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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[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
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___ to ___
Commission File Number 0-22229
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VITAL IMAGES, INC.
(Exact name of Registrant as specified in its charter)
Minnesota 42-1321776
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3300 Fernbrook Lane, N. Suite 200
Plymouth, Minnesota 55447
(Address of principal (Zip Code)
executive offices)
(612) 915-8000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section12(g) of the Act:
Common Stock, $.01 par value
Preferred Stock Purchase Rights
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K.
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The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 29, 2000 was $38,620,197.
The number of shares outstanding of the issuer's classes of common stock as of
February 29, 2000: Common stock, $.01 Par Value - 6,715,954.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of registrant's definitive Proxy Statement in connection with the
Annual Meeting of Shareholders to be held May 11, 2000 ("2000 Proxy Statement")
are incorporated by reference into Part III.
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VITAL IMAGES, INC.
FORM 10-K
TABLE OF CONTENTS
Page
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PART I
Item 1. Business............................................................3
Item 2. Properties.........................................................23
Item 3. Legal Proceedings..................................................23
Item 4. Submission of Matters to a Vote of Security Holders................23
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters..........................................................24
Item 6. Selected Financial Data............................................25
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................26
Item 8. Financial Statements and Supplementary Data........................31
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................................31
PART III
Item 10. Directors and Executive Officers of the Registrant.................32
Item 11. Executive Compensation.............................................32
Item 12. Security Ownership of Certain Beneficial Owners and
Management.......................................................32
Item 13. Certain Relationships and Related Transactions.....................32
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K......................................................33
Signatures.........................................................34
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995. For
this purpose, any statements contained in this Form 10-K that are not statements
of historical fact may be deemed to be forward-looking statements. Without
limiting the foregoing, words such as "may," "will," "expect," "believe,"
"anticipate," "estimate," or "continue" or the negative or other variations
thereof or comparable terminology are intended to identify forward-looking
statements. These statements by their nature involve substantial risks and
uncertainties, and actual results may differ materially depending on a variety
of factors, including those set forth in the section below entitled "Important
Factors."
Item 1. BUSINESS
Vital Images, Inc. ("Vital Images" or the "Company") was incorporated in Iowa in
September 1988. In March 1997, the Company re-incorporated under the laws of the
state of Minnesota. The Company's principal executive offices are located at
3300 Fernbrook Lane, N., Suite 200, Plymouth, MN 55447 (telephone (612)
915-8000, facsimile (612) 915-8010, e-mail - [email protected] ). From May
24, 1994 through May 11, 1997, the Company was a wholly-owned subsidiary of
Bio-Vascular, Inc. ("Bio-Vascular").
Business Description
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Vital Images develops, markets and supports medical visualization and analysis
software for use primarily in clinical diagnosis, surgical planning and medical
screening. The Company's software applies proprietary computer graphics and
image processing technologies to a wide variety of data supplied by computed
tomography ("CT") scanners, magnetic resonance ("MR") imaging devices and
ultrasound scanning equipment. Vital Images' products allow clinicians to create
both two- and three-dimensional views of human anatomy and to non-invasively
navigate within these images to better visualize and understand internal
structures and pathologies. The Company believes that its high-speed
visualization technology and customized protocols cost-effectively bring 3D
visualization and analysis into the routine, day-to-day practice of medicine.
Vitrea(R), Vital Images' advanced medical visualization and analysis product for
radiological and surgical applications, received FDA clearance in November 1996
and was released for sale in October 1997. Due to its speed and ease-of-use,
management believes that Vitrea is the first 3D medical visualization product
with the ability to appeal primarily to the clinical market. Historically, 3D
medical visualization software was slow, difficult to use, and operated only on
expensive workstations. Consequently, the functionality of such software was
appealing only for research applications. The Company's Vitrea software combines
speed with ease-of-use to enable a physician to access, manipulate and analyze
3D images, typically in less than five minutes. In December 1999, the Company
released Vitrea 2, a Microsoft(R) Windows NT(TM) compatible version of its
Vitrea software for 2D/3D visualization and analysis of medical image data.
Vitrea 2 is Vital Images' first 3D-volume visualization software product
available for Windows on Intel-based computers and provides the speed and
ease-of-use the medical community demands for diagnosis and treatment planning
in a clinical environment. The Company offers Vitrea primarily as an integrated
software and hardware system, consisting of Vitrea software installed on a
computer workstation. To date, the Company has licensed approximately 180 copies
of Vitrea to hospitals, clinics and other sites, including eight of the nation's
top 11 hospitals.
The Company believes that growing acceptance of 3D visualization and analysis
offers Vital Images numerous market expansion opportunities. Research and
development efforts are currently focused on using the Company's base of
visualization technology to expand to other imaging modalities, such as x-ray
angiography, as well as expanding the features and functions in the current
modalities. Vital Images is also developing visualization and analysis tools for
non-invasive screening applications, such as CT colonography for colon cancer
screening, surgical planning, intra-operative visualization and real-time
interventional 3D visualization.
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The global market for 3D visualization and analysis is largely unpenetrated and
growing rapidly. Today, only a small percentage of hospitals and clinics have
purchased 3D visualization products for use in diagnostic imaging. Recent
technological advances in both computer hardware and software development have
dramatically improved the cost-to-performance ratio, bringing the prices for 3D
visualization and analysis products into the reach of most healthcare providers.
In addition, increasing acceptance of industry standards, the increasing number
of images being produced by medical imaging devices and new clinical
applications, among other factors, are also driving demand for visualization and
analysis products. Based on an increasing number of 3D procedures being
performed as a result of growing use of imaging technology, new 3D screening
procedures, and broader acceptance of 3D applications, Vital Images estimates
that the potential worldwide market for 3D visualization software and
workstations will grow to more than $1 billion within the next three to five
years.
Technology
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The two core technologies underlying the Company's products are "customized
protocols" which make Vitrea simple to use and a visualization technique known
as "volume rendering." A feature critical to Vitrea's speed and ease-of-use are
its customized protocols, which provide automated 2D and 3D renderings of
scanner data, optimized for individual clinical applications. Vital Images'
engineers and clinical collaborators have selected specific views for each type
of exam Vitrea supports, in order to provide immediate, useful 2D and 3D views
for the user. After the selected patient data has been retrieved, Vitrea
provides the clinician with six views with all visualization parameters pre-set
for the specific type of clinical exam. The visualization settings for these
views are stored in Vitrea's software and are automatically and adaptively
applied to each patient study, optimizing the views displayed. By applying this
proprietary protocol technique, the system anticipates the clinician's needs and
provides immediately useful views of the patient data. The use of customized
protocols automates the complex and time-consuming approaches inherent in many
competing 3D visualization products and eliminates the need for the user to be
proficient in operating complex graphics programs. The Company has been issued
Patent No. 5,986,662 from the U.S. Patent and Trademark Office for its mechanism
for automated protocol selection.
Volume rendering is an advanced technique for displaying two- or
three-dimensional views on a computer monitor that the Company believes has
significant advantages over the alternative technique, known as "surface
rendering." Volume rendering permits the direct display of all of the imaging
data without mathematical modeling and allows interactive control of the level
of "transparency" of the data. By comparison, surface rendering requires the
creation of artificial surfaces based on selected imaging data, and the
usefulness of the resulting visual image is largely dependent on where these
surfaces are "set" by the clinical technician. Volume rendering is not dependent
on the creation of artificial surfaces and allows visualization of varying
components that might otherwise be eliminated from a surface rendered image due
to surface approximation. Because volume rendering uses all of the data and
information collected by the imaging equipment, the Company believes
visualization processes that use volume rendering provide clinicians with better
images to define and display pathology and anatomy in a more useful manner
Until recently, volume rendering was largely overlooked by visualization
companies because the computer power necessary to perform volume rendering was
significantly more expensive and intensive than the requirements for surface
rendering. The Company's experience with volume rendering has its basis in the
efforts of Vincent J. Argiro, Ph.D., the founder of the Company, who developed
three-dimensional visualization software using volume rendering as an aid in his
research in developmental neuroscience. Dr. Argiro focused on accelerating the
performance of volume rendering on standard computer platforms. As a result of
his work, he developed expertise in accelerated volume rendering, which forms
the core of the Company's volume rendering technology. Because the performance
of standard computer platforms has increased while the relative cost of such
performance has decreased, the Company believes that volume rendering has become
a more accessible imaging solution for routine clinical applications.
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The Company believes the combination of customized protocols and accelerated
volume rendering offered by Vitrea, together with improved computer performance,
allows it to deliver a simple, fast and affordable visualization product.
Industry Background
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Medical practices in the areas of diagnostic imaging, surgery and cancer
treatment have changed dramatically over the past 20 years, due in part to the
introduction of a variety of new imaging, visualization, analysis, computer,
networking, catheter and navigation technologies. The result has been the rapid
adoption and increased use of CT, MR and ultrasound devices, and the
incorporation of new physician-care practices based on the imaging information
provided by these devices.
Each of these imaging technologies captures data that provides a physician with
a graphical representation of the inside of the human body. These images have
traditionally been viewed as a series of two-dimensional, cross-sectional slices
on x-ray-type film. As computer processing speed increased, software performance
improved and networking technologies developed, manufacturers of scanning
equipment began offering integrated systems that allowed clinicians to view,
analyze and manipulate these medical images in a digital environment. These
systems first visualized individual slices, or pictures, on a computer monitor
and later provided views of multiple slices. More recently, visualization
systems began to permit viewing and manipulation of large, multiple slice data
sets as a single, three-dimensional image on a computer workstation. Today, the
medical visualization industry involves the creation, visualization,
manipulation, analysis and communication of medical images in two and three
dimensions.
The medical visualization industry and the markets for medical visualization and
analysis products have historically lagged the market for imaging devices due to
the lack of industry standards for the generation, transmission and storage of
medical imaging data and due to computer costs and performance considerations.
Over the past several years, a number of technical and cost barriers to growth
in the medical visualization industry and the picture archive and communication
systems ("PACS") industry have begun to erode. In particular, the medical
industry has embraced an image transmission and archiving standard called DICOM,
promulgated by the American College of Radiology and the National Electronic
Manufacturer's Association. This standard permits imaging, visualization,
networking and archiving systems from different vendors to work cooperatively
within a single network. In addition, the cost-to-performance ratio of computer
products used in visualization and PACS has improved dramatically, bringing the
prices for medical visualization and analysis capabilities and PACS within the
grasp of most healthcare providers. The Company believes that the increasing
acceptance of industry standards such as DICOM and the improvements in the
cost-to-performance ratio for clinical workstations will support continued
market growth in the medical visualization and PACS industries.
Vital Images also expects that a number of other advantages of 3D medical
visualization and analysis products will support growth in the medical
visualization industry:
o Diagnoses based on 2D images, or "slices," require the clinician to
"assemble" a 3D view mentally to understand the true anatomy and
pathology. Given the industry pressure on cost-effective outcomes, 3D
imaging is a valuable tool for accelerating diagnoses, potentially
eliminating unnecessary tests and treatment, optimizing the use of
minimally invasive surgery and therapies, and gaining additional
insight needed for clinical decisions.
o Spatial relationships are of paramount importance in surgery, and 3D
views displaying anatomy and pathology can greatly aid in surgical
planning. Three-dimensional visualization has the potential to promote
improved surgical outcomes by giving surgeons a better "road map" from
which to plan their operative procedures. Interactive navigation of
volume data from scanners may also have the capability to spare
patients from invasive procedures like endoscopy or conventional
angiography.
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o Recent technology improvements in CT and MR scanners enable them to
generate an increasing number of slices per exam, resulting in up to
1000 images, which is more than 5 times as many images as the same
study less than five years ago. This makes the viewing of printed
images on x-ray film, rather than in a visualization system,
logistically impractical and expensive.
o Increased use of medical visualization technology has the potential to
enhance radiologists' ability to communicate their findings to fellow
clinicians, referring physicians and patients. In addition, the
integration of these clinical disciplines through electronic
visualization, networking and the Internet has the potential to
provide the opportunity for greater cross-discipline coordination due
to increased speed, access to information and the resulting ability to
perform consultative, interactive planning and examination on computer
workstations.
Markets
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The Company participates in the developing medical visualization market. This
market has several segments, each at its respective stage of maturity and with
its own level of market penetration. The medical visualization market also
interrelates with a number of other markets such as the diagnostic imaging
equipment market, the PACS market and the hospital and clinical information
systems markets. Medical visualization and analysis software and systems have
application and/or potential in diagnostic screening and radiology, remote
diagnosis and consultation (e.g., telemedicine), surgical assessment, planning,
navigation and follow-up, and radiation and chemotherapy treatment planning and
medical education. The customers for these applications include radiology,
surgery and oncology departments of hospitals and research centers, diagnostic
imaging and screening centers, outpatient surgery centers, clinics and physician
groups.
The Company believes that the worldwide market for medical visualization and
analysis systems is largely unpenetrated and growing rapidly. Today, a small
percentage of hospitals and clinics have purchased 3D visualization systems for
use in diagnostic imaging. Recent technological advances in both computer
hardware and software development have dramatically improved the
cost-to-performance ratio bringing the prices for 3D visualization and analysis
products into the reach of most healthcare providers. In addition, increasing
acceptance of industry standards, the increasing number of images being produced
by medical imaging devices and new clinical applications, among other factors,
are also driving demand for visualization and analysis products. Based on an
increasing number of 3D procedures being performed as a result of growing use of
imaging technology, new 3D screening procedures, and broader acceptance of 3D
applications, Vital Images estimates that the potential worldwide market for 3D
visualization software and workstations will grow to more than $1 billion within
the next three to five years.
As discussed above, the overall market for medical visualization and analysis
software and systems is developing rapidly, as the related technology and
products that define this market are relatively new and undergoing rapid change.
Medical visualization and analysis software and system solutions for diagnostic
radiology have existed for the last several years. However, most have been
expensive, slow, difficult to use and of limited clinical application. The use
of medical visualization and analysis software and systems to assist in surgical
planning and navigation has only begun to emerge into clinical practice in the
last five years. While medical visualization and analysis software and systems
have been used in these applications and to support cancer treatment planning in
the past, the Company believes that perspective, three-dimensional volume
rendering represents an untapped resource to practitioners for diagnostic
screening and radiology, surgical planning and navigation and cancer treatment.
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Strategy
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The Company's goal is to be the leading provider of medical visualization and
analysis software that improves clinical outcomes and reduces costs. To achieve
this goal, Vital Images intends to implement the following key strategies:
o Develop and maintain leading-edge technology. The Company intends to
continue its overall strategy of developing and marketing leading-edge
medical visualization and analysis software for a variety of medical
applications. As part of this strategy, the Company will continue to
improve the speed and performance of its Vitrea software. In
particular, the Company will be focused on developing additional
protocols that enhance the ease-of-use of Vitrea, as well as efforts
to increase the number of platforms on which Vitrea will operate.
o Further penetrate the visualization market. The Company intends to
expand its sales and marketing staff and increase its marketing
efforts in order to continue building momentum for the acceptance and
purchase of Vitrea and its other products. A key challenge for the
Company involves reaching and educating physicians and clinicians as
to the benefits of the Vitrea software. By convincing the ultimate
users of the benefits of its system, the Company believes that it can
successfully influence purchasing decisions for medical institutions
purchasing or upgrading their imaging technology. In addition, the
Company will work to expand its appeal by implementing additional 2D
capability as well as ensuring that its technology will easily
integrate into hospital networks.
o Further develop applications for the Company's visualization
technology. The Company intends to leverage its core competencies in
volume rendering, computer graphics, network technologies and clinical
applications. The Company plans to develop and offer a full range of
medical visualization and analysis software tools for radiological
diagnosis, surgical planning and intra-operative visualization. The
Company believes that significant new opportunities exist for the
application of its innovative technologies for the diagnosis and
treatment of cardiovascular disease, cancer and orthopedics.
o Continue to seek collaborative partnerships with leading medical
institutions. The Company has historically sought out and developed
collaborative relationships with several prestigious medical
institutions to develop and test the Company's visualization tools.
The Company will continue to pursue collaborations to focus on
developing products that will improve clinical outcomes and reduce
costs for the practices of medical imaging and surgery. In addition to
collaborations with medical institutions, the Company intends to
selectively pursue further joint development efforts similar to its
PACS relationship with ALI Technologies ("ALI").
Products and Product Development
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Vitrea. In December 1995, the Company assessed its business strategy and
determined that to optimize its dedicated participation in the medical field, it
needed to create a new product for direct clinical application. The objective
for this new product effort was to produce an easy-to-use, clinical software
tool to allow radiologists and other clinicians to use two- and
three-dimensional visualization in their routine clinical processes. Unlike its
VoxelView software, the Company set out to design this new software product for
users with clinical knowledge, rather than computer graphics expertise.
Specifications for this new product, called Vitrea, were developed in early
1996, with software development beginning in late spring of that year. The
Company submitted 510(k) documentation in September 1996 for Vitrea and was
granted marketing clearance by the FDA in November 1996 for use as a clinical
diagnostic and surgical planning device when used with CT and MR medical imaging
data. Vitrea was first released for sale to customers in October 1997. In
December 1999, the Company released Vitrea 2, a Microsoft(R) Windows NT
compatible version of its Vitrea
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software for 2D/3D visualization and analysis of medical image data. Vitrea 2 is
Vital Images' first 3D-volume visualization software product available for
Windows NT and provides the speed and ease-of-use the medical community demands
for diagnosis and treatment planning in a clinical environment.
Vitrea capitalizes on the Company's experience in medical visualization and
provides clinicians with an easy-to-use tool for radiological diagnosis and
surgical planning, and represents the Company's most important step to date as a
provider of a range of clinical tools for broad distribution to the medical
visualization market. Vitrea's primary features are its high-speed rendering
capability and the ability to provide two- and three-dimensional viewing for
routine diagnosis and surgical planning, without requiring the user to be
trained in computer graphics techniques. The Company believes that both of these
features, speed and ease-of-use, now make it possible to use three-dimensional
medical visualization in daily clinical routines. A Vitrea user, following a
built-in clinical workflow, can view the image data in two or three dimensions
using visualization settings based on specific clinical applications stored
within the system, as dedicated visualization protocols. The user may then
interactively navigate around, or "fly through," the image to view
clinically-relevant anatomies and pathologies. Vitrea software also allows the
user to capture views by taking "snapshots," which can be integrated into
customized reports for electronic transmission and archiving through a DICOM
network or to another location via the Internet.
Vitrea software conforms to the latest medical imaging and computer industry
standards, such as OpenGL(TM) computer graphics application programming
interface (API) and DICOM.
The Company offers Vitrea primarily as an integrated software and hardware
system, consisting of Vitrea software installed on a computer workstation.
Pursuant to purchasing arrangements between the Company and computer resellers,
the Company purchases computer workstations at a nominal discount, installs its
Vitrea software, and markets the package as an integrated medical visualization
and analysis solution, thereby implementing the Company's strategy to develop,
market, sell and support an integrated visualization and analysis workstation.
Currently Vitrea operates on PC workstations from Hewlett-Packard Company and
Dell Computer Corporation, and UNIX workstations from Silicon Graphics, Inc..
The Company also sells a limited number of software licenses without the related
workstation hardware. The list price for an integrated workstation and software
package is approximately $80,000, and the list price for the Vitrea software
without a workstation is approximately $60,000.
In addition to its immediate clinical applications, Vitrea software also
incorporates a number of additional technological advances, thereby making it
adaptable to routine clinical use in surgical navigation and cancer treatment
and for integration into diagnostic imaging equipment manufactured by other
companies. In particular, Vitrea software was written using advanced programming
techniques, a modular, object-oriented design, C++ programming language, and a
shared messaging structure. The Company believes these characteristics make it
practical to modify Vitrea software to suit the clinical needs of surgical
navigation and oncology, as well as allowing diagnostic equipment manufacturers
to integrate Vitrea software or its components into imaging system consoles and
off-line review stations, thereby providing the Company with the opportunity to
leverage the Vitrea software development investment into new commercial areas.
VScore. In August 1999, the Company introduced its VScore software for coronary
artery calcium scoring. The VScore software product is the Company's first
add-on option to the Company's Vitrea visualization and analysis product. The
VScore option adds the functionality to non-invasively quantify calcium in the
four major coronary arteries using CT image data. In the future, the Company
intends to develop and offer similar add-on products for a variety of other
medical applications. The list price of the VScore software is $14,000.
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Advanced 3DI. In August 1996, the Company entered into a product development
agreement with ATL Ultrasound, Inc., one of the leading ultrasound system
vendors. Pursuant to this agreement, each party agreed to collaborate
exclusively with the other for a period of five years in connection with the
development of three-dimensional visualization products for medical diagnostic
ultrasound imaging applications, provided that the Company may collaborate with
other parties in connection with products to be used in multi-modality
environments (i.e., environments that offer multiple imaging technologies and
not just ultrasound imaging). ATL reimburses the Company for certain product
development costs and has responsibility for obtaining regulatory approvals.
Intellectual property developed jointly by the parties pursuant to this
agreement is jointly owned by the parties, each with the right to use or license
such intellectual property. The Company typically receives $5,000 to $10,000 for
each Advanced 3DI sale by ATL. In September of 1998, ATL was acquired by Royal
Phillips Electronics, a competitor of the Company's in the 3D visualization
workstation market. During 1999, the Company experienced a trend of steadily
declining revenue from sales of Advanced 3DI. Accordingly, the Company is not
anticipating significant revenue in the foreseeable future from ATL for sales of
Advanced 3DI.
VoxelView. The Company's VoxelView software received marketing clearance from
the FDA in November 1995 for use as a clinical diagnostic and surgical planning
device when used with CT and MR medical imaging data. VoxelView software is sold
primarily to medical researchers, although it is sometimes used by radiologists
and surgeons as a clinical diagnostic and planning tool. VoxelView software's
primary capability is the ability to provide volume rendered, three-dimensional
views of human anatomy using three-dimensional image data sets from imaging
devices such as CT and MR scanners. VoxelView software is a highly flexible
tool, allowing the clinician or researcher to interactively control many
visualization parameters, including brightness, contrast, color, transparency,
shading, lighting, texture, reflectivity and orientation. However, the need to
control these visualization parameters limits the usefulness of VoxelView
software in the routine clinical setting, where an end user may be a skilled
medical technician lacking expertise in computer graphics techniques. VoxelView
is sold only as a software package without computer hardware, and the Company
does not actively market this product. The list price for a VoxelView software
license is $20,000.
Maintenance and Support. In addition to its system and software products, the
Company also offers maintenance and support services to its customers, as well
as certain other services such as installation and training. Maintenance
services for VoxelView software have typically been offered to licensees on an
annual basis, and provide for software updates, error correction, telephone
support and other general maintenance services in exchange for an annual
maintenance fee. In connection with the licensing of Vitrea software, the
Company also markets similar annual maintenance services for both Vitrea
software and the integrated Vitrea system, pursuant to which the Company
provides software updates, minor feature enhancements, error correction,
telephone support and general maintenance services for an annual fee of
approximately $7,000. Outside of these maintenance services, the Company is
required by FDA regulation to provide certain levels of support to end users as
a result of the use of its products as medical devices. Maintenance services
currently marketed by the Company do not include installation, training, testing
and other services, whether on- or off-site, as such services are charged
separately by the Company.
License fees accounted for 63%, 61% and 62% of total revenue in each of the
fiscal years ended December 31, 1999, 1998 and 1997, respectively. Maintenance
and services comprised 13%, 11% and 24% of total revenue for the years ended
December 31, 1999, 1998 and 1997, respectively, while hardware accounted for
24%, 28% and 14% of total revenue for the years ended December 31, 1999, 1998
and 1997, respectively.
The Company expensed $2,525,000, $1,815,000 and $2,255,000 incurred in its
research and development efforts in each of the fiscal years ended December 31,
1999, 1998 and 1997, respectively.
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Collaborative Relationships
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Vital Images has formed collaboration relationships with some of the leading
universities and physicians in medicine and medical visualization to develop
what it believes to be the most innovative and clinically relevant visualization
solutions. Vital Images has entered into clinical collaboration agreements with
universities and physicians to:
o Identify new clinical applications where visualization can improve
clinical outcomes and reduce costs;
o Develop clinical routines that incorporate Vital Images' visualization
software in normal diagnostic and surgical planning practices;
o Develop new features that facilitate and improve diagnosis and
surgical planning for Vital Images' future products;
o Assess the clinical value of Vital Images' visualization software for
given applications; and
o Develop automated rendering protocols for 3D CT or MR data.
The following universities and physicians have entered into agreements with
Vital Images for the purpose of forming collaborative relationships:
o Duke University Medical Center
o Hospital of the University of Pennsylvania
o Mallinckrodt Institute of Radiology at the Washington University
School of Medicine
o Stanford University Medical Center
o David W. Stoller, M.D. (California Advanced Image/Raytel Imaging)
o UCLA Medical Center
o University of Iowa Hospital and Clinics
o University of Minnesota-Fairview University Medical Center
o University of North Carolina at Chapel Hill
o Yale University School of Medicine
In general, the Company's agreements with its collaborative partners do not
provide such collaborators with any ownership of technology developed by the
Company in connection with the collaboration and do not provide for the payment
of any fees or royalties to such collaborators. However, the Company is
obligated to pay a royalty to the Stanford University Medical Center equal to
one-half of one percent of the Company's software license revenue from the sale
of Vitrea through September 2000.
Competition
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The medical visualization market is developing and growing rapidly. It is
intensely competitive, subject to rapid change and significantly affected by new
product introductions and other market activities of industry participants. The
Company's primary competitors are the various diagnostic imaging system
suppliers, which are typically large, multinational companies, having far
greater financial and technical resources than the Company, and which also have
well established sales and distribution networks for their products. These
companies, including GE Medical Systems, Siemens Medical Systems, Inc., Marconi
Medical Systems and Philips Medical Systems, are engaged in the business of
developing and marketing medical imaging systems, such as CT and MR equipment.
These competitors either offer, or will likely seek to offer, 3D visualization
capabilities
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integrated into their products in addition to the 2D visualization capabilities
typically provided as a part of the operator's console on the imaging equipment
itself. This visualization capability may be internally developed by these
companies, or may be licensed from independent vendors. In order to compete
effectively with these companies, Vital Images must convince customers to
separate their purchasing decisions regarding the imaging equipment itself from
the selection and purchase of the visualization workstations instead of
purchasing an entire integrated system manufactured by one entity. To a lesser
extent, the Company also faces competition from other visualization systems and
software suppliers, PACS vendors, hospital, radiology and clinical system
suppliers, and internal development projects sponsored by hospital radiology
departments.
Other visualization systems and software suppliers compete on the basis of
volume rendering or other visualization technologies, such as surface rendering.
PACS companies sometimes provide visualization capability in addition to their
image archiving and networking products. Vendors of hospital, clinical and
radiology information systems have also diversified into the PACS and medical
visualization product lines, either through internal development or business
development. These companies, which may be large or small, attempt to offer an
integrated system covering a full range of administrative, clinical and
radiology information management capabilities to healthcare providers. Finally,
some research and university healthcare institutions may attempt to develop
their own visualization systems. These institutions have in the past, and may in
the future, attempt to secure FDA clearance for such systems, and to license
such systems or technology for general commercial sale.
The Company's competitive strength is based on its ability to: (i) provide
differentiated medical visualization and analysis products that operate in
multi-vendor network and image source environments; (ii) provide clinical
quality, three-dimensional images, volume rendered at high speed with
interactive navigation on a relatively low cost standard computer; (iii)
integrate clinical knowledge from its collaborative clinical partners into its
products; (iv) leverage its visualization technology across multiple clinical
disciplines, including radiology, surgical planning and medical screening; (v)
offer a "DICOM client" product which can operate on any DICOM network,
independent of the imaging system and network provider; and (vi) serve both
original equipment manufacturers ("OEM") and end-user customers through the
development of a modular end-user product that can easily be segmented for OEM
customers.
The Company believes that product quality, performance, functionality and
features, quality of support and service, reputation and price are also
important competitive factors. The Company believes that customers will prefer
Vitrea because it is simple, fast and affordable. While price has been less
significant than other factors, increasing competition in the medical
visualization market may result in price reductions and reduced gross margins.
In particular, should one or more of the diagnostic imaging system suppliers
choose to provide or distribute more competitive visualization products than
those offered by the Company, the Company's business, financial condition and
results of operations could be materially adversely affected.
Marketing and Distribution
- --------------------------
The Company markets Vitrea both as a software package and as part of an
integrated software and hardware system to radiologists, surgeons, primary care
physicians and medical researchers. The Company markets its products directly to
end-user customers, such as hospitals and clinics, as well as to select
diagnostic imaging companies, digital imaging equipment manufacturers and PACS
companies for resale as a Vital Images' branded product. In December 1999, the
Company established a strategic marketing alliance with ALI, a leader in the
management of clinical data. Both Vital Images and ALI can now offer an
integrated solution to the data management requirements of the new generation of
CT and MR scanners.
In addition, the Company markets its products directly to select OEMs on either
a standard basis or, in the case of Advanced 3DI, a customized basis. In
connection with its OEM opportunities, the Company will either provide complete
systems for resale by such OEMs or will provide elements of its technology for
incorporation into the products and systems of such OEMs.
11
<PAGE>
The Company markets its products both domestically and internationally. In the
United States, the Company markets its products through its direct sales force
as well as through OEMs and resellers. Internationally, the Company markets its
products through OEMs and resellers. See Note 9 to the Financial Statements -
"Major Customers and Geographic Data" for information regarding the Company's
export sales. As of December 31, 1999, the Company had eight direct salespeople
in the U.S., one international reseller salesperson, one OEM customer and 13
international resellers.
Customers and Customer Support
- ------------------------------
As of December 31, 1999, the Company has sold approximately 180 separate
software licenses for Vitrea for use in approximately 150 different sites,
including hospitals, clinics and other sites. The Company's customers include
America's most renowned hospitals, including the following eight of the top 11
hospitals listed in U.S. News and World Report's honor roll of top hospitals:
o Massachusetts General Hospital o Stanford Medical Center
o Duke University o Barnes-Jewish Hospital
o University of California--Los Angeles o Hospital of the University of
o Cleveland Clinic Pennsylvania
o Mayo Clinic
In addition, the advantages of Vitrea software -- simple, fast and affordable --
have also appealed to hospitals and clinics in smaller population areas
including:
o Allen Memorial Hospital-Waterloo, Iowa
o Campbell County Memorial Hospital--Gillette, Wyoming
o Diagnostic Radiology Associates of Wisconsin--Rice Lake, Wisconsin
o Northeast Regional Medical Center--Kirksville, Missouri
o Palmetto Baptist Medical Center--Columbia, South Carolina
The Company is committed to rapid response to customer service requests.
Customer support representatives are available during the Company's business
hours to answer questions about the operation, maintenance and repair of the
Company's products.
Intellectual Property
- ---------------------
Although the Company has filed patent applications with respect to certain
aspects of its technology, it generally does not rely on patent protection with
respect to its products and technologies. Instead, the Company relies primarily
on a combination of trade secret and copyright law, employee and third-party
nondisclosure agreements and other protective measures to protect intellectual
property rights pertaining to its products and technologies. Because of the
rapid pace of technological change in the medical visualization industry, the
Company believes that patent, trade secret and copyright protection are less
significant to its competitive position than factors such as the knowledge,
ability and experience of its personnel; new product developments and
enhancements; and ongoing, reliable product maintenance and support.
The Company has been issued Patent No. 5,986,662 from the U.S. Patent and
Trademark Office for its mechanism for automated protocol selection, which is
utilized in the Vitrea software. The use of automated protocol selection within
Vitrea allows the user to view image data in two or three dimensions using
visualization settings based on specific clinical applications stored within the
software. This unique technology adds significantly to the simplicity of use of
the software -- a key advantage over competing technologies.
12
<PAGE>
The Company does not own all of the software and other technologies used in its
products, but it has the licenses from third parties that the Company believes
are necessary for using that technology in its current products. It may be
necessary to renegotiate with such third parties for inclusion in any new
versions of the Company's current products or any new products. Such third party
licenses may not be available on reasonable terms, or at all.
Manufacturing and Service
- -------------------------
The Company's manufacturing efforts are limited to the production, quality
assurance and distribution of its software, which is distributed on CD-ROM. The
software is sent to the customer site and loaded into a computer workstation.
The software for Vitrea is loaded into the workstation by Company personnel, as
part of the Company's installation services, which are priced and billed
incrementally to the software license billing. In addition to the loading of
software into the computer, the Company's installation services also include
integrating Vitrea workstations into customers' computer networks, configuring
the network requirements and validating software operability on site. VoxelView
software is typically sold alone and loaded into the computer equipment with
telephone assistance from the Company, as needed.
The Company relies primarily on its own software development as its core
competence. The Company sources certain utility software from third parties, see
"Intellectual Property" above, and the operating system for integrated computer
workstations from other parties. In addition, the Company sources systems
components, computers and computer peripherals from third party suppliers.
Governmental Regulation
- -----------------------
As medical devices, the Company's medical visualization and analysis products
are subject to extensive and rigorous regulation by numerous governmental
authorities, principally the FDA and corresponding foreign agencies. In the
United States, the FDA administers the Federal Food, Drug and Cosmetic Act and
its amendments. These regulations classify medical devices as either Class I, II
or III devices, which are subject to general controls, special controls or
pre-market approval requirements, respectively. Most Class I and II devices, as
well as some Class III devices, can be cleared for marketing pursuant to a
510(k) pre-market notification. The process of obtaining a 510(k) clearance
typically can take several months to a year or longer.
Class III devices generally require more stringent clinical investigation and
pre-market clearance requirements. In such cases, the FDA will require that the
manufacturer submit a pre-market approval ("PMA") application that must be
reviewed and approved by the FDA prior to the sale and marketing of the device
in the United States. The process of obtaining a PMA can be expensive, uncertain
and lengthy, frequently requiring anywhere from one to several years from the
date of FDA submission, if approval is obtained at all. Moreover, a PMA, if
granted, may include significant limitations on the indicated uses for which a
product may be marketed.
Vitrea and VoxelView are classified as Class II medical devices and have
received marketing clearance from the FDA as the result of 510(k) submissions.
Specifically, Vitrea has been cleared to be marketed for use with CT and MR
scanners, and the Company's VScore software has been cleared for use in coronary
artery calcium scoring. ATL is responsible for obtaining any FDA approval
necessary for the marketing and sale of Advanced 3DI. Future products, add-on
options to existing software, and expanded claims of efficacy will likely
require additional 510(k) applications.
In the early 1990's, the review time by the FDA to clear medical devices for
commercial release lengthened and the number of clearances, both of 510(k)
submissions and PMA's, decreased. In response to public and congressional
concern, the FDA Modernization Act of 1997 was adopted with the intent of
bringing better definition to the clearance process. Although this Act has
resulted in improved cycle times for product clearance, there can be no
assurance that the FDA review process will not involve delays or that certain
clearances will be granted on a timely basis.
13
<PAGE>
The Company is also increasingly becoming subject to regulation in those foreign
countries in which it sells its products. Many of the regulations applicable to
the Company's products in such countries are similar to those of the FDA. The
Company's ability to successfully market and sell its products internationally
depends in large part on its ability to comply with such foreign regulatory
requirements. Vitrea software has been CE marked, indicating conformance with
applicable sections of the Medical Device Directive 93/42/EEC, which allows the
product to be marketed in the member countries of the European Communities.
The Company is also subject to periodic inspections by the FDA, whose primary
purpose is to audit the Company's compliance with quality system regulations
established by the FDA and other applicable government standards. Regulatory
action may be initiated in response to audit deficiencies or to product
performance problems. The Company believes that its manufacturing and quality
control procedures are in essential compliance with the requirements of the FDA
regulations.
The financial arrangements through which the Company markets, sells and
distributes its products may be subject to certain federal and state laws and
regulations in the United States with respect to the provision of services or
products to patients who are Medicare or Medicaid beneficiaries. Violations of
these laws and regulations may result in civil and criminal penalties, including
substantial fines and imprisonment. In a number of states, the scope of these
laws and regulations have been extended to include the provision of services or
products to all patients, regardless of the source of payment, although there is
variation from state to state as to the exact provisions of such laws or
regulations. In other states, and, on a national level, several health care
reform initiatives have been proposed which would have a similar impact. The
Company believes that its operations and its marketing, sales and distribution
practices currently comply in all respects with all current fraud and abuse and
physician anti-referral laws and regulations, to the extent they are applicable.
Third Party Reimbursement and Cost Containment
- ----------------------------------------------
The Company's products are purchased primarily by hospitals, clinics and other
users that bill various third party payors for the services provided to the
patients. These payors, which include Medicare, Medicaid, private insurance
companies and managed care organizations, reimburse part or all of the costs and
fees associated with the procedures utilizing the Company's products. The
visualization services performed using the Company's software are covered by
current CPT codes (Current Procedural Terminology, as defined by the Healthcare
Financing Administration). As such, hospitals providing services on the
Company's visualization workstations can seek reimbursement by using existing,
approved CPT codes. Medicare and Medicaid reimbursement for hospitals is based
on a fixed amount for admitting a patient with a specific diagnosis. Because of
this fixed reimbursement method, hospitals have incentives to use less costly
methods in treating Medicare and Medicaid patients, and will frequently make
capital expenditures to take advantage of less costly treatment technologies.
Frequently, reimbursement is reduced to reflect the availability of a new
procedure or technique and, as a result, hospitals are generally willing to
implement new cost-saving technologies before these downward adjustments take
effect. Likewise, because the rate of reimbursement for certain physicians who
perform certain procedures has been, and may in the future, be reduced in the
event of changes in the resource-based relative value scale method of payment
calculation, physicians may seek greater cost efficiency in treatment to
minimize any negative impact of reduced reimbursement. Any amendments to
existing reimbursement rules and regulations which restrict or terminate the
reimbursement eligibility (or the extent or amount of coverage) of medical
procedures using the Company's products or the eligibility (or the extent or
amount of coverage) of the Company's products could have a material adverse
impact on business.
In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be, proposals by legislators and regulators
and third party payors to reduce these costs. There has also been a significant
increase in the number of Americans enrolling in some form of managed care plan
and, in addition, many hospitals participate in or have agreements with HMOs. It
has become a typical practice for hospitals to affiliate themselves with as many
managed care plans as possible. Higher managed care penetration typically
14
<PAGE>
drives down the prices of healthcare procedures, which in turn places pressure
on medical supply prices. This causes hospitals to implement tighter vendor
selection and certification processes, by reducing the number of vendors used,
purchasing more products from fewer vendors and trading discounts on price for
guaranteed higher volumes to vendors. Hospitals have also sought to control and
reduce costs over the last decade by joining group purchasing organizations or
purchasing alliances. The Company cannot predict what continuing or future
impact these practices, the existing or proposed legislation, or such third
party payor measures may have on its future business.
Employees
- ---------
As of February 29, 2000, the Company had 57 full-time employees, with 20
involved in research and development, 16 in sales and marketing, 8 in technical
support functions and 13 in administrative functions.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the names of the executive officers of the Company as of
February 29, 2000, their ages, the year first elected as an executive officer of
the Company and employment for the past five years.
NAME AGE TITLE
- ---------------------------------------------------------------------------
Albert Emola 49 President, Chief Executive Officer
and Director
Vincent J. Argiro, Ph.D. 44 Chief Technology Officer, Founder
and Director
Steven P. Canakes 44 Vice President - Sales
David M. Frazee 39 Vice President - Engineering
Gregory S. Furness 45 Vice President - Finance, Chief
Financial Officer, Treasurer
and Secretary
Jay D. Miller 40 General Manager and
Vice President - Business Development
Robert C. Samec 47 Vice President - Regulatory Affairs and
Quality Assurance
Albert Emola. Mr. Emola was appointed President and Chief Executive Officer of
Vital Images in December 1999. From January 1999 until December 1999, Mr. Emola
served as an independent management consultant to start-up medical device
companies. From August 1994 to January 1999, he served as President and Chief
Executive Officer of Flexmedics Corporation, a designer and manufacturer of
nitinol-based medical products. From May 1991 until August 1994, Mr. Emola
served as a consultant to other start-up medical companies requiring broad-based
strategic direction and implementation. Mr. Emola also served at St. Jude
Medical, Inc. from November 1985 to May 1991, most recently as Vice President of
Corporate Development.
15
<PAGE>
Vincent J. Argiro, Ph.D. Dr. Argiro, the Founder of the Company, was named Chief
Technology Officer of Vital Images in October 1995. From May 1994 until May
1997, Dr. Argiro also served as a Vice President of Bio-Vascular, the former
parent company of Vital Images. Dr. Argiro served as a director of Bio-Vascular
from May 1994 until March 1996. Following the acquisition of the Company by
Bio-Vascular in May 1994, Dr. Argiro served as President of the Company until
October 1995. Dr. Argiro served as Chairman of the Board of the Company from
1988 until May 1994. From 1988 to 1990 and from September 1991 to June 1992, Dr.
Argiro also served as President of the Company.
Steven P. Canakes. Mr. Canakes was named Vice President - Sales in March 2000.
Prior to that he was the Company's Vice President - U.S. Sales from August 1998
to March 2000 and its Director of U.S. Sales from March 1998 to August 1998.
From July 1996 to March 1998, Mr. Canakes was Vice President of Business
Development for MedManagement, LLC in Plymouth, Minnesota. From February 1994 to
July 1996, Mr. Canakes served as Vice President of Sales for Medintell Systems
and Value Health Corporation, a Medintell Systems Division. Prior to February
1994, Mr. Canakes was a CT Product Sales Manager for Picker International, Inc.
David M. Frazee. Mr. Frazee was named Vice President - Engineering in March
1999. From July 1998 to March 1999, Mr. Frazee served as a Manager in the
Solution Strategies Practice of Whittman-Hart, Inc. From April 1997 to July
1998, Mr. Frazee was Director of Program Management and Internet Products at
LodgeNet Entertainment, Inc. Prior to April 1997, Mr. Frazee held several
systems and software development and management positions at GE Medical Systems,
Inc., most recently as Manager of the Global Software Applications Operation.
Gregory S. Furness. Mr. Furness was named Vice President - Finance, Chief
Financial Officer, Treasurer and Secretary of Vital Images in February 1997.
From December 1987 to December 1996, Mr. Furness served as Executive Vice
President and Chief Financial Officer of CAMAX Manufacturing Technologies, Inc.,
a computer-aided manufacturing software developer, which was acquired by
Structural Dynamics Research Corporation in June 1996. Prior to December 1987,
Mr. Furness was employed as Vice President, Finance and Chief Financial Officer
of Mizar, Inc., and as an audit manager at Deloitte and Touche LLP. Mr. Furness
is a Certified Public Accountant.
Jay D. Miller. Mr. Miller was named General Manager and Vice President -
Business Development in August 1998 and served as the Company's Vice President -
Marketing and Business Development from February 1997 to August 1998. From 1989
until his employment by the Company, Mr. Miller was employed by GE Medical
Systems, Inc. in positions of increasing responsibility in the marketing area,
including serving as product manager and global product line strategy for MR
imaging products and marketing manager for the cardiology market segment. Prior
to 1989, Mr. Miller was employed by Siemens Medical Systems in technical
marketing.
Robert C. Samec. Mr. Samec was named Vice President - Regulatory Affairs and
Quality Assurance in October 1998. Mr. Samec served as Vice President,
Regulatory/Quality of ContiMed, Inc., a urologic device developer from October
1997 to October 1998. Prior to October 1997, Mr. Samec spent 15 years with
Aequitron Medical, Inc., a developer of portable respiratory devices, where he
was Vice President, Regulatory Affairs/Quality Assurance.
ITEM 1A - IMPORTANT FACTORS
The following factors are important and should be considered carefully in
connection with any evaluation of the Company's business, financial condition,
results of operations and prospects. Additionally, the following factors could
cause the Company's actual results to materially differ from those reflected in
any forward-looking statements of the Company.
16
<PAGE>
Historical Operating Losses
- ---------------------------
The Company had operating losses of $3,303,000, $3,467,000, and $5,211,000 for
the years ended December 31, 1999, 1998 and 1997, respectively, and with the
exception of the fiscal year ended October 31, 1995, has incurred operating
losses each year since 1990. As of December 31, 1999, the Company's accumulated
deficit was $17,229,000. The Company's ability to attain and maintain
profitability will depend on, among other things, its ability to successfully
market its products, make new product offerings, respond to competitive
developments and attract and retain qualified sales, technical and management
employees. There can be no assurance that the Company will achieve profitable
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Dependence on Market Growth
- ---------------------------
The medical visualization industry in which the Company markets its products is
still developing due to the fairly recent availability of high performance
computers at reduced prices, the recent adoption of industry standards for the
generation, transmission and storage of medical imaging data, and changing
medical practices. Historically, there has been a perception that
three-dimensional imaging was too slow or difficult for clinical use. This
perception was due largely to the relatively slower processing speed of
workstations available in the past. Although the Company believes that the
recent advances in the affordability of high performance computers and in the
development of industry standards for the generation, transmission, and storage
of imaging data will provide opportunities for growth in the medical
visualization industry, given the uncertainties associated with the developing
stage of this industry, there can be no assurance that it will continue to
develop in the manner anticipated by the Company. Accordingly, there can be no
assurance that the medical visualization industry will provide growth
opportunities for the Company and its software products or that the Company's
business strategies will be successful as the medical visualization industry
continues to evolve. Ultimately, if the medical visualization industry fails to
develop as the Company expects, the Company's business, results of operations
and financial condition will be materially and adversely affected.
New Product Acceptance
- ----------------------
The Company's success depends on its ability to successfully market its Vitrea
software for clinical use, and the ability and willingness of physicians to use
two- and three-dimensional visualization software in clinical diagnosis,
surgical planning, patient screening, and other diagnosis, surgical, and
treatment protocols. The three-dimensional visualization offered by Vitrea
represents a new alternative to the conventional methods traditionally used for
viewing medical images in the clinical setting. The acceptance of Vitrea by
physicians and other clinicians will depend on the Company's ability to educate
those users as to the speed, ease-of-use and benefits offered by the Vitrea
system, as well as the timely introduction of new features and functions by the
Company. There can be no assurance that users will prefer three-dimensional
visualization software over less expensive two-dimensional visualization
software, or that the Company will succeed in its efforts to further develop,
commercialize, and achieve market acceptance for its Vitrea product, or for any
other product in the clinical setting. See "Business--Technology," "--Industry
Background," "--Markets" and "--Competition."
Substantial Reliance on a Single Product
- ----------------------------------------
Revenue from software and hardware sales of the Vitrea system constituted 78% of
the Company's total revenue for the year ended December 31, 1999 and 71% of the
Company's total revenue for the year ended December 31, 1998. Further, the
Company anticipates that revenue from the sale of Vitrea will continue to
account for a substantial portion of the Company's revenue for the foreseeable
future. As such, the failure of physicians to accept Vitrea would have a
material adverse impact on the Company's results of operations and financial
condition. The Company no longer markets, but has occasional sales of, its
VoxelView software product, which is used primarily by medical researchers.
17
<PAGE>
Need for Additional Capital
- ---------------------------
If the Company's operations progress as anticipated, of which there can be no
assurance, the Company believes that its existing cash balances, together with
cash flows from operations and borrowings available under its credit facility,
should be sufficient to satisfy its cash requirements for at least the next 12
months.
The timing of the Company's future capital requirements will depend on a number
of factors, including, but not limited to, the ability of Vital Images to
successfully market its products; the ability and willingness of physicians to
use two- and three-dimensional visualization software in clinical diagnosis,
surgical planning, patient screening and other diagnosis, surgical, and
treatment protocols; the impact of competition in the medical visualization
business; the ability of the Company to differentiate its products from
competing products; the capital equipment budget constraints of some potential
purchasers; the ability of the Company to build an effective sales and
distribution force; and the ability to enhance existing products and develop new
products on a timely basis. To the extent that the Company's operations do not
progress as anticipated, additional capital may be required sooner. There can be
no assurance that any required additional capital will be available on
acceptable terms, or at all, and the failure to obtain any such required capital
would have a material adverse effect on Vital Images' business. The issuance of
additional equity securities may result in dilution of current shareholder
voting and ownership interests. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Highly Competitive Industry
- ---------------------------
The Company faces intense competition in the medical visualization industry. The
Company expects technology to continue to develop rapidly, and the Company's
success will depend to a large extent on its ability to maintain a competitive
position with its products. Companies competing with the Company in the medical
visualization industry include large, established manufacturers of CT and MR
imaging equipment. Companies such as GE Medical Systems, Siemens Medical
Systems, Inc., Marconi Medical Systems and Philips Medical Systems typically
offer their own imaging software and visualization workstations as part of their
integrated imaging and scanner systems. The Company's ability to successfully
market and sell its current medical visualization products to prospective
customers depends, in part, on its ability to persuade such customers to
separate the purchase of CT or MR equipment from the selection and purchase of
visualization workstations. In addition to having significantly greater capital
and staffing resources for research and development that are critical to success
in the rapidly changing medical visualization industry, such companies also have
well-established marketing and distribution networks and have a competitive
advantage in marketing visualization and analysis tools as an integrated part of
their imaging products. While price has been less significant than other
factors, increasing competition may result in price reductions and reduced gross
margins. Additionally, the Company faces competition from other entities, such
as other information storage and retrieval vendors, hospital, radiology and
clinical systems suppliers and internal development projects sponsored by
hospital radiology departments. There can be no assurance that the Company will
be able to compete effectively with such manufacturers or competing entities.
See "Business--Technology," "--Industry Background" and "--Competition."
Risk of Technological Obsolescence
- ----------------------------------
The medical imaging and visualization market is characterized by rapid
innovation and technological change. There can be no assurance that the Company
will be able to compete effectively in the marketplace or that products
developed by its competitors will not render its products obsolete or
non-competitive. Similarly, there can be no assurance that the Company's
competitors will not succeed in developing or marketing products that are viewed
as providing superior clinical performance or are less expensive than the
Company's products currently marketed or to be developed.
18
<PAGE>
Dependence on Major Customers
- -----------------------------
One of the Company's principal distribution channels is to sell its Vitrea
product and visualization workstations for inclusion with the delivery of
medical imaging equipment being sold by Toshiba America Medical Systems
("Toshiba"). Sales by the Company to Toshiba accounted for approximately 21% and
23% of the Company's total revenue for the years ended December 31, 1999 and
1998, respectively. Management believes a limited number of large customers may
continue to account for a significant portion of the Company's revenue during
any given period for the foreseeable future. The Company currently has no
long-term purchase or other agreements with any of its customers and sales are
generally made pursuant to purchase orders. A reduction, delay, or cancellation
of orders from one or more of its significant customers likely would have a
material adverse effect on the Company's operating results.
Fluctuations in Operating Results
- ---------------------------------
The Company may experience significant fluctuations in future annual and
quarterly operating results. If these fluctuations occur, they may result in
volatility in the price of the Company's common stock. Quarterly revenues and
operating results may fluctuate as a result of a variety of factors including,
but not limited to, the timing of significant orders, the timing of product
enhancements and new product introductions by the Company, its competitors and
its customers, the pricing of the Company's products, changes in customers'
budgets, and competitive conditions, many of which are beyond the control of the
Company. Toshiba recently began marketing and selling a new high speed CT
scanner, the Aquilion(TM). While the Company anticipated that Toshiba would ship
the Aquilion in greater quantities during 1999, Toshiba is not yet delivering
the Aquilion to its customers in the quantities anticipated by the Company. To
the extent that sales or deliveries of the Aquilion by Toshiba fluctuate, such
fluctuation may affect the quarterly operating results of the Company.
Government Regulation
- ---------------------
The Company's products are subject to regulation by the FDA and by comparable
agencies in foreign countries. In the United States, the FDA regulates the
development, introduction, manufacturing, labeling and recordkeeping procedures
for medical devices, including medical visualization and analysis software and
systems. The process of obtaining marketing clearance from the FDA for new
products and new applications for existing products can be time-consuming and
expensive. All of the current products actively marketed by the Company have
received marketing clearance from the FDA pursuant to 510(k) pre-market
notifications. Vitrea has been approved to be marketed for use with CT and MR
scanners, and the Company's VScore software has been approved for use in
coronary artery calcium scoring. ATL Ultrasound, Inc. ("ATL") is responsible for
obtaining any FDA approval necessary for the marketing and sale of Advanced 3DI.
There can be no assurance, however, that clearance will be granted with respect
to future products or enhancements, or that FDA review will not involve delays
that would adversely affect the Company's ability to market such future products
or enhancements. In addition, there can be no assurance that future products or
enhancements will not be subject to the more lengthy and expensive pre-market
approval process with the FDA.
Even if regulatory approvals to market a product are obtained from the FDA,
these approvals may entail limitations on the indicated uses of the product.
Product approvals by the FDA can also be withdrawn due to failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
approval. The FDA could also limit or prevent the distribution of the Company's
products and has the power to require the recall of such products. FDA
regulations depend heavily on administrative interpretation, and there can be no
assurance that future interpretations made by the FDA or other regulatory bodies
will not adversely affect the Company. The FDA may inspect the Company and its
facilities from time to time to determine whether the Company is in compliance
with various regulations relating to specification, development, documentation,
validation, testing, quality control and product labeling. A determination that
the Company is in violation of such regulations could lead to imposition of
civil penalties, including fines, product recalls or product seizures and, in
extreme cases, criminal sanctions.
19
<PAGE>
The Company markets its products both domestically and internationally.
International regulatory bodies have established varying regulations governing
product standards, packaging requirements, labeling requirements, import
restrictions, tariff regulations, duties and tax requirements. The inability or
failure of the Company to comply with the varying regulations or the imposition
of new regulations could restrict its ability to sell its products
internationally and could thereby adversely affect the Company's business. See
"Business--Governmental Regulation."
Uncertain Protection for Intellectual Property; Possible Claims of Others
- -------------------------------------------------------------------------
Although the Company has filed patent applications with respect to certain
aspects of its technology, it generally does not rely on patent protection with
respect to its products and technologies. Instead, the Company relies primarily
on a combination of trade secret and copyright law, employee and third-party
nondisclosure agreements and other protective measures to protect intellectual
property rights pertaining to its products and technologies. There can be no
assurance that these measures will provide meaningful protection of the
Company's trade secrets, know-how or other intellectual property in the event of
any unauthorized use, misappropriation or disclosure or that others will not
independently develop similar technologies or duplicate any technology developed
by the Company. In addition, to the extent that any patents are applied for,
there can be no assurance that such applications will result in issued patents
or, if issued, that such patents will be held to be valid or will otherwise be
of value. While the Company does not believe that its products and technologies
infringe any existing patents or intellectual property rights of third parties,
there can be no assurance that such infringement does not exist. The costs of
defending an intellectual property claim could be substantial and could
adversely affect the Company, even if it was ultimately successful in defending
any such claims. If the Company's products or technologies were found to
infringe the rights of a third party, the Company could be required to pay
significant damages or license fees or cease production, which could have a
material adverse effect on the Company's business. See "Business--Intellectual
Property."
Product Liability Risk; Limited Insurance Coverage
- --------------------------------------------------
The manufacture and sale of products used in the practice of medicine entail
significant risk of product liability claims. While the Company currently
maintains product liability insurance in the amount of $6,000,000 per occurrence
and $7,000,000 in total and also maintains errors and omissions coverage in the
amount of $6,000,000 per occurrence and in total, there can be no assurance that
its coverage limits will be adequate to protect the Company from any liabilities
it might incur in connection with the sale of its products, or that the Company
will be able to maintain this level of coverage in the future. The Company also
will require increased product liability coverage as additional products and
updates are released. Such insurance is expensive and in the future may not be
available on acceptable terms, if at all. A successful product liability claim
or series of such claims against the Company in excess of the Company's
insurance coverage could have a material adverse effect on its business.
Dependence on Key Employee; Need to Hire Additional Personnel
- -------------------------------------------------------------
The Company depends upon the continued active participation of Dr. Vincent J.
Argiro, its Chief Technology Officer and Founder. Loss of the services of Dr.
Argiro could have a material adverse effect on the Company's future business.
Dr. Argiro does not have an employment agreement with the Company, but does have
a confidentiality and non-competition agreement with the Company. The Company
maintains key life insurance coverage on Dr. Argiro's life in the amount of
$500,000.
The Company's ability to enhance and develop markets for its current products as
well as to introduce new products to the marketplace also depends on its ability
to attract and retain qualified scientific and management personnel. The Company
competes for such personnel with other companies, academic institutions,
government entities and organizations, many of which have substantially greater
capital resources, name recognition, and research and development capabilities
than the Company. There can be no assurance that the
20
<PAGE>
Company will be successful in recruiting or retaining such personnel. The
inability of the Company to recruit and retain such personnel would have a
material adverse effect on the Company's business.
Management of Growth
- --------------------
The execution of the Company's business plan will place increasing demands on
the Company's existing management and resources. There can be no assurance that
the Company will be able to effectively manage any expansion of its business,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on Third-Party Reimbursement
- ---------------------------------------
The Company's products are purchased by hospitals, clinics and other users,
which bill various third party payors, such as government health programs,
private health insurance plans, managed care organizations and other similar
programs, for the health care goods and services provided to their patients.
There is currently a Current Procedural Terminology (CPT) reimbursement code for
procedures which utilize the Company's products. However, the amount of such
reimbursement varies by location and is subject to change. Payors may deny
reimbursement if they determine that a product used in a procedure was not used
in accordance with established payor protocol regarding cost-effective treatment
methods or was used for an unapproved indication. Third party payors are
increasingly challenging the prices charged for medical services and, in some
instances, have put pressure on service providers to lower their prices or
reduce their services. The Company is unable to predict what changes will be
made in the reimbursement methods used by third party healthcare payors. There
can be no assurance that procedures in which the Company's products are used
will be considered cost effective by third party payors, that reimbursement for
such procedures will be available or, if available, that payors' reimbursement
levels will not adversely affect the Company's ability to sell its products on a
profitable basis. In addition, there have been and may continue to be proposals
by legislators, regulators and third party payors to curb further these costs in
the future. Failure by hospitals and other users of the Company's products to
obtain reimbursement from third party payors, changes in third party payors'
policies toward reimbursement for procedures using the Company's products or
legislative action could have a material adverse effect on the Company's
business. See "Business--Third Party Reimbursement and Cost Containment."
Uncertainty of Health Care Reform
- ---------------------------------
The levels of revenue and profitability of medical technology companies may be
affected by the efforts of government and third party payors to contain or
reduce the costs of health care through various means. In the United States
there have been, and the Company expects that there will continue to be, a
number of federal, state, and private proposals to control health care costs.
These proposals may contain measures intended to control public and private
spending on health care as well as to provide universal public access to the
health care system. If enacted, these proposals may result in a substantial
restructuring of the health care delivery system. Significant changes in the
nation's health care system could have a substantial impact on the manner in
which the Company conducts its business and could have a material adverse effect
on the Company's business, financial condition and results of operations.
Possible Issuances of Preferred Stock; Certain Anti-Takeover Considerations
- ---------------------------------------------------------------------------
The Company's Articles of Incorporation authorize the Company's Board of
Directors, without any action by its shareholders, to establish the rights and
preferences of up to 5,000,000 shares of currently undesignated preferred stock.
Such shares of preferred stock could possess voting and conversion rights which
could adversely affect the voting power of the holders of the common stock and
may have the effect of delaying, deferring or preventing a change in control of
the Company. No shares of preferred stock or other senior equity securities are
currently designated and there is no plan to designate or to issue any such
securities.
21
<PAGE>
The Company is also subject to certain "anti-takeover" provisions of the
Minnesota Business Corporation Act. In addition, the Company has adopted a
Shareholder Rights Plan (the "Rights Agreement") designed to protect the Company
and its shareholders from unsolicited attempts to acquire the Company. These
measures may, in certain circumstances, deter or discourage takeover attempts
and other changes in control of the Company not approved by its Board of
Directors, and may have a depressive effect on any market for the Company's
stock. As a result, the Company's shareholders may lose opportunities to dispose
of their shares at the higher prices typically available in takeover attempts or
that may be available under a merger proposal. In addition, these measures may
have the effect of permitting the Company's current directors to retain their
positions and place them in a better position to resist changes that the
Company's shareholders may wish to make if they are dissatisfied with the
conduct of the Company's business.
Effects of Trading in the Over-the-Counter Market
- -------------------------------------------------
The Company's common stock is traded in the over-the-counter market on the OTC
Electronic Bulletin Board. Consequently, the liquidity of the Company's common
stock may be impaired, not only in the number of shares that may be bought and
sold, but also through delays in the timing of transactions, and coverage by
security analysts and the news media may also be reduced. As a result, prices
for shares of the Company's common stock may be lower than might otherwise
prevail if the Company's common stock were traded on a national securities
exchange or listed on the Nasdaq Stock Market. Further, the recent adoption of
new eligibility standards and rules for broker dealers who make a market in
shares listed on the OTC Electronic Bulletin Board may limit the number of
brokers willing to make a market in the Company's common stock.
Limited Market For Securities
- -----------------------------
There is a limited trading market for the Company's common stock, which is not
listed on any national stock exchange or The Nasdaq Stock Market. The Company's
securities are subject to the "penny stock rules" adopted pursuant to Section
15(g) of the Securities Exchange Act of 1934, which applies to non-Nasdaq
companies whose common stock trades at less than $5 per share or has tangible
net worth of less than $2,000,000. These "penny stock rules" require, among
other things, that brokers who sell covered "penny stock" to persons other than
"established customers" complete certain documentation, make suitability
inquiries of investors and provide investors with certain information concerning
trading in the security, including a risk disclosure document and quote
information under certain circumstances. Many brokers have decided not to trade
"penny-stock" because of the requirements of the "penny stock rules" and, as a
result, the number of broker-dealers willing to act as market makers in such
securities is limited. There can be no assurance that an established trading
market will develop, the current market will be maintained or a liquid market
for the Company's common stock will be available in the future.
No Dividends
- ------------
The Company has not paid cash dividends on its common stock in the past and does
not intend to do so in the foreseeable future. See "Dividend Policy."
Limitations on Director Liability
- ---------------------------------
The Company's Articles of Incorporation provide that a director of the Company
shall not be personally liable to the Company or its shareholders for monetary
damages for breach of fiduciary duty as a director, with certain exceptions.
These provisions may discourage shareholders from bringing suit against a
director for breach of fiduciary duty and may reduce the likelihood of
derivative litigation brought by shareholders on behalf of the Company against a
director. In addition, the Company's Bylaws provide for mandatory
indemnification of directors and officers to the fullest extent permitted by
Minnesota law.
22
<PAGE>
Item 2. PROPERTIES
The Company's principal office is located in Plymouth, Minnesota, where the
Company currently occupies approximately 24,000 square feet under a lease that
expires July 31, 2005. Under certain conditions contained in the lease, the
Company has the option to expand its facilities.
The Company considers its current facilities adequate for its current needs and
believes that suitable additional space will be available as needed.
Item 3. LEGAL PROCEEDINGS
The Company is not engaged in any legal proceedings at this time.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There was no matter submitted to the vote of security holders during the fourth
quarter of 1999.
23
<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock has traded on the OTC Bulletin Board under the symbol
"VTAL" since May 14, 1997. The following table sets forth, for each of the
periods indicated, the high and low closing bid quotations for the Company's
Common Stock as reported by the OTC Bulletin Board. Such prices reflect
inter-dealer prices, do not include adjustments for retail mark-ups, mark-downs
or commissions and may not necessarily represent actual transactions.
High Low
------- -------
1999
----
Fourth Quarter $5.3750 $3.2500
Third Quarter 8.3750 4.0000
Second Quarter 8.3750 2.8750
First Quarter 4.6250 1.5000
1998
----
Fourth Quarter 2.1250 1.0625
Third Quarter 3.2188 1.1250
Second Quarter 3.2500 1.7500
First Quarter 2.3125 1.0000
1997
----
Fourth Quarter 1.6875 1.1875
Third Quarter 2.1250 1.6250
Second Quarter 2.5000 1.5000
(commencing May 14, 1997)
The Company has never paid or declared any cash dividends on its Common Stock
and does not intend to pay dividends on its Common Stock in the near future. To
date, the Company has incurred losses and presently expects to retain its future
anticipated earnings to finance development and expansion of its business. As of
February 29, 2000, there were approximately 4,200 beneficial owners and
approximately 1,200 registered holders of record of the Company's Common Stock.
24
<PAGE>
Item 6. SELECTED FINANCIAL DATA
The following selected financial data for each of the fiscal years in the
five-year period ended December 31, 1999 is derived from the audited financial
statements of the Company and the notes thereto. The information set forth below
should be read in conjunction with the Company's financial statements, including
the notes thereto, and "Management's Discussion and Analysis of Financial
Condition and Results of Operations," which are included elsewhere in this
Annual Report on Form 10-K.
(In thousands, except per share data)
<TABLE>
<CAPTION>
For the Two
For the Years Ended Months For the Years Ended
or As of Ended or As or As of
December 31, of December 31, October 31,
----------------------------- --------------- --------------------
1999 1998 1997(1) 1996(1) 1996(1) 1995(1)
------- ------- ------- --------------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Statements of Operations:
Revenue $ 6,623 $ 4,527 $ 1,218 $ 65 $ 882 $2,894 (2)
Gross margin 5,080 3,302 915 53 720 2,488 (2)
Operating expenses:
Selling, general and
administrative 5,858 4,954 3,871 328 1,805 879
Research and development 2,525 1,815 2,255 333 1,460 1,357
------- ------- ------- ------- ------- ------
Operating income (loss) (3,303) (3,467) (5,211) (608) (2,545) 252 (2)
Net income (loss) $(3,218) $(3,209) $(4,774) $ (521) $(2,546) $ 253
======= ======= ======= ======= ======= ======
Net income (loss)
per share - basic (3) $ (0.64) $ (0.66) $ (1.00) $ (0.11) $ (0.54) $ 0.07
======= ======= ======= ======= ======= ======
Weighted average common shares
outstanding - basic (3) 5,046 4,841 4,772 4,745 4,716 3,786
======= ======= ======= ======= ======= ======
Net income (loss)
per share - diluted (3) $ (0.64) $ (0.66) $ (1.00) $ (0.11) $ (0.54) $ 0.06
======= ======= ======= ======= ======= ======
Weighted average common shares
outstanding - diluted (3) 5,046 4,841 4,772 4,745 4,716 4,031
======= ======= ======= ======= ======= ======
Balance Sheets:
Working capital (deficiency) $ 5,409 $ 3,360 $ 6,415 $ 6,214 $ (258) $(144)
Total assets 8,666 5,938 8,296 10,493 943 739
Short and long-term debt - - - - - -
Total equity 6,098 4,134 7,253 9,720 174 321
</TABLE>
(1) Reflects Vital Images' results as a wholly-owned subsidiary of Bio-Vascular
from January 1995 through May 12, 1997. Vital Images was merged with
Bio-Vascular in May 1994 in a transaction accounted for as a
pooling-of-interests and subsequently spun-off as an independent,
publicly-owned company in May 1997. Results of operations during the period
from January 1995 through May 12, 1997 include allocations of certain
general corporate expenses of Bio-Vascular.
(2) Includes $1,500 of one-time license fee revenue, which contributed $1,322
to gross margin and operating income.
(3) For periods after and including May 12, 1997, basic and diluted net loss
per share is computed using the weighted average common shares outstanding
during the period. Common share equivalents are not included in the net
loss per share calculations since they are anti-dilutive.
For periods prior May 12, 1997, the weighted average common shares
outstanding used in the net income (loss) per share calculation is one-half
of the weighted average of Bio-Vascular common shares outstanding based on
the distribution of one share of the Company's common stock for each two
shares of Bio-Vascular's common stock. To the extent the common share
equivalents are dilutive, the weighted average common shares include
one-half of Bio-Vascular's weighted average common share equivalents.
25
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Vital Images develops, markets and supports medical visualization and analysis
software for use primarily in clinical diagnosis, surgical planning and medical
screening. The Company's software applies proprietary computer graphics and
image processing technologies to a wide variety of data supplied by computed
tomography ("CT") scanners, magnetic resonance ("MR") imaging devices and
ultrasound scanning equipment. Vital Images' products allow clinicians to create
both two- and three-dimensional views of human anatomy and to non-invasively
navigate within these images to better visualize and understand internal
structures and pathologies. The Company believes that its high-speed
visualization technology and customized protocols cost-effectively bring 3D
visualization and analysis into the routine, day-to-day practice of medicine.
The Company, which operates in a single business segment, markets its products
to healthcare providers and to manufacturers of diagnostic imaging systems
through a direct sales force in the United States and independent distributors
in international markets.
On October 28, 1996, the Board of Directors of Bio-Vascular, Inc.
("Bio-Vascular"), the former parent company of Vital Images, approved a plan to
spin off and establish Vital Images as an independent, publicly-owned company.
On May 12, 1997 (the "Distribution Date"), Bio-Vascular distributed all of the
shares of Vital Images to the shareholders of Bio-Vascular (the "Distribution"),
and on that date Vital Images began operating as an independent public company.
All Bio-Vascular shareholders of record as of May 5, 1997 received one share of
Vital Images common stock for each two shares of Bio-Vascular stock held on that
date, and cash in lieu of fractional shares. As a result of Bio-Vascular's
spin-off of Vital Images, Vital Images' financial statements and notes thereto
report the business of Vital Images as an independent company. Vital Images is
currently traded on the OTC Bulletin Board under the symbol VTAL.
In anticipation of the Distribution, Bio-Vascular assigned to Vital Images,
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996. Subsequently, Bio-Vascular's Board of Directors agreed to make
such additional contributions as were necessary to bring cash, cash equivalents
and marketable securities to a combined total of $10,000,000 effective as of the
Distribution Date. On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balance to $10,000,000.
Additionally, Bio-Vascular made capital contributions to Vital Images of
approximately $3,200,000 representing net advances of cash over the period
beginning May 24, 1994, the date on which Vital Images was acquired by
Bio-Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular.
Revenue
Total revenue increased 46% to $6,623,000 in 1999 compared with $4,527,000 in
1998. Total revenue in 1998 increased 272% from total revenue of $1,218,000 in
1997. These increases were primarily the result of volume increases in shipments
of Vitrea(R), the Company's flagship medical visualization and analysis
software. Software and hardware revenue from the Vitrea platform totaled
$5,143,000, or 78% of total revenue in 1999, compared with $3,234,000, or 71% of
total revenue in 1998, and $404,000, or 33% of total revenue in 1997. Vitrea
revenue increased 59% in 1999 compared with 1998 and 700% in 1998 compared with
1997. Vitrea was first released for sale to customers in October 1997. In
addition, there were increases in maintenance and service revenue related to
Vitrea sales in 1999 as compared with 1998 and from 1998 compared with 1997.
Royalties received from the Company's license agreement with Paradigm
Geophysical Corporation ("Paradigm") decreased in 1999 as compared to 1998 but
increased in 1998 as compared with 1997. Revenue received under the license
agreement with Paradigm was $462,000, $618,000 and $313,000 in 1999, 1998 and
1997, respectively. License fee revenue and maintenance revenue from
VoxelView(R) software, the Company's product for the research market, was flat
in 1999 as compared to 1998 and decreased in 1998 as compared to 1997.
26
<PAGE>
Gross Margin
The gross margin percentage increased to 77% in 1999 from 73% in 1998 and 75% in
1997, primarily as a result of increasing the price of the Company's Vitrea
system. The Vitrea system, consisting of Vitrea software and third-party
hardware and peripherals, is designed to offer end users an integrated
visualization and analysis system. The Company receives only a nominal discount
in purchasing the third-party hardware and peripheral components of the Vitrea
system, and the Company's gross margin on the resale of these system components
approximates its discount. The Company anticipates that as hardware revenue
related to the sale of Vitrea software continues to account for a significant
proportion of the Company's total revenue, the overall gross margin percentage
will approximate the results of 1999.
Sales and Marketing
Sales and marketing expenses were $3,886,000, or 59% of total revenue,
$2,955,000, or 65% of total revenue, and $2,167,000, or 178% of total revenue,
for 1999, 1998 and 1997, respectively. The increase from 1998 to 1999 was
primarily due to increased compensation costs as a result of additional
personnel and sales commissions. There were also increases in travel expenses as
well as advertising and promotion expenses related to selling and promoting the
Vitrea product. Depreciation expense also increased in 1999 as compared with
1998, primarily due to equipment purchases used for the additional personnel and
equipment for tradeshows. The increase from 1997 to 1998 was primarily due to
increased compensation costs as a result of increased sales commissions and
additional personnel and increased travel expenses related to selling and
promoting the Vitrea product The Company expects sales and marketing costs to
increase in future periods primarily as a result of the cost of additional sales
personnel.
Research and Development
Research and development expenses were up 39% to $2,525,000, or 38% of total
revenue, in 1999 from $1,815,000, or 40% of total revenue, in 1998. The increase
was primarily due to a decrease in reimbursement of $285,000 of engineering
costs pursuant to a software development contract with ATL Ultrasound, Inc.
("ATL") and an increase in compensation and recruiting costs due to the hiring
of additional personnel. There was also an increase in depreciation expense
primarily the result of equipment purchases to support the additional personnel
as well as to support the development of Vitrea2 for Windows NT(TM). Research
and development expenses were $2,255,000, or 185% of total revenue, in 1997. The
decrease in 1998 from the 1997 level was primarily due to reimbursement of
$285,000 of engineering costs pursuant to the development contract with ATL,
fewer software engineers and a decrease in travel expenses. The Company
anticipates that research and development expenses will increase in future
periods as additional releases of Vitrea software are developed.
General and Administrative
General and administrative expenses were $1,971,000, or 30% of total revenue,
$1,999,000, or 44% of total revenue, and $1,703,000, or 140% of total revenue,
in 1999, 1998, and 1997, respectively. The decrease from 1998 to 1999 was
primarily due to the absence of costs in 1999 related to the resignation of the
Company's former Chief Executive Officer and the decrease of expenses related to
the closing of the Company's Iowa facility, primarily due to negotiating an
early termination of the lease for that facility. These decreases were partially
offset by increases in shareholder communications and compensation costs. The
increase from 1997 to 1998 was due primarily to a charge of $180,000 in
connection with the resignation of the Company's former Chief Executive Officer
and expenses of $100,000 related to the planned closing of the Company's Iowa
facility. In December 1998, the Company made a decision to consolidate its
operations at its headquarters in Minnesota and close its facility in Iowa. In
addition, compensation expense increased as a result of increased staffing and
compensation costs for employees hired in 1997 that were present for all of
1998. Incremental costs associated with being an independent public company,
including professional fees and shareholder
27
<PAGE>
reporting, also contributed to the increase. These increases were partially
offset by a decrease of $441,000 related to stock-based compensation costs in
1997. The Company believes that general and administrative costs will increase
in future periods primarily due to increased compensation expense for employees
hired in 1999 that will be present for all of 2000 as well as additional costs
related to the Company's new facility.
Results of Operations
The increasing revenues from Vitrea shipments net of the increased expenses
attributable to the development of the Company's infrastructure and the
development and promotion of the Vitrea product, resulted in an operating loss
of $3,303,000 for 1999 compared with an operating loss of $3,467,000 for 1998
and an operating loss of $5,211,000 for 1997.
Interest Income
There was $91,000 of interest income for 1999, compared with $264,000 in 1998
and $443,000 in 1997. The decreases in interest income from 1997 to 1998 and
from 1998 to 1999 were due to a lower balance of cash, cash equivalents and
marketable securities throughout the year as a result of the use of cash to fund
the Company's operations.
Income Taxes
The income tax provisions for 1999, 1998 and 1997 consist solely of certain
state minimum fees. A valuation allowance has been established to completely
reserve for the deferred tax assets of the Company. As a wholly-owned subsidiary
of Bio-Vascular through May 11, 1997, the Company did not file separate federal
income tax returns, but rather was included in the federal income tax returns
filed by Bio-Vascular. For purposes of the Company's financial statements prior
to the Distribution, the Company's allocated income tax provisions were based on
the "separate return" method.
Liquidity and Capital Resources
As of December 31, 1999, the Company had $5,333,000 in cash and cash
equivalents. The Company's working capital was $5,409,000 and the Company had no
material borrowings. The Company has entered into a collateralized line of
credit agreement with a bank for $950,000. Borrowings under the agreement are
limited to the lower of $950,000 or the Company's borrowing base, which consists
of a specified percentage of certain accounts receivable. The Company is also
required to maintain a cash and cash equivalents balance of at least $1,000,000
at the lending bank. As of December 31, 1999, the Company has two outstanding
letters of credit, totaling $350,000, collateralized by the line of credit and
its available borrowings under the agreement were $600,000.
Cash used in operations increased to $3,064,000 for 1999 from $2,342,000 in
1998. For 1997, $4,075,000 was used in operations. Cash flows were used
primarily to fund operating losses in each of the years 1999, 1998 and 1997,
which were partially offset by non-cash expenses for depreciation and
amortization and the provision for uncollectible accounts receivable in 1999,
1998 and 1997 and stock-based compensation in 1999 and 1997. Increases in
accounts receivable decreased cash flows and increases in current liabilities
increased cash flows in each of the years 1999, 1998 and 1997. Changes in
deferred revenue resulted in increased cash flows in 1999 and 1998 and in
decreased cash flows in 1997.
The increases in current liabilities in 1999, 1998 and 1997 were due primarily
to increases in accounts payable and accrued payroll and other liabilities. The
increases in accounts receivable and accounts payable were due primarily to
volume increases in Vitrea sales and costs related thereto, respectively. The
increase in accrued payroll and other liabilities in 1999 was primarily due to
increases in accrued vacation, royalties and commissions, offset by a decrease
in accrued bonuses. The increases in accrued payroll and other liabilities in
28
<PAGE>
1998 and 1997 were due primarily to increases in bonuses, commissions and
accrued vacation pay related to increases in employee headcount.
Net investing activities provided $1,474,000 and $3,555,000 of cash in 1999 and
1998, respectively, primarily due to the conversion of marketable securities
into cash. In 1997, the Company used $3,776,000 in investing activities
primarily due to the investment of cash in marketable securities. The Company
added property and equipment of $512,000, $423,000 and $796,000 in 1999, 1998
and 1997, respectively, primarily for computer equipment to accommodate the
increases in employee headcount in 1999, 1998 and 1997 and for
telecommunications equipment to accommodate the Company's move into new
facilities in 1997.
Cash provided by financing activities totaled $5,171,000, $91,000 and $1,818,000
in 1999, 1998 and 1997, respectively. A private placement of the Company's
common stock and warrants completed by the Company in December 1999 was
primarily responsible for the cash provided by financing activities in 1999. Net
cash investments made by Bio-Vascular of $1,798,000 accounted for nearly all of
the cash from financing activities in 1997. During 1999, 1998 and 1997, net cash
of $426,000, $91,000 and $20,000, respectively, was provided by proceeds from
the Company's stock option plans.
The Company has never paid or declared any cash dividend and does not intend to
pay dividends in the near future. The Company has commitments for approximately
$500,000 of capital expenditures related to the Company's new office facilities.
See Note 6 to the financial statements, "Lease Commitments," for additional
commitments and contingencies. The Company expects to use cash in the near term
as it continues to develop the infrastructure to support its business and
develop the market for its products.
If the Company's operations progress as anticipated, of which there can be no
assurance, management believes that its cash, and cash equivalents and
borrowings available under the credit agreement should be sufficient to satisfy
its cash requirements for at least the next twelve months. The timing of the
Company's future capital requirements, however, will depend on a number of
factors, including the ability and willingness of physicians to use
three-dimensional visualization and analysis software in clinical diagnosis,
surgical planning, patient screening and other diagnosis and treatment
protocols; the ability of the Company to successfully market its products; the
ability of the Company to differentiate its volume rendering software from
competing products employing surface rendering or other technologies; the
ability of the Company to build an effective sales and distribution channel; the
impact of competition in the medical visualization business; and the ability of
the Company to enhance existing products and develop new products on a timely
basis. To the extent that the Company's operations do not progress as
anticipated, additional capital may be required sooner. There can be no
assurance that any required additional capital will be available on acceptable
terms or at all, and the failure to obtain any such capital would have a
material adverse effect on the Company's business.
Year 2000
Many computer programs and embedded computer chips were unable to distinguish
between the year 1900 and the year 2000. Therefore, some computer hardware and
software needed to be modified prior to the year 2000 in order to remain
functional. This is commonly known as the year 2000 ("Y2K") issue.
The Company has a formal program in place with an assigned year 2000 project
team to ensure that its critical areas will operate normally at the turn of the
century and beyond. Throughout 1999, the year 2000 project team determined areas
where contingency planning was needed. The planning efforts included, but were
not limited to, identification and mitigation of potential serious business
interruptions and establishing crisis response processes to address unexpected
problems.
Through the date of this filing, the Company has not experienced any significant
Y2K issues. The Company will continue to monitor its Y2K status during the
coming year and will devote the necessary resources to resolve all significant
Y2K issues in a timely manner.
29
<PAGE>
The costs incurred by the Company in addressing its Y2K readiness issues were
primarily non-incremental compensation costs and were not material to the
Company's operating results. The Company currently estimates that the total
additional costs for addressing any Y2K readiness will not be material to the
Company's operating results. These costs are being expensed as they are
incurred.
The Company's statements regarding its year 2000 readiness are forward-looking
statements and are, therefore, subject to change as a result of known and
unknown factors. The Company's cost estimates could be influenced by the
Company's ability to successfully identify all year 2000 issues, the nature and
amount of remediation required, the availability and cost of trained personnel
in this area and the year 2000 success that key third parties and customers
attain. While these and other unforeseen factors could have a material adverse
impact on the Company's financial position, results of operations or liquidity
in future periods due to possible business disruptions caused by a lack of third
party year 2000 readiness, management believes that it has implemented an
effective year 2000 compliance program that will minimize the possible negative
consequences to the Company.
The Year 2000 readiness disclosure statement set forth above is a "Year 2000
Readiness Disclosure" under the federal Year 2000 Information and Readiness
Disclosure Act.
Foreign Currency Transactions
Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars.
Inflation
Management believes inflation has not had a material effect on the Company's
operations or on its financial condition.
Recent Accounting Pronouncements
In June 1998, The FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new statement establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133, as amended by SFAS No.
137, is effective for the Company beginning January 1, 2001. The Company does
not expect SFAS No. 133 to materially affect its financial position or results
of operations.
In January 1999, the AICPA issued SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions," which will retain
the limitations of SOP 97-2 on what constitutes vendor-specific objective
evidence of fair value. SOP 98-9 will be effective for the Company for
transactions entered into beginning January 1, 2000. The Company believes that
its current revenue recognition policies and practices are consistent with the
provisions of the new guidance.
Market Risk
The Company is exposed to market risk related to changes in the fair value of
its financial instruments due to changes in interest rates. As of December 31,
1999, the Company did not own any financial instruments.
30
<PAGE>
Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 and
information that are based on management's beliefs as well as on assumptions
made by, and upon information currently available to, management. When used in
this Annual Report on Form 10-K, the words "expect," "anticipate," "intend,"
"plan," "believe," "seek," and "estimate," or similar expressions are intended
to identify such forward-looking statements. However, this Annual Report on Form
10-K also contains other forward-looking statements. Forward-looking statements
are not guarantees of future performance and are subject to certain risks,
uncertainties and assumptions, including, but not limited to, the following
factors, which could cause the Company's future results and shareholder values
to differ materially from those expressed in any forward-looking statements made
by or on behalf of the Company: the dependence on market growth of the industry
in which the Company operates; the extent to which the Company's products gain
market acceptance; the need for and availability of additional capital; the
potential for litigation regarding patent and other intellectual property
rights; the introduction of competitive products by others; dependence on major
customers; fluctuations in quarterly results; the progress of product
development; the availability of third party reimbursement; and the receipt and
timing of regulatory approvals and other factors detailed from time to time in
the Company's filings with the Securities and Exchange Commission, including
those set forth under the heading "Important Factors" included in Item 1 of this
Annual Report on Form 10-K.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements, supplemental schedule and Report
of Independent Accountants thereon, all of which are included in this
Annual Report on Form 10-K, are listed in Item 14 (a) (1) of this Form
10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
31
<PAGE>
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
(a) Directors of the Registrant.
The information under the caption "Election of Directors" in the
Company's 2000 Proxy Statement is incorporated herein by reference.
(b) Executive officers of the Registrant.
Information concerning Executive Officers of the Company is included
in this Report on page 15 under Item 1, "Executive Officers of the
Registrant."
(c) Compliance with 16(a) of the Securities Exchange Act of 1934.
The information under the caption "Compliance with Section 16 (a)" in
the Company's 2000 Proxy Statement is incorporated herein by
reference.
Item 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation" and
"Director Compensation" in the Company's 2000 Proxy Statement is
incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Beneficial Ownership of Common
Stock" in the Company's 2000 Proxy Statement is incorporated herein by
reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There are no reportable transactions.
32
<PAGE>
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) The following financial statements and supplemental schedule
of Vital Images, Inc. and Report of Independent Accountants thereon
are included herein:
Page
----
Report of Independent Accountants..................................35
Balance Sheets as of December 31, 1999 and 1998....................36
Statements of Operations for the years ended December 31,
1999, 1998 and 1997..............................................37
Statements of Shareholders' Equity for the years ended
December 31, 1999, 1998 and 1997.................................38
Statements of Cash Flows for the years ended December 31, 1999,
1998 and 1997....................................................39
Notes to Financial Statements......................................40
Schedule II. Valuation and Qualifying Accounts.....................53
(a) (2) Included in Item 14 (a) (1) above
All other schedules to the financial statements required by Article 7
of Regulation S-X are not required under the related instructions or
are inapplicable and therefore have been omitted.
(a) (3) LISTING OF EXHIBITS
The Exhibits required to be a part of this Report are listed in the
Index to Exhibits which follows the Financial Statement Schedule on
page 54.
(b) REPORTS ON FORM 8-K
On December 27, 1999 the Company filed a report on Form 8-K relating to
the completion of a private placement of an aggregate of 1,650,000
units (the "Units"), each Unit consisting of one share of the Company's
common stock and a Redeemable Common Stock Purchase Warrant for the
purchase of one share of the Company's common stock.
(c) EXHIBITS
Included in Item 14 (a) (3) above.
33
<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, in Minneapolis, Minnesota,
on the 21st day of March 2000.
VITAL IMAGES, INC.
By: /s/ Gregory S. Furness
---------------------------------------
Gregory S. Furness
Chief Financial Officer and
Vice President-Finance
(Chief Accounting Officer)
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report
has been signed by the following persons in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/Albert Emola President, Chief Executive Officer March 21, 2000
- -------------------------- and Director
Albert Emola (Principal Executive Officer)
/s/Gregory S. Furness Chief Financial Officer, March 21, 2000
- -------------------------- Vice President-Finance, Treasurer
Gregory S. Furness and Secretary
(Chief Accounting Officer)
/s/Douglas M. Pihl Chairman of the Board and Director March 21, 2000
- --------------------------
Douglas M. Pihl
/s/Vincent J. Argiro Chief Technology Officer, Founder March 21, 2000
- -------------------------- and Director
Vincent J. Argiro
/s/James B. Hickey, Jr. Director March 21, 2000
- --------------------------
James B. Hickey, Jr.
/s/Richard W. Perkins Director March 21, 2000
- --------------------------
Richard W. Perkins
/s/Michael W. Vannier Director March 21, 2000
- --------------------------
Michael W. Vannier
/s/Sven A. Wehrwein Director March 21, 2000
- --------------------------
Sven A. Wehrwein
</TABLE>
34
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Vital Images, Inc.:
In our opinion, the financial statements listed in the index appearing under
Item 14(a)(1) present fairly, in all material respects, the financial position
of Vital Images, Inc. (the "Company") at December 31, 1999 and 1998, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States. In addition, in our opinion, the
financial statement schedule listed in the index appearing under Item 14(a)(1)
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
February 11, 2000
35
<PAGE>
VITAL IMAGES, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
As of December 31,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,332,885 $ 1,751,615
Marketable securities -- 1,985,556
Accounts receivable, net of allowance for doubtful
accounts of $93,000 and $78,000 as of December 31, 1999
and 1998, respectively 2,005,114 1,149,109
Prepaid expenses and other current assets 463,309 135,117
------------ ------------
Total current assets 7,801,308 5,021,397
Property and equipment, net 864,479 916,238
------------ ------------
TOTAL ASSETS $ 8,665,787 $ 5,937,635
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 831,741 $ 505,260
Accrued payroll 539,977 587,261
Deferred revenue 758,110 380,851
Other current liabilities 262,183 188,381
------------ ------------
Total current liabilities 2,392,011 1,661,753
Deferred revenue 175,360 141,615
------------ ------------
Total liabilities 2,567,371 1,803,368
Commitments
Shareholders' equity:
Preferred stock: $0.01 par value; 5,000,000 shares
authorized; none issued or outstanding as of
December 31, 1999 and 1998 -- --
Common stock: $0.01 par value; 20,000,000 shares
authorized; 6,695,867 and 4,870,497 shares issued and
outstanding as of December 31, 1999 and 1998,
respectively 66,959 48,705
Additional paid-in capital 23,260,227 18,096,707
Accumulated deficit (17,228,770) (14,011,145)
------------ ------------
Total shareholders' equity 6,098,416 4,134,267
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 8,665,787 $ 5,937,635
============ ============
</TABLE>
(The accompanying notes are an integral part of the financial statements.)
36
<PAGE>
VITAL IMAGES, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Revenue:
License fees $ 4,181,750 $ 2,734,783 $ 751,810
Maintenance and services 831,196 511,564 290,769
Hardware 1,610,414 1,281,004 175,592
----------- ----------- -----------
Total revenue 6,623,360 4,527,351 1,218,171
Cost of revenue:
License fees 139,025 147,387 143,135
Maintenance and services 197,705 120,989 3,309
Hardware 1,206,846 956,767 157,032
----------- ----------- -----------
Total cost of revenue 1,543,576 1,225,143 303,476
Gross margin 5,079,784 3,302,208 914,695
Operating expenses:
Sales and marketing 3,886,295 2,955,317 2,167,400
Research and development 2,524,670 1,814,602 2,255,030
General and administrative 1,971,435 1,999,141 1,703,024
----------- ----------- -----------
Total operating expenses 8,382,400 6,769,060 6,125,454
Operating loss (3,302,616) (3,466,852) (5,210,759)
Interest income 90,991 263,668 443,439
----------- ----------- -----------
Loss before income taxes (3,211,625) (3,203,184) (4,767,320)
Income taxes 6,000 6,265 6,500
----------- ----------- -----------
Net loss $(3,217,625) $(3,209,449) $(4,773,820)
=========== =========== ===========
Net loss per share - basic and diluted $ (0.64) $ (0.66) $ (1.00)
=========== =========== ===========
Weighted average common shares
outstanding - basic and diluted 5,045,530 4,840,814 4,771,739
=========== =========== ===========
</TABLE>
(The accompanying notes are an integral part of the financial statements.)
37
<PAGE>
VITAL IMAGES, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common Stock Additional
---------------------- Paid-In Deferred
Shares Amount Capital Compensation
---------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Balances as of December 31, 1996 1,000 $ 10 $13,003,047 $(440,834)
Cancellation of common stock owned
by Bio-Vascular (1,000) (10) -- --
Contribution of capital from Bio-Vascular -- -- 1,797,814 --
Issuance of common stock in connection
with spin-off from Bio-Vascular 4,772,422 47,724 3,150,996 --
Amortization of deferred compensation -- -- -- 440,834
Cancellation of restricted stock (2,565) (25) 25 --
Issuance of common stock under
Employee Stock Purchase Plan 15,776 158 20,490 --
Issuance of common stock awards 20,928 209 34,452 --
Comprehensive income (loss):
Net loss -- -- -- --
Change in unrealized loss
on marketable securities -- -- -- --
Total comprehensive income (loss)
---------- -------- ----------- ---------
Balances as of December 31, 1997 4,806,561 48,066 18,006,824 --
Cancellation of restricted stock (2,383) (24) 24 --
Issuance of common stock
upon exercise of stock options 41,925 419 57,391 --
Issuance of common stock under
Employee Stock Purchase Plan 24,394 244 32,468 --
Comprehensive income (loss):
Net loss -- -- -- --
Total comprehensive income (loss)
---------- -------- ----------- ---------
Balances as of December 31, 1998 4,870,497 48,705 18,096,707 --
Cancellation of restricted stock (1,881) (19) 19 --
Stock-based compensation -- -- 10,781 --
Issuance of common stock upon
exercise of stock options 153,484 1,535 358,306 --
Issuance of common stock under
Employee Stock Purchase Plan 23,767 238 66,407 --
Issuance of common stock in
connection with private placement,
net of offering costs 1,650,000 16,500 4,728,007 --
Comprehensive income (loss):
Net loss -- -- -- --
Total comprehensive income (loss)
---------- -------- ----------- ---------
Balances as of December 31, 1999 6,695,867 $ 66,959 $23,260,227 $ --
========== ======== =========== =========
<CAPTION>
Net Accumulated
Investment Other Total
by Bio- Accumulated Comprehensive Shareholders'
Vascular Deficit Income (Loss) Equity
----------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
Balances as of December 31, 1996 $ 3,198,710 $ (6,027,876) $(13,125) $9,719,932
Cancellation of common stock owned
by Bio-Vascular 10 -- -- --
Contribution of capital from Bio-Vascular -- -- -- 1,797,814
Issuance of common stock in connection
with spin-off from Bio-Vascular (3,198,720) -- -- --
Amortization of deferred compensation -- -- -- 440,834
Cancellation of restricted stock -- -- -- --
Issuance of common stock under
Employee Stock Purchase Plan -- -- -- 20,648
Issuance of common stock awards -- -- -- 34,661
Comprehensive income (loss):
Net loss -- (4,773,820) --
Change in unrealized loss
on marketable securities -- -- 13,125
Total comprehensive income (loss) (4,760,695)
----------- ------------ -------- ----------
Balances as of December 31, 1997 -- (10,801,696) -- 7,253,194
Cancellation of restricted stock -- -- -- --
Issuance of common stock
upon exercise of stock options -- -- -- 57,810
Issuance of common stock under
Employee Stock Purchase Plan -- -- -- 32,712
Comprehensive income (loss):
Net loss -- (3,209,449) --
Total comprehensive income (loss) (3,209,449)
----------- ------------ -------- ----------
Balances as of December 31, 1998 -- (14,011,145) -- 4,134,267
Cancellation of restricted stock -- -- -- --
Stock-based compensation -- -- -- 10,781
Issuance of common stock upon
exercise of stock options -- -- -- 359,841
Issuance of common stock under
Employee Stock Purchase Plan -- -- -- 66,645
Issuance of common stock in
connection with private placement,
net of offering costs -- -- -- 4,744,507
Comprehensive income (loss):
Net loss -- (3,217,625) --
Total comprehensive income (loss) (3,217,625)
----------- ------------ -------- ----------
Balances as of December 31, 1999 $ -- $(17,228,770) $ -- $6,098,416
=========== ============ ======== ==========
</TABLE>
(The accompanying notes are an integral part of the financial statements.)
38
<PAGE>
VITAL IMAGES, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------------
1999 1998 1997
----------- ------------ -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,217,625) $ (3,209,449) $(4,773,820)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 563,420 504,949 511,085
Stock-based compensation 10,781 -- 475,495
Provision for uncollectible accounts
receivable 15,000 52,313 12,452
Other -- 40,267 --
Changes in operating assets and
liabilities:
Accounts receivable (871,005) (620,292) (504,218)
Prepaid expenses and other current
assets (328,192) 129,709 (65,511)
Accounts payable 326,481 301,681 116,049
Deferred revenue 411,004 109,803 (84,197)
Accrued payroll and other liabilities 26,518 349,067 237,816
----------- ------------ -----------
Net cash used in operating
activities (3,063,618) (2,341,952) (4,074,849)
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (511,661) (423,240) (795,828)
Increase in other assets -- -- (17,011)
Investments in marketable securities (1,014,444) (9,522,092) (9,826,875)
Maturities of marketable securities 3,000,000 13,500,000 6,863,411
----------- ------------ -----------
Net cash provided by (used in)
investing activities 1,473,895 3,554,668 (3,776,303)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from private placement 4,744,507 -- --
Net investment by Bio-Vascular -- -- 1,797,814
Purchases of common stock under
stock option plans 426,486 90,522 20,648
----------- ------------ -----------
Net cash provided by financing
activities 5,170,993 90,522 1,818,462
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 3,581,270 1,303,238 (6,032,690)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 1,751,615 448,377 6,481,067
----------- ------------ -----------
CASH AND CASH EQUIVALENTS, END OF
YEAR $ 5,332,885 $ 1,751,615 $ 448,377
=========== ============ ===========
</TABLE>
(The accompanying notes are an integral part of the financial statements.)
39
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(1) Business Description, Background and Basis of Presentation
Business Description
Vital Images, Inc. (the "Company" or "Vital Images") develops, markets and
supports visualization and analysis software for use primarily in clinical
diagnosis, surgical planning and medical screening. The Company's software
applies proprietary computer graphics and image processing technologies to a
wide variety of data supplied by computed tomography, magnetic resonance imaging
devices and ultrasound scanning equipment. Vital Images' products allow
clinicians to create both two- and three-dimensional views of human anatomy and
to non-invasively navigate within these images to better visualize and
understand internal structures and pathologies. The Company believes that its
high-speed visualization technology and customized protocols cost-effectively
bring 3D visualization and analysis into the routine, day-to-day practice of
medicine. The Company, which operates in a single business segment, markets its
products to healthcare providers and to manufacturers of diagnostic imaging
systems through a direct sales force in the United States and independent
distributors in international markets.
Background
On October 28, 1996, the Board of Directors of Bio-Vascular, Inc.
("Bio-Vascular"), the former parent company of Vital Images, approved a plan to
spin off and establish Vital Images as an independent, publicly-owned company.
On May 12, 1997 (the "Distribution Date"), Bio-Vascular distributed all of the
shares of Vital Images to the shareholders of Bio-Vascular (the "Distribution"),
and on that date Vital Images began operating as an independent public company.
All Bio-Vascular shareholders of record as of May 5, 1997 received one share of
Vital Images common stock for each two shares of Bio-Vascular stock held on that
date, and cash in lieu of fractional shares.
In anticipation of the Distribution, Bio-Vascular assigned to Vital Images,
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996. Subsequently, Bio-Vascular's Board of Directors agreed to make
such additional contributions as were necessary to bring cash, cash equivalents
and marketable securities to a combined total of $10,000,000 effective as of the
Distribution Date. On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balance to $10,000,000.
Additionally, Bio-Vascular made capital contributions to Vital Images of
approximately $3,200,000 representing net advances of cash over the period
beginning May 24, 1994, the date on which Vital Images was acquired by
Bio-Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular.
Basis of Presentation
The financial statements for periods subsequent to May 11, 1997 reflect the
assets, liabilities, shareholders' equity, revenues and expenses of the Company
on a stand-alone basis. The financial statements for periods prior to May 12,
1997 reflect the assets, liabilities, equity, revenues and expenses of the
Company as it was operated as a wholly-owned subsidiary of Bio-Vascular. Prior
to May 12, 1997, the Statements of Operations include an allocation of certain
general corporate expenses of Bio-Vascular for administration, accounting,
finance, human resources and regulatory functions. These allocations were based
on estimates of personnel time and effort spent on the Company. Management
believes these allocations were made on a reasonable basis. Corporate overhead
allocations were $77,000 for the year ended December 31, 1997.
40
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
The Company's financing requirements through the Distribution Date were
represented primarily by cash transactions with Bio-Vascular and are reflected
in the "Net Investment by Bio-Vascular" equity account. Activity in the Net
Investment by Bio-Vascular equity account relates to net cash received from
Bio-Vascular through intercompany advances to fund the Company's operating
deficits. These amounts received from Bio-Vascular were considered to be capital
contributions, as the Company did not have the ability to substantially repay
these advances. The financial information included herein for periods prior to
the Distribution may not necessarily be indicative of the financial position,
results of operations or cash flows of the Company, if it had been a separate,
independent company during the periods prior to the Distribution.
(2) Summary of Significant Accounting Policies
Use of Estimates
The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Financial Instruments
The Company considers all highly liquid investments acquired with an original
maturity of three months or less to be cash equivalents. Investments having
original maturities in excess of three months are classified as marketable
securities. Investments are classified as short-term or long-term on the balance
sheet based on their maturity date. All of the Company's marketable securities
are classified as available-for-sale and all mature in one year or less.
Available-for-sale investments are recorded at market value, which is based on
quoted market prices, with unrealized holding gains and losses included as a
separate component of shareholders' equity. The Company uses a specific
identification cost method to determine the gross realized gains and losses on
the sale of its securities.
Concentration of Credit Risk
Cash is held primarily by one financial institution. Cash equivalents and
marketable securities are invested in money market accounts and a limited number
of corporate bonds. The Company's customer base is generally concentrated with a
small base of customers. The Company reviews the creditworthiness of its
customers prior to product shipment and generally does not require collateral.
41
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the related asset's estimated useful life, generally
three to seven years. Leasehold improvements are amortized over the shorter of
their estimated useful lives or the remaining terms of the related leases. The
asset cost and related accumulated depreciation or amortization are adjusted for
asset retirement or disposal with the resulting gain or loss, if any, credited
or charged to other income.
Revenue Recognition
The Company recognizes revenue in accordance with AICPA Statement of Position
("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-4. Revenue is
derived from the licensing of computer software, sales of system hardware,
maintenance and from services consisting of installation, training and
consulting services.
In software arrangements that include the rights to multiple software products,
system hardware, specified upgrades, maintenance or services, the Company
allocates the total arrangement fee among each deliverable based on the relative
fair value of each of the deliverables determined based on vendor-specific
objective evidence.
Revenue from license fees is recognized when persuasive evidence of an agreement
exists, shipment of the product has occurred, no significant Company obligations
with regard to implementation remain, the fee is fixed or determinable and
collection is probable. Revenue allocable to maintenance is recognized on a
straight-line basis over the periods in which it is provided. The Company
evaluates arrangements that include services to determine whether those services
are essential to the functionality of other elements of the arrangement.
Currently, the Company does not consider its services to be essential, and
accordingly, revenue allocable to the services is recognized as the services are
performed. Hardware revenue is recognized upon shipment.
Research and Development Costs
Costs related to research, design and development of products are charged to
research and development expense as incurred. Software development costs are
capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release to
customers. The Company uses the working model approach to determine
technological feasibility. Generally, the Company's products are released soon
after technological feasibility has been established. As a result, the Company
has not capitalized any software development costs, since such costs have not
been significant.
Income Taxes
The Company accounts for income taxes using the asset and liability method.
Deferred income tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amounts expected to be realized.
As a wholly-owned subsidiary of Bio-Vascular through May 11, 1997, the Company
did not file separate federal income tax returns, but rather was included in the
federal income tax returns filed by Bio-Vascular. The Company's allocated income
tax provision for the period from January 1, 1997 through May 11, 1997 is based
on the "separate return" method and consist solely of certain state minimum
fees.
42
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Net Loss Per Share
For periods after the Distribution, net loss per share is computed using the
weighted average common shares outstanding during the period. Common share
equivalents are not included in the net loss per share calculations since they
are anti-dilutive. Warrants and options to purchase common stock could
potentially dilute basic earnings per share in future periods, if the Company
generates net income.
For periods prior to the Distribution, the weighted average common shares
outstanding used in the net loss per share calculation is one-half of the
weighted average of Bio-Vascular common shares outstanding based on the
distribution of one share of the Company's common stock for each two shares of
Bio-Vascular's common stock pursuant to the Distribution. Common share
equivalents are not included in the net loss per share calculations, since they
are anti-dilutive.
Stock-Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 123 Accounting for
Stock-Based Compensation, encourages but does not require companies to record
compensation cost for stock-based compensation awards at fair value. The Company
has chosen to continue to account for stock options using the intrinsic value
method prescribed by APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. Accordingly, compensation cost for stock
options granted is measured as the excess, if any, of the value of the Company's
stock as of the date of the grant over option exercise price. Such compensation
cost is amortized on a straight-line basis over the underlying vesting term of
the option. The Company complies with the disclosure provisions of SFAS No. 123.
Recent Accounting Pronouncements
In June 1998, The FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new statement establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133, as amended by SFAS No.
137, is effective for the Company beginning January 1, 2001. The Company does
not expect SFAS No. 133 to materially affect its financial position or results
of operations.
In January 1999, the AICPA issued SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions," which will retain
the limitations of SOP 97-2 on what constitutes vendor-specific objective
evidence of fair value. SOP 98-9 will be effective for the Company for
transactions entered into beginning January 1, 2000. The Company believes that
its current revenue recognition policies and practices are consistent with the
provisions of the new guidance.
43
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(3) Supplemental Financial Statement Information
Cash and Cash Equivalents and Marketable Securities
December 31,
------------------------------
1999 1998
------------ -----------
Cash and cash equivalents:
Cash $ - $ 201,217
Corporate debt securities - 999,167
Money market funds 5,332,885 551,231
------------ -----------
Cash and cash equivalents $ 5,332,885 $ 1,751,615
============ ===========
Marketable securities:
Corporate debt securities $ - $ 1,985,556
----------- -----------
Marketable securities $ - $ 1,985,556
============ ===========
Cost approximates market for all classifications of financial instruments.
Realized gains and losses were not significant for the years ended December 31,
1999, 1998 and 1997.
Property and Equipment
December 31,
----------------------------
1999 1998
----------- -----------
Furniture and fixtures $ 188,958 $ 203,229
Equipment 2,122,651 1,708,556
Computer software 316,274 242,117
Leasehold improvements - 23,048
----------- -----------
Total property and equipment 2,627,883 2,176,950
Less accumulated depreciation and amortization (1,763,404) (1,260,712)
------------ ------------
Property and equipment, net $ 864,479 $ 916,238
=========== ===========
44
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(4) Line of Credit
In March 1999, the Company obtained a credit agreement with a bank for a
short-term line of credit for borrowings up to $950,000. Borrowings under the
line of credit agreement bear interest at one-half percent over the prime rate
as printed in the Wall Street Journal (8.50% as of December 31, 1999).
Borrowings under the agreement are limited to the lower of $950,000 or the
Company's borrowing base, which consists of a specified percentage of certain
accounts receivable. Borrowings under the agreement are collateralized by
substantially all of the Company's assets. The line of credit agreement is
renewable on an annual basis and contains certain restrictive covenants which,
among other things, require the Company to maintain a net worth of at least
$2,000,000 and cash and cash equivalents of at least $1,000,000 at the lending
bank. As of December 31, 1999, the Company has two outstanding letters of
credit, totaling $350,000, collateralized by the line of credit. There were no
actual amounts outstanding under the credit agreement as of December 31, 1999
and the available borrowings were $600,000.
(5) Deferred Revenue
Deferred revenue consists of deferred licensing and maintenance revenue and also
includes amounts received from ATL Ultrasound, Inc. ("ATL") in August 1996 to
enter into an exclusive development agreement with the Company. The agreement
with ATL is a five-year agreement to co-develop the Company's 3D volume
rendering technology for use in ATL's ultrasound imaging systems. The contract
fee revenue of $300,000 received in 1996 from ATL is being amortized on a
straight-line basis over the five-year term of the agreement.
(6) Lease Commitments
The Company leases office facilities under a non-cancelable operating lease in
Minneapolis, Minnesota expiring February 9, 2000. Under the terms of the lease
the Company is also required to contribute to the cost of certain operating
expenses. Total rent expense, including charges for monthly operating costs, was
$417,000, $368,000 and $234,000 for the years ended December 31, 1999, 1998 and
1997, respectively.
In October 1999, the Company entered into a non-cancelable office facilities
lease in Plymouth, Minnesota commencing on February 1, 2000 and expiring on July
31, 2005. Under the terms of the lease the Company is also required to
contribute to the cost of certain operating costs.
Scheduled minimum lease payments for the next five years are approximately as
follows:
Year Ending
December 31,
------------
2000 $ 310,000
2001 330,000
2002 330,000
2003 347,000
2004 349,000
-------------
Total $ 1,666,000
=============
45
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(7) Shareholders' Equity
Change in Authorized Shares
Prior to the Distribution, Bio-Vascular, the Company's sole shareholder,
approved an increase in the number of authorized shares of capital stock from
1,000 shares to 25,000,000 shares and the reservation of 5,000,000 of such
shares as undesignated preferred stock, having such rights, preferences and
designations as determined by the Board of Directors. As a result, the Company's
authorized capital stock as of December 31, 1999 consists of 20,000,000 shares
of common stock and 5,000,000 shares of preferred stock.
Rights Plan
In April 1997, the Company declared a dividend distribution of one Preferred
Stock Purchase Right for each outstanding share of the Company's common stock
(the "Rights"). With certain exceptions, the Rights become exercisable only in
the event that (i) an acquiring party accumulates 15% or more of the Company's
common stock, (ii) a party announces an offer to acquire 15% or more of the
Company's common stock, or (iii) the acquisition of a substantial amount of the
Company's common stock by a person whom the Board of Directors has determined is
an Adverse Person as defined in the underlying Rights Agreement. Each Right
entitles the holder to purchase one-thousandth of a share of the Company's
Series A Junior Preferred Stock at a price of $20.00 (the "Exercise Price"). If
a person or group becomes the beneficial owner of 15% or more of the Company's
common stock or the Board of Directors determines that a person is an Adverse
Person, each holder of a Right shall thereafter have the right to receive
preferred stock having a fair market value equal to two times the Exercise
Price. Upon the occurrence of certain mergers, combinations or acquisitions of
the Company's assets, each holder of a Right shall thereafter have the right to
receive that number of shares of common stock of the acquiring company which
equals the Exercise Price of the Right divided by one-half of the current market
price of such common stock as of the date of the occurrence of the event. The
Company is generally entitled to redeem the Right at $.001 per Right at any time
until ten days following the acquisition of 15% or more of the Company's common
stock or ten days after the point at which the Company's Board of Directors
determines that a person is an Adverse Person, as defined by the Rights
Agreement. The Rights expire on April 30, 2007, if not previously redeemed or
exercised.
Restricted Stock
Under certain compensation agreements, an arrangement which provides for awards
of restricted common stock to key management was adopted by Bio-Vascular in
1992. Pursuant to the agreement governing the Company's spin-off from
Bio-Vascular (the "Distribution Agreement"), Vital Images assumed its
proportionate share of obligations represented by such restricted shares such
that 25,375 restricted shares were issued by the Company on the Distribution
Date in connection with the spin-off from Bio-Vascular. As of December 31, 1999,
1,224 shares of restricted stock, generally vesting over a remaining period of
one to two years, remain unearned by certain key Bio-Vascular employees.
46
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Stock Option Plans
In connection with the Distribution, Bio-Vascular, as the sole shareholder of
the Company, approved and adopted several option plans and stand-alone option
grants, which covered employees of both Vital Images and Bio-Vascular. The
adopted plans include the Incentive Stock Option Adjustment Plan, the 1990
Management Incentive Stock Option Plan, the 1992 Director Stock Option
Adjustment Plan, the 1992 Stock Option Plan, and the 1995 Stock Incentive
Adjustment Plan (collectively, the "Mirror Plans"). Each of these plans is
intended to mirror the provisions of a corresponding Bio-Vascular plan that was
in effect at the time of the Distribution. As each Bio-Vascular option plan
generally provided for the termination of options following termination of
employment, each of the Mirror Plans, as well as each of the stand-alone option
grants (the "Mirror Grants"), were approved and adopted to provide that the
Distribution would not cause a termination of any Vital Images employee for the
purposes of such plans or option grant, and that Bio-Vascular options held by
Vital Images employees following the Distribution would remain exercisable
following the Distribution, so long as such employees remain employed by Vital
Images or any subsidiary. Similar provisions were also adopted with respect to
Vital Images options held by Bio-Vascular employees. On the Distribution Date,
608,534 options were issued in connection with the Mirror Plans and the Mirror
Grants (collectively, the "Mirror Options"). These options have vesting periods
ranging from less than one year up to four years and terms ranging from less
than one year up to ten years. No additional grants may be made pursuant to any
of the Mirror Plans.
In May 1997, Bio-Vascular, as the sole shareholder of the Company, approved and
adopted the Vital Images, Inc. 1997 Stock Option and Incentive Plan (the "Stock
Option Plan"), which became effective on the Distribution Date. Under the terms
of the plan, the Board of Directors may grant options and other stock-based
awards to key employees to purchase shares of the Company's common stock at an
option exercise price equal to or greater than 85% of the fair market value on
the date of grant. The options are exercisable at such times, in installments or
otherwise, as the Board of Directors may determine. Generally, these options are
incentive stock options with a term of eight years and are exercisable to 28% of
the total grant one year after the date of grant and 2% per month thereafter. In
May 1999, the shareholders of the Company approved an increase of 500,000 common
shares, bringing the total number of shares of common stock that may be issued
or awarded under the Stock Option Plan to 1,425,000. As of December 31, 1999,
there are 253,746 shares available for grant under the Stock Option Plan.
Also in May 1997, Bio-Vascular, as the sole shareholder of the Company, approved
and adopted the Vital Images, Inc. 1997 Director Stock Option Plan (the
"Director Plan") (together with the Stock Option Plan, the "1997 Plans"), which
became effective on the Distribution Date. The Director Plan provides
non-employee directors with automatic grants of stock options, and allows the
Board of Directors to make additional discretionary option grants to any or all
directors. Options that are granted under the Director Plan are generally
granted with an option price equal to the fair market value on the date of
grant, with a term of eight years, are non-qualified options and become
exercisable in three equal annual installments beginning on the first occurring
December 31 after the date of grant. In May 1999, the shareholders of the
Company approved an increase of 105,000 common shares, bringing the total number
of shares of common stock that may be issued or awarded under the Director Plan
to 210,000. As of December 31, 1999, there are 115,000 shares available for
grant under the Director Plan.
Certain non-plan options were granted to certain officers of the Company in 1998
and 1999. In February 1998, the Company reserved and granted 300,000
non-qualified, non-plan options to an officer of the Company. These non-plan
options have a term of eight years, vest over a two year period and were granted
at exercise prices at least equal to fair market value of the Company's common
stock on the date of grant. In December 1999, 100,000 of these non-plan options
were cancelled. In December 1999, the Company reserved an additional 75,000 and
granted an additional 175,000 non-qualified, non-plan options to another officer
of the
47
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Company. These non-plan options have a term of eight years and are exercisable
to 28% of the total grant one year after the date of grant and 2% per month
thereafter.
The following table summarizes stock option activity for 1999, 1998 and 1997:
Weighted-Average
Exercise
Shares Under Price Per
Option Share
---------- ----------------
Total outstanding as of December 31, 1996 -- --
Mirror Options granted 608,534 $2.85
Options granted 482,268 2.34
Options exercised -- --
Options canceled (143,784) 2.40
---------- -----
Total outstanding as of December 31, 1997 947,018 2.66
Options granted 731,000 2.06
Options exercised (41,925) 1.38
Options canceled (195,775) 2.30
---------- -----
Total outstanding as of December 31, 1998 1,440,318 2.44
Options granted 693,750 4.22
Options exercised (153,484) 2.34
Options canceled (169,674) 3.60
---------- -----
Total outstanding as of December 31, 1999 1,810,910 $3.02
========== =====
Options exercisable as of:
December 31, 1997 437,583 $2.86
December 31, 1998 654,850 $2.59
December 31, 1999 847,640 $2.41
Various price ranges and weighted average information for options outstanding as
of December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Outstanding Options Exercisable Options
- ------------------- ------------------------------------------------- ------------------------------------
Number Weighted Weighted Number Weighted
Range of Outstanding Average Average Exercisable as Average
Exercise Prices as of Dec 31, Remaining Exercise Price of Dec 31, Exercise Price
1999 Contractual Life 1999
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.96 - 1.83 341,570 5.65 years $1.27 235,840 $1.24
1.88 - 2.31 278,165 5.81 years 2.22 194,125 2.20
2.38 - 3.05 371,866 5.36 years 2.44 280,467 2.44
3.21 - 4.64 460,063 7.31 years 3.89 120,712 4.51
4.72 - 6.27 359,246 7.18 years 4.80 16,496 5.84
----------- --------
1,810,910 847,640
=========== =======
</TABLE>
48
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Employee Stock Purchase Plan
The 1997 Employee Stock Purchase Plan (the "ESPP") was approved and adopted by
Bio-Vascular, as the sole shareholder of the Company, in May 1997. The ESPP,
which became effective on July 1, 1997, enables eligible employees to purchase
the Company's common stock at 85% of the fair market value of the stock on the
date an offering commences or on the date an offering terminates, whichever is
lower. The ESPP covers an aggregate of up to 250,000 shares of common stock that
can be issued and sold to participating employees of the Company through a
series of three-month offerings, beginning July 1, 1997. The ESPP covers
substantially all employees, subject to certain limitations. Each employee may
elect to have up to 10% of his or her base pay withheld and applied toward the
purchase of shares in each such offering. Purchases under the ESPP for 1999 were
23,767 shares generating proceeds to the Company of $66,645 at an average
purchase price of $2.80; for 1998 there were 24,394 shares purchased, generating
proceeds to the Company of $32,712 at an average purchase price of $1.34; and
for 1997 there were 15,776 shares purchased, generating proceeds to the Company
of $20,648 at an average purchase price of $1.31. As of December 31, 1999, there
are 186,063 shares of common stock reserved for purchases under the ESPP.
Stock-Based Compensation
If compensation cost for the Mirror Options, the ESPP, the Stock Option Plan,
the Director Plan and the non-plan options been determined based on the fair
value on the grant dates for awards in 1999, 1998 and 1997 consistent with the
provisions of SFAS No. 123, the Company's net loss and net loss per share for
1999, 1998 and 1997 would have been increased to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
For the Years Ended December 31,
---------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss As reported $(3,217,625) $(3,209,449) $(4,773,820)
Pro forma $(3,745,000) $(3,647,000) $(5,009,000)
Net loss per share - As reported $ (0.64) $ (0.66) $ (1.00)
basic and diluted Pro forma $ (0.74) $ (0.75) $ (1.05)
The weighted average fair values of options granted were:
Options under the 1997 Plans $3.47 $1.28 $1.44
Options under ESPP $0.50 $0.24 $0.26
Non-plan options $2.80 $0.60 $ -
Mirror Options $ - $ - $1.21
</TABLE>
The weighted average fair value for the Mirror Options, the 1997 Plans and the
non-plan options was based on the fair value on the date of grant. The fair
value of options under the ESPP was based on the 15 percent purchase discount.
The fair value for the Mirror Options, the 1997 Plans and the non-plan options
was calculated using the Black-Sholes option pricing model with the following
weighted average assumptions:
For the Years Ended December 31,
----------------------------------------
1999 1998 1997
---------- ---------- ----------
Expected option life 6.0 years 5.2 years 4.4 years
Expected volatility factor 91.7% 88.7% 60.1%
Expected dividend yield 0% 0% 0%
Risk-free interest rate 5.97% 5.53% 6.42%
49
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
The pro forma effects on the net losses for 1999, 1998 and 1997 are not
necessarily representative of the pro forma effect that may occur on the net
income (loss) of future periods.
Warrants
In December 1999, the Company completed a private placement of 1,650,000 units
at $3.25 per unit. Each unit consisted of one share of the Company's common
stock and a redeemable, five-year warrant to purchase an additional share of
common stock at $3.75 per share. The warrants are immediately exercisable and
expire in December 2004. The warrants may be redeemed by the Company at any time
before December 2004 at a redemption price of $.01 per warrant, upon notice of
such redemption, provided that (i) the closing bid price of the Company's common
stock exceeds $5.75 per share for any thirty consecutive trading days prior to
such notice and (ii) a registration statement covering the resale of the warrant
shares has been filed by the Company with the Securities and Exchange Commission
and is effective as of the date of such notice.
The Company also issued warrants to the underwriter in the private placement to
purchase 163,651 shares of the Company's common stock at $3.25 per share. The
warrants are immediately exercisable and expire in December 2004.
None of the warrants have been exercised as of December 31, 1999.
(8) Income Taxes
The income tax provision for each of the periods presented represents state
minimum taxes. As of December 31, 1999, the Company has net operating loss
carryforwards of approximately $14,121,000 for federal income tax reporting
purposes and unused research and development credits of approximately $542,000,
which expire in varying amounts from 2004 to 2019. For financial reporting
purposes, a valuation allowance has been established to completely reserve for
the Company's deferred tax assets related to those carryforwards.
As a result of Bio-Vascular's acquisition of the Company in May 1994, the
Company experienced an ownership change as defined by the Internal Revenue Code
(the "Code"). Under the Code, the amount of pre-acquisition net operating loss
carryforwards and research and development credits that can be used to offset
future taxable income and income taxes will be limited. As of the date of the
Company's acquisition by Bio-Vascular, the Company had approximately $1,600,000
of net operating loss carryforwards and approximately $137,000 of research and
experimentation credits, both of which will be subject to limitation under the
Code.
The significant components of the Company's tax-effected net deferred tax
assets, based on an assumed effective tax rate of 40%, are:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net operating loss carryforwards $ 5,649,000 $ 4,309,000
Research and development tax credit carryforwards 542,000 437,000
Deferred compensation 230,000 230,000
Other, net 226,000 159,000
----------- -----------
Net deferred tax assets before valuation allowance 6,647,000 5,135,000
Less valuation allowance (6,647,000) (5,135,000)
----------- -----------
Net deferred tax assets $ - $ -
=========== ===========
</TABLE>
50
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(9) Major Customers and Geographic Data
<TABLE>
<CAPTION>
Significant Percentage of
Customer Revenue Total Revenue
--------------- ----------- -------------
<S> <C> <C> <C>
Year ended December 31, 1999 Toshiba America $ 1,377,000 21%
Medical Systems
Year ended December 31, 1998 Toshiba America $ 1,020,000 23%
Medical Systems
Paradigm $ 618,000 14%
Geophysical
Corporation
Year ended December 31, 1997 Paradigm $ 313,000 26%
Geophysical
Corporation
</TABLE>
In August 1995, the Company entered into a source code license agreement with
Paradigm Geophysical Corporation ("Paradigm") granting Paradigm a worldwide,
exclusive license for use in oil and gas exploration applications. Under the
agreement, Paradigm became both the exclusive developer and marketer of
VoxelGeo(R). The Company receives royalty payments based upon cash collections
from sales of VoxelGeo software by Paradigm. These royalty payments will cease
on January 1, 2001 or when the aggregate amount of royalties received equals
$2,000,000, whichever occurs earlier. During 1999, the Company received royalty
payments of $462,000. Through December 31, 1999, aggregate royalty payments
received by the Company under this license agreement totaled $1,393,000.
The Company's accounts receivable is generally concentrated with a small base of
customers. As of December 31, 1999, two customers, each accounting for more than
10% of accounts receivable, accounted for 28% of accounts receivable, while as
of December 31, 1998, two customers, each accounting for more than 10% of
accounts receivable, accounted for 22% of accounts receivable.
Export revenue accounted for 8%, 7% and 18% of total revenue for the years ended
December 31, 1999, 1998 and 1997, respectively. Substantially all of the
Company's export sales are negotiated, invoiced and paid in U.S. dollars.
51
<PAGE>
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Export sales by geographic area are summarized as follows:
For the Years Ended December 31,
-------------------------------------------
1999 1998 1997
---------- ---------- ----------
Europe $ 312,000 $ 222,000 $ 146,000
Asia and Pacific Region 133,000 77,000 45,000
Canada, Mexico and others 64,000 8,000 26,000
(10) Employee Benefit Plan
During 1997, the Company adopted the Vital Images, Inc. Salary Savings Plan (the
"Plan"), which is intended to qualify under Section 401(k) of the Internal
Revenue Code, as amended. The Plan covers substantially all employees. Each
employee may elect to contribute to the Plan through payroll deductions of up to
25% of his or her salary, subject to certain limitations. At the discretion of
the Board of Directors, the Company may make matching contributions equal to a
percentage of the salary reduction contributions or other discretionary amounts.
There were no contributions to the Plan by the Company in 1999, 1998 or 1997.
52
<PAGE>
SCHEDULE II
Vital Images, Inc.
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Balance as of Charges to Balance
Beginning Cost and as of End
Description of Period Expenses Deductions of Period
- -------------------------------- ------------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended December 31, 1999 $78,000 $15,000 $ - $93,000
======= ======= ======= =======
Year ended December 31, 1998 $40,000 $52,313 $14,313 $78,000
======= ======= ======= =======
Year ended December 31, 1997 $49,500 $12,452 $21,952 $40,000
======= ======= ======= =======
</TABLE>
53
<PAGE>
VITAL IMAGES, INC.
FORM 10-K
INDEX TO EXHIBITS
Item No. Description
- -------- -----------
3.1 Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.1 to the Company's registration statement
on Form 10 (File No. 0-22229)).
3.2 By-laws of the Company (incorporated by reference to Exhibit 3.2
to the Company's registration statement on Form 10 (File No.
0-22229)).
4.1 Form of common stock Certificate of the Company (incorporated by
reference to Exhibit 4.3 to the Company's registration statement
on Form 10 (File No. 0-22229)).
4.2 Rights Agreement, dated effective as of May 1, 1997 between the
Company and American Stock Transfer and Trust Company, which
includes as Exhibit B the form of Rights Certificate (incorporated
by reference to Exhibit 4.4 to the Company's registration
statement on Form 10 (File No. 0-22229)).
4.3 Certificate of Designation, Preferences and Rights of Series A
Junior Preferred Stock of the Company (incorporated by reference
to Exhibit 4.5 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.1 Form of Distribution Agreement, effective as of May 2, 1997
between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.1 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.2 Form of Employee Benefits Agreement, effective as of May 2, 1997,
between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.2 to the Company's registration statement
on Form 10 (File No. 0-22229)).
54
<PAGE>
10.3 Form of Tax Sharing Agreement, effective as of May 2, 1997,
between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.3 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.4 Form of Transition Services Agreement, effective as of May 2, 1997
between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.4 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.5 Incentive Stock Option Adjustment Plan (incorporated by reference
to Exhibit 10.5 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.6 1990 Stock Option Plan (incorporated by reference to Exhibit 10.6
to the Company's registration statement on Form 10 (File No.
0-22229)).
10.7 1992 Stock Option Plan (incorporated by reference to Exhibit 10.7
to the Company's registration statement on Form 10 (File No.
0-22229)).
10.8 1992 Director Stock Option Adjustment Plan (incorporated by
reference to Exhibit 10.8 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.9 1995 Stock Incentive Adjustment Plan (incorporated by reference to
Exhibit 10.9 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.10 Employee Stock Purchase Plan (incorporated by reference to Exhibit
10.10 to the Company's registration statement on Form 10 (File No.
0-22229)).
10.11 1997 Stock Option and Incentive Plan (incorporated by reference to
Exhibit 10.11 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.12 1997 Director Stock Option Plan (incorporated by reference to
Exhibit 10.12 to the Company's registration statement on Form 10
(File No. 0-22229)).
55
<PAGE>
10.13 License Agreement dated August 25, 1995 between the Company and
Paradigm Geophysical Corporation (formerly CogniSeis Development,
Inc.) (incorporated by reference to Exhibit 10.14 to the Company's
registration statement on Form 10 (File No. 0-22229)).
10.14 Lease agreement dated May 14, 1993, as amended April 15, 1997,
between Vital Images, Inc. and Douglas Green IRA Trust
(incorporated by reference to Exhibit 10.15 to the Company's
registration statement on Form 10 (File No. 0-22229)).
10.15 Lease Agreement dated January 31, 1997 between ACKY - 3100 Lake
Limited Partnership and the Company (incorporated by reference to
Exhibit 10.16 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.16 Form of Change in Control Agreement between the Company and Andrew
M. Weiss, Vincent J. Argiro, Ph.D., David A. Davis, Gregory S.
Furness and Jay D. Miller (incorporated by reference to Exhibit
10.17 to the Company's registration statement on Form 10 (File No.
0-22229)).
10.17 Joint Development Agreement dated August 14, 1996 between the
Company and ATL Ultrasound, Inc.* (incorporated by reference to
Exhibit 10.18 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.18 Sales and Marketing Agreement dated August 14, 1996 between the
Company and ATL Ultrasound, Inc.* (incorporated by reference to
Exhibit 10.19 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.19 Software License Agreement dated August 1, 1997 between the
Company and Duke University (incorporated by reference to Exhibit
10.20 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 0-22229)).
10.20 Severance Agreement dated February 13, 1998 between the Company
and Mr. Weiss (incorporated by reference to Exhibit 10.21 to the
Company's Annual Report on Form 10-K for the year ended December
31, 1997 (File No. 0-22229)).
10.21 Employment Agreement dated February 1, 1998 between the Company
and Douglas M. Pihl (incorporated by reference to Exhibit 10.22 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 0-22229)).
56
<PAGE>
10.22 Non-qualified Stock Option Agreement dated February 24, 1998
between the Company and Douglas M. Pihl (incorporated by reference
to Exhibit 10.23 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 (File No. 0-22229)).
10.23 Loan Agreement dated March 19, 1999 between the Company and
Riverside Bank (incorporated by reference to Exhibit 10.24 to the
Company's Form 10-Q for the quarter ended March 31, 1999 (File No.
0-22229)).
10.24 Promissory Note dated March 19, 1999 between the Company and
Riverside Bank (incorporated by reference to Exhibit 10.25 to the
Company's Form 10-Q for the quarter ended March 31, 1999 (File No.
0-22229)).
10.25 Commercial Security Agreement dated March 19, 1999 between the
Company and Riverside Bank (incorporated by reference to Exhibit
10.26 to the Company's Form 10-Q for the quarter ended March 31,
1999 (File No. 0-22229)).
10.26 Lease agreement dated October 19, 1999 between St. Paul
Properties, Inc. and the Company (incorporated by reference to
Exhibit 10.27 to the Company's Form 10-Q for the quarter ended
September 30, 1999 (File No. 0-22229)).
23.1 Consent of PricewaterhouseCoopers LLP (filed herewith
electronically).
27.1 Financial Data Schedule (filed herewith electronically).
* Portions of such exhibit are subject to a request for confidential
treatment filed with the Commission by the Registrant.
57
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 333-26797, 333-30771, 333-39213, 333-39189,
333-69761, 333-69765, 333-93413 and 333-93407) of Vital Images, Inc. of our
report dated February 11, 2000 relating to the financial statements and
financial statement schedule, which appears in this Form 10-K.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
March 17, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS AND RELATED NOTES FOR THE YEAR ENDED DECEMBER 31, 1999 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 5,332,885
<SECURITIES> 0
<RECEIVABLES> 2,098,114
<ALLOWANCES> 93,000
<INVENTORY> 206,023
<CURRENT-ASSETS> 7,801,308
<PP&E> 2,627,883
<DEPRECIATION> 1,763,404
<TOTAL-ASSETS> 8,665,787
<CURRENT-LIABILITIES> 2,392,011
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0
<COMMON> 66,959
<OTHER-SE> 6,031,457
<TOTAL-LIABILITY-AND-EQUITY> 8,665,787
<SALES> 5,792,164
<TOTAL-REVENUES> 6,623,360
<CGS> 1,345,871
<TOTAL-COSTS> 1,543,576
<OTHER-EXPENSES> 8,382,400
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (3,211,625)
<INCOME-TAX> 6,000
<INCOME-CONTINUING> (3,217,625)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,217,625)
<EPS-BASIC> (0.64)
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