<PAGE> 1
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 June 30, 1999
------------------------
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
----------------
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)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.0001 Per Share
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 August 12, 1999, there were 8,101,296 shares outstanding of the issuer's
common stock.
<PAGE> 2
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
VITALCOM INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ -----------
(Unaudited) (Audited)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 11,694,917 $10,460,810
Short-term investments 3,444,706 5,369,213
Accounts receivable, net 3,669,890 4,615,295
Inventories, net 1,245,133 1,391,899
Prepaid expenses 134,513 140,647
------------ -----------
Total current assets 20,189,159 21,977,864
Property
Machinery and equipment 1,537,691 1,503,905
Office furniture and computer equipment 2,362,143 2,200,732
Leasehold improvements 181,778 173,883
------------ -----------
4,081,612 3,878,520
Less accumulated amortization and depreciation (2,536,913) 2,223,301)
------------ -----------
Property, net 1,544,699 1,655,219
Other assets 123,484 133,894
Goodwill, net 439,295 455,573
------------ -----------
$ 22,296,637 $24,222,550
============ ===========
</TABLE>
2
<PAGE> 3
VITALCOM INC.
BALANCE SHEETS - (Continued)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 610,642 $ 429,987
Accrued payroll and related costs 685,627 804,887
Accrued warranty costs 700,582 757,448
Accrued liabilities 441,848 711,255
Current portion of capital lease obligations 27,574 24,990
------------ ------------
Total current liabilities 2,466,273 2,728,567
Capital lease obligations, less current portion 15,464 31,552
Redeemable preferred stock, 5,000,000 shares authorized,
$.001 par value; no shares issued and outstanding
at June 30, 1999 and December 31, 1998, respectively -- --
Stockholders' equity (deficit):
Common stock, including paid-in capital, $.0001 par value;
25,000,000 shares authorized, 8,158,596 and 8,162,972 shares
issued and outstanding at June 30, 1999 and December 31, 1998,
respectively 37,618,175 37,491,563
Note receivable for common stock sales (30,590) (30,590)
Treasury stock, at cost (154,475) --
Accumulated deficit (17,618,210) (15,998,542)
------------ ------------
Net stockholders' equity 19,814,900 21,462,431
------------ ------------
$ 22,296,637 $ 24,222,550
============ ============
</TABLE>
3
<PAGE> 4
VITALCOM INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ----------------------------
1999 1998 1999 1998
----------- ----------- ----------- ------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenues $ 3,600,254 $ 5,427,579 $ 8,410,354 $ 10,528,305
Cost of revenues 1,777,662 2,362,916 3,802,988 4,842,451
----------- ----------- ----------- ------------
Gross profit 1,822,592 3,064,663 4,607,366 5,685,854
Operating expenses
Sales and marketing 1,486,305 1,814,631 3,057,626 3,535,541
Research and development 1,281,492 1,337,210 2,406,966 2,514,600
General and administration 541,304 501,060 1,132,199 1,115,909
----------- ----------- ----------- ------------
Total operating expenses 3,309,101 3,652,901 6,596,791 7,166,050
Operating loss (1,486,509) (588,238) (1,989,425) (1,480,196)
Other income, net 203,960 243,726 387,756 461,994
----------- ----------- ----------- ------------
Loss before provision for income taxes (1,282,549) (344,512) (1,601,669) (1,018,202)
Provision for income taxes 9,000 6,300 18,000 12,600
----------- ----------- ----------- ------------
Net loss $(1,291,549) $ (350,812) $(1,619,669) $ (1,030,802)
=========== =========== =========== ============
Net loss per basic and diluted common share $ (0.16) $ (0.04) $ (0.20) $ (0.13)
=========== =========== =========== ============
Weighted average basic and diluted common shares 8,210,871 8,193,699 8,196,927 8,121,867
</TABLE>
4
<PAGE> 5
VITALCOM INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------------------
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (1,619,669) $ (1,030,802)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 329,890 343,989
Loss on disposal of property 3,644 7,176
Changes in operating assets and liabilities:
Accounts receivable 945,405 820,734
Inventories 146,766 19,792
Prepaid expenses and other current assets 6,134 (20,322)
Accounts payable 180,656 (269,492)
Accrued payroll and related costs (119,260) (394,358)
Accrued warranty costs (56,866) (86,620)
Income taxes payable (61,690) 3,785
Accrued liabilities (207,717) 34,461
------------ ------------
Net cash used in operating activities (452,707) (571,657)
Cash flows from investing activities:
Purchases of property (206,736) (141,241)
Proceeds from sale of short-term investments 1,924,507 --
(Increase) decrease in other assets 10,410 (149,718)
------------ ------------
Net cash provided by (used in) investing activities 1,728,181 (290,959)
Cash flows from financing activities:
Repayment of capital lease obligation and long-term debt (13,504) (15,959)
Net proceeds from issuance of common stock 126,612 188,801
Repurchase of common stock (154,475) --
------------ ------------
Net cash provided by (used in) financing activities (41,367) 172,842
Net increase (decrease) in cash and cash equivalents 1,234,107 (689,774)
Cash and cash equivalents, beginning of period 10,460,810 18,157,160
------------ ------------
Cash and cash equivalents, end of period $ 11,694,917 $ 17,467,386
============ ============
Supplemental disclosures of cash flow information:
Interest paid $ 2,403 $ 8,327
============ ============
Income taxes paid $ 12,480 $ 9,666
============ ============
Supplemental schedule of noncash transactions:
Notes receivable for stock sales $ -- $ 457,052
============ ============
</TABLE>
5
<PAGE> 6
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, 1998 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 June 30, 1999, and
the results of its operations and its cash flows for the three-month and
six-month periods ended June 30, 1999 and 1998. 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 six-month periods ended June 30, 1999 and 1998, the diluted weighted average
shares were equal to the basic weighted average shares because the conversion of
options was anti-dilutive.
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 six months ended June
30, 1999:
<TABLE>
<CAPTION>
Number of
Number of Price per options
shares share exercisable
--------- -------------- -----------
<S> <C> <C> <C>
Balance, December 31, 1998 1,440,040 $0.60 to $4.00
Granted 363,790 $1.50 to $3.00
Exercised (11,750) $0.60 to $1.28
Canceled (130,482) $0.60 to $5.72
---------
Balance, June 30, 1999 1,661,598 $0.60 to $4.00 413,334
=========
</TABLE>
At June 30, 1999, 530,023 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 six months ended June 30, 1999:
<TABLE>
<CAPTION>
Number of
Number of Price per options
shares share exercisable
--------- -------------- -----------
<S> <C> <C> <C>
Balance, December 31, 1998 48,057 $3.00 to $4.00
Canceled (17,855) $3.00 to $6.00
-------
Balance, June 30, 1999 30,202 $3.00 to $4.00 16,151
=======
</TABLE>
At June 30, 1999, 69,798 options were available for grant under the
1996 Plan.
6
<PAGE> 7
There were no stock transactions under the 1996 Director Option Plan (the
"Director Plan") for the six months ended June 30, 1999. At June 30, 1999,
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. 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 six months ended June 30, 1999 the Company issued 34,867
shares of Common Stock under the ESPP for $46,303.
4. Segment Reporting
Utilizing the management approach, the Company has broken down its business
based upon sales through its two distribution channels. The Company does not
allocate operating expenses to these segments, nor does it allocate specific
assets to these segments. Therefore, segment information reported includes only
net sales.
Selected information regarding the Company's product sectors is as follows:
<TABLE>
<CAPTION>
Enterprise Monitoring
OEM Products Products
--------------- -----------------------
<S> <C> <C>
Six months ended June 30, 1999
Net Sales...................... $5,223,567 $3,186,787
Six months ended June 30, 1998
Net Sales...................... $5,682,656 $4,845,649
</TABLE>
5. Subsequent Event
Stock Repurchase Program -In April 1999, the Company announced its plans to
implement a stock repurchase program whereby up to 800,000 shares of its Common
Stock may be purchased in the open market from time to time. As of August 12,
1999, 137,350 shares of Common Stock had been repurchased by the Company at an
aggregate price of $154,475.
Recent Accounting Pronouncements--In June 1997, the FASB issued Statement of
Financial Accounting Standard No. 130 (SFAS 130), Reporting Comprehensive
Income. This statement is effective for fiscal years commencing after December
15, 1997. SFAS 130 establishes standards for the reporting and disclosure of
comprehensive income (revenues, expenses, gains and losses) in a full set of
general purpose financial statements. For the six months ended June 30, 1999,
there was no difference between comprehensive income and amounts currently
reported in the Company's financial statements.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Accounting Position No. 98-1 (SOP 98-1), Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use. SOP 98-1 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use and requires costs incurred in the application development
stage (whether internal or external) to be capitalized. This SOP is applicable
to all financial statements for fiscal years beginning after December 15, 1998.
Management does not believe the implementation of SOP 98-1 will have a material
effect on the Company's financial position or results of operations.
7
<PAGE> 8
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities.
SFAS 133 establishes new standards of accounting and reporting for derivative
instruments and hedging activities. SFAS 133 requires that all derivatives be
recognized at fair value in the statement of financial position, and that the
corresponding gains or losses be reported either in the statement of operations
or as a component of comprehensive income, depending on the type of hedging
relationship that exists. Management does not believe the implementation of SFAS
133 will have a material effect on the Company's financial position or results
of operations.
In October 1997, the FASB issued Statement of Position No. 97-2 (SOP 97-2),
Software Revenue Recognition. SOP 97-2 establishes new standards of accounting
for multiple element arrangements and post-contract customer support and
services. With the Company's introduction of after sales support programs
including software maintenance, extended hardware warranty and hardware
obsolescence programs, providing upgrades when and if available, and promotional
programs to move its customers to its new Enterprise Monitoring system for the
e-Hospital, when and if available, the Company will begin accounting for these
contracts under SOP 97-2, deferring revenue to future periods. If successful in
its promotional offering and after sales support programs, revenues received
from these contracts will be deferred to future periods under SOP 97-2, which
could have a material adverse effect on revenues in the third and fourth
quarters of 1999.
8
<PAGE> 9
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 CONSTITUTE
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 THE SALES
CYCLE FOR ENTERPRISE MONITORING SYSTEMS, SEASONAL VARIATIONS IN SALES OF ITS
ENTERPRISE MONITORING SYSTEMS AND OEM PRODUCT SALES, CONTINUED REDUCTION IN THE
COST OF MATERIAL AND MANUFACTURING OVERHEAD, LOWER COSTS, THAT THE COMPANY
EXPECTS TO SPEND APPROXIMATELY $600,000 IN CAPITAL EXPENDITURES IN THE NEXT SIX
MONTHS, THAT THE COMPANY BELIEVES THAT EXISTING CASH RESOURCES AND ITS LINE OF
CREDIT FACILITIES WILL BE SUFFICIENT TO FUND THE COMPANY'S OPERATIONS FOR THE
NEXT TWELVE MONTHS, THAT THE COMPANY INTENDS TO IMPLEMENT A STOCK REPURCHASE
PROGRAM, THE OUTCOME OF ANY REGULATORY DEVELOPMENT, THE PROBABLE FCC LICENSING
OF A NEW BAND FOR MEDICAL TELEMETRY AND THE COMPANY'S INTENT TO DEVELOP RF
PRODUCTS TO OPERATE IN THIS NEW BAND, POTENTIAL NEW PRODUCTS, REBUILDING OF THE
COMPANY'S FUNNEL OF POTENTIAL NEW ENTERPRISE MONITORING SYSTEMS SALES, THE
COMPANY'S ESTIMATED EXPENDITURES FOR YEAR 2000 COMPLIANCE, THE EXPECTED EFFECT
OF YEAR 2000 COMPLIANCE ON THE COMPANY AND THE EFFECT AND TIMING OF YEAR 2000
COMPLIANCE ON THE COMPANY'S CUSTOMERS. ACTUAL RESULTS MAY VARY SUBSTANTIALLY
FROM THESE FORWARD-LOOKING STATEMENTS FOR MANY REASONS, INCLUDING BUT NOT
LIMITED TO THOSE SET FORTH UNDER THE CAPTION "- FACTORS THAT MAY AFFECT FUTURE
OPERATING RESULTS AND FINANCIAL CONDITION". 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 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.
In July 1999 the Company announced a new product to be sold by the
Company's direct sales force "Enterprise Monitoring for the Electronic
Hospital". The new Enterprise Monitoring system for the e-Hospital will replace
the Company's existing product line of Enterprise Monitoring products sold by
its direct sales force, includes open system architecture, enterprise-wide
connectivity with web-enabled access, more connections to other manufacturers'
monitoring equipment and other additional features and functions. In addition,
it is the platform for the Company's anticipated implementation of the new
medical radio frequency (RF) bands proposed by industry to the Federal
Communications Commission (FCC). In connection with the introduction of its new
Enterprise Monitoring System for the e-Hospital the Company has re-priced its
products, introduced after sales support products including software
maintenance, extended hardware warranty and hardware obsolescence programs. The
Company is offering after sales support agreements and upgrades, when and if
available, to its existing hospital customers at a promotional price through
December 31, 1999.
Revenues from sales of Enterprise Monitoring systems sold by the
Company's direct sales force are recognized upon shipment. Revenues from sales
of its Enterprise Monitoring system for the e-Hospital will also be recognized
upon shipment. However, revenues from the Company's promotional offer to
existing customers to move to its new Enterprise
9
<PAGE> 10
Monitoring System for the e-Hospital and after sales support programs for new
customers will be deferred to future periods under SOP 97-2, Software Revenue
Recognition, which includes accounting for multiple element arrangements and
post-contract customer support and services. If the Company is successful in its
promotional efforts the Company could experience lower revenues in the third and
fourth quarters of 1999 due to the deferral of revenues under SOP 97-2. The
sales cycle for Enterprise Monitoring systems has typically been from nine to 18
months. The Company has experienced seasonal variations in sales of its
Enterprise 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.
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. For more information on issues pertaining to
the Year 2000, see "Factors that May Affect Future Operating Results And
Financial Condition" - Year 2000 Computer Systems Compliance.
RESULTS OF OPERATIONS - THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 1999
AND JUNE 30, 1998
Total Revenues. Total revenues consist of revenue from sales of Enterprise
Monitoring systems and OEM products, together with fees for installation and
servicing of Enterprise Monitoring products. Total revenues decreased 33.7% to
$3.6 million in the three months ended June 30, 1999 from $5.4 million for the
three months ended June 30, 1998. Total revenues decreased 20.1% to $8.4 million
in the six months ended June 30, 1999 from $10.5 million in the six months ended
June 30, 1998. Management believes that a contributing factor to the decrease in
Enterprise Monitoring revenues was delayed sales agreements as hospitals
diverted spending to address other vendors' year 2000 issues. The decrease in
OEM revenues resulted from a shift in sales strategy by a large OEM customer
following its sale to new investors that adversely impacted revenues. It is
unclear to the Company what effect if any of any future sales to this OEM
customer.
Gross Margins. Cost of goods sold generally includes material, direct labor,
overhead and for Enterprise Monitoring systems, installation expenses. Cost of
sales decreased 24.8% to $1.8 million in the three months ended June 30, 1999
from $2.4 million in the three months ended June 30, 1998. Gross margin
decreased to 50.6% in the second quarter of 1999 compared to 56.5% for the
second quarter of 1998. The decrease in gross margin in the second quarter of
1999 as compared to the second quarter of 1998 was due to the lower percentage
of Enterprise Monitoring systems sold, whose distribution channel is directly to
the hospital which generates a higher gross margin.
Cost of goods sold decreased 21.5% to $3.8 million for the six month period
ended June 30, 1999 from $4.8 million in the six months ended June 30, 1998.
Gross margin improved to 54.8% in the six months ended June 30, 1999 compared to
54.0% for the six months ended June 30, 1998. The increase in gross margin in
the first six months of 1999 as compared to the same period of 1998 was due
primarily to the reductions in overhead and materials costs.
10
<PAGE> 11
Sales and Marketing Expenses. Sales and marketing expenses include payroll,
commissions and related costs attributable to Enterprise Monitoring systems and
OEM sales and marketing personnel, travel and entertainment expenses and other
promotional expenses. Sales and marketing expenses were $1.5 million, or 41.3%
of total revenue in the three months ended June 30, 1999, as compared to $1.8
million or 33.4% of total revenue for the three months ended June 30, 1998. The
$328,326 decrease in sales and marketing expenses in the second quarter of 1999
as compared to the second quarter of 1998 was primarily due to lower salary and
commission expenses in addition to lower travel charges. This was due in part by
the reduction in the number of sales representatives as the Company is actively
in the process of recruiting and expanding both the OEM and Direct sales force.
Sales and marketing expenses were $3.1 million, or 36.4% of total revenue in the
six months ended June 30, 1999, as compared to $3.5 million or 33.6% of total
revenue in the six months ended June 30, 1998. The $477,915 decrease in sales
and marketing expenses in the six months ended June 30, 1999 as compared to the
six months ended June 30, 1998 was due to the lower salary, commission, and
travel expenses resulting from lower revenue volume.
Research and Development Expenses. Research and development expenses include
payroll and related costs attributable to research and development personnel,
prototyping expenses, consulting and other costs. Research and development
expenses were $1.3 million or 35.6% of total revenue in the three months ended
June 30, 1999, as compared to $1.3 million or 24.6% of total revenue in the
three months ended June 30, 1998.
Research and development expenses were $2.4 million, or 28.6% of total revenue
in the six months ended June 30, 1999, as compared to $2.5 million or 23.9% of
total revenue in the six months ended June 30, 1998. The $107,634 decrease in
research and development expenses in the first six months of 1999 as compared to
the first six months of 1998 was due to lower recruitment 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 $541,304 or 15.0% of total revenue in the three
months ended June 30, 1999, as compared to $501,060 or 9.2% of total revenue in
the three months ended June 30, 1998. The increase in general and administrative
expenses in the second quarter of 1999 as compared to the second quarter of 1998
was primarily attributable to higher outside professional fees.
General and administrative expenses were $1.1 million, or 13.5% of total revenue
in the six months ended June 30, 1999, as compared to $1.1 million or 10.6% of
total revenue in the six months ended June 30, 1998.
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
$203,960 in the three months ended June 30, 1999, as compared to $243,726 in the
three months ended June 30, 1998. The decrease resulted from lower income
derived from the Company's short-term investments related to the Company's cash
position.
Other income, net, was $387,756 in the six months ended June 30, 1999, as
compared to $461,994 in the six months ended June 30, 1998. The decrease
resulted from the lower income derived from the Company's short-term
investments.
Provision for Income Taxes: The Company had minimum state tax provisions of
$9,000 and $6,300 in the three months ended June 30, 1999 and 1998,
respectively. For the six months ended June 30, 1999 the Company had minimum
state tax provisions of $18,000 and $12,600 for the six months ended June 30,
1999 and 1998.
11
<PAGE> 12
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 year ended December 31, 1996,
the Company issued 2,300,000 shares of common stock in its initial public
offering, raising $25.6 million, net of expenses. At June 30, 1999 the Company
had $15.1 million in cash and cash equivalents, and short-term investments as
compared to $15.8 million at December 31, 1998.
In the first six months of 1999, the Company used cash in operating
activities of $452,707 to fund a $1,619,669 net loss. In addition, $207,717 was
used for accrued liabilities and $119,260 was used for payroll and related
costs. Uses of cash were partially offset by cash provided from the $945,405
reduction in accounts receivable, $329,890 in non-cash adjustments provided by
depreciation and amortization of fixed assets and intangible assets, and
$180,656 in the increase in accounts payable.
The Company provided $1,728,181 in cash from investing activities of
which $1,924,507 was provided by the sale of short-term investments. Cash used
for investing activities was $206,736 for the purchase of capital equipment in
the first six months of 1999.
The Company used $41,367 in cash from financing activities in the
first six months of 1999, principally, $154,475 in cash was used to repurchase
the Company's Common Stock. This was partially offset by $126,612 in net
proceeds from the issuance of the Company's Common Stock for the matching
contribution to its 401(k) plan and Common Stock purchased through its ESPP
plan.
In the first six months of 1998, the Company used cash in operating
activities of $571,657 to fund a $1,030,802 net loss. In addition, $394,358 was
used for payroll and related costs, $269,492 was used to pay down accounts
payable and $86,620 was attributable to the reduction in the accrued warranty
charges. Uses of cash were partially offset by $820,734 in cash provided from
the reduction in accounts receivable and $343,989 in non-cash adjustments
provided by depreciation and amortization of fixed assets and intangible assets.
The Company used $290,959 for investing activities in the first six
months of 1998. The principal components were $149,718 for the prepayment of
Directors and Officer's Liability Insurance and $141,241 in cash used to
purchase capital equipment.
The Company received $172,842 in net cash from financing activities in
the first six months of 1998. This included $188,801 in net proceeds from the
issuance of Common Stock offset partially by $15,959 in cash used in the
repayment of capital lease obligations.
At June 30, 1999, the Company's principal sources of liquidity
consisted of $15.1 million of cash, cash equivalents, and short-term investments
and $5.0 million of available credit facilities. In December 1998, 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
either the bank's prime rate or LIBOR interbank market rate, as selected by the
Company. In July 1999, the Company and Silicon Valley Bank amended the Agreement
to provide the Company with the ability to repurchase additional shares of its
Common Stock, provided that the total amount paid does not exceed $2,000,000 in
any fiscal year. The bank does not have security interest in any of the
Company's assets until the Company is borrowing under the line of credit. The
Agreement expires in December 1999. At June 30, 1999, 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 1.75 to 1, maintain tangible net worth of not less
than $18,000,000, maintain a ratio of total liabilities to tangible net worth of
not more than .75 to 1, and not incur a net loss (after taxes) for the fiscal
year ending December 31, 1999 in excess of $2,000,000.
The Company's principal commitment at June 30, 1999 consisted of a
lease on its office and manufacturing facility. The Company expects to spend
approximately $600,000 for capital expenditures during the remaining six months
of 1999.
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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.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS AND FINANCIAL CONDITION
Dependence on Increased Market Acceptance of Enterprise Monitoring
Systems. Since 1995, the Company's sales levels for its Enterprise Monitoring
systems have been lower than expected, which, together with investments and
expense levels that are incurred based on the expectation of higher sales, has
resulted in net losses in each year since 1995 and has had a material adverse
effect on the Company's business, operating results and financial condition. If
the Company is not successful in increasing sales levels of its Enterprise
Monitoring systems in future periods, the Company's business, operating results
and financial condition will continue to be materially adversely affected.
Introduction of New Product - Enterprise Monitoring System for the
e-Hospital- and Deferred Revenue. In July 1999 the Company announced a new
product to be sold by the Company's direct sales force - "Enterprise Monitoring
for the Electronic Hospital". The new Enterprise Monitoring system for the
e-Hospital will replace the Company's existing product line of Enterprise
Monitoring products sold by its direct sales force, includes open system
architecture, enterprise-wide connectivity with web-enabled access, more
connections to other manufacturers' monitoring equipment and other additional
features and functions. In addition, it is the platform for the Company's
anticipated implementation of the new medical radio frequency (RF) bands
proposed by industry to the Federal Communications Commission (FCC). In
connection with the introduction of its new Enterprise Monitoring System for the
e-Hospital the Company has re-priced its products, introduced after sales
support products including software maintenance, extended hardware warranty and
hardware obsolescence programs. The Company is offering after sales support
agreements and upgrades, when and if available, to its existing hospital
customers at a promotional price through December 31, 1999.
Revenues from sales of Enterprise Monitoring systems sold by the
Company's direct sales force are recognized upon shipment. Revenues from sales
of its Enterprise Monitoring system for the e-Hospital will also be recognized
upon shipment. However, revenues from the Company's promotional offer to
existing customers to move to its new Enterprise Monitoring System for the
e-Hospital and after sales support programs for new customers will be deferred
to future periods under SOP 97-2, Software Revenue Recognition, which includes
accounting for multiple element arrangements and post-contract customer support
and services. If the Company is successful in its promotional efforts the
Company could experience lower revenues in the third and fourth quarters of 1999
due to the deferral of revenues under SOP 97-2. In addition, as customers
analyze the Company's new offerings, contract signings could be delayed, which
could also contribute to lower revenues in the third and fourth quarters of
1999.
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
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 Enterprise 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 deferral of orders as
customers divert time and budgets to year 2000 issues; 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
to software "bugs" or errors; regulatory compliance and timing of regulatory
clearances; changes in government regulations and other regulatory developments;
and general economic factors.
The Company's products are generally shipped as orders are received.
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
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magnified by the Company's inability to maintain gross margins and to decrease
spending to compensate for the revenue shortfall. This dynamic has contributed
to the Company's net losses in the past. 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.
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 Enterprise
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.
Possible Delisting of Securities from the Nasdaq National Market. The
Company's Common Stock trades on the Nasdaq National Market. The Nasdaq National
Market's continued listing standards require the Company to have (i) at least
750,000 shares publicly held; (ii) a market value of publicly held shares of at
least $5 million; (iii) net tangible assets of at least $4 million; (iv) at
least 400 shareholders of round lots; and (v) a minimum bid price of at least $1
per share. The Company believes that it currently does not meet item (ii) above,
and it is possible that the Company could fall below other criteria in the
future. Accordingly, the Company may be subject to possible delisting procedures
in the future from the Nasdaq National Market. In this regard, the Company
received notice from the Nasdaq National Market that Nasdaq would review the
Company's compliance. The Company has a hearing before a panel authorized by The
Nasdaq Stock Market Board of Directors in mid-August 1999. If the Company does
not achieve compliance by the time of the panel's ruling, which is anticipated
to be four to six weeks after the hearing date, or if the panel does not grant
the Company additional time in which to become compliant, it may become delisted
from the Nasdaq National Market and moved to the Nasdaq Small Cap market which
could adversely affect the ability or willingness of investors to purchase the
Company's securities and therefore would severely adversely affect the market
liquidity for the Company's securities.
Competition. The Company's Enterprise Monitoring systems compete with
systems offered by a number of competitors, including Hewlett-Packard Company,
SpaceLabs, Inc. and General Electric Company, all 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. While the Company is not
aware of any competitive open system multi-parameter Enterprise Monitoring
systems currently available, the Company's OpenNet applications may face
significant competition in the future from Health Care Information Service
("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 or that such OEM will change sales strategy to
focus their efforts on other markets and products. Any such design or
manufacturing election or business strategy decision by one or more of such OEM
customers could have a material adverse effect on the Company's business,
operating results and financial condition.
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In addition, the Company may in the future elect to incorporate in its
OEM products the hardware and software for larger networks and expand the number
of OEM customers with the hardware and software required for 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. Although the Company believes that its OEM customers would not
compete with its Enterprise Monitoring systems because the Enterprise Monitoring
systems are sold to hospitals and IHDNs who elect to install larger, more
dispersed systems, the Company could face competition with its OEM customers to
the extent hospitals forego purchasing the Company's facility-wide Enterprise
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%, 53.7% and
57.9% of the Company's total net revenues in 1996, 1997 and 1998, respectively,
have historically been to a small number of OEM customers. In 1998, Quinton
Instrument Company and Datascope Corporation accounted for approximately 19.7%
and 22.6%, respectively, of the Company's total revenues. In the six months
ended June 30, 1999, Quinton Instrument Company and Datascope Corporation
accounted for approximately 22% and 33%, 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 Enterprise 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
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.
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 Food and Drug
Administration'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
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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
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
were required to implement HDTV by December 31, 1998 and other markets will be
required to implement 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 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. In 1998 the FCC expanded the usable UHF frequencies
for medical RF from the licensed 450 MHz to 470 MHz band to the previously
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.
During 1998 the Company joined a task force created by the American
Hospital Association (AHA) and the FDA called the Spectrum Selection Workgroup
Medical Telemetry Task Force (the "Task Force") along with several other medical
RF users, including its competitors. The purpose of the Task Force is to respond
to potential interference problems from HDTV, land mobile users and low power
television to wireless patient monitoring devices. The Task Force's mission is
to identify spectrum candidates for future medical telemetry use, evaluate use
and make recommendations to the FCC. As such, the Task Force has petitioned the
FCC to license the UHF 608 MHz to 614 MHz band, currently reserved for radio
astronomy, for medical use. The Task Force submitted its proposals to the FCC in
the second quarter of 1999. The Task Force asked the FCC to expedite licensing
for medical RF applications in the 608 MHz to 614 MHz band. The FCC has issued a
proposed rule and the proposed rule is now available for public commentary. It
is anticipated that the final ruling would be made before the end of 1999. In
the event the FCC approves this license, which the Company believes is probable,
the Company may be at a disadvantage in the marketplace if one or more of its
competitors develop and introduce RF products in this new band before the
Company introduces products in the new band, resulting in lost or delayed
revenues. In addition, the costs of developing RF transmitter and receiver
products in this new band could be expensive or divert research and development
resources from other projects resulting
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in higher costs and delayed projects. 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.
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. The
Company in the past had to incur warranty expenditures for upgrades that had
adverse expenses to the periods. Even unsuccessful claims could result in the
expenditure of funds in litigation and diversion of management time and
resources.
Year 2000 Computer Systems Compliance. Many computer systems,
software, and electronic equipment accept only two-digit entries in the date
code field. Therefore "00" for the year 2000 could be interpreted to be the year
1900, resulting in an invalid date. These systems will need to be changed to
distinguish 21st century dates. In addition, certain systems and products do not
correctly process "leap year" dates. As a result, in the next 12 months,
computer systems, software ("IT Systems"), and other equipment, such as
elevators, phones, office equipment, and manufacturing equipment used by many
companies may need to be upgraded, repaired, or replaced to comply with "Year
2000" and "leap year" requirements.
All products the Company is currently selling and installing are Y2K
compliant. The Company's Enterprise Monitoring systems and OEM central stations
use a personal computer (PC) platform and include operating system, display,
clinical analysis and networking software. The Company's research and
development department has evaluated all Company Enterprise Monitoring products
built and shipped on or after January 1, 1990. Test procedures included testing
for (a) transition dates of December 31, 1999 to January 1, 2000 and December
31, 2000 to January 1, 2001; (b) leap year transition dates of February 28, 2000
to February 29, 2000 and February 29, 2000 to March 1, 2000; (c) a powered-down
rollover test; (d) a powered-up rollover test; (e) a check of the date and time
of history events and full disclosure on monitor displays; (f) alarms set and
check for correct functioning after the transition dates and times; and (g)
verification for printouts for a three month period during the transition dates.
The Company tested a total of 111 hardware and software combinations. Of the 111
product combinations tested 40 combinations are compliant and Y2K certified, 35
are compliant with a simple workaround such as a power-down and power-up, 32 are
not fully compliant, but which have relatively simple workarounds to provide a
solution for the product to make it compliant, and 4 are not compliant and have
no work around. All of the Company's Enterprise Monitoring customers have
received a technical bulletin explaining the status of the Company's Y2K
compliance requirements and applicable workarounds, if necessary. Recently the
Company expanded its testing beyond the generally accepted Y2K criteria
enumerated above
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to include testing for dates of January 1, 2001 and beyond. Testing has been
completed for the expanded year 2001 and beyond analysis. Tests verify that the
Company's 486 based personal computer products that print reports with an
invalid date are limited to two of the four Y2K tested software versions found
non-compliant and for which there is no work around. The Company has provided a
letter and technical bulletin to those customers that are affected by older
versions of hardware and software that exhibit invalid dates after 2001. The
Company believes that it does not have any contractual obligation to update or
replace any software or equipment for its customers at no charge. The Company's
OEM customers are responsible for Y2K compliance and support for their end user
customers. All of the Company's transmitters, receivers (RF products) and
display monitors are Year 2000 compliant based on the fact that none of these
devices contain a real time clock that would pose a Year 2000 date compliance
issue.
The Company has conducted an internal review of most of its internal
systems, including inventory, manufacturing, planning, finance, human resources,
payroll, automation, laboratory, and research systems. The systems affected by
the Year 2000 problem are divided into eight categories including the Company's
Enterprise Monitoring systems and OEM central stations discussed above. Business
Computer Systems comprise any mainframe, midrange, or PC based computer system
used in corporate operations. These systems generally involve application code
provided by third-party vendors supported by internal staff. Technical
Infrastructure are specific computer and process control software systems. End
User Computing comprise the PC and server based office automation. Suppliers,
Agents, and Service Providers comprise the software formulated by our suppliers,
banks, utilities, and other suppliers. Manufacturing, Warehousing, Servicing
Equipment comprise the equipment on our factory floor and warehouse areas that
may be date dependent, especially micro-processor controlled devices.
Environmental Operations in Plant, Offices and Other Sites comprise the
Company's HVAC, security/access system, elevators, PBX, fire and alarm systems,
and other systems of this nature. Dedicated Research and Development Test
Facilities comprise controllers, devices, instruments etc. in the Company's test
facilities.
As part of the Company's review to assure compliance with Year 2000,
the Company has formed a task force (the "Y2K Task Force") to oversee Year 2000
and leap year issues. The Y2K Task Force has reviewed all IT Systems and Non-IT
Systems that have been determined not to be Year 2000 and leap year compliant
and has identified and begun implementation of solutions to ensure such
compliance. The Company has prioritized the remediation effort to fix critical
business systems first, non-critical systems second, and cosmetic changes to
reports and displays last. Key critical business systems, such as Financials
(General Ledger, Purchasing, Accounts Payable, Accounts Receivable and Fixed
Assets) and Material Requirements Planning, are currently 100% compliant.
Remaining critical and non-critical business systems are expected to be
completed by the end of 1999 and cosmetic changes to reports and displays are
anticipated to be completed in the fourth quarter of 1999. As part of
contingency planning, the Company is developing procedures for those areas that
are critical to its business. These plans will be designed to mitigate serious
disruptions to the business beyond the end of 1999. The major efforts in
contingency planning occurred in the last quarter of 1998 with the expectation
that contingency plans will be in place by the end of the third quarter of 1999.
The Company has contacted its major customers, vendors, and service
suppliers whose systems failures potentially could have a significant impact on
the Company's operations to verify their Year 2000 readiness to determine
potential exposure to Year 2000 issues. The Company has been informed by 75
percent of its major customers, vendors, and service suppliers that such
suppliers will be Year 2000 compliant by the end of 1999. Failure of these third
parties systems to timely achieve Year 2000 compliance could have a material
adverse effect on the business, financial condition, results of operations and
prospects of the Company. Year 2000 problems could affect many of the Company's
production, distribution, plant equipment, financial and administrative
operations. Systems critical to the business which have been identified as
non-Year 2000 compliant are either being replaced or corrected through
programming modifications. The Company has not determined the state of
compliance of certain third-party suppliers of services such as phone companies,
long distance carriers, financial institutions and electric companies. The
failure of any one could severely disrupt the Company's ability to carry on its
business as will as disrupt the business of the Company's customers.
Remediation of problems discovered will be corrected through internal
efforts, vendor upgrades, replacement, or decommissioning of obsolete systems
and equipment. External and internal costs associated with these efforts are
currently expected to be approximately $200,000. As of June 30, 1999, the
Company had spent less than $20,000 on
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costs associated with the Year 2000 effort. The Company does not expect the
costs relating to Year 2000 remediation to have a material effect on results of
operations or financial condition.
Failure to provide Year 2000 and leap year compliant business
solutions to customers or to receive such business solutions from its suppliers
could result in liability to the Company or otherwise have a material adverse
effect on the Company's business, results of operations or financial condition.
The Company could be affected through disruptions in the operation of the
enterprises with which the Company interacts or from general widespread problems
or an economic crisis resulting from non-compliant Year 2000 systems. Despite
the Company's efforts to address the Year 2000 effect on its internal systems
and business operations, such effect could result in a material disruption of
its business or have a material adverse effect on the Company's business,
financial condition or results of operations.
Dependence on Sole Source Components; Component, Assembly & Systems
Obsolescence. 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. In addition, from time to time, certain components, subassemblies and
systems used by the Company are discontinued by manufacturers, requiring the
Company to replace the components, subassembly or system with an equivalent
product or if no such equivalent can be identified to modify and re-validate the
product design. Any inability to obtain such components on a timely basis or at
commercially reasonable prices or to redesign the product in a timely manner
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. In recent years, the
Company has experienced a high degree of turnover in its senior management team.
These management changes have involved disruptions to the Company's day-to-day
operations, have interrupted continuity in customer relationships and have
created delays in sales cycles or product release schedules. Although the
Company believes that its existing 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company's financial instruments include cash and long-term debt.
At June 30, 1999, the carrying values of the Company's financial instruments
approximated their fair values based on current market prices and rates.
It is the Company's policy not to enter into derivative financial
instruments. The Company does not currently have any significant foreign
currency exposure since it does not transact business in foreign currencies. Due
to this, the Company does not have significant overall currency exposure at June
30, 1999. The Company's market risk disclosures are not material and are
therefore not required
19
<PAGE> 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In July 1999 the Company filed two legal actions. The first lawsuit
was filed against a company formed by two former officers and two former
employees of the Company, and is a complaint for trade secret misappropriation,
conversion, statutory unfair competition, common law unfair competition, breach
of contract, and breach of fiduciary duty. The second action was filed against a
company formed by a former consultant to the Company and alleges breach of
contract and intentional interference with contractual relations and economic
advantage.
Item 4. Submission of Matters to a Vote of Security-Holders
The Company held an Annual Meeting of Stockholders on May 20, 1999. At
the Annual Meeting, the following votes were cast for the proposals indicated:
Proposal One: Election of Directors:
<TABLE>
<CAPTION>
Name For Withheld
---- --- --------
<S> <C> <C>
Frank T. Sample 7,706,739 8,764
Patrick T. Hackett 7,706,853 8,650
Jack W. Lasersohn 7,706,853 8,650
Timothy T. Weglicki 7,706,853 8,650
</TABLE>
Proposal Two: Ratification of the appointment of Deloitte & Touche LLP as
independent public accountants of the Company for the fiscal period ending
December 31, 1999:
<TABLE>
<S> <C>
For 7,712,503
Against 1,000
Abstain 2,000
</TABLE>
Item 5. Other Information
Pursuant to the Company's Bylaws, stockholders who wish to bring matters or
propose nominees for director at the Company's 2000 annual meeting of
stockholders must provide specified information to the secretary of the Company
not less than ninety (90) days prior to the first anniversary of the 1999 annual
meeting (i.e., ninety (90) days prior to May 20, 2000), unless such matters are
included in the Company's proxy statement pursuant to Rule 14a-8 under the
Securities Exchange Act, as amended.
Item 6. Exhibits and Reports on Form 8-K
Exhibits:
10.1 Silicon Valley Bank Amendment to Loan Agreement
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the reporting period.
20
<PAGE> 21
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 August 12, 1999.
VITALCOM INC.
/s/ Frank T. Sample
------------------------------------------------
Frank T. Sample
President, Chief Executive Officer
/s/ Shelley B. Thunen
------------------------------------------------
Shelley B. Thunen
Vice President Finance and
Chief Financial Officer
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<C> <S>
10.1 Silicon Valley Bank Amendment to Loan Agreement
27.1 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 10.1
[SILICON VALLEY BANK LETTERHEAD]
AMENDMENT TO LOAN AGREEMENT
DATE: July 9, 1999
BORROWER: VitalCom Inc.
1. This amendment to Loan Agreement is entered into between Silicon Valley
Bank ("Silicon") and the Borrower named above ("Borrower"). The Parties
agree to amend the Loan and Security Agreement between them, dated February
26, 1993, as amended from time to time (the "Loan Agreement"), as follows,
effective as of the date hereof. (Capitalized terms used but not defined in
this Amendment shall have the meanings set forth in the Loan Agreement).
2. Section 4.6, Negative Covenants-Exceptions, is hereby amended to read as
follows:
Without Silicon's prior written consent, Borrower may do the following,
provided that, after giving effect thereto, no Event of Default has
occurred and no event has occurred which, with notice or passage of time or
both, would constitute an Event of Default, and provided that the following
are done in compliance with all applicable laws, rules and regulations: (i)
repurchase shares of Borrower's stock, provided that the total amount paid
by Borrower for such stock does not exceed $2,000,000 in any fiscal year.
Except as herein expressly amended, all of the terms and provisions of the Loan
Agreement, and all other documents and agreements between Silicon and Borrower
shall continue in full force and effect and the same are hereby ratified and
confirmed.
BORROWER:
VITALCOM INC.
By: /s/
------------------------------
Title: Chief Financial Officer
SILICON:
SILICON VALLEY BANK
By: /s/
------------------------------
Title: Vice President
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 11,695
<SECURITIES> 3,445
<RECEIVABLES> 4,017
<ALLOWANCES> (347)
<INVENTORY> 1,245
<CURRENT-ASSETS> 20,189
<PP&E> 4,082
<DEPRECIATION> (2,537)
<TOTAL-ASSETS> 22,297
<CURRENT-LIABILITIES> 2,466
<BONDS> 0
0
0
<COMMON> 37,433
<OTHER-SE> (17,618)
<TOTAL-LIABILITY-AND-EQUITY> 22,297
<SALES> 3,600
<TOTAL-REVENUES> 3,600
<CGS> 1,778
<TOTAL-COSTS> 1,778
<OTHER-EXPENSES> 3,309
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (204)
<INCOME-PRETAX> (1,283)
<INCOME-TAX> 9
<INCOME-CONTINUING> (1,292)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,292)
<EPS-BASIC> (0.16)
<EPS-DILUTED> (0.16)
</TABLE>
