<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, 1999
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 0-19943
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PROTOCOL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Oregon 93-0913130
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8500 SW Creekside Place, Beaverton, OR 97008
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(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
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(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 17, 2000 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $ 91,637,592. There were 8,179,442
shares of Common stock of the registrant outstanding at March 17, 2000.
Documents Incorporated by Reference
-----------------------------------
Part of Form 10-K Into
Document Which Incorporated
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Portions of the Proxy Statement for the
2000 Annual Meeting of Shareholders Part III
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PART I
ITEM 1. BUSINESS
GENERAL
Protocol Systems, Inc. made its first commercial shipment of patient monitors
in 1988. Since that date, the Company has sold over 55,000 vital signs
monitors. 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. The Company's products are designed to address
customers requirements for more efficient and flexible utilization of patient
monitoring equipment and technology. The Company's Propaq family of 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 work station further
increases monitoring flexibility by allowing a clinician to observe and
control up to 60 Propaq monitors, Modem Propaqs, QuikSign-tm- monitors, and/or
Protocol Cordless ECG telemetry transmitters from a dedicated Sun Microsystems
UNIX-based workstation.
The Company also markets vital signs technologies and subsystems on an OEM
basis to medical device manufacturers under the Pryon-tm- label. Capnography
(end-tidal CO2), the Company's first OEM technology, is the measurement and
graphical display of carbon dioxide concentration present in a patient's
airway. Since 1989, over 35,000 CO2 systems have been sold world-wide. The
Company has recently expanded its OEM product offering with the introduction
of an ECG/Respiration ASIC and a non-invasive blood pressure module.
The Company operates in a single industry segment: the design, manufacture,
sale and servicing of medical patient monitoring equipment, including
instruments, systems and technologies. Sales of the Company's products by
geographic region are shown in the notes to the consolidated financial
statements.
MARKET FOR PATIENT MONITORING EQUIPMENT
The principal purchasers of patient monitoring equipment are hospitals; other
customers include outpatient surgery centers, clinics, physician offices,
emergency transportation units and military field applications.
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.
PATIENT MONITORING MARKET SEGMENTS
The patient monitoring market may be divided into five market segments:
transport monitors, portable bedside monitors, high-end systems, low-end
systems and telemetry systems. Each segment is 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.
TRANSPORT MONITORS. This market segment includes portable monitors used both
inside and outside the hospital for transporting critically ill patients.
Small size, light weight, ruggedness and long battery life are the
distinguishing requirements of this segment. The Company is the world-wide
leader in transport monitoring.
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 and Propaq CS monitors and the
Acuity central station 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 Company's monitors and the central monitoring capability
of the Acuity central station 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 central station, with its central monitoring capability,
is designed to meet the requirements of this market segment. Subsequent
enhancements to the Acuity software, including arrhythmia detection, ST
segment analysis, 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-registered trademark- monitoring system provides
such ECG telemetry monitoring for ambulating patients.
PRODUCTS
The Company believes that its products presently address a significant portion
of the worldwide patient vital sign monitoring market. The Company's highly
portable multiple-parameter monitors and ECG telemetry transmitters networked
to Acuity central workstations allow hospitals to realize the benefits of
Flexible Monitoring-tm-. 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.
PROPAQ MONITORS AND OPTIONS. The Company's principal product line, Propaq
portable patient monitors, is used in hospitals, outpatient surgery centers,
clinics, physician offices, emergency transportation units and military field
applications 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; and body
temperature.
The Propaq Encore retains all of the monitoring capabilities and portability
of the Propaq 100 Series monitor. In addition, the Propaq Encore monitor
provides a superior quality high resolution display, an enhanced user
interface, respiration monitoring using impedance pneumography, diagnostic
level 5-lead ECG monitoring capability and mainstream and/or sidestream Carbon
Dioxide (CO2) monitoring. Propaq Encore monitors can be configured to monitor
neonatal, pediatric or adult patients.
The Company introduced the Modem Propaq monitor in 1997. This monitor
provides all the functionality of the Propaq monitors and is able to transmit
multiple patient vital signs data via a simple telephone modem to the Acuity
central station. The Modem propaq gives the health care provider the
flexibility to remotely monitor patients located both inside and outside the
hospital from a central nursing station.
In 1998, the Company introduced Smartcuf-tm- technology that further increases
the Propaq's reliability and accuracy by filtering artifact for even more
reliable non-invasive blood pressure (NIBP) measurements. The patented
software synchronizes its NIBP readings with the patient's ECG which
eliminates the "noise" affecting blood pressure measurement created by
external stimuli such as patient motion or vibration, delivering more accurate
blood pressure measurements.
In September 1999, the Company introduced the Propaq CS monitor which offers a
large, touch-zone color display capable of displaying up to four waveforms and
two vectors of ECG. The Propaq CS monitor is available with all the same
vital sign parameters and options available with the Propaq Encore monitor.
The features of the Propaq CS are suited for bedside applications, including
neonatal general and intensive care, pediatric wards, pediatric intensive care
and pediatric outpatient and specialty areas, as well as gastrointestinal
endoscopy, bronchoscopy, emergency departments, post anesthesia units, labor
and delivery rooms, surgical and intensive care unit transport, outpatient
surgery and respiratory and cardiac step-down units.
FLEXIBLE MONITORING SYSTEM. The Flexible Monitoring System-tm- is the
product of a co-development effort with Massachusetts General Hospital and was
introduced by the Company in 1991. The Flexible Monitoring 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. Individual workstations in
various clinical departments can be linked together to provide an integrated,
enterprise wide system. 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 central station 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.
Central station monitoring has been predominately used in intensive care
environments in which bedside monitors are permanently wired to a central
station. Flexible monitoring re-defines traditional central station
monitoring by allowing portable monitors to be placed anywhere patient needs
dictate and route vital signs information back to a workstation over low cost
communication networks. Propaq monitors can easily be connected to the Acuity
central station as the hospital's needs dictate through the use of a simple
snap-in modular plug similar to a standard network 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 and reduces the cost of transporting patients to more
traditional monitoring systems.
Full disclosure, arrythmia and ST segment analysis options are available with
the Flexible Monitoring System. The full disclosure software version for the
Acuity central station provides the ability to capture and later retrieve each
second of patient vital signs data for the previous 96-hour period. 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. The ST Segment Analysis software option analyzes the
ST Segment of a patient's ECG for changes that may indicate myocardial
ischemia or injury.
The Company introduced Networked Acuity patient monitoring systems in 1998.
Networked Acuity systems operate as Vital Signs ServersTM, each capable of
centrally monitoring local and remote groups of patients resident on multiple
Networked Acuity systems. These systems, both inside and outside the
hospital, connect smaller hospitals or clinics, or floors within a single
hospital such as areas outside the ICU, providing a number of benefits to the
user. Remote viewing and control of both real-time and historical full
disclosure waveform information, for consultation on any patient's vital signs
data, is easily accessible from any of the connected Acuity central stations.
From admission to discharge, a seamless patient flow record is automatically
generated as the patient moves from one Networked Acuity system to another.
Furthermore, the Networked Acuity system configured with an additional review
station can provide "mission critical" back-up capability to another Networked
Acuity system within the enterprise in the event of a hardware or software
failure.
In November 1999, the Company introduced a low cost central monitoring station
for networking Propaq portable patient monitors. The central station,
manufactured by Vidco, Inc., networks up to eight Propaq monitors and
simultaneously displays the monitors' vital signs data from a large color
display. The central station displays all vital sign parameters provided by
the Propaq patient monitors including heart rate, ECG, noninvasive blood
pressure, invasive blood pressure, pulse oximetry, impedance respiration,
temperature and capnography.
In March 2000, the Company announced the FlexNet wireless patient monitoring
network providing vital signs data and patient information from anywhere to
anywhere, including secure access over the Internet. FlexNet seamlessly links
multiple devices such as wireless portable monitors and ambulatory telemetry
monitors to central surveillance workstations and/or to remote personal
computers (PCs) via the Internet. FlexNet can facilitate the communication of
multiple monitoring devices fully configured with a comprehensive complement
of vital signs parameters including heart rate, ECG, pulse oximetry,
noninvasive and invasive blood pressure, respiration and capnography among
others. In addition, other devices gaining increasing use by clinicians such
as Internet Protocol (IP) telephones, personal digital assistants (PDAs), and
wireless PCs may also be seamlessly and simultaneously supported on the same
wireless FlexNet network. FlexNet utilizes Symbol Technology's Spectrum24
- -registered trademark- radio module that operates in the 2.4 GHz band using
spread-spectrum modulation. Utilizing this technology, FlexNet can not only
support comprehensive and sophisticated patient monitoring networks, but can
also do so while providing superior noise tolerance and communications
integrity. The FlexNet Access Points can support both wireless portable
monitors and ambulatory telemetry devices unlike other systems, which must layer
two antenna systems in order to accommodate both types of monitoring devices.
Clinicians can also remotely access the FlexNet's vital signs data via a
variety of devices including PDAs, PCs, and IP telephones through common
Internet browsers supported by Protocol's secure Vital Signs Server. The
FlexNet wireless network can also be seamlessly integrated with existing
hardwired patient monitoring systems from Protocol Systems. The Company
expects FlexNet to be available for customer shipments in the fourth quarter
of 2000 pending FDA market clearance.
In March 2000, the Company announced the Micropaq-tm- ambulatory patient
monitor, which combines the functionality and form of a patient worn telemetry
monitor with the display, alarms and parameters of a standalone portable vital
signs monitor. This monitor provides one or two channels of ECG, heart rate,
pulse oximetry and nurse call capabilities. It is principally designed for
use in cardiac care with ambulatory patients connected wirelessly to the
Company's FlexNet-tm- network and the Acuity central workstation. The monitor
is also appropriate for a number of monitoring applications outside of cardiac
care because it provides a liquid crystal display of vital signs data and will
operate standalone outside of the wireless network. The Company expects the
first version of the Micropaq monitor, including ECG, heart rate, and pulse
oximetry, to be available for customers shipments in the fourth quarter of
2000 pending FDA market clearance. A later version including a noninvasive
blood pressure option featuring the Company's Smartcuf patient motion artifact
resistant technology is expected the following year.
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 an Acuity central
station and/or Propaq monitor.
QUIKSIGNS MONITOR. In 1997, the Company entered into an agreement with Welch
Allyn, Inc. under which Welch Allyn manufactures the QuikSigns monitor under
the Company's name and provides the Company with U.S. hospital distribution
and marketing rights. The QuikSigns product is a spot-check patient monitor
that adds to the breadth of Protocol's product line, and is ideal for
gathering routine and procedural vital signs data. The instrument quickly and
non-invasively monitors blood pressure, blood oxygen and temperature, and
features data storage and printing capabilities.
OEM PRODUCTS. The Company manufactures solutions for CO2 monitoring
applications that include mainstream and sidestream CO2 sensors for OEM
applications as well as stand-alone monitors. The sidestream CO2 sensor and
related hardware and software are used 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 and
related hardware and software are used in hospital venues for intubated
patients. The Company also manufactures a line of consumable products that
are used in conjunction with its CO2 sensors.
In November 1999, the Company introduced an ECG Application Specific
Integrated Circuit (ASIC) monitoring subsystem. This new subsystem is small,
requires low power and provides a high performance ECG monitoring front-end
for integration into patient monitoring devices. The Company also introduced
the LC101 sidestream CO2 monitoring subsystem for integration into patient
monitoring devices providing noninvasive vital sign measurements of ETCO2,
inspired carbon dioxide and breath rate using a simple nasal cannula.
MARKETING AND DISTRIBUTION
DOMESTIC. The Company markets its products domestically through both Company-
employed sales representatives and independent distributors. The Company's
domestic sales managers supervise its direct sales representatives and
independent distributors, 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, 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
1995, the Company received approval from the U. S. Air Force for in-flight use
of the 100 Series Propaq monitor. In 1997, the Propaq Encore was approved for
use during all phases of flight on all U.S. Air Force aircraft.
The Company's national accounts managers negotiate and manage the Company's
group contracts with organizations such as MAGNET, MedEcon, University
Hospital Consortium and Kaiser Permanente. In 1998, the Company signed an
exclusive 3-year purchasing agreement with American Medical Response, the
largest ambulance service and emergency physician practice manager in the U.S.
In March 2000, the Company announced two additional group contracts, a two-
year agreement with Amerinet for the portable patient monitoring category of
Amerinet's Cardiovascular Clinical Service Program and a three-year agreement
to provide portable patient monitoring equipment to Novation. The Company
currently has group contracts which include more than 65% of the acute care
hospitals in the U.S.
The Company has developed a financial modeling tool called Proforma-tm- to help
hospitals evaluate the financial impact of Flexible Monitoring on the
institutions. Proforma facilitates sales of Flexible Monitoring systems by
helping customers re-engineer their patient flow thereby helping the hospital
lower patient care costs.
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 90 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 international sales managers supervise,
assist and train this network of international distributors. The Company
believes that its ability to meet foreign regulatory requirements and provide
monitors in nine languages is an important international marketing advantage.
In February 1999, the Company entered into a four-year marketing and
representation agreement with Medtronic Physio-Control ("Physio"), that gives
Physio exclusive marketing, distribution and service rights for the Company's
Propaq and Acuity patient monitoring instruments and systems in France and
most of Germany.
OEM. The Company's marketing strategy is to establish and develop OEM
customer relationships with U.S. and international patient monitoring systems
manufacturers. OEM subassemblies and accessories are sold directly to
customers by a dedicated OEM sales and marketing group within the Company.
OEM customers include Mallinckrodt, Spacelabs Medical, Datex-Ohmeda, Nihon
Kohden, and Welch Allyn among others.
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, and
Asia/Pacific (New Zealand). The Company provides maintenance and repair
classes for distributors and the biomedical engineering personnel of its
hospital customers. In addition, Protocol has developed a "Partners in Care"
program designed to provide clinical education and training to customers
installing Flexible Monitoring systems.
WARRANTIES. The Company warrants its products sold from one to three years
depending on product category and geography (domestic vs. international).
Optional extended warranty and service contracts are available for all Propaq
products and the Acuity central stations.
BACKLOG. Backlog generally consists of purchase orders for products
deliverable within twelve months. Sales in any quarter are dependent on orders
booked and shipped during that quarter. Accordingly, the Company does not
consider backlog to be a significant indication of future performance.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts focus on developing new
products and expanding the capabilities of existing products. The Company's
research and development staff consists of 57 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 1999, 1998, and
1997, research and development expenses, net of reimbursed expenditures, were
$6.7 million, $8.3 million, and $8.7 million, respectively.
MANUFACTURING
The Company'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 most of its parts from outside suppliers and
relies upon a number of single-source suppliers to provide certain parts for
its products, including pulse oximetry, display subassemblies and certain
circuit board assemblies. 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.
The Company typically purchases components pursuant to open purchase orders
placed from time to time in the ordinary course of business. 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, the Company's quality assurance group inspects,
operates and verifies calibration and conformance with the customer order of
all products prior to shipment.
The Company has received ISO 9001 and EN 46001 certifications in 1998. In
September 1998, the Company successfully completed an unannounced Good
Manufacturing Practices (GMP) audit by the FDA. The audit was completed with
no adverse observations and without the issuance of Form 483.
COMPETITION
The patient monitoring 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, Agilent Technologies, GE Marquette
Medical Systems, Medical Data Electronics, Inc., Siemens Medical Electronics,
and Spacelabs Medical, Inc. Principal OEM competitors include Novametrix and
Oridion. 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 ten U.S. patents, and has ten 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 thirteen U.S. registered trademarks, has one
U.S. trademark registration application pending, and owns eight registered
trademarks in various countries. In addition, the Company holds copyrights
with respect to its proprietary software. 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. The Company 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 Propaq family of 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 monitors and to sell 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.
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.
ITEM 2. PROPERTIES
The Company's principal office is located in Beaverton, Oregon. The Company
leases approximately 95,000 square feet at the Beaverton, Oregon location
under a lease that expires in December 2005. The primary manufacturing,
warehousing, research and development, sales, marketing and administrative
activities of the Company are conducted from this facility which is nearly
fully utilized and 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, 1999.
<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 17, 2000, there were 137 stockholders of record of Protocol common
stock and approximately 3,000 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:
1999 -- QUARTER ENDED HIGH LOW
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December 31, 1999 $9.00 $6.00
September 30, 1999 9.13 6.88
June 30, 1999 9.50 5.88
March 31, 1999 8.75 6.00
1998 -- QUARTER ENDED HIGH LOW
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December 31, 1998 $8.50 $6.13
September 30, 1998 9.63 7.88
June 30, 1998 10.38 7.69
March 31, 1998 10.25 6.75
During the fourth quarter of 1999, 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 91,357 shares of Common Stock were issued
at exercise prices ranging from $1.32 to $7.00. 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>
(in thousands, except Years Ended December 31,
per share amounts) 1999 1998 1997 1996 1995
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<S> <C> <C> <C> <C> <C>
Operations Data
Sales $66,317 $67,323 $64,094 $66,894 $59,602
Income from operations before
special charges 5,515 3,252 3,316 7,377 6,010
Income (loss) from operations 5,515 (2,182) 3,316 5,005 6,010
Net income (loss) 6,291 (675) 3,356 4,078 5,398
Per Share Data
Basic earnings (loss) per share .77 (.08) .38 .47 .64
Diluted earnings (loss) per share .76 (.08) .36 .44 .60
Weighted average number of shares
used in the computation of earnings
(loss) per share:
Basic 8,176 8,487 8,859 8,672 8,460
Diluted 8,321 8,487 9,253 9,373 9,004
Dividends declared -- -- -- -- --
Balance Sheet Data
Cash and investments $23,989 $18,748 $25,570 $22,703 $24,267
Working capital 36,651 39,296 42,475 43,783 30,853
Total assets 59,838 55,851 63,755 59,045 57,220
Long-term debt and capital lease
obligations, excluding current
maturities - -- -- -- 1,795
Shareholders' equity 51,951 47,746 55,678 51,309 46,793
</TABLE>
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations
1999 Compared to 1998
- ---------------------
SALES. Sales decreased 1.5% to $66.3 million in 1999 from $67.3 million in
1998.
Domestic sales, excluding Original Equipment Manufacturer sales of Pryon
Medical Device Technology (MDT) products and GenESA devices (OEM sales),
decreased 2.9% to $43.7 million (65.8% of total sales) in 1999 from $45.0
million (66.8% of total sales) in 1998 primarily as a result of a decrease in
the number of Acuity central stations and related monitors sold. This
decrease was partially offset by a $787,000 increase in U.S. military revenues
and sales of the new Propaq CS monitor of $825,000 in the fourth quarter of
1999.
International sales, excluding international OEM sales, decreased 4.5% to
$15.5 million (23.4% of total sales) in 1999 from $16.2 million (24.1% of
total sales) in 1998. This decline in international sales was primarily due
to a decline in the number of units sold in Asia reflecting soft international
markets in that region, partially offset by sales of the new Propaq CS monitor
of $277,000 in the fourth quarter of 1999.
OEM sales increased 16.6% to $7.2 million (10.8% of total sales) in 1999 from
$6.1 million (9.1% of total sales) in 1998 primarily due to a $1.5 million
increase in MDT CO2 product shipments. This increase was partially offset by
a $496,000 decrease in sales of GenESA devices to Gensia Automedics, Inc.
GROSS PROFIT. Gross profit as a percentage of sales decreased to 49.1% in
1999 from 50.9% in 1998. The decrease in gross profit was primarily due to an
increase in sales of products which carry a relatively low margin, such as OEM
products and QuikSigns monitors, combined with slightly higher discounts on
domestic sales.
RESEARCH AND DEVELOPMENT. Research and development expenses decreased 19.1%
to $6.7 million in 1999 compared to $8.3 million in 1998. This decrease was
primarily the result of the relocation of the Pryon operations from Menomonee
Falls, Wisconsin to the Company's Beaverton, Oregon facility in 1998 which
resulted in a reduction in the total number of research and development
employees. As a percentage of sales, research and development expenses were
10.1% in 1999 and 12.3% in 1998.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses decreased 10.5% to $20.3 million in 1999 from $22.7 million in 1998.
This decrease resulted primarily from the closure of the Company's subsidiary
offices and the direct sales organizations in Germany and France initiated at
the end of 1998 and the reduction in the number of administrative employees as
a result of the relocation of the Pryon operations in the third quarter of
1998. As a percentage of sales, selling, general and administrative expenses
were 30.7% in 1999 and 33.8% in 1998.
SPECIAL CHARGES. During 1998, the Company incurred special charges of $5.4
million which included $3.2 million related to the restructuring of the
Company's worldwide operations and $2.2 million to relocate the operations of
the Company's Pryon subsidiary from Wisconsin to Oregon. Cash payments during
1999 related to these special charges totaled $1,540,000 and consisted
primarily of employee severance benefits and lease termination costs. As of
December 31, 1999, special charges of $102,000, related primarily to certain
contract terminations, had not been disbursed. The Company anticipates that
these remaining balances will be expended by the end of 2000. No special
charges were incurred in 1999.
OTHER INCOME. Other income (net) increased to $2.6 million in 1999 from
$982,000 in 1998 primarily due to the 1999 SICOR litigation settlement,
partially offset by foreign exchange losses related to the liquidation of the
Company's French and German subsidiaries. During 1999, the Company reached a
settlement with SICOR, Inc. (formerly Gensia SICOR, Inc.) relating to
litigation the Company commenced against Gensia SICOR, Inc. and Gensia
Automedics in July 1998 alleging they breached a development and supply
agreement to develop and supply a closed-loop drug delivery and monitoring
device. Under terms of this settlement, SICOR, Inc. and Gensia Automedics
have agreed to pay the Company a total of $3.7 million over the next two
years.
PROVISION FOR (BENEFIT FROM) INCOME TAXES. The provision for income taxes
was $1.8 million in 1999 compared to a benefit from income taxes of $525,000
in 1998, producing annual effective tax rates of 22.3% and (43.7%),
respectively. The difference in the effective taxes rates between 1999 and
1998 was primarily due to the significant change in pretax income (loss)
caused by the special charges incurred in 1998, partially offset by benefits
from utilization of net operating loss and research and experimentation tax
credit carryovers in 1999.
NET INCOME (LOSS). Net income in 1999 was $6.3 million or $0.76 per diluted
share compared to net loss of $675,000 or $0.08 per diluted share in 1998.
The increase in net income was primarily due to reduced operating expenses and
special charges as a result of the relocation of the Pryon manufacturing
facility and the worldwide restructuring in 1998, and increased 1999 other
income primarily related to the SICOR litigation settlement. Excluding unusual
items consisting of $1.6 million of SICOR settlement income and $125,000 of
foreign exchange losses (net $1.1 million after tax, or $.13 per diluted
share), net income for 1999 was $5.2 million, or $.63 per diluted share.
Excluding unusual items consisting of $5.4 million of special charges
associated with the worldwide restructuring and the relocation of Pryon (net
$4.0 million after tax, or $0.47 per diluted share), net income for 1998 was
$3.3 million, or $.39 per diluted share.
Net income exclusive of unusual items is a non-GAAP measure, and investors
should not rely on it as a substitute for GAAP measures. Because the 1999
SICOR settlement and the 1998 worldwide restructuring and relocation of the
Pryon subsidiary were unusual in nature, management believes that a measure of
net income excluding these items is meaningful and useful to investors as it
provides an alternative basis with which management and investors can assess
the profitability of the Company's core operations.
1998 Compared to 1997
- ---------------------
SALES. Sales increased 5.0% to $67.3 million in 1998 from $64.1 million in
1997.
Domestic sales, excluding Original Equipment Manufacturer sales of Pryon
Medical Device Technology (MDT) products and GenESA devices (OEM sales),
increased 17.6% to $45.0 million (66.8% of total sales) in 1998 from $38.2
million (59.6% of total sales) in 1997 primarily as a result of a $7.0 million
increase in U.S. military revenues due to an increase in unit sales of Propaq
Encore monitors.
International sales, excluding international OEM sales, decreased 7.4% to
$16.2 million (24.1% of total sales) in 1998 from $17.5 million (27.3% of
total sales) in 1997. This decline in international sales was principally due
to the continued strength of the U.S. dollar against foreign currencies and
soft international markets, particularly in Europe and Asia.
OEM sales decreased 26.5% to $6.1 million (9.1% of total sales) in 1998 from
$8.4 million (13.1% of total sales) in 1997 primarily due to a $2.1 million
decrease in sales to certain of the Company's MDT customers. Additionally,
there was a slight decrease in sales of GenESA devices to Gensia Automedics.
GROSS PROFIT. Gross profit as a percentage of sales decreased to 50.9% in
1998 from 51.3% in 1997. The decrease in gross profit as a percentage of
sales was primarily due to manufacturing inefficiencies and production start
up costs resulting from the relocation of the Pryon operations from Menomonee
Falls, Wisconsin to the Company's Beaverton, Oregon facility in 1998.
RESEARCH AND DEVELOPMENT. Research and development expenses decreased 4.3% to
$8.3 million in 1998 compared to $8.7 million in 1997. This decrease was
primarily the result of the relocation of the Pryon operations from Menomonee
Falls, Wisconsin to the Company's Beaverton, Oregon facility in 1998 which
resulted in a reduction in the total number of research and development
employees. As a percentage of sales, research and development expenses were
12.3% in 1998 and 13.5% in 1997.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 8.8% to $22.7 million in 1998 from $20.9 million in 1997.
This increase resulted primarily from the establishment of direct sales
organizations in Germany and France in 1998 and an increase in the number of
direct sales representatives and clinical application specialists employed by
the Company to expand the field sales and service operations. As a percentage
of sales, selling, general and administrative expenses were 33.8% in 1998 and
32.6% in 1997.
SPECIAL CHARGES. The Company incurred special charges of $5.4 million during
1998. These special charges included $3.2 million related to the
restructuring of the Company's worldwide operations, which was comprised of a
$1.6 million write-down of the Universal Defibrillator Module (UDM) purchased
in 1995 as part of the acquisition of Omeara Limited, $933,000 costs related
to the closure of the direct sales organizations in Germany and France which
include termination costs for 16 employees, lease termination costs and write-
down of assets of direct sales organizations to net realizable value, and
$644,000 of severance costs for 14 terminated domestic employees and a
severance package for the founder and Chief Technical Officer who resigned in
1998. Additionally, special charges of $2.2 million were incurred to relocate
the operations of the Company's Pryon subsidiary from Wisconsin to Oregon.
These costs include employee severance, write-off of assets that will not be
utilized in Oregon, lease and other contract terminations, and costs to
relocate key employees as well as inventory and equipment. The relocation
resulted in a reduction of 56 employees from manufacturing, engineering and
administrative functions.
OTHER INCOME. Other income (net) decreased to $982,000 in 1998 from $1.1
million in 1997 primarily due to a reduction in the cash and investments
balance as the Company utilized $8.9 million of its available cash to
repurchase common stock in 1998.
PROVISION FOR (BENEFIT FROM) INCOME TAXES. The benefit from income taxes was
$525,000 in 1998 compared to a provision for income taxes of $1.0 million in
1997, producing annual effective tax rates of (43.7%) and 23.5%, respectively.
The difference in the effective taxes rates between 1998 and 1997 was
primarily due to the significant change in pretax income (loss) caused by the
special charges incurred in 1998.
NET INCOME (LOSS). The net loss in 1998 was $675,000 or $0.08 per diluted
share compared to net income of $3.4 million or $0.36 per diluted share in
1997. Excluding unusual items consisting of special charges associated with
the worldwide restructuring and the relocation of Pryon, net income for 1998
would have been $3.3 million or $0.39 per diluted share.
Net income exclusive of unusual items is a non-GAAP measure, and investors
should not rely on it as a substitute for GAAP measures. Because the
worldwide restructuring and relocation of the Pryon subsidiary were unusual in
nature, management believes that a measure of net income excluding these items
is meaningful and useful to investors as it provides an alternative basis with
which management and investors can assess the profitability of the Company's
core operations.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1999, the Company had cash and investment balances totaling
$24.0 million. Working capital balances decreased to $36.7 million at
December 31, 1999 from $39.3 million at December 31, 1998 primarily due to a
reduction in inventory and accounts receivable balances. The current ratio
decreased slightly to 5.6:1 at December 31, 1999 from 5.9:1 at December 31,
1998. The Company's portfolio of long-term investments increased by $6.0
million in 1999.
Operating activities generated positive cash flows of $10.1 million in 1999
primarily due to income from operations of $6.3 million as well as a decrease
in inventory and accounts receivable balances. Cash of $1.9 million was used
for the acquisition of property and equipment in 1999. During 1999, the
Company repurchased 407,000 shares of common stock at a weighted average
purchase price of $7.94 per share. Proceeds from stock option and stock
purchase plans and related tax benefits were $1.1 million in 1999.
No significant commitments for capital expenditures have been entered into as
of December 31, 1999. 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 2000 and the
foreseeable future.
YEAR 2000 ISSUES
Prior to December 31, 1999, the Company initiated and completed a
comprehensive Year 2000 analysis. To date, the Company has not, nor to the
Company's knowledge, have the Company's suppliers and third party vendors,
experienced any material Year 2000-related problems. However, the Company
cannot determine if it will be subject to Year 2000 problems in the future
that have not been identified to date.
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and Results
of Operations and other sections of the Annual Report contain statements, that
are 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. In addition, such
statements could be affected by other factors discussed elsewhere in this
Annual Report and from time to time in the Company's other Securities and
Exchange Commission filings and reports, and by general industry and market
conditions and growth rates, and general domestic and international economic
conditions. Such forward-looking statements speak only as of the date on
which they are made and the Company does not undertake any obligation to
update any forward-looking statement to reflect events or circumstances after
the date of this Report. If the Company does update or correct one or more
forward-looking statements, investors and others should not conclude that the
Company will make additional updates or corrections with respect thereto or
with respect to other forward-looking statements.
The Company's quarterly operating results have fluctuated in the past and may
continue to fluctuate in the future depending on factors such as increased
competition, timing of new product announcements, pricing changes by the
Company or its competitors, length of sales cycles, market acceptance or
delays in the introduction of new products or enhanced versions of existing
products, timing of significant orders, regulatory approval requirements,
product mix and economic factors and conditions generally and in the market
for the Company's products specifically. In particular, the Company's
quarterly operating results have fluctuated as a result of the unpredictable
size and timing of military patient monitoring equipment procurements, and
seasonal or other changes in customer buying patterns. A substantial portion
of the Company's revenue in each quarter results from orders booked in that
quarter. Accordingly, revenue from quarter to quarter is difficult to
forecast. The Company's expense levels are based, in part, on its
expectations as to future revenue. If revenue levels are below expectations,
operating results are likely to be adversely affected. In particular, net
income may be disproportionately affected by a reduction in revenue because
only a small portion of expenses vary with revenue. Results of operations in
any period should not be considered indicative of the result to be expected
for any future period, and fluctuations in operating results may also result
in fluctuations in the price of the Company's common stock. No assurance can
be given that the Company will be able to grow in future periods or that its
operations will remain profitable.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
SFAS No. 133 also requires that changes in the derivative's fair value be
recognized currently in results of operations unless specific hedge accounting
criteria are met. SFAS No. 133 is effective for fiscal years beginning after
June 15, 2000. The Company does not expect SFAS No. 133 to have a material
impact on its Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of foreign currency fluctuations due to a
small portion of its international sales. The Company minimizes its risk to
foreign currency fluctuations as international sales through independent
distributors are made in U.S. dollars which has helped reduce any foreign
currency risk.
As of December 31, 1999, the Company had an investment portfolio of fixed
income securities, including those classified as cash and cash equivalents,
short-term investments and long-term investments of $21.5 million. These
securities are subject to interest rate fluctuations. An increase in interest
rates could adversely affect the market value of the Company's fixed income
securities.
The Company does not use derivative financial instruments in its investment
portfolio to manage interest rate risk. The Company does, however, limit its
exposure to interest rate and credit risk by establishing and strictly
monitoring clear policies and guidelines for its investment portfolio. The
weighted average maturity of the investment portfolio may not exceed 360 days
and no single investment may have a maturity date of greater than two years.
The guidelines also establish credit quality standards and limit the exposure
to one issue, issuer, or type of instrument. Due to these factors the exposure
to market and credit risk is not expected to be material.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS
- --------------------
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.
/s/Robert F. Adrion /s/Edward M. Kolasinski
- ---------------------------- -----------------------------
Robert F. Adrion, Ph.D. Edward M. Kolasinski
Chief Executive Officer, President Vice-President,
Finance/Chief Financial
Officer
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, 1999 and 1998 and the
related consolidated statements of operations and comprehensive income,
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1999. 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, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999 in conformity with generally
accepted accounting principles.
/s/ KPMG LLP
Portland, Oregon
January 21, 2000
<PAGE>
PROTOCOL SYSTEMS, INC.
Consolidated Statements of Operations and Comprehensive Income
(in thousands except per share amounts)
<TABLE>
<CAPTION>
Years ended December 31,
------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Sales $66,317 $67,323 $64,094
Cost of sales 33,733 33,029 31,212
------ ------ ------
Gross profit 32,584 34,294 32,882
Operating expenses:
Research and development expenses 6,722 8,304 8,675
Selling, general and administrative expenses 20,347 22,738 20,891
Special charges -- 5,434 --
------ ------ ------
Total operating expense 27,069 36,476 29,566
------ ------ ------
Income (loss) from operations 5,515 (2,182) 3,316
Other income (expense):
Interest income 1,089 1,016 1,104
Other 1,496 (34) (32)
------ ------ ------
Total other income 2,585 982 1,072
------ ------ ------
Income (loss) before income taxes 8,100 (1,200) 4,388
Provision for (benefit from) income taxes 1,809 (525) 1,032
------ ------ ------
Net income (loss) 6,291 (675) 3,356
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (98) 87 (41)
Unrealized holding gain (loss) arising during
the period (119) 20 1
------ ------ ------
Other comprehensive income (loss) (217) 107 (40)
------ ------ ------
Comprehensive income (loss) $6,074 ($568) $3,316
------ ------ ------
Earnings (loss) per share:
Basic $0.77 ($0.08) $0.38
------ ------ ------
Diluted $0.76 ($0.08) $0.36
------ ------ ------
Weighted average number of shares used in
the computation of earnings (loss) per share:
Basic 8,176 8,487 8,859
Diluted 8,321 8,487 9,253
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
PROTOCOL SYSTEMS, INC.
Consolidated Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
December 31,
-----------------------
1999 1998
------ ------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $10,470 $ 8,023
Short-term investments 3,487 6,680
Accounts receivable:
Trade, less allowance for doubtful accounts
of $450 and $420 at 1999 and 1998,
respectively 16,615 17,654
Other 1,468 317
Inventories, net 10,080 12,218
Prepaid expenses and other current assets 2,418 2,469
------- ------
Total current assets 44,538 47,361
Long-term investments 10,032 4,045
Property and equipment, net 3,912 4,041
Other assets 1,356 404
------- ------
$59,838 $55,851
------- ------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,750 $ 2,584
Accrued liabilities 5,057 5,383
Deferred revenue and customer deposits 80 98
------ ------
Total current liabilities 7,887 8,065
Deferred income taxes -- 40
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value. Authorized
10,000 shares; none issued and outstanding
at 1999 and 1998 -- --
Common stock, $.01 par value. Authorized
30,000 shares; issued and outstanding
8,032 at 1999 and 8,207 at 1998 80 82
Additional paid-in capital 26,216 28,105
Unearned compensation (26) (48)
Accumulated other comprehensive income(loss) (12) 205
Retained earnings 25,693 19,402
------ ------
Total shareholders' equity 51,951 47,746
------ ------
$59,838 $55,851
------ ------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
PROTOCOL SYSTEMS, INC.
Consolidated Statements of Shareholders' Equity
(in thousands)
<TABLE>
<CAPTION>
Accumulated Total
Common stock Additional other share-
----------------- paid-in Unearned comprehensive Retained holders'
Shares Par value capital compensation income(loss) earnings equity
------ --------- --------- ----------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1996 8,744 $87 $34,363 $-- $138 $16,721 $51,309
Common stock
issued under
stock purchase
and stock
option plans 191 2 879 -- -- -- 881
Tax benefit from
stock option
incentive plans -- -- 81 -- -- -- 81
Vesting of shares
issued for
purchase of
subsidiary -- -- 91 -- -- -- 91
Other comprehensive
loss -- -- -- -- (40) -- (40)
Net income -- -- -- -- -- 3,356 3,356
------ ------- ------- ------- ------- -------- -------
Balance at
December 31, 1997 8,935 89 35,414 -- 98 20,077 55,678
Common stock
issued under
stock purchase
and stock
option plans 208 2 1,183 -- -- -- 1,185
Tax benefit from
stock option
incentive plans -- -- 147 -- -- -- 147
Repurchase of
common stock (956) (9) (8,922) -- -- -- (8,931)
Issuance of common
stock under
restricted stock
award agreement 20 -- 192 (192) -- -- --
Amortization of
unearned
compensation -- -- -- 144 -- -- 144
Vesting of shares
issued for
purchase of
subsidiary -- -- 91 -- -- -- 91
Other comprehensive
income -- -- -- -- 107 -- 107
Net loss -- -- -- -- -- (675) (675)
------ ------- ------- ------- ------- -------- -------
Balance at
December 31, 1998 8,207 82 28,105 (48) 205 19,402 47,746
Common stock
issued under
stock purchase
and stock
option plans 219 2 1,062 -- -- -- 1,064
Tax benefit from
stock option
incentive plans -- -- 82 -- -- -- 82
Repurchase of
common stock (407) (4) (3,225) -- -- -- (3,229)
Issuance of common
stock under
restricted stock
award agreement 13 -- 101 (101) -- -- --
Amortization of
unearned
compensation -- -- -- 123 -- -- 123
Vesting of shares
issued for purchase
of subsidiary -- -- 91 -- -- -- 91
Other comprehensive
loss -- -- -- -- (217) -- (217)
Net income -- -- -- -- -- 6,291 6,291
------ ------ ------- ------- ------- ------- --------
Balance at
December 31, 1999 8,032 $80 $26,216 ($26) ($12) $25,693 $51,951
------ ------ ------- ------- ------- ------- --------
</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,
-------------------------------
1999 1998 1997
-------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $6,291 $(675) $3,356
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 2,175 2,353 2,365
Asset impairment 50 2,466 --
Amortization of bond premium 133 186 312
Provision for deferred income taxes (413) (562) (250)
Other non-cash items 129 144 --
Changes in operating assets and liabilities:
Accounts receivable 273 (1,808) (653)
Inventories 2,061 1,331 (1,098)
Prepaid expenses and other assets (866) (120) (130)
Accounts payable and accrued liabilities 307 (169) 569
Deferred revenue and customer deposits (17) (24) (20)
------ ------ ------
Net cash provided by operating activities 10,123 3,122 4,451
Cash flows from investing activities:
Purchase of investments (15,534) (10,871) (14,539)
Proceeds from maturity of investments 12,488 13,292 16,715
Acquisition of property and equipment (1,926) (2,090) (2,198)
Expenditures for other assets (261) (264) (36)
------- ------ ------
Net cash provided by (used in) investing
activities (5,233) 67 (58)
Cash flows from financing activities:
Proceeds from stock option and stock purchase plans
and related tax benefits 1,146 1,332 962
Repurchase of common stock (3,229) (8,931) --
------- ------- ------
Net cash provided by (used in) financing
activities (2,083) (7,599) 962
Effect of exchange rates on cash and cash equivalents (360) 176 (1)
------- ------- ------
Net increase (decrease) in cash and cash
equivalents 2,447 (4,234) 5,354
Cash and cash equivalents at beginning of year 8,023 12,257 6,903
------- -------- ------
Cash and cash equivalents at end of year $10,470 $8,023 $12,257
------- -------- ------
Supplemental disclosures of cash flow information:
Cash paid for income taxes $1,485 $989 $933
Supplemental schedule of noncash financing activities:
Increase in investment due to release of escrowed
shares of common stock $91 $91 $91
</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 (SFAS) No. 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
less than one year. Long-term investments consist of highly-rated notes and
bonds from a variety of issuers with maturities of greater than one year and
less than two years.
At December 31, 1999, the fair market value of short-term and long-term
investments was $13,519,000 while short-term and long-term investments stated
at amortized cost were $13,585,000 resulting in an unrealized holding loss of
$66,000. At December 31, 1998, the fair market value of short-term and long-
term investments was $10,725,000 while short-term and long-term investments
stated at amortized cost were $10,672,000 resulting in an unrealized holding
gain of $53,000. Unrealized holding gains and losses on available-for-sale
securities are reported as a separate component of shareholders' equity until
realized.
INVENTORIES
Inventories consist 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. Depreciation is computed using the
straight-line method over the estimated useful lives of the various 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 $1,986,000, $2,203,000, and $2,058,000, for 1999, 1998, and
1997, respectively.
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes certain software development costs incurred in
accordance with the provisions of SFAS No. 86 "Accounting for Software to be
Sold, Leased, or Otherwise Marketed". 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 $0, $190,000, and $26,000, in 1999,
1998, and 1997, respectively.
Amortization expense related to capitalized software development costs of
$129,000, $148,000, and $202,000 was recorded in 1999, 1998, and 1997.
Amortization of capitalized software costs is included in cost of sales in the
consolidated statements of operations. Accumulated amortization at December
31, 1999 and 1998 was $1,192,000 and $1,063,000, respectively.
INTANGIBLE ASSETS
Intangible assets, which are classified as other non-current assets, are
stated at historical cost less accumulated amortization. The Company's
intangible assets consist primarily of patents and technology rights. The
patents are amortized using the straight-line method over their estimated
economic lives of ten years. Amortization of the technology rights will
commence upon the initial sale of the related product.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's foreign subsidiaries is the local
currency. Assets and liabilities of the foreign subsidiaries 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 the active foreign subsidiaries are included as a
separate component of consolidated shareholders' equity. Adjustments
resulting from translation of the remaining balance sheets of the discontinued
French and German subsidiary operations are reported as transaction gains and
losses, included in other income (loss) in 1999.
Cash flows from the foreign subsidiaries 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.
BASIC AND DILUTED EARNINGS PER SHARE
The Company reports earnings per share in accordance with SFAS No. 128,
"Earnings per Share" which requires the presentation of both basic earnings
per share and diluted earnings per share. Basic earnings per share is
computed using the weighted average number of common shares outstanding and
diluted earnings per share is computed using the weighted average number of
common shares outstanding and dilutive potential common shares assumed to be
outstanding during the period using the treasury stock method. Dilutive
potential common shares consist of options to purchase common stock.
FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable approximate fair value due to the short-term nature of these
instruments. Fair value estimates are made at a specific point in time, based
on relevant market information about the financial instrument when available.
These estimates are subjective in nature and involve uncertainties and matters
of significant judgement and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
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.
STOCK-BASED COMPENSATION PLANS
The Company accounts for its stock plans in accordance with the provisions of
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 Accounting
Principles Board (APB) Opinion 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 (loss) and earnings (loss) per share.
NOTE 2. BALANCE SHEET COMPONENTS (IN THOUSANDS)
The components of inventories, net of
reserve are as follows: December 31,
1999 1998
------ ------
Raw materials $ 4,670 $ 4,939
Work in process 1,916 2,838
Finished goods 2,043 2,207
Demonstration instruments 1,451 2,234
------- -------
Inventories, net $10,080 $12,218
------- -------
The components of property and
equipment are as follows:
Equipment $13,622 $12,111
Furniture and fixtures 1,776 1,910
Leasehold improvements 487 551
------ ------
15,885 14,572
Less accumulated depreciation
and amortization 11,973 10,531
------ ------
Property and equipment, net $ 3,912 $ 4,041
------ ------
The components of accrued liabilities
are as follows:
Accrued salaries, wages and
related liabilities $2,827 $2,588
Accrual for special charges 102 1,642
Reserve for warranties 923 915
Income taxes payable 587 --
Other liabilities 618 238
------ -------
Total accrued liabilities $5,057 $5,383
------ -------
The components of accumulated other
comprehensive income are as follows:
Unrealized holding gain (loss)
on investments ($66) $53
Foreign currency translation adjustment 54 152
------ ------
Total accumulated other
comprehensive income (loss) ($12) $205
------ ------
NOTE 3. SHAREHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of $.01 par value
preferred stock. At December 31, 1999, 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.
COMMON STOCK OPTIONS
Pursuant to the Company's 1998, 1992 and 1987 stock option plans, the Board of
Directors has the authority to grant incentive stock options. The incentive
stock options generally 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 1998 and 1992
stock option plans. The option price for the non-statutory stock options is
determined by the Board of Directors on the date of grant, but generally is
not 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.
On August 6, 1999, the Company's Board of Directors granted 152,944 non-
statutory stock options to its President and Chief Executive Officer. These
options were not pursuant to any of the Company's stock option plans. These
options vest at a rate of 25% per year following the grant date and expire ten
years from the date of grant. These options were issued at the fair market
value of the Company's common stock on the date of grant.
Under the Company's 1993 Stock Option Plan for Nonemployee Directors, each
nonemployee director receives an initial option to purchase 20,000 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 receives 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, 1999, there were 202,944, 115,064 and 0 stock options
available under the 1998, 1992 and 1987 option plans, respectively and 217,000
non-statutory stock options available for grant under the 1993 option plan for
nonemployee directors. The Company has reserved 2,294,890 shares of common
stock for future issuance pursuant to these plans.
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 upon the occurrence of certain events, 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
The 1994 Employee Stock Purchase Plan allows employees of the Company to
accumulate funds of up to 10% of their cash compensation to purchase shares of
the Company's common stock. Under the plan, 85,340, 101,289, and 91,736
shares of common stock were issued in 1999, 1998, and 1997, respectively. The
Company has reserved 199,894 shares of common stock for future issuance under
this plan.
RESTRICTED STOCK AWARD
On August 18, 1999, the Company's Board of Directors awarded a stock grant of
10,000 common shares with a fair value of $7.87 per share to the Chairman of
the Board. This stock award is subject to vesting ratably over a six month
period and other terms as specified at the time of issuance by a committee of
the Board of Directors. Unearned compensation expense is recognized ratably
over the vesting period.
Stock grants of up to 60,000 common shares may be issued to the Chief
Executive Officer in future years beginning in 2002 based on the attainment of
certain performance criteria.
STOCK REPURCHASE PLAN
On May 19, 1999 and January 7, 1998, the Board of Directors authorized the
repurchase of the Company's currently outstanding shares of common stock of up
to 500,000 and 1,000,000 shares, respectively. The Company has repurchased
407,000 and 956,000 and shares of common stock in 1999 and 1998, respectively.
NOTE 4. STOCK-BASED COMPENSATION
At December 31, 1999, the Company had five plans providing for stock
compensation; four fixed option plans under which options are granted to
acquire company stock at exercise prices equal to 100% of the fair value of
the stock 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. Additionally, the Company issued 152,944 options in
1999 and 80,000 options in 1998 that were not pursuant to any of the stock
option plans.
The Company applies APB No. 25 in accounting for these options and,
accordingly, no compensation cost has been recognized with respect thereto.
Had compensation cost for these options been determined consistent with SFAS
No. 123, the Company's net income (loss) and basic and diluted earnings (loss)
per share would have been reduced to the proforma amounts shown in the
following table:
1999 1998 1997
------ ------ ------
Net income (loss)
(in thousands) As reported $ 6,291 ($ 675) $ 3,356
Pro-forma $ 4,750 ($ 2,420) $ 1,811
Basic earnings (loss)
per share As reported $ 0.77 ($ 0.08) $ 0.38
Pro-forma $ 0.58 ($ 0.29) $ 0.20
Diluted earnings (loss)
per share As reported $ 0.76 ($ 0.08) $ 0.36
Pro-forma $ 0.58 ($ 0.29) $ 0.20
The pro forma information presented above includes only the effects of
applying SFAS No. 123 to options granted after 1994. Because options
generally vest over a number of years and additional awards are made each
year, the pro forma 1998 and 1997 amounts are not representative of the effect
SFAS No. 123 would have had on net income (loss) and earnings (loss) per share
had it been applied to options granted prior to 1995. Similarly, the
resulting pro forma compensation costs may not be representative of that
expected in future years.
The fair value of compensation costs reflected in the above pro forma amounts
were determined using the Black-Scholes option pricing model and the following
weighted-average assumptions:
Years ended December 31,
------------------------
1999 1998 1997
------ ------ ------
Risk-free interest rate 5.72% 5.19% 6.18%
Expected dividend yield 0% 0% 0%
Expected life (in years) 5 5 5
Expected volatility 62% 61% 60%
Under the Black-Scholes option pricing model the weighted-average grant date
fair value of options granted during 1999, 1998 and 1997 was $4.48, $4.91 and
$4.80, respectively.
Information with respect to the Company's options for 1999, 1998 and 1997 is
provided below:
<TABLE>
<CAPTION>
Weighted-average
Number of shares exercise price per share
---------------- ------------------------
<S> <C> <C>
Balance at December 31, 1996 1,359,303 8.51
Granted 535,154 8.38
Exercised (108,408) 2.02
Cancelled (408,426) 12.93
---------
Balance at December 31, 1997 1,377,623 7.66
Granted 278,620 8.76
Exercised (112,083) 3.98
Cancelled (108,222) 8.66
---------
Balance at December 31, 1998 1,435,938 $ 8.09
Granted 609,490 7.74
Exercised (132,770) 3.71
Cancelled (152,776) 7.87
---------
Balance at December 31, 1999 1,759,882 $ 8.30
---------
</TABLE>
Additional information regarding options as of December 31, 1999 is as
follows:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
- ------------- ------------------------------------- ------------------------
Weighted- Weighted- Weighted-
Range of average average average
exercise Number remaining exercise Number exercise
prices outstanding life price exercisable price
- ------------- ------------------------------------- ------------------------
<C> <C> <C> <C> <C> <C>
$ 0.35-$ 6.00 180,846 2.25 years $ 4.04 180,846 $ 4.04
6.13- 7.50 554,305 7.48 years 7.08 224,237 6.98
7.56- 8.50 469,061 9.35 years 8.14 54,768 8.03
8.63- 20.75 555,670 6.39 years 11.04 480,732 11.07
----------- -----------
$ 0.35-$20.75 1,759,882 7.10 years $ 8.30 960,583 $ 8.53
----------- -----------
</TABLE>
NOTE 5. 401(K) RETIREMENT INVESTMENT PLAN
The Company has a Retirement Investment Plan (the Plan) that qualifies as a
deferred salary arrangement under Section 401(k) of the Internal Revenue Code.
Under the Plan, participating U.S. employees may defer a portion of their
pretax earnings, up to the Internal Revenue Service annual contribution limit.
The Company currently matches 25% of eligible employee's contributions on the
first 5% of employee's earnings deferred. Employer matching contributions vest
over 5 years, 20% for each year of service completed. The Company's matching
contributions to the Plan were $145,000, $169,000, and $170,000, for 1999,
1998, and 1997, respectively.
NOTE 6. EARNINGS PER SHARE
The following is a reconciliation of the denominators of the basic and diluted
computations of earnings (loss) per share. There are no reconciling items for
the numerators, which consist of net income (loss) for all periods presented.
<TABLE>
<CAPTION>
For years ended December 31,
----------------------------
1999 1998 1997
-------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Per Per Per
(in thousands except share share share
per share amounts) Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings (loss): 8,176 $0.77 8,487 ($0.08) 8,859 $0.38
Effect of dilutive stock
options 145 -- 394
----- ----- -----
Diluted earnings (loss): 8,321 $0.76 8,487 ($0.08) 9,253 $0.36
----- ------ ----- ----- ----- -----
</TABLE>
The number of options to purchase shares of common stock that were outstanding
but were not included in the computation of diluted earnings per share were
827,000, 1,414,000, and 414,000, for 1999, 1998, and 1997, respectively.
These options were not included in the diluted earnings per share calculation
in 1999 and 1997 because the options' exercise prices were greater than the
average market prices of the shares. These options were not included in the
diluted loss per share calculation in 1998 because the Company incurred a net
loss for the year.
NOTE 7. SPECIAL CHARGES
During the third quarter of 1998, the Company incurred special charges of
$2,246,000 to relocate its wholly owned subsidiary, Pryon Corporation
("Pryon"), from Menomonee Falls, Wisconsin to the Company's Beaverton, Oregon
facility in order to improve operating efficiencies. During the fourth quarter
of 1998, the Company incurred additional special charges of $3,188,000 as it
discontinued the development of its defibrillator project and restructured its
worldwide operations. This restructuring included the closure of its
subsidiary offices and direct sales organizations in France and Germany,
elimination of 14 positions at the Company's headquarters in Beaverton, Oregon
and the resignation of the founder and Chief Technical Officer. Cash payments
during 1999 related to these special charges totaled $1,540,000 and consisted
primarily of employee severance benefits and lease termination costs.
As of December 31, 1999, special charges of $102,000, related primarily to
certain contract terminations, had not been disbursed. The Company
anticipates that these remaining balances will be expended by the end of 2000.
NOTE 8. LITIGATION SETTLEMENT
On August 2, 1999 the Company reached a settlement with SICOR, Inc. (formerly
Gensia SICOR, Inc.) relating to litigation the Company commenced against
Gensia SICOR, Inc. and Gensia Automedics in July 1998 alleging they breached a
development and supply agreement to develop and supply a closed-loop drug
delivery and monitoring device. Under terms of this settlement, SICOR, Inc.
and Gensia Automedics have agreed to pay the Company a total of $3.7 million
over the next two years. During 1999, the Company recognized in other income
$1,611,000 related to this settlement.
NOTE 9. LEASES
The Company leases its primary office and manufacturing facilities in
Beaverton, Oregon under a long-term operating lease which expires in December
2005. 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:
Years ending
December 31, (in thousands)
------------- --------------
2000 $ 986
2001 1,090
2002 1,076
2003 1,127
2004 1,136
Thereafter 1,204
-------
Total future minimum lease payments $6,619
-------
Total rental expense for all operating leases was $880,000, $886,000, and
$767,000 for the years ended December 31, 1999, 1998, and 1997, respectively.
NOTE 10. INCOME TAXES
Domestic and foreign pre-tax income (loss) consists of the following:
<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------
(in thousands) 1999 1998 1997
- -------------- ------ ------ ------
<S> <C> <C> <C>
Domestic $ 7,803 $ 1,786 $ 4,587
Foreign 297 (2,986) ( 199)
------- ------ ------
Total $ 8,100 ($ 1,200) $ 4,388
------- ------ ------
</TABLE>
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
For the year ended December 31,
-------------------------------
(in thousands) 1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Current:
Federal $1,808 ($ 40) $1,080
Foreign 7 5 4
State 407 72 198
------ ------ ------
2,222 37 1,282
Deferred:
Federal (344) (74) (156)
Foreign (14) (482) (65)
State (55) (6) (29)
------ ------ ------
(413) (562) (250)
------ ------ ------
Total $1,809 ($ 525) $1,032
------ ------ ------
</TABLE>
A reconciliation showing the reasons for the difference between the Company's
effective tax rate and the statutory Federal income tax rate of 34% is as
follows:
<TABLE>
<CAPTION>
For the year ended December 31,
-------------------------------
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Federal statutory rate 34.0 % (34.0%) 34.0 %
State taxes, net of federal benefit 3.4 2.3 2.5
Research and experimentation credits (1.8) (27.5) (7.6)
Tax benefit of foreign sales corporation (1.2) (3.1) (2.3)
Tax benefit of exempt interest income (2.0) (18.8) (5.6)
Increase (decrease) in valuation allowance (6.4) 34.4 --
Net operating loss carryovers utilized (4.0) -- --
Other, net 0.3 3.0 2.5
------ ------ ------
Effective tax rate 22.3 % (43.7%) 23.5 %
------ ------ ------
</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, 1999 and 1998 are presented below:
<TABLE>
<CAPTION>
(in thousands)
1999 1998
----- -----
<S> <C> <C>
Deferred tax assets:
Inventory valuation adjustments $ 601 $ 513
Other non-deductible accruals 1,264 717
Net operating loss carryovers -- 322
Tax credit carryovers 456 632
Other 308 684
------- -------
Gross deferred tax assets 2,629 2,868
Valuation allowance (591) (1,172)
------- -------
Deferred tax assets 2,038 1,696
Deferred tax liabilities:
Depreciation -- (40)
Intangible technology rights -- 55
Software development costs -- (84)
------ -------
Deferred tax liabilities -- (69)
------ -------
Net deferred taxes $ 2,038 $1,627
------ -------
</TABLE>
Net current deferred taxes - asset $ 1,889 $1,667
Net long-term deferred taxes - asset (liability) $ 149 ($ 40)
The Company has established a valuation allowance for certain deferred tax
assets of $591,000 at December 31, 1999. The valuation allowance was
$1,172,000 and $987,000 at December 31, 1998 and 1997, respectively. The net
decrease of $581,000 in 1999 was mainly due to recognition of the benefits of
expected utilization of net operating loss and research & experimentation
credit carryovers. Management believes that it is more likely than not that
the results of future operations will generate sufficient income to realize
the net deferred tax assets as of December 31, 1999.
At December 31, 1999, the Company had available federal research &
experimentation tax credit carryovers of $338,000, expiring in the years 2018
through 2019, and alternative minimum tax credit carryovers of $75,000 with no
expiration date.
NOTE 11. SEGMENT INFORMATION
The Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise
and Related Information" during 1998. In accordance with SFAS No. 131 the
Company has identified a single operating 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. Sales to the U.S. Government were
$11,195,000, $10,410,000, and $3,388,000, in 1999, 1998, and 1997,
respectively. No other customer or country constituted more than 5% of total
sales. Sales by geographic region were as follows for the years ended
December 31:
<TABLE>
<CAPTION>
(in thousands) 1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
United States $48,491 $49,306 $45,365
International 17,826 18,017 18,729
------- ------- -------
Total Sales $66,317 $67,323 $64,094
------- ------- -------
</TABLE>
<PAGE>
SUPPLEMENTARY DATA
- ------------------
QUARTERLY FINANCIAL SUMMARY (UNAUDITED DATA)
<TABLE>
<CAPTION>
(in thousands except common stock Quarters ended
prices and per share amounts) ------------------------------------------------
March 31 June 30 September 30 December 31
--------- -------- ------------ ------------
<S> <C> <C> <C> <C>
1999
Sales $14,299 $16,753 $16,528 $18,737
Gross profit 6,955 8,049 8,280 9,300
Income from operations 705 1,535 1,498 1,777
Net income 725 1,323 2,428 1,815
Basic earnings per share .09 .16 .30 .23
Diluted earnings per share .09 .16 .29 .22
Weighted average number of shares
used in the computation of earnings
(loss) per share:
Basic 8,241 8,314 8,214 8,023
Diluted 9,385 8,453 8,388 8,146
1998
Sales $14,920 $16,960 $17,530 $17,913
Gross profit 6,913 8,967 9,478 8,936
Income (loss) from operations 39 721 (1,041) (1,901)
Net income (loss) 230 673 (557) (1,021)
Basic earnings (loss) per share .03 .08 (.07) (.12)
Diluted earnings (loss) per share .03 .08 (.07) (.12)
Weighted average number of shares
used in the computation of earnings
per share:
Basic 8,794 8,501 8,389 8,267
Diluted 9,134 8,845 8,389 8,267
</TABLE>
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is included under the captions "Election
of Directors", "Management" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's Proxy Statement for the 2000 Annual Meeting of
Shareholders 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 Proxy Statement for the 2000 Annual Meeting of
Shareholders 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 Proxy
Statement for the 2000 Annual Meeting of Shareholders 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) The following documents are filed as part of this Form 10-K:
(1) FINANCIAL STATEMENTS
Report of Management
Report of Independent Accountants for the fiscal years ended
December 31, 1999 and 1998
Consolidated Statements of Operations and Comprehensive
Income - Years ended December 31, 1999, 1998 and 1997
Consolidated Balance Sheets - As of December 31, 1999 and 1998
Consolidated Statements of Stockholders' Equity - Years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows - Years ended
December 31, 1999, 1998 and 1997
(2) FINANCIAL STATEMENT SCHEDULE
Schedule II - Valuation and Qualifying Accounts
Report of Independent Accountants on Financial Statement Schedules
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.
(A) (3) EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
3.1 Fourth Restated Articles of Incorporation of Protocol Systems, Inc. (1)
3.2 Restated Bylaws of Protocol Systems, Inc. (1)
4.0 Rights Agreement dated March 20, 1992 between Protocol Systems, Inc. and First
Interstate Bank of Oregon, N.A. (1)
10.1 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. (1)
10.2 Form of Indemnity Agreements between Protocol Systems, Inc. and its Executive
Officers and Directors. (1)
10.3 Protocol Systems, Inc. 1987 Key Employee's Incentive Stock Option Plan, as amended
on January 21, 1992. (1)
10.4 Protocol Systems, Inc. 1987 Non-Statutory Stock Option Plan, as amended on January
21, 1992. (1)
10.5 Protocol Systems, Inc. 1992 Stock Incentive Plan as amended on January 24, 1995 (3)
10.6 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. (1)
10.7 Amendment to Business Park Lease between Protocol Systems, Inc., Koll-Copley
Partners and Petula Associates dated October 6, 1993. (2)
10.8 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. (2)
10.9 Protocol Systems, Inc. 1993 Stock Option Plan for Nonemployee Directors as amended
February 10, 1999 (8)
10.10 Amendment to Business Park Lease between Protocol Systems, Inc., Koll-Copley
Partners and Petula Associates dated December 24, 1997 (4)
10.11 Protocol Systems, Inc. 1994 Employee Stock Purchase Plan as amended on May 19,1999
(8)
10.12 Protocol Systems, Inc. 1998 Stock Incentive Plan as amended on May 19, 1999 (8)
10.13 Protocol Systems, Inc. Non-Qualified Stock Option Agreement dated March 6, 1998
(6)
10.14 Protocol Systems, Inc. Restricted Stock Award Agreement dated April 3, 1998 (5)
10.15 Executive Employment Agreement between Protocol Systems, Inc. and Allen L. Oyler
dated July 1, 1998 (7)
10.16 Executive Employment Agreement between Protocol Systems, Inc. and Carl P. Hollstein
dated July 1, 1998 (7)
10.17 Executive Employment Agreement between Protocol Systems, Inc. and James P. Fee
dated July 1, 1998 (7)
10.18 Executive Employment Agreement between Protocol Systems, Inc. and James P. Welch
dated July 1, 1998 (7)
10.19 Executive Employment Agreement between Protocol Systems, Inc. and Richard L. Roa
dated July 1, 1998 (7)
10.20 Executive Employment Agreement between Protocol Systems, Inc. and Donald M. Abbey
dated July 1, 1998 (7)
10.21 Amendment to Business Park Lease between Protocol Systems, Inc., Koll-Copley
Partners and Petula Associates dated March 19, 1999
10.22 Protocol Systems, Inc. Non-Qualified Stock Option Agreement dated August 6, 1999
(9)
10.23 Executive Employment Agreement between Protocol Systems, Inc. and Robert F. Adrion
dated August 1, 1999 (10)
22.0 Subsidiaries of the Registrant
23.0 Consent of Accountants
27.1 Financial Data Schedule for the year ended December 31, 1999
(1) Incorporated herein by reference to the Company's Registration Statement on Form S-1
dated January 22, 1992, File No. 33-45067.
(2) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993.
(3) Incorporated herein by reference to the Company's Registration Statement on Form S-4
dated April 9, 1996, File No. 333-03316.
(4) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997.
(5) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1999.
(6) Incorporated herein by reference to the Company's Registration Statement on S-8
dated August 13, 1998, File No. 333-61415.
(7) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1998.
(8) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1999.
(9) Incorporated herein by reference to the Company's Registration Statement on S-8
dated October 19, 1999, File No. 333-89315.
(10) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1999.
</TABLE>
(b) No reports on Form 8-K were filed during the quarter ended December 31,
1999.
<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 30, 2000 By: /s/ Robert F. Adrion
-------------- -----------------------
Robert F. Adrion, Ph.D.
President and Chief Executive Officer
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>
/s/ Robert F. Adrion President and Chief March 30, 2000
- --------------------------- Executive Officer (Principal --------------
Robert F. Adrion, Ph.D. Executive Officer)
/s/ Edward M. Kolasinski Vice-President, Finance and Chief March 30, 2000
- --------------------------- Financial Officer --------------
Edward M. Kolasinski (Principal Financial and Accounting
Officer)
/s/ David F. Bolender Chairman of the Board of March 30, 2000
- --------------------------- Directors --------------
David F. Bolender
/s/ Steven E. Wynne Director March 30, 2000
- -------------------------- --------------
Steven E. Wynne
/s/ Ronald S. Newbower, Ph.D. Director March 30, 2000
- ------------------------------- --------------
Ronald S. Newbower, Ph.D.
/s/ Frank E. Samuel, Jr. Director March 30, 2000
- --------------------------- --------------
Frank E. Samuel, Jr.
/s/ Curtis M. Stevens Director March 30, 2000
- ---------------------------- --------------
Curtis M. Stevens
</TABLE>
<PAGE>
<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, 1997:
Allowance for doubtful
accounts $ 252 $ 147 -- $ 41(1) $ 358
Allowance for sales returns 100 187 -- -- 287
Inventory obsolescence and
valuation reserves 785 530 -- 313(2) 1,002
Reserve for warranties 985 1,177 -- 1,078(3) 1,084
Reserve for product upgrades 3 245 -- 56(4) 192
Year ended December 31, 1998:
Allowance for doubtful
accounts $ 358 $ 114 -- $ 52(1) $ 420
Allowance for sales returns 287 134 -- 181(5) 240
Inventory obsolescence and
valuation reserves 1,002 329 -- 605(2) 726
Reserve for warranties 1,084 511 -- 680(3) 915
Reserve for product upgrades 192 (98) -- 68(4) 26
Year ended December 31, 1999:
Allowance for doubtful
accounts $ 420 $ 131 -- $ 101(1) $ 450
Allowance for sales returns 240 432 -- -- 672
Inventory obsolescence and
valuation reserves 726 441 -- 92(2) 1,075
Reserve for warranties 915 902 -- 894(3) 923
Reserve for product upgrades 26 (5) -- 21(4) 0
</TABLE>
(1) Deductions primarily represent write-offs of accounts receivable during
the period.
(2) Deductions primarily represent inventory scrapped, sold or upgraded during
the period.
(3) Deductions primarily represent inventory and labor costs incurred
repairing products under warranty.
(4) Deductions primarily represent inventory and labor costs incurred for
product upgrades performed during the period.
(5) Deductions primarily represent product returns and recognition of
deferred revenue for upgrades performed during the period.
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of Protocol Systems, Inc.:
Under the date of January 21, 2000, we reported on the consolidated balance
sheets of Protocol Systems, Inc. and subsidiaries as of December 31, 1999 and
1998, and the related consolidated statements of operations and comprehensive
income, shareholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1999, which are included in the 1999
annual report to shareholders. These consolidated financial statements and
our report thereon are included in the annual report on Form 10-K for the year
1999. 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 LLP
Portland, Oregon
January 21, 2000
SIXTH AMENDMENT TO LEASE
DATE CHANGE/RENTAL ADJUSTMENT
That certain Lease dated 10/16/90 by and between Koll Copley partners
and Petula Associates, Ltd., assigned to Petula Associates Ltd., an
Iowa corporation and Principal Mutual Life Insurance company, an Iowa
corporation doing business as KC Creekside Phase I, assigned to PS
Business Parks, L.P., Landlord, and Protocol Systems, Inc., Tenant, is
amended this 19th day of March, 1999 solely as hereinafter described.
1.h. Term of Lease:
8500 SW Creekside Place
Renewal Commencement Date: January 1, 2001
Expiration Date: December 31, 2005
8605 SW Creekside Place
Commencement Date: April 1, 1999
Expiration Date: December 31, 2005
1.i. Base Monthly Rent:
8500 SW Creekside Place
January 1, 2001 - December 31, 2003 $61,581
January 1, 2004 No rent, operating expenses
only
February 1, 2004 - December 31, 2005 $67,996
8605 SW Creekside Place
April 1, 1999 - June 30, 1999 $10,220 and operating
expenses on 14,000 s.f.
July 1, 1999 - June 30, 2002 $29,279
July 1, 2002 No rent, operating expenses
only
August 1, 2002 - December 31, 2005 $32,329
All other terms and conditions of said Lease shall remain in full force
and effect.
IN WITNESS WHEREOF, Landlord and Tenant have executed this Amendment as
of the date first written above.
LANDLORD: PS Business Parks, L.P., a California limited
Partnership
By: Eileen Newkirk, Assistant Vice President
By PS Business Parks, Inc., its general partner
TENANT: Protocol Systems, Inc.
EXHIBIT 22.0
SUBSIDIARIES OF THE REGISTRANT
Jurisdiction of
Subsidiary Incorporation
- ---------- ----------------
Protocol Medical Systems Limited Northern Ireland
Protocol U.K. Limited Oregon
Protocol Systems Foreign Sales Corporation Guam
Protocol Systems, S.A.R.L. France
Protocol Systems, GmbH Germany
Exhibit 23.0
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, 333-
17705, 333-61423, 333-61419, 333-61415, 333-89309, 333-89313 and 333-
89315) on Form S-8 of Protocol Systems, Inc. of our reports dated
January 21, 2000, relating to the consolidated balance sheets of
Protocol Systems, Inc. and subsidiaries as of December 31, 1999 and
1998, and the related consolidated statements of operations and
comprehensive income, shareholders' equity, and cash flows for each of
the years in the three-year period ended December 31, 1999, and all
related financial statement schedules, which reports appear in the
December 31, 1999 annual report on Form 10-K of Protocol Systems, Inc.
/s/ KPMG LLP
March 24, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Protocol
Systems, Inc. Consolidated Balance Sheet as of December 31, 1999 and
Consolidated Statement of Operations and Comprehensive Income for the year ended
December 31, 1999 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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 10,470
<SECURITIES> 13,519
<RECEIVABLES> 16,615<F1>
<ALLOWANCES> 450
<INVENTORY> 10,080
<CURRENT-ASSETS> 44,538
<PP&E> 15,885
<DEPRECIATION> 11,973
<TOTAL-ASSETS> 59,838
<CURRENT-LIABILITIES> 7,887
<BONDS> 0
0
0
<COMMON> 80
<OTHER-SE> 51,871
<TOTAL-LIABILITY-AND-EQUITY> 59,838
<SALES> 66,317
<TOTAL-REVENUES> 66,317
<CGS> 33,733
<TOTAL-COSTS> 33,733
<OTHER-EXPENSES> 24,484
<LOSS-PROVISION> 631
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 8,100
<INCOME-TAX> 1,809
<INCOME-CONTINUING> 6,291
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,291
<EPS-BASIC> 0.77
<EPS-DILUTED> 0.76
<FN>
<F1>Net of allowance
</FN>
</TABLE>
