<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 September 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
(Registrant's 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, 1999, there were 7,917,563 shares outstanding of the issuer's
common stock.
<PAGE> 2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VITALCOM INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
-------------------------------
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------ ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 9,731,375 $ 10,460,810
Short-term investments 3,227,295 5,369,213
Accounts receivable, net 3,364,152 4,615,295
Unbilled accounts receivable 237,216 --
Inventories, net 1,348,560 1,391,899
Prepaid expenses 122,383 140,647
------------ ------------
Total current assets 18,030,981 21,977,864
Property
Machinery and equipment 1,532,141 1,503,905
Office furniture and computer equipment 2,463,386 2,200,732
Leasehold improvements 181,778 173,883
------------ ------------
4,177,305 3,878,520
Less accumulated amortization and depreciation (2,672,527) (2,223,301)
------------ ------------
Property, net 1,504,778 1,655,219
Other assets 484,552 133,894
Long-term installments receivable, net 927,124 --
Goodwill, net 431,160 455,573
------------ ------------
$ 21,378,595 $ 24,222,550
============ ============
</TABLE>
2
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VITALCOM INC.
BALANCE SHEETS - (CONTINUED)
<TABLE>
<CAPTION>
-------------------------------
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------ ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 345,962 $ 429,987
Accrued payroll and related costs 750,814 804,887
Accrued warranty costs 656,745 757,448
Accrued liabilities 917,973 711,255
Current portion of capital lease obligations 27,574 24,990
------------ ------------
Total current liabilities 2,699,068 2,728,567
Long-term deferred revenue 871,652 --
Capital lease obligations, less current portion 8,431 31,552
Redeemable preferred stock, 5,000,000 shares authorized,
$.001 par value; no shares issued and outstanding
at September 30, 1999 and December 31, 1998, respectively -- --
Stockholders' equity (deficit):
Common stock, including paid-in capital, $.0001 par value;
25,000,000 shares authorized, 7,878,096 and 8,162,972 shares
issued and outstanding at September 30, 1999 and December 31,
1998, respectively 37,619,695 37,491,563
Note receivable for common stock sales (30,590) (30,590)
Treasury stock, at cost (740,154) --
Accumulated deficit (19,049,507) (15,998,542)
------------ ------------
Net stockholders' equity 17,799,444 21,462,431
------------ ------------
$ 21,378,595 $ 24,222,550
============ ============
</TABLE>
3
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VITALCOM INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
----------------------------- -----------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues $ 3,764,575 $ 4,689,435 $ 12,174,929 $ 15,217,740
Cost of revenues 2,133,145 2,287,559 5,936,133 7,130,010
------------ ------------ ------------ ------------
Gross profit 1,631,430 2,401,876 6,238,796 8,087,730
Operating expenses
Sales and marketing 1,449,137 1,630,209 4,506,763 5,165,750
Research and development 1,335,532 1,001,293 3,742,498 3,515,893
General and administration 558,000 495,768 1,690,199 1,611,677
------------ ------------ ------------ ------------
Total operating expenses 3,342,669 3,127,270 9,939,460 10,293,320
Operating loss (1,711,239) (725,394) (3,700,664) (2,205,590)
Other income, net 288,943 217,926 676,699 679,920
------------ ------------ ------------ ------------
Loss before provision for income taxes (1,422,296) (507,468) (3,023,965) (1,525,670)
Provision for income taxes 9,000 6,300 27,000 18,900
------------ ------------ ------------ ------------
Net loss $ (1,431,296) $ (513,768) $ (3,050,965) $ (1,544,570)
============ ============ ============ ============
Net loss per basic and diluted common share $ (0.18) $ (0.06) $ (0.37) $ (0.19)
============ ============ ============ ============
Weighted average basic and diluted common shares 8,115,767 8,208,259 8,169,576 8,152,583
============ ============ ============ ============
</TABLE>
4
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VITALCOM INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
-------------------------------
NINE MONTHS ENDED
SEPTEMBER 30,
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (3,050,965) $ (1,544,570)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 473,639 470,069
Loss on disposal of property 5,299 79,778
Changes in operating assets and liabilities:
Accounts receivable 1,251,143 (913,468)
Unbilled accounts (237,216) --
receivable
Inventories 43,339 (29,574)
Prepaid expenses and other current assets 18,264 (12,048)
Long-term installments receivable (927,124) --
Accounts payable (84,025) (127,838)
Accrued payroll and related costs (54,073) (452,250)
Accrued warranty costs (100,703) (141,913)
Income taxes payable (59,814) (21,410)
Accrued liabilities 266,532 (12,789)
------------ ------------
Net cash used in operating activities (2,455,704) (2,706,013)
Cash flows from investing activities:
Purchases of property (304,084) (206,507)
Increase in long-term deferred revenue 871,652 --
Proceeds from sale of short-term investments 2,141,918 --
Increase in other assets (350,658) (149,070)
------------ ------------
Net cash provided by (used in) investing activities 2,358,828 (355,577)
Cash flows from financing activities:
Repayment of capital lease obligation and (20,537) (22,264)
long-term debt
Net proceeds from issuance of common stock 128,132 194,900
Repurchase of common stock (740,154) --
------------ ------------
Net cash provided by (used in) financing (632,559) 172,636
activities
Net decrease in cash and cash equivalents (729,435) (2,888,954)
Cash and cash equivalents, beginning of period 10,460,810 18,157,160
------------ ------------
Cash and cash equivalents, end of period $ 9,731,375 $ 15,268,206
============ ============
Supplemental disclosures of cash flow information:
Interest paid $ 3,324 $ 10,663
============ ============
Income taxes paid $ 19,610 $ 14,161
============ ============
</TABLE>
5
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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, 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 September 30,
1999, and the results of its operations and its cash flows for the three-month
and nine-month periods ended September 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 nine-month periods ended September 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 nine months ended
September 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 415,790 $1.50 to $3.00
Exercised (16,750) $0.60 to $1.28
Canceled (172,548) $0.60 to $5.72
---------
Balance, September 30, 1999 1,666,532 $0.60 to $4.00 487,042
=========
</TABLE>
At September 30, 1999, 515,089 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, 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 (25,697) $3.00 to $6.00
---------
Balance, September 30, 1999 22,360 $3.00 to $4.00 12,525
=========
</TABLE>
At September 30, 1999, 77,640 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 nine months ended September 30, 1999. At September 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 nine months ended September 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>
Networked
OEM Monitoring
Products Products
---------- ----------
<S> <C> <C>
Nine months ended September 30, 1999
Net Sales.............................. $8,428,759 $3,746,170
Nine months ended September 30, 1998
Net Sales.............................. $9,266,080 $5,951,660
</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. On October 21, 1999
the Company announced that it has concluded purchasing its Common Stock. The
Company purchased 363,550 shares of Common Stock at an aggregate price of
$740,154.
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 nine months ended September 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.
The implementation of SOP 98-1 has not had 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 Networked Monitoring System for the
e-Hospital, when and if available, the Company will account for these contracts
under SOP 97-2, which may require deferral of revenue to future periods. Such
contracts require extended payment terms which will typically be between three
and five years and the deferral of revenue must take place because the Company
does not have a history of collecting beyond the standard payment terms. 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 fourth
quarter of 1999. The Company began recognizing revenue under support programs
during the third quarter of fiscal year 1999. These arrangements are reflected
in the balance sheet as unbilled accounts receivable, long-term installment
receivables and long-term deferred revenue.
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, BUT ARE NOT LIMITED TO,
THOSE REGARDING (1) THE SALES CYCLE FOR NETWORKED MONITORING SYSTEMS AND
PATIENTNET SYSTEMS, SEASONAL VARIATIONS IN SALES OF ITS NETWORKED MONITORING
SYSTEMS AND OEM PRODUCT SALES, (2) ANTICIPATED RECRUITING AND EXPANSION OF THE
DIRECT SALES FORCE, (3) THAT THE COMPANY WILL BE ABLE TO RENEW OR ENTER INTO A
NEW LINE OF CREDIT WITH REVISED FINANCIAL COVENANTS, (4) THE COMPANY'S
ANTICIPATED CAPITAL EXPENDITURES IN THE FOURTH QUARTER OF 1999, (5) THE
COMPANY'S BELIEF THAT EXISTING CASH RESOURCES AND ITS LINE OF CREDIT FACILITIES
WILL BE SUFFICIENT TO FUND THE COMPANY'S OPERATIONS FOR THE NEXT TWELVE MONTHS,
(6) THE OUTCOME OF ANY REGULATORY DEVELOPMENT, (7) 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, (8) POTENTIAL NEW PRODUCTS, (9) REBUILDING OF THE
COMPANY'S FUNNEL OF POTENTIAL NEW PATIENTNET SYSTEMS SALES, (10) THE ANTICIPATED
EFFECTS OF COMPLIANCE WITH FASB STATEMENT OF POSITION NO. 97-2, (11) 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 PatientNet
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 - "PatientNet". PatientNet, an enterprise monitoring system
for the e-Hospital, will replace the Company's existing product line of
Networked 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 PatientNet for the e-Hospital the Company
has re-priced its products, introduced after sales support products including
software maintenance, and 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 Networked Monitoring Systems sold by the Company's direct
sales force are recognized upon shipment. Revenues from sales of its PatientNet
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 PatientNet System for
9
<PAGE> 10
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 fourth quarter of 1999 due to
the deferral of revenues under SOP 97-2. The sales cycle for Networked
Monitoring Systems has typically been from nine to eighteen months and the
Company expects that the sales cycle for PatientNet Systems will be similar. 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 have 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 software, RF or hardware products or the enhancement of
existing products may require capitalization of such expenses in the future.
In the next two quarters, 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 NINE-MONTH PERIODS ENDED SEPTEMBER 30,
1999 AND SEPTEMBER 30, 1998
Total Revenues. Total revenues consist of revenue from sales of Networked
Monitoring Systems, after sales support programs in accordance with SOP 97-2 and
OEM products, together with fees for installation and servicing of Networked
Monitoring products. Total revenues decreased 19.7% to $3.7 million in the three
months ended September 30, 1999 from $4.7 million for the three months ended
September 30, 1998. Total revenues decreased 20.0% to $12.2 million in the nine
months ended September 30, 1999 from $15.2 million in the nine months ended
September 30, 1998. Management believes that the decrease in Networked
Monitoring revenues was due to delayed sales agreements as hospitals diverted
spending to address other vendors' Year 2000 issues and as customers analyze the
Company's new product offerings and after sales support programs, including the
Company's promotional offering to existing customers. In the quarter, the
Company recognized its first revenues in accordance with SOP 97-2 for after
sales contracts for two customers. 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, that a sales reduction to this customer will have on future OEM
revenues.
Gross Margins. Cost of goods sold generally includes material, direct labor,
overhead and for Networked Monitoring Systems, installation expenses. Gross
margin decreased to 43.3% in the third quarter of 1999 compared to 51.2% for the
third quarter of 1998. The decrease in gross margin in the third quarter of 1999
as compared to the third quarter of 1998 was due to the lower percentage of
Networked Monitoring Systems sold, which typically generates a higher gross
margin, the product mix of Networked Monitoring products during the quarter
which were heavier in low margin service and support and lower in higher margin
software products, and to a lesser extent the normal variation in OEM product
mix.
Gross margin decreased to 51.2% in the nine months ended September 30, 1999
compared to 53.1% for the nine months ended September 30, 1998. The decrease in
gross margin in the first nine months of 1999 as compared to the same period of
1998 was due primarily to the lower percentage of Networked Monitoring Systems
sold and the product mix for Networked Monitoring Systems and OEM Systems.
10
<PAGE> 11
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 $1.4 million, or 38.5%
of total revenue in the three months ended September 30, 1999, as compared to
$1.6 million or 34.8% of total revenue for the three months ended September 30,
1998. The $181,072 decrease in sales and marketing expenses in the third quarter
of 1999 as compared to the third quarter of 1998 was primarily due to lower
salary and commission expenses in addition to lower travel charges. This was due
in part to lower salary, commission and travel expenses resulting from lower
revenue volume, the reduction in the number of direct sales representatives as
the Company is actively in the process of recruiting and expanding the direct
sales force and a temporary reduction in OEM sales personnel during the third
quarter of 1999.
Sales and marketing expenses were $4.5 million, or 37.0% of total revenue in the
nine months ended September 30, 1999, as compared to $5.2 million or 33.9% of
total revenue in the nine months ended September 30, 1998. The $658,987 decrease
in sales and marketing expenses in the nine months ended September 30, 1999 as
compared to the nine months ended September 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 35.5% of total revenue in the three months ended
September 30, 1999, as compared to $1.0 million or 21.4% of total revenue in the
three months ended September 30, 1998. The $334,239 increase in research and
development expenses in the third quarter of 1999 as compared to the third
quarter of 1998 was primarily due to outside contract expenses related to the
development of prototype hardware products.
Research and development expenses were $3.7 million, or 30.7% of total revenue
in the nine months ended September 30, 1999, as compared to $3.5 million or
23.1% of total revenue in the nine months ended September 30, 1998. The $226,605
increase in research and development expenses in the first nine months of 1999
as compared to the first nine months of 1998 was due to increased outside
contract 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 $558,000 or 14.8% of total revenue in the three
months ended September 30, 1999, as compared to $495,768 or 10.6% of total
revenue in the three months ended September 30, 1998. The $62,232 increase in
general and administrative expenses in the third quarter of 1999 as compared to
the third quarter of 1998 was primarily attributable to higher salary and
benefits expenses.
General and administrative expenses were $1.7 million, or 13.9% of total revenue
in the nine months ended September 30, 1999, as compared to $1.6 million or
10.6% of total revenue in the nine months ended September 30, 1998. The $78,522
increase in general and administrative expenses in the first nine months of 1999
as compared to the first nine months of 1998 was due to higher salaries and
benefits expenses and higher outside professional fees associated with corporate
legal matters.
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, increased to
$288,943 in the three months ended September 30, 1999, as compared to $217,926
in the three months ended September 30, 1998. The increase resulted from
interest income derived from the imputed interest associated with after sales
support contracts in accordance with SOP 97-2, offset in part by lower income
derived from the Company's short-term investments related to the Company's cash
position.
Other income, net, was $676,699 in the first nine months ended September 30,
1999, as compared to $679,920 in the first nine months ended September 30, 1998.
The decrease resulted from the lower income derived from the Company's
short-term investments, offset in part by interest income derived from the
imputed interest associated with after sales support contracts in accordance
with SOP 97-2.
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Provision for Income Taxes. The Company had minimum state tax provisions of
$9,000 and $6,300 in the three months ended September 30, 1999 and 1998,
respectively. The Company had minimum state tax provisions of $27,000 and
$18,900 for the nine months ended September 30, 1999 and 1998, respectively.
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 and cash
and cash equivalent balances. 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 September 30, 1999 the Company had
$13.0 million in cash and cash equivalents, and short-term investments as
compared to $15.8 million at December 31, 1998.
In the first nine months of 1999, the Company used cash in operating activities
of $2,455,704. Uses of cash include a $3,050,965 net loss, $927,124 for
long-term installment receivable, $237,216 for unbilled accounts receivable and
$100,703 reduction in warranty accruals. Uses of cash were partially offset by
cash provided from the $1,251,143 reduction in accounts receivable, $473,639 in
non-cash adjustments provided by depreciation and amortization of fixed assets
and intangible assets, and $266,532 in the increase in accrued liabilities.
The Company provided $2,358,828 in cash from investing activities, of which
$2,141,918 was provided by the sale of short-term investments. In addition,
$871,652 was provided by the deferral of revenues associated with after sales
support agreements implemented in the third quarter of 1999. Cash used for
investing activities was $350,658 for the increase in other assets and $304,084
for the purchase of capital equipment in the first nine months of 1999.
The Company used $632,559 in cash from financing activities in the first nine
months of 1999, resulting principally from $740,154 in cash used to repurchase
the Company's Common Stock. This was partially offset by $128,132 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 nine months of 1998, the Company used cash in operating activities
of $2,706,013. Uses of cash include a $1,544,570 net loss, $913,468 increase in
accounts receivables, $452,250 decrease in payroll and related costs, $141,913
reduction in the accrued warranty charges and $127,838 decrease in accounts
payable. Uses of cash were partially offset by $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 for purchases under the Company's ESPP plan and matching
contributions to its 401 (k) plan, offset partially by $22,264 in cash used in
the repayment of capital lease obligations.
At September 30, 1999, the Company's principal sources of liquidity consisted of
$13.0 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. Any advances made to the Company are secured by a security
interest in the Company's assets. The Agreement expires in December 1999. At
September 30, 1999, there were no borrowings outstanding under the Agreement.
The Company was in compliance with the financial covenants that require that the
Company maintain a quick assets ratio of not less than 1.75 to 1 and maintain a
ratio of total liabilities to tangible net worth of not more than .75 to 1. The
Company was not in compliance with covenants that require it to maintain a
tangible net worth of not less than $18,000,000 and not incur a net loss (after
taxes) for the fiscal year ending December 31, 1999 in excess of $2.0 million.
The Company anticipates renewing or entering into a new line of credit with
revised covenants during the fourth quarter of 1999 with which it will be
compliant.
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The Company's principal commitment at September 30, 1999 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 1999.
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 PatientNet Systems. Since 1995,
the Company's sales levels for its Networked 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 PatientNet Systems in future
periods, the Company's business, operating results and financial condition will
continue to be materially adversely affected.
Introduction of New Product - PatientNet 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 - "PatientNet, an enterprise monitoring
solution for the electronic hospital". The new PatientNet System for the
e-Hospital will replace the Company's existing product line of Networked
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 Networked 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 Networked Monitoring Systems sold by the Company's
direct sales force are recognized upon shipment. Revenues from sales of its
PatientNet 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 PatientNet 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 fourth quarter 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
fourth quarter of 1999. During the third quarter of 1999, the Company recognized
its first two after sale support agreements and the balance sheet reflects both
the short and long-term effects of accounting for arrangements under SOP 97-2.
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 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 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.
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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 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 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 Networked
Monitoring Systems has typically been nine to eighteen 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.
Transfer of Securities from the Nasdaq National Market to the Nasdaq
SmallCap Market and Possible Delisting of Securities from the Nasdaq Small Cap
Market. The Company's Common Stock historically traded on the Nasdaq National
Market and was moved to the Nasdaq Small Cap Market during the third quarter of
1999 as the Company did not meet one National Market continued listing
requirement that the market value of publicly held shares must be at least $5
million. The Nasdaq Small Cap Market's continued listing standards require the
Company to have (i) at least 500,000 shares publicly held; (ii) a market value
of publicly held shares of at least $1 million; (iii) net tangible assets of at
least $2 million; (iv) at least 300 shareholders of round lots; (v) at least two
market makers and (vi) a minimum bid price of at least $1 per share. If the
Company fails to comply with the listing standards, it may become delisted from
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 Networked 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 currently available open system multi-parameter system which is
directly competitive with the Company's Networked Monitoring Systems, 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 customers 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
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or more of such OEM customers could have a material adverse effect on the
Company's business, operating results and financial condition.
In addition, the Company may in the future elect to incorporate in its OEM
products the hardware and software for larger networks and 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 Networked Monitoring Systems because the Networked 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 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%, 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 nine months
ended September 30, 1999, Quinton Instrument Company and Datascope Corporation
accounted for approximately 20% and 37%, 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
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. The
implementation of the Balanced Budget Act of 1997, effective January 2000, which
includes reductions in Medicare reimbursements to hospitals, may result in
reduced capital equipment and operating budgets for many hospitals. 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
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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 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 withhold approval or request
additional information. 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 public commentary period for the proposed rule has been
closed. It is anticipated that the final ruling would be made during the first
or second quarter of 2000. In the
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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 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 has incurred
warranty expenditures for upgrades that adversely affected the Company's results
of operations. 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 Networked 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 Networked 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,
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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 Networked Monitoring customers have received a technical
bulletin explaining the status of the Company's Y2K compliance requirements and
applicable workarounds, if necessary. The Company also expanded its testing
beyond the generally accepted Y2K criteria enumerated above to include testing
for dates of January 1, 2001 and beyond. 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 a 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 Networked
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 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
virtually all 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.
18
<PAGE> 19
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 September 30, 1999, the
Company had spent less than $50,000 on 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
September 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
September 30, 1999. The Company's market risk disclosures are not material and
are therefore not required.
19
<PAGE> 20
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.
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 November 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
- ------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
22
<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> SEP-30-1999
<CASH> 9,731
<SECURITIES> 3,227
<RECEIVABLES> 3,711
<ALLOWANCES> (347)
<INVENTORY> 1,349
<CURRENT-ASSETS> 18,031
<PP&E> 4,177
<DEPRECIATION> (2,673)
<TOTAL-ASSETS> 21,379
<CURRENT-LIABILITIES> 2,699
<BONDS> 0
0
0
<COMMON> 37,589
<OTHER-SE> (19,790)
<TOTAL-LIABILITY-AND-EQUITY> 21,379
<SALES> 3,765
<TOTAL-REVENUES> 3,765
<CGS> 2,133
<TOTAL-COSTS> 2,133
<OTHER-EXPENSES> 3,343
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (289)
<INCOME-PRETAX> (1,422)
<INCOME-TAX> 9
<INCOME-CONTINUING> (1,431)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,431)
<EPS-BASIC> (0.18)
<EPS-DILUTED> (0.18)
</TABLE>
