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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 September 30, 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 33-0538926
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
15222 DEL AMO AVENUE
TUSTIN, CALIFORNIA 92780
(Address of principal executive offices and zip code)
(714) 546-0147
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of November 12, 1998 there were 8,136,368 shares outstanding of the issuer's
common stock.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VITALCOM INC.
BALANCE SHEETS
ASSETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
(UNAUDITED) (AUDITED)
Current assets
Cash and cash equivalents $ 15,268,206 $ 18,157,160
Accounts receivable, net 4,766,534 3,853,066
Inventories 1,842,073 1,812,499
Prepaid expenses 281,510 269,462
------------ ------------
Total current assets 22,158,323 24,092,187
Property
Machinery and equipment 1,521,780 1,464,903
Office furniture and computer equipment 2,099,098 2,044,083
Leasehold improvements 102,188 87,351
------------ ------------
3,723,066 3,596,337
Less accumulated amortization and depreciation (2,098,526) (1,659,939)
------------ ------------
Property, net 1,624,540 1,936,398
Other assets 201,005 51,935
Goodwill, net 596,067 627,549
------------ ------------
$ 24,579,935 $ 26,708,069
============ ============
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VITALCOM INC.
BALANCE SHEETS - (CONTINUED)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
(UNAUDITED) (AUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 457,906 $ 585,744
Accrued payroll and related costs 745,805 1,198,055
Accrued warranty costs 826,332 968,245
Accrued liabilities 1,315,606 1,353,675
Current portion of capital lease obligations 24,990 21,120
------------ ------------
Total current liabilities 3,370,639 4,126,839
Capital lease obligations, less current portion 38,032 60,296
Redeemable preferred stock, 5,000,000 shares
authorized, $.001 par value; no shares issued and
outstanding at September 30, 1998 and
December 31, 1997, respectively -- --
Stockholders' equity:
Common stock, including paid-in capital, $.0001 par
value; 25,000,000 shares authorized, 8,102,760 and
8,038,547 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively 37,226,064 37,031,165
Accumulated deficit (16,054,800) (14,510,231)
------------ ------------
Net stockholders' equity 21,171,264 22,520,934
------------ ------------
$ 24,579,935 $ 26,708,069
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VITALCOM INC.
STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
Revenues $ 4,689,435 $ 5,723,325 $ 15,217,740 $ 15,326,288
Cost of sales 2,287,559 2,947,150 7,130,010 8,230,408
------------ ------------ ------------ ------------
Gross profit 2,401,876 2,776,175 8,087,730 7,095,880
Operating expenses
Sales and marketing 1,630,209 2,081,625 5,165,750 6,733,123
Research and development 1,001,293 1,195,981 3,515,893 3,485,228
General and administration 495,768 580,345 1,611,677 1,838,565
------------ ------------ ------------ ------------
Total operating expenses 3,127,270 3,857,951 10,293,320 12,056,916
Operating loss (725,394) (1,081,776) (2,205,590) (4,961,036)
Other income, net 217,926 246,597 679,920 708,557
------------ ------------ ------------ ------------
Loss before provision for income taxes (507,468) (835,179) (1,525,670) (4,252,479)
Provision for income taxes 6,300 6,300 18,900 19,890
------------ ------------ ------------ ------------
Net loss $ (513,768) $ (841,479) $ (1,544,570) $ (4,272,369)
============ ============ ============ ============
Net loss per basic and diluted
common share $ (0.06) $ (0.11) $ (0.19) $ (0.53)
Weighted average basic and diluted
common shares 8,208,259 8,012,814 8,152,583 7,991,115
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VITALCOM INC.
STATEMENTS OF CASH FLOWS
-----------------------------
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
1998 1997
----------- ----------
(UNAUDITED)
Cash flows from operating activities:
Net loss $(1,544,570) $(4,272,369)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 470,069 549,997
Loss on disposal of property 79,778 10,446
Changes in operating assets and liabilities:
Accounts receivable (913,468) (898,254)
Inventories (29,574) 1,021,760
Income taxes receivable 2,687,745
Prepaid expenses and other current assets (12,048) (68,242)
Accounts payable (127,838) (564,806)
Accrued payroll and related costs (452,250) 186,271
Accrued warranty costs (141,913) (24,067)
Accrued marketing commitments (309,377)
Income taxes payable (21,410)
Accrued liabilities (12,789) 22,057
----------- -----------
Net cash used in operating activities (2,706,013) (1,658,839)
Cash flows from investing activities:
Purchases of property (206,507) (366,012)
Proceeds from sale of property 7,027
(Increase) decrease in other assets (149,070) 31,482
----------- -----------
Net cash used in investing activities (355,577) (327,503)
Cash flows from financing activities:
Repayment of capital lease obligation and
long-term debt (22,264) (15,713)
Net proceeds from issuance of common stock 194,900 108,973
----------- -----------
Net cash provided by financing activities 172,636 93,260
Net decrease in cash and cash equivalents (2,888,954) (1,893,082)
Cash and cash equivalents, beginning of period 18,157,160 20,120,203
----------- -----------
Cash and cash equivalents, end of period $15,268,206 $18,227,121
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid $ 10,663 $ 9,833
Income taxes paid $ 14,161 $ 229,665
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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 September 30,
1998, and the results of its operations and its cash flows for the three-month
and nine-month periods ended September 30, 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
and nine-month periods ended September 30, 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 nine months ended
September 30, 1998:
NUMBER OF
NUMBER OF PRICE PER OPTIONS
SHARES SHARE EXERCISABLE
----------- ---------------- ------------
Balance, December 31, 1997 1,604,853 $0.60 to $15.75
Granted 297,825 $3.156 to $4.4375
Exercised (28,250) $0.60 to $1.41
Canceled (340,579) $1.28 to $15.75
---------
Balance, September 30, 1998 1,533,849 $0.60 to $15.75 417,279
=========
At September 30, 1998, 683,459 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 nine months ended September 30, 1998:
NUMBER OF
NUMBER OF PRICE PER OPTIONS
SHARES SHARE EXERCISABLE
--------- --------------- -----------
Balance, December 31, 1997 69,325 $5.50 to $6.00
Canceled (16,561) $4.97 to $6.00
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Balance, September 30, 1998 52,764 $4.97 to $6.00 22,991
=======
At September 30, 1998, 47,236 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 nine months ended September 30, 1998. At September 30,
1998, 60,000 options were available for grant under the Director Plan and no
options were exercisable.
The Company has reserved an aggregate of 300,000 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. In May 1998 the Company's stockholders approved an increase in
the number of shares available for issuance under the ESPP from 150,000 shares
to 300,000 shares. 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. In the nine months ended September 30, 1998 the Company
issued 26,099 shares of Common Stock under the ESPP for $88,737.
SUBSEQUENT EVENTS
NOTE PURCHASE AGREEMENTS - In February 26, 1997, the Company issued an aggregate
of 15,000 shares of its Common Stock to a consultant of the Company for a
purchase price of $4.875 per share payable in cash and a non-recourse promissory
note secured by the pledge of the Common Stock to the Company. On September 29,
following the consultant's election to default on the note, the Company
cancelled the 15,000 shares of Common Stock pursuant to the note and stock
pledge.
In March 26, 1998, the Company issued an aggregate of 103,000 shares of its
Common Stock to a former employee of the Company for a purchase price of $4.4375
per share payable in cash and a non-recourse promissory note secured by the
pledge of the Common Stock to the Company. On September 29, 1998, following the
employee's election to default on the note, the Company cancelled the 103,000
shares of Common Stock pursuant to the note and stock pledge.
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
September 30, 1998. The Company has no reportable differences between
comprehensive loss and net loss, as reported at September 30, 1998 and September
30, 1997.
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(TM) 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 ABILITY OF THE COMPANY TO MEET YEAR 2000
COMPLIANCE, THE ESTIMATE OF YEAR 2000 EXPENDITURES AS BEING LIMITED TO $50,000
TO $200,000, IMPROVEMENTS IN THE COMPANY'S GROSS MARGINS, REDUCTIONS IN MATERIAL
AND OVERHEAD COSTS, THE EXPECTATION THAT THE COMPANY WILL SPEND APPROXIMATELY
$200,000 FOR CAPITAL EXPENDITURES IN THE REMAINING THREE 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
"FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" BELOW. ADDITIONAL INFORMATION
IS AVAILABLE IN OTHER COMPANY REPORTS AND OTHER DOCUMENTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION.
GENERAL
VitalCom Inc. (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, which consist of proprietary radio frequency ("RF")
communications components, clinical analysis software and display and networking
software 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.
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.
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RESULTS OF OPERATIONS - THREE-MONTH AND NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1998 AND SEPTEMBER 30, 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 decreased 18.1% to
$4.7 million in the three months ended September 30, 1998 from $5.7 million for
the three months ended September 30, 1997. This was due to lower Networked
Monitoring systems business in the quarter.
Total revenues decreased 0.7% to $15.2 million in the nine months ended
September 30, 1998 from $15.3 million in the nine months ended September 30,
1997. This slight decrease was due to lower sales of Networked Monitoring
systems with sales through the Company's OEM distribution channel remaining
relatively flat.
GROSS MARGINS. Cost of goods sold generally includes material, direct labor,
overhead and, for Networked Monitoring systems, installation expenses. Cost of
sales decreased 22.4% to $2.3 million in the three months ended September 30,
1998 from $2.9 million in the three months ended September 30, 1997. Gross
margin improved to 51.2% in the third quarter of 1998 compared to 48.5% for the
third quarter of 1997. The increase in gross margin in the third quarter of 1998
as compared to the third quarter of 1997 was due to reductions in material and
overhead costs.
Cost of goods sold decreased 13.4% to $7.1 million for the nine month period
ended September 30, 1998 from $8.2 million in the nine months ended September
30, 1997. Gross margin improved to 53.1% in the nine months ended September 30,
1998 compared to 46.3% for the nine months ended September 30, 1997. The
increase in gross margin in the first nine months of 1998 as compared to the
same period of 1997 was due primarily to reductions in material and overhead
costs.
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 $1.6 million, or 34.8%
of total revenue in the three months ended September 30, 1998, as compared to
$2.1 million or 36.4% of total revenue for the three months ended September 30,
1997. The $451,416 decrease in sales and marketing expenses in the third quarter
of 1998 as compared to the third quarter of 1997 was primarily due to lower
salary and travel charges related to lower headcount.
Sales and marketing expenses were $5.2 million, or 33.9% of total revenue in the
nine months ended September 30, 1998, as compared to $6.7 million or 43.9% of
total revenue in the nine months ended September 30, 1997. The $1,567,373
decrease in sales and marketing expenses in the third quarter of 1998 as
compared to the third quarter of 1997 was due to the lower salary and travel
expenses related to lower headcount.
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
$1.0 million or 21.4% of total revenue in the three months ended September 30,
1998, as compared to $1.2 million or 20.9% of total revenue in the three months
ended September 30, 1997. The $194,688 decrease in research and development
expenses in the third quarter of 1998 as compared to the third quarter of 1997
was due primarily to lower salary expenses associated with the lower headcount
in 1998 as compared to the 1997 level.
Research and development expenses were $3.5 million, or 23.1% of total revenue
in the nine months ended September 30, 1998, as compared to $3.5 million or
22.7% of total revenue in the nine months ended September 30, 1997. The $30,665
increase in research and development expenses in the first nine months of 1998
as compared to the first nine months of 1997 was due primarily to the increase
in professional services expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expense includes
accounting, finance, information systems, human resources, general
administration, executive officers and professional fee expenses. General and
administrative expenses were $495,768 or 10.6% of total revenue in the three
months ended September 30, 1998, as compared to $580,345 or 10.1% of total
revenue in the three months ended September 30, 1997. The $84,577 decrease in
general and administrative expenses in the third quarter of 1998 as compared to
the third quarter of 1997 was primarily attributable to lower professional
service fees.
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General and administrative expenses were $1.6 million, or 10.6% of total revenue
in the nine months ended September 30, 1998, as compared to $1.8 million or
12.0% of total revenue in the nine months ended September 30, 1997. The $226,888
decrease in general and administrative expenses in the first nine months of 1998
as compared to the first nine months of 1997 was due to lower salary and related
charges in addition to reduced professional service fees.
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
$217,926 in the three months ended September 30, 1998, as compared to $246,597
in the three months ended September 30, 1997. The decrease resulted from lower
income derived from the Company's short-term investments due to the lower cash
position at September 30, 1998 compared to September 30, 1997.
Other income, net, was $679,920 in the nine months ended September 30, 1998, as
compared to $708,557 in the nine months ended September 30, 1997. This decrease
was the result of the lower income derived from the Company's short-term
investments.
PROVISION FOR INCOME TAXES: The Company accrued minimal state tax provisions of
$6,300 and $6,300 in the three months ended September 30, 1998 and September 30,
1997. For the nine months ended September 30, 1998, the Company had $18,900 in
comparison to $19,890 for the nine months ended September 30, 1997. The amount
recorded represents minimum state taxes.
At September 30, 1998, the Company had research and development credit
carryforwards of approximately $496,219 and $359,650 for federal and state tax
purposes, respectively. At September 30, 1998, the Company also had net
operating loss carryforwards for federal and state income tax purposes of
approximately $4,715,236 and $3,380,217 respectively. 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 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
September 30, 1998 the Company had $15.3 million in cash and cash equivalents as
compared to $18.2 million at December 31, 1997.
In the first nine months of 1998, the Company used cash in operating
activities of $2,706,013 to fund a $1,544,570 net loss. Of the net cash used in
operating activities, $913,468 was used for the increase in receivables,
$452,250 was used for payroll and related costs, $141,913 was attributable to
the reduction in the accrued warranty charges and $127,838 was used
to pay down accounts payable. Uses of cash were partially offset by the $470,069
in non-cash adjustments provided by depreciation and amortization of fixed
assets and intangible assets.
The Company used $355,577 for investing activities in the first nine
months of 1998. The principal components were $206,507 to purchase capital
equipment and $149,070 for the prepayment of Directors and Officers' Liability
Insurance.
The Company received $172,636 in net cash from financing activities in
the first nine months of 1998. This included $194,900 in net proceeds from the
issuance of common stock offset partially by $22,264 in cash used in the
repayment of capital lease obligations.
In the first nine months of 1997, the Company used cash in operating
activities of $1,658,839 to fund a $4,272,369 net loss. Of the net cash used in
operating activities, $898,254 was used in relation to the increase in accounts
receivable, $564,806 was used for the reduction in accounts payable and $309,377
was used for the reduction in accrued marketing commitments. The Company
generated cash through a decrease in income taxes receivable of $2,687,745 and
the reduction of inventories of $1,021,760. In the same period, the Company used
$327,503 for investing activities which consisted of $366,012 for purchases of
property and equipment and generated $31,482 from a decrease in other long-term
assets. In addition, $93,260 was provided by financing activities which
consisted of $108,973 from the issuance of common stock, offset, in part, by
$15,713 for payments on capital lease obligations.
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At September 30, 1998, the Company's principal sources of liquidity
consisted of $15.3 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 expired in August 1998. The Company
is currently negotiating the Agreement and anticipates completing the Agreement
in the fourth quarter of 1998 with terms similar to those currently in place. At
September 30, 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 September 30, 1998 consisted of a
lease on its office and manufacturing facility. The Company expects to spend
approximately $200,000 for capital expenditures during the remaining three
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.
YEAR 2000 ISSUES
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. These date code
fields will need to accept four digit entries to distinguish 21st century dates
from 20th century dates. As a result, in less than two years, computer systems
and/or software used in many companies may need to be upgraded to comply with
such "Year 2000" requirements.
The Company has determined that it will be necessary to modify or
replace portions of its hardware and software so that its internal information
systems properly utilize dates beyond December 31, 1999. The Company has
received confirmation from vendors of certain purchased software used for its
internal information systems that current releases or upgrades, if installed,
are designed to be Year 2000 compliant. The Company is in the process of
installing such upgrades to its current systems and believes that substantially
all of the upgrades will be completed by December 31, 1998. The Company also is
in the process of assessing its non-information technology systems, such as
security alarm systems, telephone systems and other systems that may have
embedded microprocessors, for Year 2000 issues and has not yet determined
whether any Year 2000 issues exist with respect to those systems. In addition,
the Company is initiating communications with its critical customer or vendor
relationships to determine the extent to which the Company may be vulnerable to
such parties' failure to resolve their own Year 2000 issues. Where practicable,
the Company will assess and attempt to mitigate its risks with respect to
failure of these entities to be Year 2000 ready. The effect, if any, on the
Company's results of operations from the failure of such parties to be Year 2000
ready is not reasonably estimable.
The Company is in the process of evaluating its own products for
potential Year 2000 issues and making such products Year 2000 compliant. The
vast majority of the Company's products are not date sensitive and the Company
does not directly rely on any of its vendors' or customers' systems. The Company
does not believe that there will be significant issues or costs associated to
make its products Year 2000 compliant; however, there can be no assurance that
such products do not contain undetected errors or defects associated with Year
2000 date functions.
The Company has been using both external and internal resources to
reprogram or replace its software for the Year 2000 issues. To date, the amounts
incurred and expenses for developing and carrying out the plan have not had a
material effect on the Company's operations. The Company plans to complete Year
2000 modifications, including testing, by early
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1999. While it is difficult to quantify the anticipated costs involved, the
Company's best estimate of expenditures is between $50,000 to $200,000 for such
upgrades. All Year 2000 issues costs to date have been and in the future will be
funded through operating cash flows. Although the Company is not aware of any
material operational issues or costs associated with preparing its products or
internal information systems for the Year 2000, there can be no assurances that
the Company will not experience serious unanticipated negative consequences
and/or material costs caused by undetected errors or defects in the technology
used in its internal systems, which are composed predominantly of third party
software and hardware.
Should the Company not be completely successful in mitigating internal
and external Year 2000 risks, this could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities at the Company or its vendors and
suppliers. The Company has not yet determined a reasonably likely worst case
scenario for failure to be Year 2000 ready and therefore has not yet developed a
contingency plan in such event.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
DEPENDENCE ON INCREASED MARKET ACCEPTANCE OF NETWORKED MONITORING
SYSTEMS. The Company's business is substantially dependent upon sales of its
Networked Monitoring systems to hospitals and IHDN's. Since 1995, sales of these
systems have not returned to 1995 sales levels and the Company's operating
results since 1995 have been affected by the lower sales levels in past due to
its inability to adjust expense levels. If the Company is not successful in
increasing sales of 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 more than 100 hospitals, there is no assurance that the
Company's products will achieve the hospital penetration that 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; market
acceptance of its Networked Monitoring systems; 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
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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. The 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 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 has elected to incorporate into some of its OEM
product offerings the hardware and software for slightly 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. As 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.
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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.
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. See statement contained in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
DEPENDENCE ON SOLE SOURCE COMPONENTS. Certain of the Company's products
use 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. In July 1998 the
Company's Vice President, Research and Development
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departed from the Company. In addition, in August 1998 the Company's Vice
President of Direct Sales departed from the Company. The addition of new senior
management has involved increased salary levels that 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 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
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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 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 that
could have a material adverse effect on the Company's business, operating
results and financial condition.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
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 November 12, 1998.
VITALCOM INC.
/s/ FRANK T. SAMPLE
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Frank T. Sample
President, Chief Executive Officer
/s/ SHELLEY B. THUNEN
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Shelley B. Thunen
Vice President Finance and
Chief Financial Officer
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
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27 Financial Data Schedule