par value;
25,000,000 shares authorized, 8,038,547 and 8,170,333 shares
issued and outstanding at December 31, 1997 and March 31, 1998,
respectively 37,121,400 37,031,165
Accumulated deficit (15,190,221) (14,510,231)
------------ ------------
Net stockholders' equity 21,931,179 22,520,934
------------ ------------
Total liabilities and stockholders' equity $ 25,850,609 $ 26,708,069
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VITALCOM INC.
STATEMENTS OF OPERATIONS
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THREE MONTHS ENDED
MARCH 31,
1998 1997
----------- -----------
(UNAUDITED)
Revenues $ 5,100,726 $ 3,973,364
Cost of sales 2,479,535 2,282,602
----------- -----------
Gross profit 2,621,191 1,690,762
Operating expenses:
Sales and marketing 1,720,910 2,361,460
Research and development 1,177,390 1,069,357
General and
administration 614,849 675,678
----------- -----------
Total operating expenses 3,513,149 4,106,495
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Operating loss (891,958) (2,415,733)
Other income, net 218,268 222,997
----------- -----------
Loss before provision for income taxes (673,690) (2,192,736)
Provision for income taxes 6,300 7,300
Net loss $ (679,990) $(2,200,036)
=========== ===========
Net loss per basic and diluted common share $ (0.08) $ (0.28)
=========== ===========
Weighted average basic and diluted common shares 8,049,236 7,958,274
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VITALCOM INC.
STATEMENTS OF CASH FLOWS
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THREE MONTHS ENDED
MARCH 31,
1998 1997
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(UNAUDITED)
Cash flows from operating activities:
Net loss $ (679,990) $ (2,200,036)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 168,922 156,789
Loss on disposal of property 7,377 6,211
Changes in operating assets and liabilities:
Accounts receivable 488,192 (436,641)
Inventories 92,674 98,398
Income taxes receivable 214,213
Prepaid expenses and other assets (263,306) (97,465)
Accounts payable 376,532 (83,546)
Accrued payroll and related costs (455,804) (10,858)
Accrued warranty costs (8,202) (7,073)
Accrued liabilities (174,261) (221,520)
------------ ------------
Net cash used in operating (447,866) (2,581,528)
activities
Cash flows from investing activities:
Purchases of property (93,688) (75,436)
Increase in other assets (25,525)
------------ ------------
Net cash used in investing activities (93,688) (100,961)
Cash flows from financing activities:
Repayment of capital lease obligation and
long-term debt (5,970) (4,484)
Net proceeds from issuance of common stock 90,235 1,320
------------ ------------
Net cash provided by (used in) financing
activities 84,265 (3,164)
Net decrease in cash and cash equivalents (457,289) (2,685,653)
Cash and cash equivalents, beginning of period 18,157,160 20,120,203
------------ ------------
Cash and cash equivalents, end of period $ 17,699,871 $ 17,434,550
============ ============
Supplemental disclosures of cash flow information:
Interest paid $ 4,429 $ 6,211
Income taxes paid $ 6,300 $ 7,956
Supplemental schedule of noncash transactions:
Notes receivable for stock sales $ 457,052 $ 195,000
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VITALCOM INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The interim condensed financial statements included herein have been prepared by
the Company without audit pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC"). Certain information and footnote
disclosures, normally included in the financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted pursuant to such SEC rules and regulations; nevertheless, the management
of the Company believes that the disclosures herein are adequate to make the
information presented not misleading. These condensed financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31, 1997 and
filed with the SEC. In the opinion of management, the condensed financial
statements included herein reflect all normal, recurring adjustments necessary
to present fairly the financial position of the Company as of March 31, 1998,
and the results of its operations and its cash flows for the three-month periods
ended March 31, 1998 and 1997. The results of operations for the interim periods
are not necessarily indicative of the results of operations for the full year.
2. NET LOSS PER SHARE
Net loss per share is computed by dividing net loss by the weighted average
number of common and common equivalent shares outstanding. For the three-month
periods ended March 31, 1998 and 1997, the diluted weighted average shares were
equal to the basic weighted average shares due to the anti-dilutive effect the
conversion of options would have given the Company's net loss for the period.
3. STOCK PLANS AND STOCKHOLDERS' EQUITY
Stock Option Plans - The following is a summary of stock option transactions
under the 1993 Stock Option Plan (the "1993 Plan") for the three months ended
March 31, 1998:
NUMBER OF
NUMBER OF PRICE PER OPTIONS
SHARES SHARE EXERCISABLE
--------- --------------- -----------
Balance, December 31, 1997 1,604,853 $0.60 to $15.75
Granted 25,000 $4.4375
Exercised (10,250) $0.60 to $1.28
Canceled (261,655) $1.28 to $15.75
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Balance, March 31, 1998 1,357,948 $0.60 to $5.72 185,090
=========
At March 31, 1998, 886,610 options were available for grant under the 1993 Plan.
The following is a summary of stock option transactions under the 1996 Stock
Option Plan (the "1996 Plan") for the three months ended March 31, 1998:
NUMBER OF
NUMBER OF PRICE PER OPTIONS
SHARES SHARE EXERCISABLE
--------- --------------- -----------
Balance, December 31, 1997 69,325 $5.50 to $6.00
Granted
Canceled (7,750) $4.97 to $6.00
---------
Balance, March 31, 1998 61,575 $4.97 to $6.00 18,483
=========
At March 31, 1998, 38,425 options were available for grant under the 1996 Plan.
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There were no stock transactions under the 1996 Director Option Plan (the
"Director Plan") for the three months ended March 31, 1998. At March 31, 1998,
60,000 options were available for grant under the Director Plan and no options
were exercisable.
The Company has reserved an aggregate of 150,000 shares of Common Stock for
issuance under its 1996 Employee Stock Purchase Plan (the "ESPP"). The ESPP was
adopted by the Board of Directors in January 1996 and approved by the Company's
stockholders prior to the consummation of the Company's initial public offering
in February 1996. The ESPP is intended to qualify under Section 423 of the
Internal Revenue Code of 1986, as amended, and permits eligible employees of the
Company to purchase Common Stock through payroll deductions of up to 10% of
their compensation provided that no employee may purchase more than $25,000
worth of stock in any calendar year. The ESPP was implemented by an offering
period commencing on February 14, 1996 and ending on the last business day in
the period ending October 31, 1996. Each subsequent offering period (an
"Offering Period") commences on the day following the end of the prior Offering
Period and has a duration of six months. The price of Common Stock purchased
under the ESPP will be 85% of the lower of the fair market value of the Common
Stock on the first or last day of each offering period. The ESPP will expire in
the year 2006. In the years ended December 31, 1996 and 1997 the Company issued
32,815 and 47,359 shares of Common Stock, under the ESPP for $153,410 and
$191,218, respectively. At March 31, 1998, $81,601 had been withheld from
employee earnings for stock purchases under the ESPP.
During the three months ended March 31, 1998, the Company issued 103,000 shares
of its common stock, under interest-bearing, nonrecourse notes in the amount of
$457,052 and received net proceeds of $11.
Recent Accounting Pronouncements--In June 1997, the FASB issued Statement of
Financial Accounting Standard No. 130 (SFAS 130), Reporting Comprehensive
Income, and No. 131 (SFAS 131), Disclosures About Segments of an Enterprise and
Related Information. The Company has adopted SFAS 130 for the period ending
March 31, 1998. The Company has no reportable differences between comprehensive
loss and net loss, as reported at March 31, 1997 and March 31, 1998.
For the current fiscal year ending December 31, 1998 the Company will adopt SFAS
No. 131, which is based on the management approach to segment reporting. SFAS
No. 131 establishes requirements to report selected segment information
quarterly and to report entity-wide disclosures about products and services,
major customers and the material countries in which the entity holds assets and
reports revenue. The Company has determined that the effect the statement will
have on its financial statements and disclosures is not material.
In October 1997, the American Institute of Certified Public Accountants issued
SOP 97-2, Software Revenue Recognition, which supercedes SOP 91-1. The
provisions of SOP 97-2 are effective for fiscal years beginning after December
15, 1997. The Company has determined that the effect that these new standards
has on its consolidated financial statements and disclosures is not material.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CERTAIN STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q,
INCLUDING THE INFORMATION SET FORTH IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, ARE FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SUCH
FORWARD-LOOKING STATEMENTS INCLUDE THOSE REGARDING SEASONAL VARIATIONS IN SALES
OF ITS NETWORKED MONITORING PRODUCTS AND ITS OEM PRODUCTS, SALES CYCLE FOR
NETWORKED MONITORING SYSTEMS AND OEM PRODUCTS, THE COMPANY'S ABILITY TO SHIP
ORDERS AS THEY ARE RECEIVED, THE CONTINUING ABILITY OF THE COMPANY TO MEET YEAR
2000 COMPLIANCE, THE ESTIMATE OF YEAR 2000 EXPENDITURES AS BEING LIMITED TO
$50,000 TO $200,000, INCREASED DEMAND FOR THE COMPANY'S PRODUCTS FOR NETWORKED
MONITORING AND OEM CUSTOMERS, THE EXPECTATION THAT THE COMPANY WILL SPEND
APPROXIMATELY $900,000 FOR CAPITAL EXPENDITURES IN THE REMAINING NINE MONTHS OF
1998 AND THAT THE COMPANY'S WORKING CAPITAL POSITION IS SUFFICIENT TO FUND THE
COMPANY'S OPERATIONS FOR AT LEAST THE NEXT TWELVE MONTHS. ACTUAL RESULTS MAY
VARY SUBSTANTIALLY FROM THESE FORWARD LOOKING STATEMENTS FOR MANY REASONS. SEE
ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS, INCLUDED IN THE
COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997, ON FILE WITH THE
SECURITIES AND EXCHANGE COMMISSION . ADDITIONAL INFORMATION IS AVAILABLE IN
OTHER COMPANY REPORTS AND OTHER DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION.
GENERAL
VitalCom (the "Company"), provides computer networks and related
communications products that acquire, interpret and distribute real time patient
monitoring information. The Company's computer and radio networks acquire
physiologic data generated by the Company's own proprietary ECG monitors and
other manufacturers' bedside equipment located throughout a healthcare facility.
The Company's networks consist of proprietary radio frequency ("RF")
communications components, clinical analysis software and display and networking
software to provide personal computer-based central station surveillance of
physiologic data from patients throughout a healthcare facility. The Networked
Monitoring(TM) systems sold to acute care hospitals and integrated health
delivery networks ("IHDNs") through the Company's direct sales force are
networked systems designed for facility-wide coverage that provide access to
real-time information at remote displays as well as at the central monitor,
remote access through a wide area network ("WAN") as well as local area network
("LAN"), offer the capability to acquire data from the Company's own ambulatory
ECG monitors as well as a variety of other manufacturers' bedside monitors and
are typically located in multiple departments throughout the healthcare
facility. The Company's Original Equipment Manufacturer ("OEM") customers
purchase central monitoring systems as well as individual components for use in
their monitoring products, which are generally for smaller departments that
require customized systems. OEM products offered by the Company acquire data
from the Company's ambulatory ECG monitor and from the OEM customer's bedside
monitoring devices or life support equipment. The central monitoring system and
display software for each OEM customer is developed specifically to meet the
specifications of a particular department specialty.
Revenues from sales of Networked Monitoring systems sold by the
Company's direct sales force are recognized upon shipment. The sales cycle for
Networked Monitoring systems has typically been from nine to 18 months. The
Company has experienced seasonal variations in sales of its Networked Monitoring
systems, with sales in the first quarter typically lower than the preceding
fourth quarter's sales due to customer budget cycles and sales remaining
relatively flat during the third quarter. Furthermore, a large percentage of a
particular quarter's shipments of Networked Monitoring systems has historically
been booked in the last weeks of the quarter.
Revenues from sales of OEM products are recognized upon shipment. The
selling cycle for OEM products varies depending upon product mix and the extent
to which the Company develops customized operating software for a particular OEM
customer. In addition, the Company has experienced seasonal variations in sales
of its OEM products, with sales in the first quarter typically lower than the
preceding fourth quarter's sales and third quarter sales of OEM products
generally being lower than other quarters.
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The Company's products are generally shipped as orders are received and,
accordingly, the Company typically operates with limited backlog. As a result,
sales in any quarter are dependent on orders booked and shipped in that quarter.
To date the Company has not capitalized software development expenses.
However, the development of new products or the enhancement of existing products
may require capitalization of such expenses in the future.
In the next two years, many companies will face a potentially serious
information systems (computer) problem because many software application and
operational programs written in the past may not properly recognize calendar
dates beginning in the Year 2000. This problem could force computers to either
shut down or provide incorrect data or information. The Company is presently in
the process of examining its computer systems and contacting its software
providers to determine whether the Company's software applications are compliant
with the Year 2000. As of March 31, 1998, the Company's enterprise resource
planning system has been validated to be Year 2000 compliant. While it is
difficult to quantify the anticipated cost involved, the Company's best estimate
of expenditures is between $50,000 to $200,000 for such upgrades since they are
part of the software and hardware that the Company's third party suppliers
normally provide to the Company. While the Company believes that its systems are
fully Year 2000 compliant, the Company intends to continue to review its
information systems for any possible problems as well as monitor its key
customers and suppliers for any impact that the Year 2000 may have on their
information systems which could then impact the Company. Although the Company
believes that its products are Year 2000 compliant, customers may be affected by
Year 2000 requirement issues as they could expend significant resources to
correct or patch other software systems for Year 2000 compliance.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 1998 AND MARCH 31, 1997
Total Revenues. Total revenues consist of revenue from sales of Networked
Monitoring systems and OEM products, together with fees for installation and
servicing of Networked Monitoring products. Total revenues increased 28.4% to
$5.1 million in the first quarter of 1998 compared to $4.0 million in the first
quarter of 1997. This increase was due primarily to the increased demand from
Networked Monitoring and OEM customers.
Gross Margins. Cost of goods sold generally includes material, direct labor,
overhead and, for Networked Monitoring systems, installation expenses. Cost of
sales increased 8.6% to $2.5 million in the first quarter of 1998 from $2.3
million in the first quarter of 1997, on a 28.4% increase in revenues in 1998.
Gross margin improved to 51.4% in the first quarter of 1998 compared to 42.6%
for the first quarter of 1997. The increase in gross margin in the first quarter
of 1998 as compared to the first quarter of 1997 was due to a more efficient
absorption of fixed costs in 1998 due to the higher revenues and a one-time
charge of $155,000 taken in 1997 associated with the termination of the Vice
President of Operations.
Sales and Marketing Expenses. Sales and marketing expenses include payroll,
commissions and related costs attributable to Networked Monitoring systems and
OEM sales and marketing personnel, travel and entertainment expenses, and other
promotional expenses. Sales and marketing expenses were $1.7 million or 33.7% of
total revenue in the first quarter of 1998, as compared to $2.4 million or 59.4%
of total revenue in the first quarter of 1997. The $640,550 decrease in sales
and marketing expenses in the first quarter of 1998 as compared to the first
quarter of 1997 was primarily attributable to lower salary charges.
Research and Development Expenses. Research and development expenses include
payroll and related costs attributable to research and development personnel,
prototyping expenses and other costs. Research and development expenses were
$1.2 million or 23.1% of total revenue in the first quarter of 1998, as compared
to $1.1 million or 26.9% of total revenue in the first quarter of 1997. The
$108,033 increase in the first quarter of 1998 as compared to the first quarter
of 1997 was due primarily to the cost of supplies incurred for development work
on prototype products.
General and Administrative Expenses. General and administrative expense includes
accounting, finance, MIS, human resources, general administration, executive
officers and professional fee expenses. General and administrative expenses were
$614,849 or 12.1% of total revenue in the first quarter of 1998, as compared to
$675,678 or 17.0% of total revenue in the first quarter of 1997. The $60,829
decrease in the first quarter of 1998 as compared to the first quarter of 1997
was attributable to a decrease in salary related charges.
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Other Income, Net. Other income, net consists primarily of interest income
earned on proceeds from the Company's initial public offering, net of payments
made in respect of outstanding indebtedness. Other income, net decreased to
$218,268 for the first quarter of 1998 from $222,997 for the first quarter of
1997. The decrease resulted from slightly lower income derived from the
Company's short-term investments.
Provision for Income Taxes: In the first quarters of 1998 and 1997, the Company
paid minimal state tax provisions of $6,300 and $7,300, respectively
representing tax payments to various states. Due to the Company's net loss
position, the utilization of its credit carryforwards depends upon future income
and may be subject to an annual limitation, required by the Internal Revenue
Code of 1986 and similar state provisions.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations (including capital expenditures)
through net proceeds from the Company's February 1996 initial public offering,
cash flow from operations, cash and cash equivalent balances, a bank line of
credit and long-term debt. During the first quarter of 1996, the Company issued
2,300,000 shares of common stock in its initial public offering, raising $25.6
million, net of expenses. At March 31, 1998 the Company had $17.7 million in
cash and cash equivalents as compared to $18.2 million at December 31, 1997.
In the first quarter of 1998, the Company used cash from operating
activities of $447,866 to fund a $679,990 net loss. In addition, $455,804 was
used for payroll and related costs, $263,306 for prepaid insurance and $174,261
for accrued liabilities. This was partially offset by $488,192 in cash provided
from the reduction in accounts receivable and $376,532 in cash provided from the
increase in accounts payable.
The Company used $93,688 for investing activities to purchase capital
equipment in the first quarter of 1998. In addition, $84,265 in cash was
provided by financing activities, principally, $90,235 in net proceeds from the
issuance of common stock.
In the first quarter of 1997 the Company used cash from operating
activities of $2,581,528 to fund a $2,200,036 net loss. In addition, $436,641 in
cash was used from an increase in accounts receivable and $214,213 in cash was
generated through a decrease in income taxes receivable. In the same period
approximately $100,961 of cash was used for investing activities and $3,164 in
cash was used in financing activities, principally in the repayment of capital
lease obligations.
At March 31, 1998, the Company's principal sources of liquidity
consisted of $17.7 million of cash and cash equivalents and $5.0 million of
available credit facilities. In August 1997, the Company renewed a secured
lending arrangement (the "Agreement") with Silicon Valley Bank, providing for a
$5.0 million revolving line of credit bearing interest at the bank's prime rate.
The bank does not have a security interest in any of the Company's assets unless
the Company is borrowing under the line of credit and fails to comply with
certain financial covenants. The Agreement expires in August 1998. At March 31,
1998, there were no borrowings outstanding under the Agreement and the Company
was in compliance with all covenants. The financial covenants require that the
Company maintain a quick assets ratio of not less than 2 to 1, maintain tangible
net worth of not less than $20,000,000, maintain a ratio of total liabilities to
tangible net worth of not more than 1 to 1 and maintain an aggregate total of
cash and marketable securities in an amount at least equal to the product of two
times the maximum amount of the Credit Line. As such, the bank held no security
interest in any of the Company's assets.
The Company's principal commitment at March 31, 1998 consisted of a
lease on its office and manufacturing facility. The Company expects to spend
approximately $900,000 for capital expenditures during the remaining nine months
of 1998.
The Company believes that existing cash resources, cash flows from
operations, if any, and line of credit facilities will be sufficient to fund the
Company's operations for at least the next twelve months.
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FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Dependence on Increased Market Acceptance of Networked Monitoring
Systems. Although the Company experienced increased Networked Monitoring revenue
growth in each quarter of 1997, sales of the Company's Network Monitoring
systems cannot be expected to achieve sequential quarter to quarter growth in
1998, sales of the Company's Networked Monitoring systems have not returned to
1995 sales levels and the Company's operating results since 1995 have been
affected by the lower sales levels. If the Company is not successful in
marketing and selling its Networked Monitoring systems, the Company's business,
operating results and financial condition would be materially adversely
affected. In addition, although the Company's Networked Monitoring products have
been installed in almost 100 hospitals, there is no assurance that the Company's
products will achieve the hospital penetration which the Company anticipates.
Fluctuations in Quarterly Results. The Company's quarterly operating
results have fluctuated in the past and may fluctuate significantly from quarter
to quarter in the future as a result of a number of factors, including, but not
limited to the size and timing of orders; the length of the sales cycle; the
Company's success in expanding its sales and marketing programs and the effects
of changes in sales force alignment; the ability of the Company's customers to
obtain budget allocations for the purchase of the Company's products; changes in
pricing policies or price reductions by the Company or its competitors; mix of
sales between Networked Monitoring systems and OEM products; the timing of new
product announcements and introductions by the Company or its competitors;
deferrals of customer orders in anticipation of new products or product
enhancements; the Company's ability to develop, introduce and market new
products and product enhancements; market acceptance of new products or product
enhancements; the Company's ability to control costs; the availability of
components; costs associated with responding software "bugs" or errors;
regulatory compliance and timing of regulatory clearances and general economic
factors.
The Company's products are generally shipped as orders are received and,
accordingly, the Company has historically operated with limited backlog. As a
result, sales in any quarter are dependent on orders booked and shipped in that
quarter and are not predictable with any degree of certainty. Further, a large
percentage of any quarter's shipments have historically been booked in the last
weeks of the quarter. In addition, a significant portion of the Company's
expenses are relatively fixed, and the amount and timing of increases in such
expenses are based in large part on the Company's expectations for future
revenues. If revenues are below expectations in any given quarter, the adverse
effect may be magnified by the Company's inability to maintain gross margins and
to decrease spending to compensate for the revenue shortfall. Further, the
Company has sometimes experienced seasonal variations in operating results, with
sales in the first quarter being lower than in the preceding fourth quarter's
sales due to customer budget cycles and sales remaining relatively flat during
the third quarter.
Lengthy Sales Cycle. The decision by a healthcare provider to replace or
substantially upgrade its clinical information systems typically involves a
major commitment of capital and an extended review and approval process, and
this review and approval process is becoming more complex, more financially
oriented and increasingly subject to overall integration into the hospital's
information systems planning. The sales cycle for the Company's Networked
Monitoring systems has typically been nine to 18 months from initial contact to
receipt of a purchase order. During this period, the Company expends substantial
time, effort and funds preparing a contract proposal and negotiating a purchase
order without any guarantee that the Company will complete the transaction. Any
significant or ongoing failure to reach definitive agreements with customers has
in the past and may in the future have a material adverse effect on the
Company's business, operating results and financial condition.
Competition. The Company's Networked Monitoring systems compete with
systems offered by a number of competitors, including Hewlett-Packard Company,
SpaceLabs, Inc. and Marquette Electronics, Inc., most of which have
significantly greater financial, technical, research and development and
marketing resources than the Company. In addition, many of these competitors
have longstanding relationships with acute care hospitals and IHDNs. There can
be no assurance that the Company will be able to sell to such hospitals or IHDNs
or that the Company will be able to compete successfully with such vendors, and
any inability to do so could have a material adverse effect on the Company's
business, operating results and financial condition. The Company's OpenNet
applications may face significant competition in the future from HCIS providers,
patient monitoring companies, life support device companies and general purpose
data network providers. Such potential competitors may elect to enter this
market and compete with
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the Company using significantly greater financial, technical, research and
development and marketing resources than are available to the Company. In
addition, the Company's success in selling its multi-parameter OpenNet networks
to hospitals and IHDNs will depend to a large extent on its ability to interface
with patient monitoring and life support devices of other vendors. Any action on
the part of such other vendors to make such interfacing more difficult or
impossible could have a material adverse effect on the Company's business,
operating results and financial condition. The market for the Company's OEM
products is also intensely competitive. The Company sells to a range of patient
monitoring and life support device companies, many of which have significantly
greater financial, technical, research and development and marketing resources
than the Company. There can be no assurance that current OEM customers will not
elect to design and manufacture patient monitoring and system components
currently supplied by the Company or elect to contract with other OEM suppliers.
Any such election by one or more of such companies could have a material adverse
effect on the Company's business, operating results and financial condition.
In addition, the Company may in the future elect to incorporate in its
OEM products the hardware and software for larger networks and real-time
redistribution of information to remote viewing stations for use in specialty
departments of hospitals for which the Company's OEM customers design and sell
their products. In the event the Company incorporates these or other features
into its OEM products, the Company believes that its OEM customers would not
compete with its Networked Monitoring systems because the Networked Monitoring
systems are sold to hospitals and IHDNs who elect to install larger, more
dispersed systems. However, the Company could face competition with its OEM
customers to the extent hospitals forego purchasing the Company's facility-wide
Networked Monitoring systems for the smaller departmental systems of its OEM
customers.
Customer Concentration; Dependence on Departmental Products. The
Company's OEM product sales, which represented approximately 55.6% and 53.7% of
the Company's total net revenues in 1996 and 1997, respectively, have
historically been to a small number of OEM customers. In 1996, Quinton
Instrument Company ("Quinton") and Datascope Corporation ("Datascope") accounted
for approximately 18.4% and 17.7%, respectively, of the Company's total revenues
and in 1997 Quinton and Datascope accounted for approximately 12.7% and 25.0%,
respectively, of the Company's total revenues. The loss of, or a reduction in
sales to, any such OEM customer would have a material adverse effect on the
Company's business, operating results and financial condition.
Technological Change; Need to Develop New Products. Many aspects of the
medical equipment industry are undergoing rapid technological change, changing
customer needs, frequent new product introductions and evolving industry
standards. Historically, the Company derived substantially all of its revenue
from sales of its Networked Monitoring systems and OEM products. The Company
believes that as the market for these products matures, VitalCom's future
success will depend upon its ability to develop and introduce on a timely basis
new products and product enhancements that keep pace with technological
developments and that address the increasingly sophisticated needs of acute care
hospitals and IHDNs. In addition, the introduction of competing products
embodying new technologies and the emergence of new industry standards could
render the Company's existing products unmarketable or obsolete. If the Company
is unable to develop and introduce product enhancements and new products in a
timely and cost-effective manner in response to changing market conditions or
customer requirements, or if the Company's new products or product enhancements,
such as SiteLink, do not achieve market acceptance, the Company's business,
operating results and financial condition will be materially adversely affected.
Uncertainty and Consolidation in Healthcare Industry. The healthcare
industry is subject to changing political, economic and regulatory influences
that may affect the procurement practices and operation of healthcare providers.
Many healthcare providers are consolidating to create larger hospitals and
IHDNs. This consolidation reduces the number of potential customers for the
Company's products, and the increased bargaining power of these organizations
could lead to reductions in the amounts paid for the Company's products. These
larger hospitals and IHDNs may concentrate their purchases on a small number of
preferred vendors with whom they have had longstanding relationships. There can
be no assurance that the Company will be able to sell to such hospitals or IHDNs
or that the Company will be able to compete successfully with such vendors. The
impact of these developments in the healthcare industry is difficult to predict
and could have a material adverse effect on the Company's business, operating
results and financial condition.
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Limited Intellectual Property Protection. The Company relies on a
combination of copyright, trade secret and trademark laws, confidentiality
procedures and contractual provisions to protect its intellectual property. The
Company seeks to protect its software, circuitry documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. The Company cannot assure that its protective measures for
proprietary rights will be adequate or that the Company's competitors will not
independently develop similar or superior technology, duplicate the Company's
products or otherwise circumvent its intellectual property rights. Although the
Company has never received a claim that its products infringe a third party's
intellectual property rights, there can be no assurance that third parties will
not in the future claim infringement by the Company with respect to current or
future products or proprietary rights. Any such claims, regardless of their
merit, could be time consuming, result in costly litigation, delay or prevent
product shipments or require the Company to enter into costly royalty or
licensing agreements. The impact of any of these developments could have a
material adverse effect on the Company's business, operating results and
financial condition.
Risk of Product Liability Claims. Certain of the Company's products
provide applications that relate to patient physiologic status or other
clinically critical information. Any failure by the Company's products to
provide accurate and timely information could result in product liability and
warranty claims against the Company by its customers or their patients. The
Company maintains insurance against claims associated with the use of its
products, but there can be no assurance that its insurance coverage would
adequately cover any claim asserted against the Company. A successful claim
brought against the Company in excess of its insurance coverage or outside the
scope of the Company's insurance coverage could have a material adverse effect
on the Company's business, operating results and financial condition. Even
unsuccessful claims could result in the expenditure of funds in litigation and
diversion of management time and resources.
Year 2000 Compliance. In the next two years, many companies will face a
potentially serious information systems (computer) problem because many software
application and operational programs written in the past may not properly
recognize calendar dates beginning in the Year 2000. This problem could force
computers to either shut down or provide incorrect data or information. The
Company is presently in the process of examining its computer systems and
contacting its software providers to determine whether the Company's software
applications are compliant with the Year 2000. As of March 31, 1998, the
Company's enterprise resource planning system has been validated to be Year 2000
compliant. While it is difficult to quantify the anticipated cost involved, the
Company's best estimate of expenditures is between $50,000 to $200,000 for such
upgrades since they are part of the software and hardware that the Company's
third party suppliers normally provide to the Company. While the Company
believes that its systems are fully Year 2000 compliant, the Company intends to
continue to review its information systems for any possible problems as well as
monitor its key customers and suppliers for any impact that the Year 2000 may
have on their information systems which could then impact the Company. Although
the Company believes that its products are Year 2000 compliant, customers may be
affected by Year 2000 requirement issues as they could expend significant
resources to correct or patch other software systems for Year 2000 compliance.
These expenditures may result in reduced capital equipment budgets for other
products, such as products offered by the Company, which could result in a
material adverse effect on the Company's business, operating results and
financial condition.
Dependence on Sole Source Components. Certain of the Company's products
utilize components that are available in the short term only from a single or a
limited number of sources, have been available only on an allocation basis in
the past and could be in scarce supply again in the future. Any inability to
obtain components in the amounts needed on a timely basis or at commercially
reasonable prices could result in delays in product introductions, interruption
in product shipments or increases in product costs, which could have a material
adverse effect on the Company's business, operating results and financial
condition until alternative sources could be developed or design and
manufacturing changes could be completed.
Risks Associated With Recent Management Changes. During 1997, the
Company had a number of changes in its management team. Effective January 1,
1997, David L. Schlotterbeck stepped down as the Company's Chief Executive
Officer, and Donald J. Judson, the Company's Chairman of the Board, assumed such
responsibilities. In March 1997, the Company hired a new Vice President, Direct
Sales and in July 1997 hired a new Vice President, Research and Development. In
October 1997, the Company hired Frank T. Sample as its new President and Chief
Executive Officer, with Mr. Judson stepping down as such. The addition of new
senior management has involved increased salary levels
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which the Company anticipates will result in increased administrative expenses
in future periods. Such management changes can also involve disruptions in the
Company's day-to-day operations, can interrupt continuity in customers
relationships and create delays in sales the cycles or product release
schedules. Although the Company believes that its new senior management will be
successful in improving the Company's business, operating results and financial
condition, there can be no assurance that such changes will not have a material
adverse effect on the Company's business, operating results and financial
condition in future periods.
Dependence on Key Personnel. The Company's success depends to a large
extent on its ability to attract and retain key personnel. The loss of the
services, either temporarily or permanently, of any of the members of senior
management or other key employees, particularly in sales and marketing and
research and development, could have a material adverse effect on the Company's
business, operating results and financial condition. In addition, the Company's
future success depends to a large extent on its ability to attract and retain
additional key management, sales and marketing and research and development
personnel. Competition for such personnel is intense. There can be no assurance
that the Company will be successful in attracting and retaining such personnel,
and the failure to do so could have a material adverse effect on the Company's
business, operating results and financial condition.
Government Regulation. The manufacture and sale of medical devices,
including the Company's products, is subject to extensive regulation by numerous
governmental authorities. In the United States, the Company's products are
regulated as medical devices and are subject to the FDA's pre-clearance or
approval requirements. The Company has received clearance from the FDA to market
its current products through the 510(k) premarket notification process. There
can be no assurance that a similar 510(k) clearance for any future product or
enhancement of an existing product will be granted or that the process will not
be lengthy. If the Company cannot establish that a product is "substantially
equivalent" to certain legally marketed devices, or if FDA regulatory changes
currently under consideration with respect to arrhythmia software are adopted,
the 510(k) clearance procedure will be unavailable and Company will be required
to utilize the longer and more expensive premarket approval ("PMA") process.
Failure to receive or delays in receipt of FDA clearances or approvals,
including the need for extensive clinical trials or additional data as a
prerequisite to clearance or approval, could have a material adverse effect on
the Company's business, operating results and financial condition. Sales of
medical devices and components outside of the United States are subject to
international regulatory requirements that vary from country to country. There
can be no assurance that the Company will be able to obtain further clearance or
approvals for its products or components on a timely basis or at all, and delays
in receipt of, loss of or failure to receive such approvals or clearances could
have a material adverse effect on the Company's business, operating results and
financial condition.
The Company's radio frequency transmitter devices are subject to
regulation by the Federal Communication Commission ("FCC"), and applicable
approvals must be obtained before shipment of such products. The Company
believes that all of its products designated for sale in the United States meet
applicable Federal Communications Commission (FCC) regulations, including US FCC
Part 15 for electromagnetic emissions. The FCC approval process starts with the
collection of test data that demonstrates that a product meets the requirements
stated in Part 15 of the FCC regulations. This data is then included as part of
a report and application that is submitted to the FCC requesting approval. The
FCC may grant or request additional information or withhold approval. Any
failure of the Company's products to conform to governmental regulations or any
delay or failure to obtain required FCC approvals in the future, if any, could
cause the delay or loss of sales of the Company's products and therefore have a
material adverse effect on the Company's business, financial condition and
result of operations.
The Company's proprietary radio frequency (RF) communication products
transmit real-time physiologic information from the patient to the central
surveillance station. These communication products currently operate in three
radio bands: VHF (174 MHz to 216 MHz, shared with TV channels 7-13); UHF (450
MHz to 470 MHz, shared with land mobile users); and the 900 MHz radio band (902
MHz to 928 MHz licensed for Spread Spectrum operation). The majority of the
Company's RF products use the vacant television frequencies in the VHF band. The
FCC is requiring all television stations to implement digital broadcasting
transmission for High Definition Television (HDTV). Major metropolitan areas
will be required to implement HDTV by December 31, 1998 and other markets by
December 31, 2006. In order to implement HDTV the FCC has granted each TV
channel an additional 6 MHz channel for digital broadcasting until the
transition period ends, at which time the broadcaster would return one of the
two channels. As TV stations use the additional 6 MHz channel for the digital
broadcasting transition, which may take years, they may
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overlap into the radio spectrum which has been used for medical RF applications.
Customers of the Company's lower power RF communication products may begin
seeing more interference in the future. This interference may result in the
Company's hospital biomedical personnel having to re-tune the Company's RF
transmitters to other channels in order to reduce interference. In the event of
high interference the Company's customers may need to purchase equipment to
transmit in the UHF frequency range. The FCC also announced that they will be
expanding the usable UHF frequencies for medical RF from the licensed 450 MHz to
470 MHz band to the unlicensed 470 MHz to 668 MHz frequency range. With VHF
frequency ranges available for medical RF use potentially becoming more limited
and the UHF frequency ranges expanding, the Company's competitors who have
historically focused their RF products in what was the more limited UHF band,
may now have a competitive advantage as compared to the Company, until such time
as the Company expands its UHF RF product offerings. Any such competitive
advantage of the Company's competitors and any additional development costs
associated with expanding the Company's UHF RF product offerings could have a
material adverse effect on the Company's business, operating results and
financial condition. Additionally, future regulatory changes could significantly
affect the Company's operations by diverting the Company's development efforts,
making current products obsolete or increasing the opportunity for additional
competition which could have a material adverse effect on the Company's
business, operating results and financial condition.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
10.1 Common Stock Purchase Agreement dated March 26, 1998 between the
Registrant and David L. Schlotterbeck.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the reporting period.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on May 12, 1998.
VITALCOM INC.
/s/ Frank T. Sample
-------------------------------------
Frank T. Sample
President and Chief Executive Officer
/s/ Shelley B. Thunen
-------------------------------------
Shelley B. Thunen
Vice President Finance and
Chief Financial Officer
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EXHIBIT INDEX
Exhibits:
10.1 Common Stock Purchase Agreement dated March 26, 1998 between the
Registrant and David L. Schlotterbeck.
27.1 Financial Data Schedule