<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Fiscal Year Ended December 31, 1996
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 0-19943
PROTOCOL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Oregon 93-0913130
______ __________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8500 SW Creekside Place, Beaverton, OR 97008
____________________________________________
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (503) 526-8500
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 $.01 per share
_______________________________________
(Title of Class)
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. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 14, 1997 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $81,884,393. There were 8,796,259 shares
of Common stock of the registrant outstanding at March 14, 1997.
Documents Incorporated by Reference
___________________________________
Part of Form 10-K Into
Document Which Incorporated
________ ____________________
Portions of the 1997 Proxy Statement Part III
<PAGE>
Part I
ITEM 1. BUSINESS
GENERAL
Protocol Systems, Inc. was incorporated in Oregon in November 1985, and made
its first commercial shipment of patient monitors in February 1988. Since
that date, the Company has sold over 40,000 vital signs monitors. In March
1992, the Company completed its initial public offering. The Company's stock
trades on the Nasdaq Stock Market under the symbol PCOL.
The Company designs, manufactures and markets patient monitoring instruments
and systems utilizing innovative design, advanced software concepts and leading
electronic technology. Protocol's products are designed to address hospitals'
needs for more efficient and flexible utilization of patient monitoring
equipment. The Company's Propaq monitors, including the 100 Series Propaq
monitors and the Propaq Encore (200 Series) monitors, combine multiple
physiologic measurement and display capabilities in a single lightweight, rugged
instrument, permitting the use of the monitor in a variety of patient care
applications. The Company's Acuity System further increases monitoring
flexibility by allowing a clinician to observe and control up to 60 Propaq
monitors from a dedicated UNIX-based workstation.
The Company operates in a single industry segment: the design, manufacture,
sale and servicing of medical instruments and systems. Sales of the Company's
products by geographic region are shown in the notes to the consolidated
financial statements.
On July 10, 1996, the Company completed the acquisition of Pryon Corporation
("Pryon"), a supplier of capnography (CO2 monitoring) products to medical
instrument manufacturers. Capnography is the measurement and graphical
display of carbon dioxide concentration, or partial pressure appearing at a
patient's airway. Pryon designs, manufactures and markets both mainstream and
sidestream sensors and instrumentation to monitor end-tidal carbon dioxide
levels present in the respired breath of critically ill and other patients.
This CO2 data, coupled with other clinical signs and information, provides
clinicians with a noninvasive means to assess the patient's ventilation,
perfusion and circulatory status. Since 1989, Pryon has sold over 20,000 CO2
monitoring systems.
MARKET FOR PATIENT MONITORING EQUIPMENT
The 1996 worldwide market for patient monitoring equipment was estimated to
be $1.85 billion annually. The principal purchasers of patient monitoring
products are hospitals; other customers include outpatient surgery centers,
subacute care centers, clinics, physician offices and emergency
transportation units.
Patient monitoring products measure, display and document physiologic
information obtained from sensors attached to the patient. Measured
parameters include electrocardiogram (ECG), invasive and non-invasive blood
pressure, pulse rate, pulse oximetry, body temperature, respiration rate,
end-tidal CO2 and other specialized parameters. Products vary from
specialized single-parameter instruments to monitors with the ability to
measure multiple parameters and interface with other instruments.
<PAGE>
PATIENT MONITORING MARKET SEGMENTS
The patient monitoring market may be divided into five segments: portable
bedside monitors, low-end systems, high-end systems, telemetry systems, and
stand-alone monitors. The segments are distinguished by the intensity and
duration of the monitoring, the acuity of the patient's condition and the
level of nursing attention devoted to each patient.
PORTABLE BEDSIDE MONITORS. Portable monitors are freestanding and movable
and typically measure multiple parameters. They are carried or wheeled with
the patient, often while he or she is being transported to or within the
hospital. They may also be left at the patient's bedside, providing
continuous longer-term monitoring when the patient's condition warrants. When
monitoring is no longer required, the monitor can be easily moved to a new
location or patient. The Company has been a leader in the development of the
portable bedside monitoring segment since its introduction of the highly
portable, multiple-parameter Propaq monitor in 1988.
HIGH-END SYSTEMS. High-end systems monitors are normally large, permanently
located adjacent to a particular hospital bed and connected to a central
monitoring station for observing multiple patients. They are used most often
in intensive care units (ICU's) where hospitals care for their more acutely
ill patients, maintain the highest nurse-to-patient ratios and provide for
constant patient monitoring. The Propaq Encore monitor and the March 1996
introduction of Acuity System software version 3.1 allow the Company to
compete in certain segments of the high-end systems market. The neonatal,
impedance respiration and 5-lead ECG capabilities of the Propaq Encore
monitor and the central monitoring capability of the Acuity System provide a
monitoring system which is suitable to neonatal, pediatric and adult
respiratory ICU applications.
LOW-END SYSTEMS. As medical monitoring manufacturers began to network their
portable bedside monitors, the low-end systems market segment emerged. These
systems allow for cost-effective, continuous monitoring of non-ICU patients.
The Company's Acuity System, with its central monitoring capability, is
designed to meet the requirements of this market segment. Subsequent
enhancements to the Acuity software, including arrhythmia detection and
96-hour full disclosure capabilities, have expanded the potential
applications for the Company's monitoring system.
TELEMETRY SYSTEMS. A telemetry system typically consists of a small unit worn
by the patient which transmits ECG data via telemetry to a central monitoring
station. They are used in situations, such as post-coronary care, where the
patient is allowed freedom of movement as part of the recovery process. The
Company's Protocol Cordless monitoring system provides such ECG telemetry
monitoring for ambulating patients.
STAND-ALONE MONITORS. This market segment includes stand-alone units which
are not connected to a central monitoring station. They are often used in
areas such as operating, emergency and recovery rooms as well as labor and
delivery units. In these environments, the monitoring needs arise from
specific procedures and the care giver is closely involved with the patient.
While some stand-alone monitors include multiple physiologic capabilities,
many measure only one parameter.
PRODUCTS
The Company believes that its products presently address approximately $1.1
billion of the $1.85 billion annual worldwide patient vital sign monitoring
market. The Company's highly portable multiple-parameter monitors and ECG
telemetry transmitters networked to Acuity System central workstations allow
hospitals to realize the benefits of Flexible Monitoring. Flexible Monitoring
allows hospitals to constantly reconfigure their monitoring capability in
order to match vital signs monitoring with patient acuity levels in the most
cost-effective way without compromising the quality of patient care.
<PAGE>
PROPAQ MONITORS AND OPTIONS. The Company's principal product line, Propaq
portable patient monitors, is used in hospitals, outpatient surgery centers,
clinics, physician offices and emergency transportation units to obtain and
display current physiologic patient information. This information enables
health care providers to continuously evaluate the patient's condition and to
assist the clinician in determining the proper medication or treatment
necessary to promote the patient's recovery. Propaq monitors lead the
industry in terms of weight, durability and battery life for any comparably
configured monitor. Propaq 100 Series monitors are available in multiple
configurations and can measure ECG; blood pressure, both invasively and
non-invasively; arterial blood oxygen saturation level (pulse oximetry);
end-tidal CO2 (ETCO2); and body temperature. Propaq monitors are available in
five languages: English, German, French, Spanish and Japanese.
The Company introduced the second generation Propaq monitor, the Propaq
Encore, in 1995. The Propaq Encore retains all of the monitoring capabilities
and portability of the 100 Series Propaq monitor. In addition, the Propaq
Encore monitor provides a brighter, higher resolution display, an enhanced
user interface, respiration monitoring using impedance pneumography and
diagnostic level 5-lead ECG monitoring capability. Propaq Encore monitors can
be configured to monitor adults or infants and neonates. The neonatal market
represents an estimated $100 million market not previously addressed by the
Company's products. The Company received clearance from the FDA to market the
adult/pediatric and neonatal versions of the Propaq Encore in the United
Sates in June 1995 and February 1996, respectively.
The Company expects to introduce the Modem Propaq monitor in the second
quarter of 1997. This monitor will provide the functionality of the Propaq
100 series and Propaq Encore monitors and will be able to transmit multiple
patient vital signs data via modem to the Acuity System.
ACUITY SYSTEM. The Acuity System is the product of a co-development effort
with Massachusetts General Hospital and was introduced by the Company in
1991. The Acuity System combines networked Propaq monitors and Protocol
Cordless transmitters with a Sun Microsystems, Inc. workstation and
proprietary Protocol software to monitor the vital signs of up to 60 patients
simultaneously. The Company's software controls the networked Propaq monitors
and Protocol Cordless transmitters with an easy-to-understand graphical user
interface display on a high-resolution color CRT screen. The Acuity System
utilizes a map to display the physical layout of the individual hospital
floor. Remote diagnostic capabilities enable the Company's service and
support personnel to evaluate system performance without user interruption
and provide timely service response. The Acuity System software is available
in three languages: English, German and French.
Central station monitoring generally has been limited to intensive care
environments in which systems monitors are permanently wired to a central
station. Propaq monitors, however, can easily be connected to the Acuity
System as the hospital's needs dictate through the use of a simple snap-in
modular plug similar to a telephone jack. The portability of Propaq monitors
and ease with which they may be connected to the system reduces the number of
monitors the hospital would otherwise need to cover a large number of beds.
The full disclosure software version for the Acuity system provides the
ability to capture and later retrieve each second of patient vital signs data
for the previous 96-hour period. The system captures all monitored vital sign
parameters for each patient being monitored by compressing the vital sign
data and archiving it for later retrieval and analysis.
The arrhythmia detection software option enables the system to detect various
types of ventricular and life-threatening arrhythmias in a patient, classify
the detected arrhythmias by category and provide an alarm when appropriate.
Arrhythmia detection is often used in areas of the hospital such as emergency
departments, cardiac telemetry units, step-down units and intermediate or
transitional care units.
<PAGE>
PROTOCOL CORDLESS TELEMETRY SYSTEM. The telemetry option provides wireless
communication of ECG signals by radio frequency (RF) waves from a portable
transmitter, generally worn by an ambulating patient, to a Propaq monitor
equipped with a built-in receiver and antenna. The receiving monitor may be
networked to the Acuity System for display of the telemetry data at the
central monitoring station. In March 1996 the Company introduced Protocol
Cordless telemetry directly from the transmitter to the Acuity central
workstation. This added capability significantly broadens the scope of
telemetry applications which the Company's products address.
OEM PRODUCTS. Pryon manufactures solutions for CO2 monitoring applications
that include mainstream and sidestream CO2 sensors for OEM applications and
stand-alone monitors for both OEM and direct distribution channels. Pryon
also manufactures a line of consumable products that are used in conjunction
with its CO2 sensors.
Pryon offers a sidestream CO2 sensor and related hardware and software on an
OEM basis for use with non-intubated patients in applications such as
post-ventilator patient assessment, conscious sedation, acute asthma
assessment in the emergency room, assessment of patient conditions on BiPAP
and other applications. The mainstream CO2 sensors are sold through the OEM
channel and are used in hospital venues for intubated patients.
Pryon manufactures the SC-300 CO2 Monitor, a stand alone instrument that
incorporates both mainstream and sidestream CO2 monitoring modalities. A
follow-up product, the SC-210 CO2 Monitor, was introduced in August 1995.
This device utilizes the SC-300 platform and provides sidestream monitoring
only and is thus a more cost effective alternative for those customers
requiring CO2 monitoring for non-intubated patients only. Pryon also
manufactures for Nellcor Puritan Bennett a complete standalone instrument
that incorporates Nellcor Puritan Bennett's oximetry and Pryon's CO2
capability.
MARKETING AND DISTRIBUTION
DOMESTIC. The Company markets its products domestically through both
Company-employed sales representatives and independent distributors. The
Company's five domestic sales managers supervise 37 direct sales
representatives, 4 independent representatives, and 2 independent
distributors, each with the non-exclusive right to sell the Company's
products in a defined geographic area. The Company intends to continue to use
a combination of direct sales representatives and independent distributors
based on the most effective sales approach for each territory.
The Company's primary market in the United States consists of approximately
6,000 hospitals, where its products are purchased for use in emergency
departments, operating rooms, post-anesthesia care units, step-down intensive
care units, special procedure rooms such as cardiac catheterization and
gastrointestinal endoscopy, labor and delivery, general-care floors, and for
transport of patients between departments.
In 1990, the General Services Administration approved the Company's Propaq
monitors for purchase by United States government agencies, including the
armed forces and Veterans' Administration hospitals. The Company's products
were added to the U.S. Government's international supply schedule in 1992. In
September 1995, the Company received approval from the U. S. Air Force for
in-flight use of the 100 Series Propaq monitor.
The Company has three full-time national accounts sales managers and has
entered into many group contracts with organizations such as AmeriNet,
University Hospital Consortium (UHC), Kaiser Permanente and others. In June
1995, the Company was exclusively awarded the Seal of Acceptance by the
Alliance of Children's Hospitals Inc., a cooperative of 33 children's
hospitals across the U.S. In September 1996, Protocol was awarded a sole
source contract for non-critical care physiological monitoring by MAGNET, a
948-hospital group purchasing organization (GPO) based in Pennsylvania. A
similar sole source renewal was signed with Sisters of the Sorrowful Mother,
a major Catholic GPO. The Company now has group contracts which include more
than half of the acute care hospitals in the U.S.
<PAGE>
INTERNATIONAL. The Company markets its products internationally through
independent distributors covering all major European and Pacific Rim markets
and has sold its products in over 80 countries. The agreements with these
distributors generally provide the exclusive right to sell the Company's
products in a specific geographic area or country subject to certain
performance requirements. A team of five international sales managers
supervise, assist and train this network of international distributors.
International sales are made in U.S. dollars to reduce foreign currency risk.
The Company believes that its ability to provide monitors in English, German,
French, Spanish or Japanese is an important international marketing advantage.
OEM. Pryon's marketing strategy is to establish and develop OEM customer
relationships with U.S. and international patient monitoring systems
manufacturers. Pryon's customers include Nellcor Puritan Bennett, SpaceLabs
Medical, Medical Data Electronics, Hellige GmbH, Nihon Kohden, NEC, Schiller
AG., G. Stemple GmbH and others.
In January 1990, the Company entered into a development and supply agreement
with Gensia Sicor, Inc. (Gensia). Under this agreement, the Company has
developed a closed-loop drug delivery and monitoring device ("GenESA
device"). The GenESA device will be used in combination with Gensia's novel
drug "Arbutamine" for the diagnosis of coronary artery disease in conjunction
with three major diagnostic modalities: electrocardiography (ECG),
echocardiography, and radionuclide perfusion imaging. OEM sales of this
device to Gensia began in the fourth quarter of 1994 with delivery of pilot
production units. In December 1994, Gensia received a recommendation for
approval from the European Committee for Proprietary Medicinal Products to
market the GenESA device to European countries. Full production of the device
for the European market began in early 1995. Production of the GenESA device
for the domestic market must await market clearance by the FDA.
CUSTOMER SUPPORT. The Company maintains a technical support group to provide
clinical in-service, installation, repair and technical training services in
support of both direct and distributor sales. Technical support offices are
currently maintained in Beaverton, Oregon, the United Kingdom, Germany and
Asia/ Pacific (New Zealand). In addition, the Company provides maintenance
and repair classes for distributors and the biomedical engineering personnel
of its hospital customers. The services of Sun Microsystems and its
third-party maintenance affiliates are available to support the Acuity
System. Pryon provides its OEM customers technical support from their offices
in Menomonee Falls, Wisconsin.
WARRANTIES. The Company warrants its Propaq products sold in the United
States and Canada for three years from the date of original delivery to the
ultimate purchaser and for one year if sold outside North America. A 90-day
warranty is provided on accessories included with the products at the time of
purchase. Sales of the Acuity System are warranted for a one-year period.
Pryon offers warranties between 9 and 15 months for OEM products and 12
months for stand-alone products. Optional extended warranty contracts are
available for all Propaq products, the Acuity system and Pryon products at
additional cost.
BACKLOG. Most customer orders are filled within 30 days of order receipt. As
a result, order backlog is normally less than one month's production. Due to
these factors, the Company does not believe backlog is an accurate indication
of future sales.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts at both the Beaverton, Oregon
and Menomonee Falls, Wisconsin locations focus on developing new products and
expanding the capabilities of existing products. The Company's research and
development staff consists of 88 individuals with collective expertise in
analog and digital circuit design, software design, networking and
communications, mechanical and packaging design, mathematics, medical and
clinical sciences, and optics and display technology. During 1996, 1995 and
1994, research and development expenses, net of reimbursed expenditures, were
$8.7 million, $6.2 million and $4.8 million, respectively. Reimbursed
research and development expenditures under the joint development agreement
with Gensia were $54,000, $88,000 and $443,000 in 1996, 1995 and 1994,
respectively.
<PAGE>
The Company has taken a leadership role in the Andover Working Group (AWG)
and CORBAmed, two industry organizations that are dedicated to the goal of
interoperability between different hospital computer systems. Using the
standards adopted by CORBAmed and AWG, Protocol will be able to transmit
Acuity System data to any system that adheres to the adopted standards and is
also programmed to utilize the kind of data the Acuity System generates. This
capability provides a seamless exchange of data between the Flexible
Monitoring system and hospital information systems. First demonstrated in
October 1996 and February 1997 at industry conferences, the capability is
expected to be included in the Acuity System communications option and
available for customer shipments in late 1997.
MANUFACTURING
Protocol's manufacturing operations consist of procurement and inspection of
components, final assembly of electronic components and extensive testing of
finished products. The Company uses subcontractors for the fabrication and
assembly of printed circuit boards. By using this approach, the Company
reduces its capital and employee requirements and can more easily and rapidly
adopt emerging manufacturing technologies.
The Company currently procures all of its parts from outside suppliers and
relies upon a number of single-source suppliers to provide certain parts for
its products, including the pulse oximetry and EL display subassemblies. To
date, the Company has been able to obtain the necessary parts to meet
manufacturing requirements. There can be no assurance, however, that supply
shortages or interruptions will not arise in the future, which could increase
the cost or delay the shipment of the Company's products or cause the Company
to incur costs to develop alternative sources, either of which could have a
material adverse effect on the Company's results of operations.
Protocol typically purchases components pursuant to open purchase orders
placed from time to time in the ordinary course of business and has no
forward purchasing or other arrangements with its suppliers. In order to
reduce the risk of supply interruption, the Company maintains close working
relationships with its suppliers and may choose to inventory selected
components.
Quality and reliability are emphasized in the design and manufacture of the
Company's products. The Company believes it manufactures its products
according to criteria that meet or exceed the requirements of all applicable
domestic and foreign regulations and standards. The Company's products
undergo thorough quality inspection and testing throughout the manufacturing
process. In addition, Protocol's quality assurance group inspects, operates
and verifies calibration and conformance with the customer order of all
products prior to shipment.
The Company's Beaverton, Oregon manufacturing facility received notification
of ISO 9001 certification in March 1997, an upgrade to the ISO 9002
certification received in May 1995 for the production of patient vital signs
monitoring systems and closed-loop drug delivery/vital signs monitoring
systems for diagnosis. In September 1995, the Company successfully completed
a combined Premarket Approval (PMA) and Good Manufacturing Practices (GMP)
audit by the FDA. The PMA audit centered on the Company's manufacturing
process for the GenESA device. The GMP audit reviewed manufacturing practices
at the Company's Beaverton, Oregon manufacturing facility. The combined audit
was completed with no adverse observations and without the issuance of Form
483.
Pryon manufactures and assembles its products at its facility in Menomonee
Falls, Wisconsin. Pryon made significant capital and other investments to
enhance its manufacturing process and systems including production specific
systems, computerized in-process test stations, automatic computerized
calibration, specialized test fixtures and an airway adapter test system. In
addition, Pryon made a significant investment in personnel and systems in the
areas of quality, regulatory and documentation control. As a result of these
efforts, Pryon received ISO9001 and EN 46001 certifications in November 1995,
and achieved self-certification status per Annex II of the Medical Device
Directive in June 1996. Pryon completed a GMP audit in October 1996. This
audit, as well as previous GMP audits, was completed with no adverse findings
and without the issuance of Form 483.
<PAGE>
COMPETITION
The patient monitoring products market is intensely competitive and
characterized by rapidly evolving technology. Selling its products in
multiple market segments, the Company faces a broad range of competitors,
many of which have financial, technical, research and development and
marketing resources significantly greater than those of the Company. The
Company's principal competitors are Datascope Corporation, Hewlett-Packard
Co., Marquette Electronics, Inc., Medical Data Electronics, Inc., Siemens
Medical Electronics, and Spacelabs Medical, Inc. Pryon's competitors include
Novametrix, Andros and Spegas. In addition to the Company's existing
competitors, other medical and electronic equipment companies could enter the
markets in which the Company competes.
The Company believes that the principal competitive factors in its market are
product depth and breadth, individual product features, reliability, customer
service, product reputation, price and effectiveness of marketing and sales
efforts. In addition, the Company believes that the speed with which
companies can identify medical needs and anticipate evolving standards of
care, develop products to meet those needs and standards, and supply
commercial quantities to the market are important competitive factors. The
Company believes that it competes favorably with respect to these factors.
PATENTS, TRADEMARKS AND COPYRIGHTS
The Company owns or has rights to nine U.S. patents, and has six U.S. patent
applications pending related to the design and manufacture of patient
monitoring instruments. The Company owns or has the rights to six foreign
patents. The Company also owns nine U.S. registered trademarks, has three
U.S. trademark registration applications pending, owns seven registered
trademarks in various countries and has two foreign trademark applications
pending. In addition, the Company holds copyrights with respect to its
proprietary software. Pryon owns or has the rights to two U.S. patents.
Although the Company has such proprietary rights, it believes that its
success depends more upon the innovative skills and technical competence of
its management and employees in responding to customer needs and changing
markets than upon ownership of such rights.
GOVERNMENT REGULATION
The manufacture and sale of the Company's products are subject to substantial
regulation by numerous governmental authorities, principally the FDA and
corresponding foreign agencies. Protocol is subject to FDA regulations,
standards and procedures with respect to registration of the Company's
manufacturing facilities and the manufacture of its medical devices and to
periodic FDA inspection for compliance therewith. The FDA also has broad
regulatory powers with respect to pre-clinical and clinical testing of new
medical devices and the manufacturing, marketing and advertising of medical
devices.
The Company is also subject to regulation in the foreign countries in which
it markets its products. Many of the regulations applicable to the Company's
products in such countries are similar to those of the FDA. However, certain
foreign regulatory agencies establish product standards and qualification
requirements for medical devices which are different from, and in some cases
more stringent than, those in the United States.
The Company has received certification that the 100 Series Propaq monitor,
the Propaq Encore monitor, and the SC-300 and SC-210 stand alone monitors
meet the essential requirements of the Medical Device Directive of the
European Union. This certification authorizes the Company to display the CE
mark on its Propaq monitors and to sell Propaq monitors in the various
countries of the European Union. Prior to obtaining this certification, the
Company was required to obtain product approvals from each of the pertinent
regulatory agencies of the individual countries of the European Union.
<PAGE>
Federal and foreign regulations regarding manufacture and sale of products
such as those of the Company, as well as regulations and practices regarding
the reimbursement of hospitals and other health care providers for the cost
of service rendered, are subject to change. Although the Company cannot
predict what impact, if any, such changes might have on its business, it is
possible that any such changes could adversely affect the Company's business.
EMPLOYEES
As of December 31, 1996, the Company had 401 employees, including 88 in
research and development, 163 in manufacturing, 103 in marketing and sales
and 36 in administration. The Company's future success will depend, in part,
on its continued ability to attract and retain qualified personnel. None of
the Company's employees are represented by collective bargaining groups and
the Company considers its relationships with employees to be good.
ITEM 2. PROPERTIES
The Company's principal offices are located in Beaverton, Oregon and
Menomonee Falls, Wisconsin. The Company leases approximately 75,000 square
feet at the Beaverton, Oregon location under a lease that expires in December
2000. The lease for 26,000 square feet at the Menomonee Falls, Wisconsin
facility expires in June 1997. The primary manufacturing, warehousing,
research and development, sales, marketing and administrative activities of
the Company are conducted from these facilities which are nearly fully
utilized and are maintained in good condition. The Company believes that the
properties subject to the lease and additional office space available under
lease options will be sufficient to accommodate its operations for the near
term.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1996.
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's common stock began trading on the Nasdaq Stock Market under the
symbol PCOL on March 24, 1992 following the Company's initial public
offering. As of March 14, 1997, there were 197 stockholders of record of
Protocol common stock and approximately 4,900 beneficial owners of common
stock. No cash dividends have been paid on the common stock and the Company
does not anticipate paying any cash dividends in the foreseeable future.
Following are the range of the high and low sales prices for the Company's
common stock as reported by Nasdaq:
1996--QUARTER ENDED: HIGH LOW
- ---------------------- -------- ---------
December 31, 1996.............................. $15.75 $ 10.00
September 30, 1996............................. 23.25 15.25
June 30, 1996.................................. 26.38 15.63
March 31, 1996................................. 17.50 10.50
1995--QUARTER ENDED: HIGH LOW
- ---------------------- -------- ---------
December 31, 1995.............................. $11.50 $ 9.88
September 30, 1995............................. 11.88 9.25
June 30, 1995.................................. 13.00 8.50
March 31, 1995................................. 12.00 8.75
During 1996, the Company sold securities without registration under the
Securities Act of 1933, as amended (the "Securities Act") upon the exercise
of certain stock options granted under the Company's stock option plans. An
aggregate of 44,112 shares of Common Stock were issued at exercise prices
ranging from $1.32 to $9.00. These transactions were effected in reliance
upon the exemption from registration under the Securities Act provided by
Rule 701 promulgated by the Securities and Exchange Commission pursuant to
authority granted under Section 3(b) of the Securities Act.
<PAGE>
Item 6. Selected Financial Data
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1996 1995 1994 1993 1992
- ---------------------------------- ----- ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Operations Data
Sales.................................... $66,894 $ 59,602 $ 48,158 $ 43,327 $ 32,157
Income from operations................... 5,005 6,010 4,098 3,823 1,630
Income excluding acquisition and
litigation charges (net of related
tax effects)........................... 6,374 5,398 3,434 2,954 1,303
Income before extraordinary item and
cumulative effect of change in
accounting principle................... 4,078 5,398 3,434 2,954 1,303
Net income............................... 4,078 5,398 3,434 3,054 1,346
Per Share Data
Net income per common and common
equivalent share excluding acquisition
and litigation charges (net of related
tax effects)........................... $ .68 $ .60 $ .40 $ .34 $ .17
Net income per common and common
equivalent share before extraordinary
item and cumulative effect of
change in accounting principle......... .44 .60 .40 .34 .17
Net income per common and common
equivalent share....................... .44 .60 .40 .35 .17
Weighted average number of common and
common equivalent shares outstanding... 9,373 9,010 8,653 8,644 7,837
Dividends declared....................... -- -- -- -- --
Balance Sheet Data
Cash and investments..................... $22,703 $ 24,267 $ 23,719 $ 19,466 $ 22,882
Working capital.......................... 43,783 30,853 33,352 30,399 25,076
Total assets............................. 59,045 57,220 48,196 42,213 37,607
Long- term debt and capital lease
obligations, excluding current
maturities............................ -- 1,795 156 387 568
Shareholders' equity..................... 51,309 46,793 39,426 34,733 30,984
</TABLE>
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ACQUISITION OF SUBSIDIARY
On July 10, 1996, the Company completed the acquisition of Pryon Corporation
(Pryon), a supplier of CO2 monitoring products to medical instrument
manufacturers. The Company issued 1,211,100 shares of the Company's common
stock in exchange for all of the outstanding capital stock of Pryon. In
addition, the Company issued options to purchase 121,159 shares of the
Company's common stock in replacement of options to purchase Pryon common
stock which were outstanding immediately prior to the acquisition. Charges of
$2.1 million were incurred inconnection with the acquisition which consisted
primarily of investment banking, legal and accounting fees.
The acquisition was accounted for as a pooling of interests and accordingly,
the financial statements of Protocol Systems, Inc., related footnote
disclosures and supplemental financial data have been restated to show the
combined results of the two companies as of the earliest period presented.
The Company continues to operate Pryon as a wholly-owned subsidiary and
continues engineering, manufacturing, and OEM sales activities at Pryon's
current facility in Menomonee Falls, Wisconsin. Further discussion of this
acquisition is included in note 9 of the notes to consolidated financial
statements.
The following discussion and analysis of Results of
Operations for 1995 and 1994 has been restated to address the combined
results of the Company including Pryon.
RESULTS OF OPERATIONS
1996 Compared to 1995
Sales. Sales increased 12.2% to $66.9 million in 1996 from $59.6
million in 1995. Instrument sales (including monitor options) increased by
$7.0 million or 17.6% from 1995. The growth in instrument sales resulted from
increased unit sales of monitors and monitor options as well as increased
average selling prices for monitors. Average selling prices for monitors rose
as unit sales of the Propaq Encore (200 Series) monitor increased and
represented a larger percentage of total monitor unit sales. Sales of the
Propaq Encore monitor, which carries a higher list price than the Company's
100 Series Propaq monitor, began in June 1995. Increases in the sales of
accessories, service, Acuity Systems and GenESA devices also contributed to
the growth in total sales.
Domestic sales, excluding Original Equipment Manufacturer (OEM) sales,
increased 25.1% to $37.7 million (56.3% of total sales) in 1996 from $30.1
million (50.5% of total sales) in 1995. The growth in domestic sales was
attributable to a significant increase in sales to the U.S. military, the
increase in sales of the Propaq Encore monitor, and the growing market
acceptance of the Company's Flexible Monitoring concept which enables
hospitals to maximize patient monitor utilization and reduce overall
monitoring costs.
International sales, excluding OEM sales, increased 13.1% to $18.8 million
(28.1% of total sales) in 1996 from $16.6 million (27.9% of total sales) in
1995. This growth in international sales was principally due to increased
sales to the Company's Japanese distributor and increased sales of the Propaq
Encore monitor. International sales are denominated in U.S. currency.
OEM sales decreased 19.0% to $10.4 million (15.6% of total sales) in 1996
from $12.9 million (21.6% of total sales) in 1995. OEM sales by Pryon
decreased by $2.7 million or 25.7% due to reductions in orders from certain
of its OEM customers. OEM sales of GenESA devices to Gensia Sicor, Inc.
increased 9.6% to $2.4 million in 1996 from $2.2 million in 1995, partially
offsetting the decrease in Pryon's sales. In December 1994, Gensia received a
recommendation for approval from the European Committee for Proprietary
Medicinal Products to market the GenESA device to European countries. Full
production of the device for the European market began in early 1995 while
production of the GenESA device for the domestic market must await clearance
by the FDA.
<PAGE>
Gross Profit. Gross profit as a percentage of sales increased from
53.4% in 1995 to 54.4% in 1996. The increase in gross profit as a percentage
of sales was largely due to the decline in OEM sales as a percentage of total
sales. OEM sales generally have lower margins than sales to end-user
customers.
Research and development. Research and development expenses increased 13.4%
to $8.8 million in 1996 from $7.7 million in 1995. The increase in expenses
consisted primarily of payroll and related costs associated with the
additional engineering headcount required to support the Company's
development activities. In addition, the inclusion of the expenses of the
Company's Northern Ireland subsidiary, Protocol Medical Systems Limited, for
a full twelve months in 1996 also contributed to the increase in expenses.
This subsidiary was acquired on July 31, 1995 and therefore, only a portion
of the year's expenses were included in 1995. As a percentage of sales,
research and development expenses were 13.1% in 1996 and 13.0% in 1995.
Selling, general and administrative. Selling, general and administrative
expenses increased 12.2% to $20.3 million in 1996 from $18.1 million in 1995.
This increase resulted primarily from rising payroll and related costs
associated with the growth of the sales organization, higher administrative
fees paid to hospital buying groups and increased travel costs for the
domestic and international sales organizations. As a percentage of sales,
selling, general and administrative expenses were 30.3% in both 1996 and
1995.
Acquisition related charges. The Company incurred expenses of $2.1 million in
1996 in connection with the acquisition of Pryon. These expenses consisted
principally of fees for investment banking, legal and accounting services as
well as other expenses related to the combination of the two companies.
Litigation settlement charges. In 1996, the Company incurred $275,000 in
expenses in connection with the settlement of litigation regarding the 1991
termination of the Company's former Canadian distributor.
Other Income. Other income (net) increased to $999,000 in 1996 from $916,000
in 1995 primarily due to reduced interest expense on the debt of Pryon.
Following the Company's acquisition of Pryon in July 1996, the outstanding
debt of Pryon was retired.
Provision for income taxes. The provision for income taxes increased to $1.9
million in 1996 from $1.5 million in 1995, representing effective tax rates
of 32.1% and 22.1%, respectively. The increase in the effective tax rate
resulted primarily from the effect of nondeductible charges related to the
acquisition of Pryon and a reduction in the tax benefit from the utilization
of Pryon's net operating loss carryovers.
1995 Compared to 1994
Sales. Sales increased 23.8% to $59.6 million in 1995
from $48.2 million in 1994. Instrument sales (including monitor options)
increased by $4.3 million or 12.3% from 1994. The growth in instrument sales
resulted from increased unit sales of monitors and monitor options as well as
increased average selling prices for monitors. Average selling prices for
monitors increased as a result of the 1995 introduction of the Propaq Encore
(200 Series) monitor, which sells for a higher list price than the Company's
100 Series Propaq monitor. Sales by Pryon to its OEM customers also increased
by $3.5 million or 50.7% in 1995. Sales of GenESA devices, Acuity Systems,
accessories and service also increased over 1994 levels.
Domestic sales, excluding Original Equipment Manufacturer (OEM) sales,
increased 22.7% to $30.1 million (50.5% of total sales) in 1995 from $24.5
million (51.0% of total sales) in 1994. The growth in domestic revenues was
attributable to the success of the Company's Flexible Monitoring concept,
which enables hospitals to maximize patient monitor utilization and reduce
overall monitoring costs, the introduction of the Propaq Encore monitor, and
increased sales to the U.S. military.
International sales, excluding OEM sales, increased 14.4% to $16.6
million (27.9% of total sales) in 1995 from $14.5 million (30.1% of total
sales) in 1994. This increase in international sales was principally
attributable to increased international military sales and the introduction
of the Propaq Encore monitor. International sales are denominated in U.S.
currency.
<PAGE>
OEM sales increased 41.6% to $12.9 million (21.6% of total sales) in 1995
from $9.1 million (18.9% of total sales) in 1994. The increase in OEM sales
was attributable primarily to a $3.5 million increase in sales by Pryon to
its OEM customers. OEM sales of GenESA devices to Gensia Sicor, Inc. of $2.2
million offset a decline in sales to Siemens Medical Electronics from $1.7
million in 1994 to $200,000 in 1995 as a result of Siemens' changing product
strategy. Sales of pilot production GenESA devices to Gensia commenced in
December 1994 and contributed $376,000 to 1994 revenues.
Gross Profit. Gross profit as a percentage of sales increased slightly to
53.4% in 1995 from 53.2% in 1994. Improved manufacturing efficiencies and an
increase in average selling prices for Pryon more than offset the negative
impacts on the gross profit percentage which resulted from an increase in
non-instrument sales as a percentage of total sales, and from sales of the
Propaq Encore monitor which has a lower margin than the Propaq 100 series
monitor. Non-instrument sales such as sales of Acuity Systems, GenESA
devices, and monitor accessories generally carry a lower gross margin than
instrument sales.
Research and development. Research and development expenses increased 25.8%
to $7.7 million in 1995 from $6.1 million in 1994. The increase in research
and development expenses resulted primarily from one-time costs related to
the development and introduction of the Propaq Encore monitor. These costs
included significant expenses incurred to expedite development of this new
product in the first quarter of 1995 as well as costs incurred for safety
testing and certification of this new monitor. Further increases in research
and development expenses resulted from engineering consumption of Propaq
Encore units for ongoing product development efforts and a reduction in
software development costs capitalized. As a percentage of sales, research
and development expenses increased to 13.0% in 1995 from 12.7% in 1994.
Selling, general and administrative. Selling, general and administrative
expenses increased 17.3% to $18.1 million in 1995 from $15.4 million in 1994.
Rising payroll and related costs as well as increased travel costs for the
domestic and international sales organizations were the primary causes of the
increase. One-time advertising and public relations costs of the Propaq
Encore product launch incurred in the second quarter of 1995 as well as
marketing expenses associated with the launch of Pryon's direct products also
contributed to the increase in expenses. As a percentage of sales, selling,
general and administrative expenses decreased to 30.3% in 1995 from 32.0% in
1994.
Other Income. Other income (net) increased to $916,000 in 1995 from $647,000
in 1994 primarily as a result of increased interest income due to higher
interest rates earned on invested balances as well as higher average
investment balances in 1995.
Provision for income taxes. The provision for income taxes increased to $1.5
million in 1995 from $1.3 million in 1994, representing effective tax rates
of 22.1% and 27.6%, respectively. The decrease in the effective tax rate
resulted primarily from the tax benefit of Pryon's utilization of net
operating loss carryovers in 1995 whereas in 1994, net operating loss
carryovers were generated by Pryon with no related tax benefit. The reduction
of valuation reserves against deferred tax assets in 1995 also contributed to
the decrease in the effective tax rate. These factors were partially offset
by the reduction of research and experimentation tax credits allowed in 1995
due to expiration of the tax code provisions allowing for such credits.
<PAGE>
NEW ACCOUNTING PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock Based
Compensation". This statement defines a fair value based method of accounting
for employee stock options or similar equity instruments. However, this
statement allows an entity to continue to measure compensation costs related
to such equity instruments in accordance with the intrinsic value based
method of accounting prescribed by APB Opinion No. 25. Entities which elect
to continue to apply the provisions of APB Opinion No. 25 are required to
make pro-forma disclosures of net income and earnings per share as calculated
using the fair value based method of accounting prescribed by SFAS No. 123.
Such disclosures are included in note 5 of the notes to consolidated
financial statements. Because the Company has elected to continue to account
for stock based compensation in accordance with APB Opinion No. 25,
implementation of this statement did not have a material effect on the
Company's financial position or results of operations.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1996, the Company's financial position remained strong as
cash and investment balances totaling $22.7 million continued to provide the
Company with a substantial source of capital and liquidity. Working capital
balances increased to $43.8 million at December 31, 1996 from $30.9 million
at December 31, 1995 primarily due to a shift in the Company's investment
portfolio towards short-term investments. The change in the mix of long-term
and short-term investments also resulted in an increase in the current ratio
to 7.0:1 at December 31, 1996 from 4.8:1 at December 31, 1995.
Operating activities generated positive cash flows of $3.4 million in 1996
despite a significant increase in inventory balances of $2.6 million which
consists primarily of finished goods inventories. During 1996, significant
cash outlays of $2.5 million were made for the acquisition of property and
equipment and $1.9 million for the retirement of Pryon's long-term debt.
No significant commitments for capital expenditures have been entered into as
of December 31, 1996. However, management will continue to explore
opportunities for strategic relationships with other companies and the
possible acquisition of technologies or businesses, all of which may require
significant future outlays of cash. Management believes that the combination
of current cash and investment balances and cash flows from operations will
be sufficient to meet the Company's liquidity and capital needs for 1997 and
the foreseeable future.
FORWARD-LOOKING STATEMENTS
The Management's Discussion and Analysis of Financial Condition and Results
of Operations and other sections of this Annual Report contain
forward-looking statements within the meaning of the Securities Litigation
Reform Act of 1995 that are based on current expectations, estimates and
projections about the Company's business, management's beliefs and
assumptions made by management. Words such as "expects," "anticipates,"
"intends," "plans," "believes," "seeks," "estimates" and variations of such
words and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, actual outcomes and results may differ materially from
what is expressed or forecasted in such forward-looking statements due to
numerous factors, including, but not limited to those discussed in this
discussion and analysis of financial condition and results of operations, as
well as those discussed elsewhere in the Annual Report and from time to time
in the Company's other Securities and Exchange Commission filings and
reports. In addition, such statements could be affected by general industry
and market conditions and growth rates, and general domestic and
international economic conditions.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
The management of Protocol Systems, Inc. is responsible for the accompanying
consolidated financial statements. These consolidated financial statements
were prepared by management in conformity with generally accepted accounting
principles and necessarily include amounts which are based on management's
best estimates and judgment.
Management is also responsible for maintaining systems of internal control to
provide reasonable assurance that assets are safeguarded, business activities
are executed in accordance with management authorization and transactions are
properly recorded.
The Audit Committee of the Board of Directors is composed of two outside
directors who are not officers or employees of the Company. These directors
meet regularly with management and with the independent auditors to review
matters related to accounting, financial reporting and the Company's systems
of internal control. The independent auditors have free access to the Audit
Committee, without management present, to discuss these matters.
James B. Moon Craig M. Swanson
President, Chief Executive Officer and Vice-President Finance, Chief
Chairman of the Board Financial Officer and Secretary
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of Protocol Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Protocol
Systems, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Protocol
Systems, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996 in conformity with generally
accepted accounting principles.
/s/KPMG Peat Marwick LLP
Portland, Oregon
January 24, 1997
<PAGE>
PROTOCOL SYSTEMS, INC.
Consolidated Statements of Operations
(in thousands except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Sales............................................................................ $ 66,894 $ 59,602 $ 48,158
Cost of sales.................................................................... 30,471 27,793 22,515
--------- --------- ---------
Gross profit........................................................... 36,423 31,809 25,643
Operating expenses:
Research and development expenses........................................... 8,754 7,719 6,134
Selling, general and administrative expenses................................ 20,292 18,080 15,411
Acquisition related charges (note 9)........................................ 2,097 -- --
Litigation settlement charges............................................... 275 -- --
--------- --------- ---------
Total operating expenses............................................... 31,418 25,799 21,545
--------- --------- ---------
Income from operations................................................. 5,005 6,010 4,098
Other income (expense):
Interest income............................................................. 1,156 1,164 822
Interest expense............................................................ (110) (186) (146)
Other....................................................................... (47) (62) (29)
--------- --------- ---------
999 916 647
Income before income taxes............................................. 6,004 6,926 4,745
Provision for income taxes (note 7).............................................. 1,926 1,528 1,311
--------- --------- ---------
Net income............................................................. $ 4,078 $ 5,398 $ 3,434
--------- --------- ---------
Net income per common and common equivalent share...................... $ 0.44 $ 0.60 $ 0.40
--------- --------- ---------
Weighted average number of common and common equivalent shares
outstanding.......................................................... 9,373 9,010 8,653
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
PROTOCOL SYSTEMS, INC.
Consolidated Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
-------- --------
ASSETS 1996 1995
- ------------------------------------------------------------------- -------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents..................................... $ 6,903 $ 3,974
Short-term investments (note 3)............................... 14,787 8,225
Accounts receivable:
Trade, less allowance for doubtful accounts of $252 and
$212 at 1996 and 1995, respectively....................... 14,923 14,727
Other....................................................... 533 700
Inventories (note 2).......................................... 12,416 9,866
Deferred income taxes (note 7)................................ 1,320 1,249
Prepaid expenses and other.................................... 166 298
------- ------
Total current assets..................................... 51,048 39,039
Long-term investments (note 3)..................................... 1,013 12,068
Property and equipment, at cost
Equipment..................................................... 10,180 7,079
Furniture and fixtures........................................ 1,419 1,832
Leasehold improvements........................................ 654 899
------- ------
12,253 9,810
Less accumulated depreciation and amortization................ 7,775 5,962
------- ------
Net property and equipment............................... 4,478 3,848
Software development costs......................................... 446 475
Other assets....................................................... 2,060 1,790
------- ------
$59,045 $57,220
------- ------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 2,480 $ 2,669
Accrued salaries, wages and related liabilities............... 2,514 2,282
Other accrued liabilities..................................... 739 696
Income taxes payable.......................................... 405 1,246
Reserve for warranties........................................ 985 1,053
Deferred revenue and customer deposits........................ 142 140
Current portion, long-term debt............................... -- 100
------- ------
Total current liabilities................................ 7,265 8,186
Long-term debt..................................................... -- 1,795
Deferred income taxes (note 7)..................................... 471 446
Commitments (note 6)............................................... -- --
Shareholders' equity (note 4):
Preferred stock, $.01 par value. Authorized 10,000 shares;
0 shares issued and outstanding at 1996 and 1995........... -- --
Common stock, $.01 par value. Authorized 30,000 shares;
issued and outstanding 8,744 at 1996 and 8,612 at 1995..... 87 86
Additional paid-in capital................................... 34,363 34,052
Unrealized holding gain on investments (note 3).............. 32 46
Retained earnings............................................ 16,721 12,643
Foreign currency translation adjustment...................... 106 (34)
------- ------
Total shareholders' equity............................... 51,309 46,793
------- ------
$59,045 $ 57,220
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
PROTOCOL SYSTEMS, INC.
Consolidated Statements of Shareholders' Equity
(in thousands)
<TABLE>
<CAPTION>
UNREALIZED FOREIGN
COMMON STOCK ADDITIONAL HOLDING GAIN CURRENCY
-------------------------- PAID IN (LOSS) ON RETAINED TRANSLATION
SHARES PAR VALUE CAPITAL INVESTMENTS EARNINGS ADJUSTMENT
----------- ------------- ----------- --------------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993................ 8,223 $ 82 $ 30,842 $ -- $ 3,811 $ --
Common stock issued under stock purchase and
stock option plans........................ 88 1 357 -- -- --
Tax benefit from stock option incentive
plans..................................... -- -- 137 -- -- --
Issuance of common stock.................... 1 -- 996 -- -- --
Unrealized holding loss on investments (note
3)........................................ -- -- -- (233) -- --
Net income.................................. -- -- -- -- 3,434 --
------- ---------- -------- --------- --------- ----------
Balance at December 31, 1994................ 8,312 83 32,332 (233) 7,245 --
------- ---------- -------- --------- --------- ----------
Common stock issued under stock purchase and
stock option plans........................ 155 2 678 -- -- --
Tax benefit from stock option incentive
plans..................................... -- -- 191 -- -- --
Common stock issued for purchase of
subsidiary................................ 145 1 851 -- -- --
Unrealized holding gain on investments (note
3)........................................ -- -- -- 279 -- --
Net income.................................. -- -- -- -- 5,398 --
Foreign currency translation adjustment..... -- -- -- -- -- (34)
------- ---------- -------- --------- --------- ----------
Balance at December 31, 1995................ 8,612 86 34,052 46 12,643 (34)
------- ---------- -------- --------- --------- ----------
Common stock issued under stock purchase and
stock option plans........................ 162 2 948 -- -- --
Tax benefit from stock option incentive
plans..................................... -- -- 531 -- -- --
Vesting of shares issued for purchase of
subsidiary................................ -- -- 92 -- -- --
Repurchase of common stock.................. (30) (1) (1,260) -- -- --
Unrealized holding loss on investments (note
3)........................................ -- -- -- (14) -- --
Net income.................................. -- -- -- -- 4,078 --
Foreign currency translation adjustment..... -- -- -- -- -- 140
------- ---------- -------- --------- --------- ----------
Balance at December 31, 1996................ 8,744 $ 87 $ 34,363 $ 32 $ 16,721 $ 106
------- ---------- -------- --------- --------- ----------
<CAPTION>
TOTAL
SHARE-
HOLDERS'
EQUITY
---------
<S> <C>
Balance at December 31, 1993................ $ 34,735
Common stock issued under stock purchase and
stock option plans........................ 358
Tax benefit from stock option incentive
plans..................................... 137
Issuance of common stock.................... 996
Unrealized holding loss on investments (note
3)........................................ (233)
Net income.................................. 3,434
----------
Balance at December 31, 1994................ 39,427
----------
Common stock issued under stock purchase and
stock option plans........................ 680
Tax benefit from stock option incentive
plans..................................... 191
Common stock issued for purchase of
subsidiary................................ 852
Unrealized holding gain on investments (note
3)........................................ 279
Net income.................................. 5,398
Foreign currency translation adjustment..... (34)
----------
Balance at December 31, 1995................ 46,793
----------
Common stock issued under stock purchase and
stock option plans........................ 950
Tax benefit from stock option incentive
plans..................................... 531
Vesting of shares issued for purchase of
subsidiary................................ 92
Repurchase of common stock.................. (1,261)
Unrealized holding loss on investments (note
3)........................................ (14)
Net income.................................. 4,078
Foreign currency translation adjustment..... 140
----------
Balance at December 31, 1996................ $ 51,309
----------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
PROTOCOL SYSTEMS, INC.
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income....................................................... $ 4,078 $ 5,398 $ 3,434
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.................................. 2,196 1,802 1,551
Amortization of bond premium................................... 398 240 217
Provision for deferred income taxes............................ (125) (390) (163)
Increase (decrease) in cash resulting from changes in:
Accounts receivable........................................ 34 (4,299) (584)
Inventories................................................ (2,530) (1,886) 25
Prepaid expenses and other assets.......................... 148 201 (221)
Accounts payable and accrued expenses...................... 142 428 566
Income taxes payable....................................... (845) 471 120
Reserve for warranties..................................... (70) 75 (48)
Deferred revenue and customer deposits..................... (6) (59) (216)
-------- --------- ---------
Net cash provided by operating activities.................. 3,420 1,981 4,681
Cash flows from investing activities:
Purchase of investments.......................................... (9,683) (25,498) (17,687)
Proceeds from maturity of investments............................ 13,764 22,966 16,612
Acquisition of property and equipment............................ (2,528) (2,228) (1,565)
Expenditures for software development............................ (205) (131) (352)
Acquisition of intangible assets................................. (200) -- (258)
Cash paid for acquisition of subsidiary, net of cash acquired.... -- (237) --
-------- --------- ---------
Net cash provided by (used in) investing activities........ 1,148 (5,128) (3,250)
Cash flows from financing activities:
Proceeds from stock option and stock purchase plan and
related tax benefit............................................. 1,481 871 495
Issuance of common stock......................................... -- -- 996
Repurchase of common stock....................................... (1,261) -- --
Proceeds from long-term debt..................................... -- 1,831 1,200
Principal payments on long-term debt............................. (1,894) (1,571) (494)
-------- --------- ---------
Net cash provided by (used in) financing activities........ (1,674) 1,131 2,197
Effect of exchange rates on cash and cash equivalents................. 35 (6) --
-------- --------- ---------
Net increase (decrease) in cash and cash equivalents....... 2,929 (2,022) 3,628
Cash and cash equivalents at beginning of year........................ 3,974 5,996 2,368
-------- --------- ---------
Cash and cash equivalents at end of year.............................. $6,903 $ 3,974 $ 5,996
-------- --------- ---------
Supplemental disclosures of cash flow information:
Cash paid for interest............................................ $ 119 $ 179 $ 135
-------- --------- ---------
Cash paid for income taxes........................................ $ 2,364 $ 1,255 $ 1,190
-------- --------- ---------
Supplemental schedule of noncash financing activities:
Increase in investment in Protocol Medical Systems, Ltd. due to
release of compensatory shares of common stock from escrow...... $ 91
Fair value of net assets of subsidiary, consisting primarily of
intangible technology assets, acquired by issuance of common
stock and liabilities incurred.................................. $ 754
Equipment capitalized under capital leases............................ $ 135
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
PROTOCOL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Protocol
Systems, Inc. and its wholly owned subsidiaries (the "Company"). All material
intercompany balances and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For purposes of these consolidated financial statements, the Company
considers all highly liquid securities purchased with an original or
effective maturity of three months or less to be cash equivalents.
INVESTMENTS
In accordance with the provisions of Statement of Financial Accounting
Standards No. 115 (SFAS 115), "Accounting for Certain Investments in
Debt and Equity Securities", all investments in marketable securities are
classified as available-for-sale and are reported at their fair market value.
Short-term investments consist of highly liquid securities with maturities of
between three and twelve months from the date of purchase. Long-term
investments consist of highly-rated state and municipal notes and bonds from
a variety of issuers with maturities of greater than one year and less than
two years.
INVENTORIES
Inventories consist primarily of raw materials, work in process, finished
goods and demonstration instruments and are valued at the lower of cost
or market. Cost is determined on the first-in, first-out basis (FIFO).
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. For equipment and furniture and
fixtures, depreciation is computed using the straight-line method over the
estimated useful lives of the assets, generally three to five years.
Leasehold improvements are amortized using the straight-line method over
a period of five years or the life of the lease, whichever is shorter.
Depreciation expense, including amortization of capital leases, totaled
$1,860,000, $1,467,000, and $1,251,000 for 1996, 1995, and 1994,
respectively.
RESEARCH AND DEVELOPMENT EXPENDITURES
The Company capitalizes certain software development costs incurred in
accordance with the provisions of Statement of Financial Accounting
Standards No. 86. These capitalized costs are amortized using the
straight-line method over the estimated economic life of the software,
which is not anticipated to exceed three years. The Company capitalized
software development costs of $205,000, $131,000, and $353,000 in 1996,
1995, and 1994, respectively.
Amortization expense related to capitalized software development costs of
$244,000, $276,000, and $267,000 was recorded in 1996, 1995, and 1994,
respectively. Amortization of capitalized software costs is included in cost
of sales in the consolidated statements of operations. Accumulated
amortization at December 31, 1996 and 1995 was $1,112,000 and $868,000,
respectively.
All other research and development costs are expensed as incurred.
<PAGE>
INTANGIBLE ASSETS
Intangible assets, which are classified as other non-current assets, are
stated at historical cost less accumulated amortization. The Company
purchased intangible assets of $258,000 consisting of patents and related
technology rights in 1994. These assets are amortized using the straight-line
method over their estimated economic lives of ten years for patents and five
years for related technology rights. Accumulated amortization of these assets
was $85,000 at December 31, 1996.
The Company acquired the technology rights to the Universal Defibrillator
Module (UDM), a compact, lightweight, microprocessor-based system, through
its acquisition in 1995 of Protocol Medical Systems Limited, formerly Omeara
Limited. The total value assigned to this asset was $1,560,000. Amortization
of this asset will commence upon the initial sale of a combined
monitor/defibrillator product.
INCOME TAXES
Deferred tax assets and liabilities are established for the temporary
differences between the financial reporting basis and the tax basis of the
Company's assets and liabilities at enacted tax rates expected to be in
effect when such amounts are realized or settled.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's foreign subsidiary, Protocol Medical
Systems Limited, is the local currency. Assets and liabilities of Protocol
Medical Systems Limited are translated into U.S. dollars at the current
exchange rate as of the balance sheet date. Revenues and expenses are
translated using a weighted average exchange rate for the period presented.
Adjustments resulting from the translation of the financial statements of
Protocol Medical Systems Limited are included as a separate component of
consolidated shareholders' equity.
Cash flows from Protocol Medical Systems Limited are calculated using its
functional currency. As a result, changes in assets and liabilities reported on
the consolidated statements of cash flows will not necessarily agree to changes
in the corresponding items on the consolidated balance sheets. The effect of
exchange rate changes on cash balances held in foreign currencies is reported
as a separate line item in the consolidated statements of cash flows.
REVENUE RECOGNITION
Revenue is recognized and all related costs, including warranty, are recorded
upon transfer of title and risk of loss to the customer which generally
occurs upon product shipment.
NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Net income per share is computed using the weighted average number of common
shares outstanding and dilutive common equivalent shares assumed to be
outstanding during the period using the treasury stock method. Common
equivalent shares consist of options to purchase common stock.
USE OF ESTIMATES
These consolidated financial statements were prepared by management in
conformity with generally accepted accounting principles and necessarily
include amounts which are based on management's best estimates and judgment.
Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for 1995 and 1994 to conform to the 1996 presentation.
<PAGE>
STOCK-BASED COMPENSATION PLANS
Prior to 1996, the Company accounted for its stock plans in accordance with
The provisions of Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation
expense would be recorded on the date of grant of an option only if the
current market price of the underlying stock exceeded the exercise price
under the option. Effective for 1996, the Company has adopted Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation", which establishes a fair value method of accounting for stock
plans. As allowed under SFAS No. 123, the Company has elected to continue to
apply the provisions of APB No. 25 to its plans covering employees and
non-employee directors, and to provide pro-forma disclosures of the effects
of SFAS No. 123 on net income and earnings per share.
NOTE 2. INVENTORIES
<TABLE>
<CAPTION>
The components of inventories are as follows:
(in thousands) 1996 1995
---- ----
<S> <C> <C>
Raw materials........................................... $ 4,921 $ 4,106
Work in process......................................... 2,307 2,991
Finished goods.......................................... 3,396 1,013
Demonstration instruments............................... 1,792 1,756
------- -------
Total inventories....................................... $ 12,416 $ 9,866
--------- -------
</TABLE>
NOTE 3. INVESTMENTS
At December 31, 1996, the fair market value of short-term and long-term
investments was $15,800,000 while short-term and long-term investments stated
at amortized cost were $15,768,000 resulting in an unrealized holding gain of
$32,000. At December 31, 1995, the fair market value of short-term and
long-term investments was $20,293,000 while short-term and long-term
investments stated at amortized cost were $20,247,000 resulting in an
unrealized holding gain of $46,000. Unrealized holding gains and losses on
available-for-sale securities are reported as a separate component of
shareholders' equity until realized.
NOTE 4. SHAREHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of $.01 par value
preferred stock. At December 31, 1996, no preferred shares were issued;
however, 100,000 shares of Series D Junior Participating Preferred Stock had
been designated and reserved. Additional series of preferred stock may be
designated and the related rights and preferences fixed by action of the
Board of Directors.
<PAGE>
COMMON STOCK OPTIONS
Pursuant to the Company's 1987 and 1992 stock option plans, the Board of
Directors has the authority to grant incentive stock options. The incentive
stock options vest at a rate of 25% per year, with the Board having authority
to accelerate the vesting schedules. The options expire ten years from the
date of grant. The incentive stock option price is determined by the Board of
Directors, but may not be less than the fair market value of the Company's
common stock on the date of grant.
Non-statutory stock options may also be granted pursuant to the 1992 stock
option plan. The option price for the non-statutory stock options is
determined by the Board of Directors on the date of grant, but may not be
less than the fair market value of the Company's common stock on the grant
date. The outstanding options vest at a rate of 25% per year, with the Board
having authority to accelerate the vesting schedules. Non-statutory options
expire ten years from the date of grant.
Pursuant to the Company's 1993 Stock Option Plan for Nonemployee Directors,
each nonemployee director will receive an initial option to purchase 10,000
shares of common stock immediately following the annual meeting of shareholders
at which such director is first elected to the Board of Directors. The initial
option grant vests ratably over a three year period. Following each subsequent
annual meeting of shareholders, each nonemployee director will receive an
additional option, which is immediately exercisable, to purchase 3,000 shares of
common stock. The option price for the non-statutory stock options granted
pursuant to the plan may not be less than the fair market value of the Company's
common stock at the date of grant. Each option expires ten years from the date
of grant.
As of December 31, 1996, there were 20,419 and 300,781 stock options
available for grant under the 1987 and 1992 option plans, respectively and
269,000 non-statutory stock options available for grant under the 1993 option
plan. The Company has reserved 1,949,503 shares of common stock for future
issuance pursuant to these plans. The following is a summary of option activity
under the Company's option plans:
<TABLE>
<CAPTION>
INCENTIVE NON-STATUTORY
STOCK OPTIONS STOCK OPTIONS
------------------------- ------------------------
<S> <C> <C> <C> <C>
NUMBER PRICE NUMBER PRICE
OF SHARES PER SHARE OF SHARES PER SHARE
---------- ------------- ----------- -----------
Outstanding at December 31,
1993.......................... 826,994 $ .35 -11.13 55,000 $ 7.25 -11.00
Exercised....................... (62,131) 1.32 - 8.75 -- --
Canceled........................ (69,582) 1.95 -11.25 (17,000) 7.25 -7.75
Granted......................... 256,134 .89 -11.25 34,773 7.75 -9.00
---------- ------------- ----------- -----------
Outstanding at December 31,
1994.......................... 951,415 .35 -11.00 72,773 7.25 -11.00
Exercised....................... (97,866) 1.32 -11.00 (7,000) 7.25
Canceled........................ (37,399) 2.55 -12.00 -- --
Granted......................... 182,188 1.06 -12.00 12,000 9.75
---------- ------------- ----------- -----------
Outstanding at December 31,
1995.......................... 998,338 .35 -12.00 77,773 7.25 -11.00
Exercised....................... (123,871) .35 -11.50 (19,000) 7.25 - 9.75
Canceled........................ (33,277) .89 -26.00 -- --
Granted......................... 381,788 10.50 -26.00 77,552 12.13 -18.75
---------- ------------- ----------- -----------
Outstanding at December 31,
1996.......................... 1,222,978 $ .35--26.00 136,325 $ 7.25 -18.75
---------- ------------- ----------- -----------
</TABLE>
<PAGE>
There were 634,803 and 600,109 incentive stock options and 59,807 and 67,841
non-statutory stock options exercisable at December 31, 1996 and 1995,
respectively.
SHAREHOLDER RIGHTS PLAN
In March 1992, the Board of Directors approved a shareholder rights plan
and declared a dividend of one preferred share purchase right for each
outstanding common share. Each right represents the right to purchase one
one-hundredth of a share of Series D Junior Participating Preferred Stock,
par value $.01 per share, at an exercise price of $40, subject to adjustment.
The rights are only exercisable ten days after a person or group acquires,
or commences a tender or exchange offer to acquire, beneficial ownership of
20% or more of the Company's outstanding common shares. Subject to the
terms of the shareholder rights plan and the discretion of the Board of
Directors, each right would entitle the holder to purchase common shares
of the Company, or of an acquiring company in certain circumstances, having
a market value of two times the exercise price of the right. The rights
expire in March 2002, but may be redeemed by action of the Board of Directors
prior to that time at $.01 per right.
EMPLOYEE STOCK PURCHASE PLAN
On May 19, 1994, the Company's shareholders approved the 1994 Employee Stock
Purchase Plan. Pursuant to this plan, employees of the Company may elect to
accumulate funds of up to 10% of their cash compensation via payroll deduction
to purchase shares of the Company's common stock. Under the plan, 45,972,
50,295, and 25,474 shares of common stock were issued in 1996, 1995, and 1994,
respectively. The Company has reserved 178,259 shares of common stock for future
issuance under this plan.
<PAGE>
NOTE 5. STOCK-BASED COMPENSATION PLANS
At December 31, 1996, the Company had four plans providing for stock
compensation; three fixed option plans under which options are granted to
acquire company stock at exercise prices equal to 100% of fair value as of the
date the option is granted, and an employee stock purchase plan, which provides
for six-month enrollment periods under which shares may be purchased at 85% of
the lesser of the fair value at the beginning or end of the enrollment period.
The Company applies APB No. 25 in accounting for these plans and,
accordingly, no compensation cost has been recognized with respect thereto. Had
compensation cost for these plans been determined consistent with SFAS No. 123,
the Company's net income and net income per common and common equivalent share
would have been reduced to the pro forma amounts shown in the following table:
<TABLE>
<CAPTION>
1996 1995
------ ------
<S> <C> <C> <C>
Net income (in thousands) As reported $4,078 $5,398
Pro forma $3,155 $5,086
Net income per share As reported $0.44 $0.60
Pro forma $0.34 $0.57
</TABLE>
The pro forma information presented above includes only the effects of
applying SFAS No. 123 to options granted in 1996 and 1995. Because options
generally vest over a number of years and additional awards are made each year,
the pro forma 1996 and 1995 amounts are not representative of the effect SFAS
No. 123 would have had on net income and earnings per share had it been applied
to options granted prior to 1995.
The fair value of compensation cost reflected in the above pro forma amounts
was determined using the Black-Scholes option pricing model and the following
weighted-average assumptions: (1) risk-free interest rate: 1996--6.14%; 1995 -
6.59%; (2) expected life of option--5 years; (3) expected volatility--.60; and
(4) expected dividends--0%.
Information with respect to the Company's fixed option plans for 1996 and
1995 is provided below:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
NUMBER OF SHARES EXERCISE PRICE PER SHARE
---------------- ------------------------
<S> <C> <C>
Balance at Dec. 31, 1994 1,024,188 $ 5.21
Granted................... 194,188 9.27
Exercised................. (104,866) 3.17
Forfeited................. (37,399) 7.79
Expired................... -- --
----------- --------
Balance at Dec. 31, 1995...... 1,076,111 6.01
----------- --------
Granted................... 459,340 14.64
Exercised................. (142,871) 3.49
Forfeited................. (33,277) 14.66
Expired................... -- --
----------- --------
Balance at Dec. 31, 1996...... 1,359,303 $ 8.51
----------- --------
</TABLE>
<PAGE>
The weighted-average grant date fair value of options granted during 1996
and 1995 was $8.33 and $5.38, respectively. Additional information regarding
options as of December 31, 1996 is as follows:
<TABLE>
<CAPTION>
OPTIONS OPTIONS EXERCISABLE
RANGE OF OUTSTANDING ------------------------------
EXERCISE NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
PRICES OUTSTANDING REMAINING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ---------------- ----------- ------------------ ----------------- ----------- -----------------
<C> <C> <S> <C> <C> <C>
$0.35 -$2.55..... 319,041 4.00 years $ 1.76 314,409 $ 1.78
$3.75 -$9.88..... 557,892 6.76 years $ 7.51 347,171 $ 7.23
$10.00 -$14.75... 364,170 9.11 years $ 12.85 27,030 $ 10.90
$15.00 -$26.00... 118,200 9.55 years $ 18.10 6,000 $ 18.75
- ----------------- --------- ---------- --------- ------- ---------
$0.35 -$26.00.... 1,359,303 6.99 years $ 8.51 694,610 $ 5.00
- ----------------- --------- ---------- --------- ------- ---------
</TABLE>
NOTE 6. LEASES
The Company leases its primary office and manufacturing facilities under
long-term operating leases which expire in December 2000 for the Beaverton,
Oregon facility and June 1997 for the Menomonee Falls, Wisconsin facility. Other
operating leases have been entered into in connection with the lease of
additional office space and capital equipment. Minimum future rental payments
under all operating leases are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31 (IN THOUSANDS)
-------------- --------------
<S> <C>
1997 $ 764
1998 683
1999 692
2000 691
2001 24
------
Total future minimum lease payments $2,854
------
</TABLE>
Total rental expense for all operating leases was $868,000, $512,000, and
$520,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
NOTE 7. INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS) 1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal $ 1,735 $ 1,644 $ 1,152
State 316 274 322
--------- --------- ---------
2,051 1,918 1,474
Deferred:
Federal (136) (368) (144)
State 11 (22) (19)
--------- --------- ---------
(125) (390) (163)
--------- --------- ---------
Total $ 1,926 $ 1,528 $ 1,311
--------- --------- ---------
</TABLE>
27
<PAGE>
A reconciliation showing the reasons for the difference between the
Company's effective tax rate and the Federal statutory income tax rate of 34% is
as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Federal statutory rate.......................... 34.0% 34.0% 34.0%
State taxes, net of federal benefit............. 4.0 3.5 4.4
Research and experimentation credits............ (3.4) (2.4) (5.9)
Tax benefit of foreign sales corporation........ (3.3) (2.4) (4.1)
Tax benefit of exempt interest income........... (4.4) (4.0) (5.0)
Decrease in valuation allowance................. (2.7) (1.9) --
Net operating loss carryovers created (utilized) (3.0) (4.4) 5.1
Non-deductible acquisition related charges...... 11.3 -- --
Other, net...................................... (.4) (.3) (.9)
------- ------- -------
Effective tax rate.............................. 32.1% 22.1% 27.6%
------- ------- -------
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1996 and 1995 are presented below:
<TABLE>
<CAPTION>
(in thousands) 1996 1995
- --------------------------------------------- ---------- ----------
<S> <C> <C>
DEFERRED TAX ASSETS:
Reserve for warranties....................... $ 380 $ 405
Inventory valuation adjustments.............. 482 559
Accrued vacation............................. 216 207
Accrued rent................................. 50 74
Allowance for doubtful accounts.............. 97 82
Net operating loss carryovers................ 330 518
Federal and state tax credit carryovers...... 392 392
Other........................................ 351 309
--------- ---------
Gross deferred tax assets...................... 2,298 2,546
Valuation allowance........................ (878) (1,223)
--------- ---------
Deferred tax assets........................ 1,420 1,323
Deferred tax liabilities:
Depreciation................................. (67) (51)
Intangible technology rights................. (446) (413)
Software development costs................... (58) (56)
--------- ---------
Deferred tax liabilities................... (571) (520)
--------- ---------
Net deferred tax assets........................ $ 849 $ 803
--------- ---------
</TABLE>
The Company has established a valuation allowance for certain deferred tax
assets of $878,000 at December 31, 1996. The valuation allowance was $1,223,000
and $1,492,000 at December 31, 1995 and 1994, respectively. The $345,000
reduction of the valuation allowance recorded in 1996 primarily resulted from
utilization of previously reserved net operating loss carryovers and a change in
the realizability of Pryon deferred tax assets.
Tax benefits of $531,000, $191,000, and $137,000 relating to the Company's
stock option incentive plans were credited directly to stockholders' equity in
1996, 1995, and 1994, respectively.
At December 31, 1996, the Company had available federal net operating loss
carryforwards of $775,000 which expire in 2009 and state net operating loss
carryforwards of $1,281,000 which expire in the years 2007 through 2009. The
Company also had available federal and state research and experimentation tax
credit carryforwards of $289,000 and $90,000, respectively, expiring in the
years 2003 through 2010.
<PAGE>
NOTE 8. DEVELOPMENT AGREEMENTS
In April 1990, the Company entered into a collaborative research and license
agreement with a domestic hospital to design a multiple-patient monitoring
system (the "Acuity System"). The Company provides discounts on certain
equipment purchased by the hospital in recognition of consultation services
performed by key hospital personnel in connection with the development of the
Acuity System. Discounts totaled approximately $124,000, $201,000, and $41,000
in 1996, 1995, and 1994, respectively. In addition, royalties are paid to the
hospital based upon a percentage of the Company's net sales of the Acuity System
and related products to other customers. Royalties paid to date have not been
material.
Royalties in the form of discounts and cash payments pursuant to this
agreement will continue through October 1997 or until the essential
characteristics of the system no longer reflect the design concepts co-developed
by the Company and the hospital. Future royalties and discounts on sales under
this agreement are not expected to have a material effect on the Company's
results of operations.
In January 1990, the Company entered into a development and supply agreement
with a pharmaceuticals corporation whereby the Company will develop and
manufacture a proprietary monitoring and drug administration device for this
corporation. Production of this device for certain international markets began
in 1994. During the years ended December 31, 1996, 1995, and 1994, research and
development expenses incurred by the Company of $54,000, $88,000, and $443,000,
respectively, have been reimbursed to the Company pursuant to this agreement.
NOTE 9. ACQUISITION OF SUBSIDIARY
On July 10, 1996, the Company issued 1,211,100 shares of common stock in
exchange for all of the outstanding capital stock of Pryon Corporation, a
supplier of CO2 monitoring products for medical instrumentation manufacturers.
In addition, the Company issued options to purchase 121,159 shares of the
Company's common stock in replacement of options to purchase Pryon common stock
which were outstanding immediately prior to the acquisition. The acquisition was
accounted for as a pooling of interests and accordingly, the financial
statements of Protocol Systems, Inc., related footnote disclosures and
supplemental financial data have been restated to show the combined results of
the two companies for all periods presented. All material intercompany balances
and transactions between the two entities have been eliminated. Sales and net
income (loss) for the individual entities are shown below for the periods prior
to the acquisition:
<TABLE>
<CAPTION>
(IN THOUSANDS) (IN THOUSANDS)
PROTOCOL PRYON ADJUSTMENTS COMBINED
<S> <C> <C> <C> <C>
Six months ended
June 30, 1996 (unaudited)
Sales.................. $ 28,806 $6,253 $(1,723) $ 33,336
Net Income............. 2,771 501 (129) 3,143
Year ended
December 31, 1995
Sales.................. 49,067 12,276 (1,741) 59,602
Net Income............. 4,678 818 (98) 5,398
Year ended
December 31, 1994
Sales.................. 41,166 8,001 (1,009) 48,158
Net Income (loss)...... 4,146 (794) 82 3,434
</TABLE>
Charges of $2,097,000, which consisted primarily of investment banking,
legal and accounting fees, were incurred in connection with the acquisition and
were charged to expense in 1996.
<PAGE>
NOTE 10. INDUSTRY AND GEOGRAPHIC INFORMATION
The Company operates in a single industry segment: the design, manufacture,
sale and servicing of medical instruments and systems. Sales are made primarily
to hospitals and other health-care related customers. Credit risk with respect
to accounts receivable is limited due to the large number and geographical
dispersion (both domestically and internationally) of entities which comprise
the Company's customer base. Export sales are made in U.S. dollars. Sales by
geographic region were as follows for the years ended December 31:
<TABLE>
<CAPTION>
(IN THOUSANDS) 1996 1995 1994
- ---------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
United States........................... $ 41,588 $ 40,080 $ 31,143
Europe.................................. 14,938 11,481 9,696
Asia and Pacific Rim.................... 7,836 6,166 5,202
Other................................... 2,532 1,875 2,117
--------- --------- ---------
Total Sales............................. $ 66,894 $ 59,602 $ 48,158
--------- --------- ---------
</TABLE>
NOTE 11. QUARTERLY FINANCIAL SUMMARY (UNAUDITED)
<TABLE>
<CAPTION>
QUARTERS ENDED
(IN THOUSANDS EXCEPT COMMON STOCK PRICES --------------------------------------------------
AND PER SHARE AMOUNTS) MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- ----------------------------------------------------- ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
1996
Sales................................................. $16,239 $17,097 $16,193 $17,365
Gross profit.......................................... 8,883 9,691 8,954 8,895
Income from operations................................ 1,880 1,964 (726) 1,887
Net income............................................ 1,553 1,591 (910) 1,844
Net income per common and common equivalent share..... .17 .17 (.10) .20
Weighted average number of common and common
equivalent shares outstanding....................... 9,369 9,537 9,433 9,267
Common stock prices:
High................................................ $17.50 $26.38 $23.25 $15.75
Low................................................. 10.50 15.63 15.25 10.00
1995
Sales................................................. $12,944 $13,343 $15,222 $18,093
Gross profit.......................................... 6,838 7,139 7,860 9,972
Income from operations................................ 781 652 1,443 3,134
Net income............................................ 813 665 1,252 2,668
Net income per common and common equivalent share..... .09 .07 .14 .29
Weighted average number of common and common
equivalent shares outstanding........................ 8,940 8,911 9,092 9,133
Common stock prices:
High................................................ $12.00 $13.00 $11.88 $11.50
Low................................................. 8.75 8.50 9.25 9.88
</TABLE>
The Company's common stock began trading on the Nasdaq Stock Market under
the symbol PCOL on March 24, 1992 following the Company's initial public
offering. The above quoted market prices represent the high and low closing sale
prices as reported by Nasdaq for the periods indicated. As of March 14, 1997,
there were 197 stockholders of record of Protocol common stock and approximately
4,900 beneficial owners of common stock. No cash dividends have been paid on the
common stock and the Company does not anticipate paying any cash dividends in
the foreseeable future.
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item regarding Directors is included under
the captions "Election of Directors," "Management" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Company's 1997 Proxy
Statement and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the caption
"Executive Compensation" in the Company's 1997 Proxy Statement and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included under the caption "Stock
Owned By Management and Principal Shareholders" in the Company's 1997 Proxy
Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
<PAGE>
Part IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The following finanical statements are set forth in Item 8 of
this Annual Report.
<TABLE>
<CAPTION>
PAGE #
------
<S> <C>
Report of Management 16
Report of Independent Accountants for the years
ended December 31, 1996 and 1995 16
Consolidated Statements of Operations--Years ended
December 31, 1996, 1995 and 1994 17
Consolidated Balance Sheets--As of December 31, 1996 and
1995 18
Consolidated Statements of Stockholders' Equity--Years
ended December 31, 1996, 1995 and 1994 19
Consolidated Statements of Cash Flows--Years ended
December 31, 1996, 1995 and 1994 20
(a) (2) Financial Statement Schedule:
Schedule II--Valuation and Qualifying Accounts s-1
Report of Independent Accountants on Financial
Statement Schedule s-2
Schedules not listed above have been omitted because the information required
to be set forth therein is not applicable or is included in the Consolidated
Financial Statements or notes thereto.
</TABLE>
<PAGE>
(a) (3) Exhibits:
<TABLE>
<CAPTION>
Sequentially
EXHIBIT Numbered
NUMBER DESCRIPTION Page
- -------- ----------- -----------
<S> <C> <C>
2.0 Agreement and Plan of Merger dated as of February 20, 1996 Among Protocol
Systems, Inc., Protocol Merger Corporation and Pryon Corporation.****
3.1 Fourth Restated Articles of Incorporation of Protocol Systems, Inc. *
3.2 Restated Bylaws of Protocol Systems, Inc. *
4.0 Rights Agreement dated March 20, 1992 between Protocol Systems, Inc. and First
Interstate Bank of Oregon, N.A. *
10.1 Distribution Agreement dated February 7, 1989 between Protocol Systems, Inc.
and Siemens Medical Electronics, Inc. *
10.2 Renewal of Distribution Agreement dated July 19, 1991 between Protocol Systems, Inc.
and Siemens Medical Electronics, Inc. *
10.3 Original Equipment Manufacturer Agreement for Purchase and Sale of Pulse Oximeter
Modules dated October 23, 1989 between Protocol Systems, Inc. and Nellcor, Incorporated,
and addendum thereto dated January 21, 1992. *
10.4 Development and Supply Agreement dated January 26, 1990 between Protocol Systems, Inc.
and Gensia Pharmaceuticals, Inc. *
10.5 Collaborative Research and License Agreement dated April 1, 1990 between Protocol Systems,
Inc. and the General Hospital Corporation (Massachusetts General Hospital). *
10.6 Form of Indemnity Agreements between Protocol Systems, Inc. and its Executive Officers and
Directors. *
10.7 Protocol Systems, Inc. 1987 Key Employee's Incentive Stock Option Plan, as amended on
January 21, 1992. *
10.8 Protocol Systems, Inc. 1987 Non-Statutory Stock Option Plan, as amended on January 21, 1992. *
10.9 Protocol Systems, Inc. 1992 Stock Incentive Plan as amended on January 24, 1995. ****
10.10 Business Park Lease dated October 26, 1990 By and Among Protocol Systems, Inc., Koll-Copley
Partners and Petula Associates and amendments thereto dated October 16, 1991 and November 6, 1991. *
10.11 Amendment to Business Park Lease between Protocol Systems, Inc., Koll-Copley Partners and Petula
Associates dated October 6, 1993. ***
10.12 Amendment to Original Equipment Manufacturer Agreement for Purchase and Sale of Pulse Oximeter
Modules dated February 25, 1993 between Protocol Systems, Inc. and Nellcor, Incorporated. ***
10.13 Protocol Systems, Inc. 1993 Stock Option Plan for Nonemployee Directors. ****
10.14 Protocol Systems, Inc. 1994 Employee Stock Purchase Plan. **
22.0 Subsidiaries of the Registrant.
23.1 Consent of Accountants.
27.1 Financial Data Schedule.
</TABLE>
- ----------------------------------------
* Incorporated herein by reference to the Company's Registration
Statement on Form S-1 dated January 22, 1992, File No. 33-45067.
** Incorporated herein by reference to the Company's Registration Statement
of Form S-8 dated January 24, 1994, File No. 33-74384.
*** Incorporated herein by reference to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1993.
**** Incorporated herein by reference to the Company's Registration
Statement of Form S-4 dated April 9, 1996, File No. 333-003316.
34
<PAGE>
(b) No reports on Form 8-K were filed during the quarter ended December
31, 1996.
35
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
PROTOCOL SYSTEMS, INC.
----------------------
(REGISTRANT)
DATE: MARCH 28, 1997 BY /S/ JAMES B. MOON
- ------------------------ --------------------------
JAMES B. MOON
PRESIDENT, CHIEF EXECUTIVE OFFICER
AND CHAIRMAN
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed below by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
President, Chief Executive Officer and Chairman of March 28, 1997
/s/ JAMES B. MOON Officer and Chairman of the Board of Directors --------------
- ------------------------------ (Principal Executive Officer)
James B. Moon
/s/ CRAIG M. SWANSON Vice-President, Chief Financial Officer and March 28, 1997
- ------------------------------ Secretary (Principal Financiial and Accounting Officer) --------------
Craig M. Swanson
/s/ STEVEN E. WYNNE Director March 28, 1997
---------------
- ------------------------------
Steven E. Wynne
/s/ RONALD S. NEWBOWER, PH.D Director March 28, 1997
- -------------------------------- ---------------
Ronald S. Newbower, Ph.D
/s/ DAVID F. BOLENDER Director March 28, 1997
- ------------------------------ ----------------
David F. Bolender
/s/ FRANK E. SAMUEL, JR. Director March 28, 1997
- ------------------------------ ---------------
Frank E. Samuel, Jr.
/s/ WILLIAM NEW, JR., M.D. Director March 28, 1997
- ------------------------------ ----------------
William New, Jr., M.D.
</TABLE>
<PAGE>S-1
PROTOCOL SYSTEMS, INC. Schedule II
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS ADDITIONS
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- -------------------------------------------------- ---------- ----------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1994:
Allowance for doubtful accounts................. 205,000 34,848 -- 49,848(1) 190,000
Allowance for sales returns..................... 50,000 -- -- 15,000(2) 35,000
Inventory obsolescence and valuation reserves... 392,820 614,990 -- 143,720(3) 864,090
Reserve for warranties.......................... 1,001,629 382,594 -- 405,716(4) 978,507
Year ended December 31, 1995:
Allowance for doubtful accounts................. 190,000 64,798 -- 42,798(1) 212,000
Allowance for sales returns..................... 35,000 65,000 -- -- 100,000
Inventory obsolescence and valuation reserves... 864,090 484,526 -- 286,101(3) 1,062,515
Reserve for warranties.......................... 978,507 577,101 -- 502,976(4) 1,052,632
Year ended December 31, 1996:
Allowance for doubtful accounts................. 212,000 111,321 -- 71,321(1) 252,000
Allowance for sales returns..................... 100,000 -- -- -- 100,000
Inventory obsolescence and valuation reserves... 1,062,515 319,553 -- 596,611(3) 785,457
Reserve for warranties.......................... 1,052,632 619,792 -- 687,400(4) 985,024
</TABLE>
- ------------------------
(1) Deductions primarily represent write-offs of accounts receivable during the
period.
(2) Deductions represent reduction of the allowance based on sales return
history.
(3) Deductions primarily represent inventory scrapped or sold during the period.
(4) Deductions primarily represent inventory and labor costs incurred repairing
products under warranty.
<PAGE>S-2
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of Protocol Systems, Inc.:
Under the date of January 24, 1997, we reported on the consolidated
balance sheets of Protocol Systems, Inc. and subsidiaries as of December 31,
1996 and 1995, and the related consolidated statements of operations,
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1996, which are included in the 1996 annual report
to shareholders. These consolidated finanical statements and our report
thereon are included in the annual report on Form 10-K for the year 1996. In
connection with our audit of the aforementioned consolidated financial
statements, we also have audited the related financial statement schedule as
listed in the accompanying index. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express
an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ KPMG Peat Marwick LLP
Portland, Oregon
January 24, 1997
<PAGE>
EXHIBIT 22.0
SUBSIDIARIES OF THE REGISTRANT
Subsidiary Jurisdiction of Incorporation
---------- -----------------------------
Pryon Corporation Wisconsin
Protocol Medical Systems Limited,
formerly Omera Limited Northern Ireland
Protocol U.K. Limited Oregon
Protocol Systems Foreign Sales Corporation Guam
<PAGE>
Exhibit 23.1
Consent of Independent Accountants
----------------------------------
The Board of Directors
Protocol Systems, Inc.:
We consent to incorporation by reference in the Registration Statements (Nos.
33-94912, 33-53992, 33-66272, 33-74384, 33-81104, 333-17703 and 333-17705) on
Form S-8 of Protocol Systems, Inc. of our reports dated January 24, 1997,
relating to the consolidated balance sheets of Protocal Systems, Inc. and
subsidiaries as of December 31, 1996 and 1995, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of
the years in the three-year period ended December 31, 1996, and all related
financial statement schedules, which reports appear in the December 31, 1996
annual report on Form 10-K of Protocol Systems, Inc.
/s/ KPMG Peat Marwick LLP
March 28, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PROTOCOL
SYSTEMS INC'S CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1996 AND
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 6,903
<SECURITIES> 15,800
<RECEIVABLES> 15,456<F1>
<ALLOWANCES> 252
<INVENTORY> 12,416
<CURRENT-ASSETS> 51,048
<PP&E> 12,253
<DEPRECIATION> 7,775
<TOTAL-ASSETS> 59,045
<CURRENT-LIABILITIES> 7,265
<BONDS> 0
0
0
<COMMON> 87
<OTHER-SE> 51,222
<TOTAL-LIABILITY-AND-EQUITY> 59,045
<SALES> 66,894
<TOTAL-REVENUES> 66,894
<CGS> 30,471
<TOTAL-COSTS> 30,471
<OTHER-EXPENSES> 30,419
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 110
<INCOME-PRETAX> 6,004
<INCOME-TAX> 1,926
<INCOME-CONTINUING> 4,078
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,078
<EPS-PRIMARY> 0.44
<EPS-DILUTED> 0.44
<FN>
<F1>NET OF ALLOWANCE
</FN>
</TABLE>
