-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R16vvGcIyM9R9UAqgt19fxEMdUh3QUNZi6o6WKCILETHDcfzCBbflCzLy0QwGixg VmIrxrQ8R+6CRjxKLUf+FA== 0000892569-99-000828.txt : 19990402 0000892569-99-000828.hdr.sgml : 19990402 ACCESSION NUMBER: 0000892569-99-000828 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VITALCOM INC CENTRAL INDEX KEY: 0001006026 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-FACILITIES SUPPORT MANAGEMENT SERVICES [8744] IRS NUMBER: 330538926 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27588 FILM NUMBER: 99579724 BUSINESS ADDRESS: STREET 1: 15222 DEL AMO AVE CITY: TUSCAN STATE: CA ZIP: 92680 BUSINESS PHONE: 7145460147 MAIL ADDRESS: STREET 1: 15222 DEL AMO AVENUE CITY: TUSTIN STATE: CA ZIP: 92680 10-K 1 FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1998 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ COMMISSION FILE NUMBER 0-27588 VITALCOM INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 3662 33-0538926 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
15222 DEL AMO AVENUE TUSTIN, CALIFORNIA 92780 (714) 546-0147 (ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, PAR VALUE $0.0001 PER SHARE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] 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 this Form 10-K. [ ] The aggregate market value of the stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on March 19, 1999 as reported on the Nasdaq National Market, was approximately $3,269,514. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. APPLICABLE ONLY TO CORPORATE ISSUERS: As of March 19, 1999, there were 8,165,222 shares outstanding of the issuer's common stock. DOCUMENTS INCORPORATED BY REFERENCE Certain information required by Part III of this Form 10-K is incorporated by reference to portions of the registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. ================================================================================ 2 PART I ITEM 1. BUSINESS BUSINESS GENERAL VitalCom (the "Company") provides Enterprise-wide patient monitoring networks and related communications products that acquire, interpret and distribute real time patient monitoring information from the Company's own proprietary ECG monitors and other manufacturers' bedside equipment. The Company's Enterprise-wide monitoring(TM) system uses proprietary radio frequency ("RF") communications components, clinical analysis software and display and networking software to provide personal computer-based central station surveillance of physiologic data from patients located throughout a healthcare enterprise. The Enterprise-wide monitoring systems are sold to large acute care hospitals and integrated health delivery networks ("IHDNs") through the Company's direct sales force. The large networked systems use local area network ("LAN") as well as wide area network ("WAN") technology to integrate real-time information from the Company's own ECG monitors as well as a variety of other manufacturers' bedside equipment. Clinicians access the information to monitor patient status in three ways: 1) through remote viewing stations -- networked personal computers located at nursing stations throughout the healthcare enterprise; 2) Remote dial-up access -- via phone dial in and modem connection to the VitalCom network; and 3) A centralized monitoring hub -- a mission control-style room manned 24-hours a day by monitoring technicians that are each trained to watch up to 48 to 56 patients. The Company's Original Equipment Manufacturer ("OEM") customers purchase and sell central monitoring systems as well as individual components for use in their monitoring products, which are generally used in small departments that require customized systems. OEM products offered by the Company acquire data from the Company's ambulatory ECG monitor and from the OEM customer's bedside monitoring devices or life support equipment. The central monitoring system and display software for each OEM customer is developed specifically to meet the specifications of a particular departmental or specialty. The Company's Enterprise-wide monitoring system collects patient monitoring or life support data from the Company's proprietary ECG monitors and other manufacturers' bedside devices, sending the data over a RF network to a central surveillance hub. Technicians manning the central surveillance hub evaluate information acquired from ambulatory and point-of-care monitors and, in the case of a patient emergency or other significant event, respond by initiating immediate contact with the appropriate caregiver through standard pager technology. Because the networks continuously distribute real-time patient information to remote displays located throughout the healthcare enterprise, the caregivers can gain immediate access to critical patient status information. The Company believes that its Enterprise-wide monitoring system enables hospitals to shorten patient stays in costly intensive care units, increase medical staff productivity, reduce costly patient transfers and improve facility utilization. Since their introduction in 1991, the Company's Enterprise-wide monitoring systems have been installed in more than 100 acute care facilities, with the largest network providing central surveillance of up to 300 patients located in multiple buildings. INDUSTRY BACKGROUND Market-driven and governmental reform initiatives have produced significant pressures on healthcare providers to control costs, resulting in managed care and provider capitation arrangements that shift the economic risk of healthcare delivery from payors to providers. In order to manage this risk, healthcare providers are changing the way in which they operate and are increasingly focusing on controlling the cost of delivering care. These cost control pressures are forcing hospitals to find ways to deliver care with fewer resources and are encouraging provider consolidation and the emergence of IHDNs. Additionally, as an increasing number of patients receive care in lower-cost, outpatient settings the overall acuity level of the remaining hospital patients increases. Consequently, acute care hospitals and IHDNs are faced with delivering quality care to 1 3 more acutely ill patients using fewer resources. In response, hospitals have increasingly turned to technological innovation for assistance. Historically, specific technological solutions have included patient bedside monitors and life support equipment to assist in caring for acutely ill patients. In high-acuity departments such as intensive care units ("ICUs"), coronary care units ("CCUs") or "step-down" units, this equipment is typically hard-wired to a central monitoring station. This departmental approach can be very costly to establish and maintain, and dedicating equipment to individual departments necessitates that patients be transferred in and out of monitored beds, creating additional transfer costs and disrupting the continuity of patient care. Outside of these specialty departments, remote bedside equipment is used to monitor and support patients. In this setting, a patient's physiologic information is only available at the patient bedside, rather than where that information can be readily available to caregivers. Additionally, caregivers in these areas are subject to high patient/caregiver ratios, have limited time to observe patient monitors and are often required to respond to false alarms that result in the unproductive and costly use of the medical staff's time. The Company believes that these existing patient monitoring solutions do not sufficiently address the needs of hospitals to manage their increasing patient acuity in a cost-effective manner. THE VITALCOM SOLUTION The Company's Enterprise-wide monitoring systems enable large acute care hospitals and IHDNs to respond to cost control pressures in the healthcare industry by reengineering labor-intensive care delivery processes to reduce costs. Principal benefits of the Company's solution include: - reducing patient stays in costly ICU and CCU departments through central surveillance of patients in less labor-intensive settings. - increasing productivity of medical staff through the use of technicians located in a centralized monitoring hub. Technicians are trained to monitor up to 48 to 56 patients each and notify caregivers when patients experience a medically significant event, through standard paging technology. - distributing patient physiologic information to remote viewing stations throughout the facility for convenient and immediate access by caregivers. - reducing costly patient transfers and improving overall facility utilization by allowing flexible bed configurations using wireless technology. - improving asset utilization with the Company's OpenNet(TM) application interfacing to third-party products through programmable interfaces. The Company's OpenNet application includes interfaces with monitoring devices from Protocol Systems, Inc., ("Protocol") Datascope Corporation ("Datascope") and Critikon Inc. ("Critikon") and life support equipment from the Nellcor Puritan Bennett division of Mallincrodt Inc. ("Mallincrodt"). - facilitating the implementation of telemedicine with the Company's SiteLink(TM) application which allows a tertiary hospital to link its Enterprise-wide monitoring system to remote facilities located even hundreds of miles away. PRODUCTS Enterprise-wide Monitoring Solutions The Company's Enterprise-wide monitoring system provides the basic architecture for current and future product offerings. In 1991, the Company introduced its computer network for ECG data providing acquisition, interpretation and distribution of patient ECG information. The OpenNet application introduced in the first half of 1996 expanded the Company's network capability to multi-parameter applications by using other manufacturers' patient monitoring and life support equipment. In November 1997, the Company introduced its SiteLink application, which allows a tertiary hospital to link its Enterprise-wide monitoring system to one at a remote facility via a dedicated T-1 special service phone line or ATM network. 2 4 The Company's Enterprise-wide monitoring system utilizes the following key components: RF technology; personal computer-based central station and proprietary display software; proprietary clinical analysis software and a proprietary network including real-time remote display and paging. The Company's RF technology collects patient physiologic data from the Company's proprietary ECG ambulatory transmitters and other manufacturers' multi-parameter bedside monitoring equipment and other manufacturers' life support equipment and transmits that data in real-time to the central surveillance hub for interpretation and distribution. A central surveillance station consists of multiple, networked personal computers and color touch-screens. The central surveillance station is capable of simultaneously displaying up to several hundred patients' physiologic data. One trained technician is capable of monitoring up to six or seven personal computers, each of which receives, interprets and displays real-time physiologic patient data, alarm settings and equipment status for up to eight patients using the Company's proprietary software. In the event that the Company's proprietary software detects a medically significant event; it responds with an audio or visual alarm and prompts the technician to issue a pager call to the responsible caregiver. The Company's proprietary software also stores up to 24 hours of real-time physiologic patient information for subsequent review. The Company's Enterprise-wide monitoring system provides for the simultaneous distribution of real-time physiologic patient information to multiple remote color touch-screen displays (remote viewing stations) located throughout the enterprise by employing proprietary real-time distribution software and industry-standard Ethernet protocols. Remote viewing stations are located throughout the enterprise, allowing caregivers to view patient physiologic data, alarm settings and equipment status for any patient connected to the network. ECG Applications. The Company's Enterprise-wide monitoring system interprets and distributes patient information acquired from an ambulatory digital telemetry transmitter, approximately the size of a television remote control that collects the information through sensors attached to the patient's chest. The Company's proprietary analysis software displays patient ECG information, including heartrate and waveform, alarm settings and equipment status for interpretation by a trained technician. In addition, the Company's proprietary clinical analysis software includes algorithms to analyze patient cardiac arrhythmias, such as asystole and ventricular fibrillation. The most recent version of the Company's analysis software received FDA clearance in January 1995. Multi-Parameter OpenNet Applications. The Company's OpenNet application uses programmable interfaces and wireless technology to acquire, interpret and distribute multi-parameter physiologic patient information, such as blood/oxygen saturation, respiration, temperature, end-tidal CO2 and blood pressure from patient monitoring and life support equipment of other vendors. The software and wireless component of the OpenNet technology have been available since March 1996. The Company's OpenNet application includes interfaces with bedside monitoring devices from Protocol, Datascope and Critikon. In November 1997 the Company received its 510(k) clearance for additional OpenNet connections to other bedside monitors and to ventilators. The ventilator feature allows clinicians to receive, display, interpret, distribute and archive respiratory data of ventilated patients, with the first interface to Mallincrodt's Series 7200 Ventilator. SiteLink(TM) Application. The Company's SiteLink application allows a tertiary hospital to link its Enterprise-wide monitoring system to the Enterprise-wide monitoring system at a remote facility, even hundreds of miles away, in real time, via a dedicated T-1 special service phone line or ATM network. Monitoring technicians at the tertiary facility provide 24-hour surveillance for the remote site in addition to the surveillance at the remote site. The tertiary facility can page caregivers if a patient at the remote facility is in distress and then can also provide clinical consultations (telemedicine) to caregivers at the remote site. The Company received FDA clearance in November 1997 for its SiteLink application, which currently is installed and running in five different locations. VitalAccess(TM) Application. During 1997 the Company introduced an application which permits multiple caregivers simultaneous access to individual patients' static patient monitoring information on the Company's Enterprise-wide monitoring system from any remote Windows 95(TM) or NT workstation. Access is routed through the Company's V-Gate server, which is sold as a separate component to an Enterprise-wide monitoring system. 3 5 V-Gate Interconnectivity Application. In 1998 the Company placed into Market Acceptance Testing (MAT) its first connection to the clinical patient record database of a healthcare information system. A healthcare information system is comprised of centralized and departmental systems for financial, practice, resource, enterprise and clinical management that includes a repository for patient history. The Company's Enterprise-wide monitoring system obtains admit and discharge information, such as name and patient identification number, from the healthcare information system and also transfers clinical patient information in numeric form from its own ECG transmitters and other manufacturers' monitoring and ventilator equipment to the healthcare information system. OEM Products The Company's OEM products are sold on a private-label basis to equipment manufacturers and integrators, all of which manufacture patient monitoring or medical devices and have multi-year working relationships with the Company. The Company's OEM products are typically used in the emergency room; post-surgical, cardiac rehabilitation and other discrete care units within a hospital. These departmental products are custom programmed to provide specialized analysis or display formats required by a particular department specialty and to allow equipment manufacturers and integrators to deliver a product that satisfies the patient monitoring and reporting requirements of their customers. The OEM products use many of the same components that are used in the Company's Enterprise-wide monitoring systems, allowing for economies of scale in development, manufacturing and inventory management. When the Company's OEM customers offer networks, they are typically smaller in size than the Enterprise-wide monitoring system networks sold by the Company's direct sales force. The OEM products include central workstations, proprietary analysis software, RF products and network solutions, but currently they do not include the ability to accept multiparameter information from other vendors' systems. During 1998, the Company expanded its product offering to one OEM customer to include the hardware and software capable of real-time distribution on a enterprise-wide basis. This OEM can sell the redistribution capability in the small (under 200 beds) hospital market. In addition, the Company believes that its work with OEM customers helps it better understand the clinical procedures and technical protocols used to create the OpenNet connections with its OEM customers and other vendors. CUSTOMERS The Company sells its Enterprise-wide monitoring systems to large acute care hospitals and IHDNs throughout the United States through its direct sales force. The Company estimates that its potential customer base includes more than 5,200 acute care hospitals in the United States. As of December 31, 1998, the Company had direct sale installations of its Enterprise-wide monitoring systems in more than 100 such hospitals and IHDNs. In addition, the Company sells its OEM products to leading patient monitoring device companies. In 1997, Quinton and Datascope accounted for approximately 12.2% and 25.0%, respectively, of the Company's total revenues and in 1998 Quinton and Datascope accounted for approximately 19.7 % and 22.6%, respectively, of the Company's total revenues. The loss of or a significant reduction in sales to any such customer would have a material adverse effect on the Company's business, operating results and financial condition. SALES AND MARKETING The Company sells its Enterprise-wide monitoring systems to large acute care hospitals and IHDNs through its direct sales force. The Company's sales force is organized by region and targets key hospitals and IHDNs within each region. The sales cycle for Enterprise-wide monitoring systems has typically been nine to 18 months from initial contact to receipt of a purchase order and generally involves multiple sales calls on hospital purchasing, information technology, administrative and clinical personnel, product demonstrations at select reference sites and on-site evaluations. The Company markets its Enterprise-wide monitoring systems through direct sales calls, product demonstrations at select reference sites, on-site product evaluations, participation in trade shows and advertising in trade publications. 4 6 Due to the long sales cycle and the fixed costs related to direct sales expenses, a failure of such direct sales efforts to create an offsetting increase in revenues and earnings would have a material adverse effect on the Company's business, operating results and financial condition. In addition, during the Company's long sales cycle for Enterprise-wide monitoring systems, it may expend substantial time, effort and funds preparing a contract proposal or negotiating a purchase order without any guarantee that it will complete the transaction. Significant or ongoing failure to reach definitive agreements with direct sales customers, which the Company has experienced in the past, would have a material adverse effect on the Company's business, operating results and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- General". The Company sells its OEM products to leading patient monitoring device companies, many of whom have had long-term working relationships with the Company. The Company's OEM sales team has significant experience in the healthcare industry. The Company markets its OEM products to its customers through expansion of existing product offerings, sales calls and participation in trade shows. CUSTOMER SUPPORT The Company provides a wide range of support services to purchasers of its Enterprise-wide monitoring system. The Company's support program includes pre-installation assistance in network design and planning; a training and maintenance program for clinical and other hospital staff prior to installation and follow-up on-site training after installation; 24-hour telephone technical support and a consignment program during the product warranty period for systems of 24 channels or more providing for the consignment of one central station, including one spare transmitter per eight beds, at no charge. The Company provides a one-year warranty on the equipment and software components of its Enterprise-wide monitoring system. The Company will repair or replace at no charge any device or software which it finds to be defective during the warranty period. The Company offers post warranty support programs for an annual fee including extended hardware warranty, software maintenance and hardware and software maintenance and upgrade programs. TECHNOLOGY The Company believes that it has developed expertise in the following core technologies: R.F. communication products, real-time application software, clinical software algorithms and networking software. The Company benefits from the expertise of its research and development staff and its investment in these core technologies. These core technologies allow the Company's networks to acquire, interpret and distribute physiologic patient information throughout the facility in real-time. The term "real-time" refers to the ability to deliver data with minimal latency on a deterministic basis. "Latency" refers to the interval of time between the actual event and the arrival of the data. "Deterministic" refers to the ability to accurately predict the period of latency. Patient physiologic information is typically shown on remote displays less than one-half second after the actual event. Radio Frequency Communication Products. The Company's proprietary radio frequency communication products transmit real-time physiologic information from the patient to the central surveillance station. These communication products operate in three radio bands: VHF (174 MHz to 216 MHz, shared with TV channels 7 - 13); UHF (450 MHz to 470 MHz shared with land mobile users) and the 900 MHz radio band (902 MHz to 928 MHz licensed for spread spectrum operations). The Company has developed over-sampling, interleaving and digital packet algorithms providing a deterministic method for reliable radio frequency transmissions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors". Real-time Application Software. The Company has a substantial investment in real-time application software. This includes modules for displaying physiologic patient information such as real-time patient wave forms, the continuous storage of patient information, trending of physiologic parameters, event storage and reporting, a pager interface and alarm handling. Clinical Software Algorithms. The Company has invested substantial efforts in developing clinical analysis software to evaluate ECG information received from the Company's transmitter and other patient 5 7 monitors to report clinically significant events. The heart beat detector uses three types of sophisticated analysis techniques to differentiate the patient's heart beat from various sources of noise. These include linear digital filtering, nonlinear transforms and decision rule algorithms. These algorithms detect and classify each heart beat for every patient on the system and detect cardiac arrhythmia events such as asystole or ventricular fibrillation. The Company's clinical software has received all required FDA approvals. Real-time Networking Software. The Company has invested in developing proprietary network algorithms that enable simultaneous viewing of real-time physiologic patient information on multiple remote viewing stations. These algorithms provide a deterministic method of handling network data collisions as well as providing the minimal latency required for real-time physiologic patient information. The Company's implementation allows for the use of industry standard network interface controllers, hubs and routers. PRODUCT DEVELOPMENT The Company's research and development strategy is to focus on expanding the capabilities of existing products and developing new products. The Company introduced its first OpenNet applications in 1996, permitting information from other manufacturers' multi-parameter patient monitoring to be displayed and distributed on the Company's Enterprise-wide monitoring system. Interfaces with bedside monitoring devices from Protocol, Datascope and Critikon, were introduced in 1996. The Company intends to continue to expand its OpenNet applications with interfaces to additional patient monitoring devices, many of which require no additional FDA clearance. In November 1997 the Company received its 510(k) clearance for additional OpenNet connectors to bedside monitors not covered in a previous 510(k) clearance and connections to ventilators. The ventilator connection allows clinicians to receive, display, interpret, distribute and archive respiratory data of ventilated patient. The first ventilator interface is to Mallincrodt's Series 7200 Ventilator. The Company received FDA clearance in November 1997 for a product application, SiteLink(TM), which enables the Company's Enterprise-wide monitoring systems at a tertiary hospital to be linked to remote facilities, even hundreds of miles away, in real-time, via a dedicated T-1 phone line. Monitoring technicians at the tertiary hospital provide 24-hour surveillance to the remote site, paging caregivers if a patient at the remote facility is in distress. The Company's VitalAccess application permits caregiver access to static patient monitoring information on the Company's Enterprise-wide monitoring system from any remote Windows 95(TM) or NT workstation. During 1998, the Company placed into MAT its first connection between the Company's Enterprise-wide network and a hospital's clinical patient record software. The Company intends to make additional connections between its Enterprise-wide monitoring network and other HCIS products and computerized patient records. The Company continues to evaluate emerging technologies in the communications industry for possible use in its products. In addition, the Company continually evaluates trends in the healthcare industry and, based on its perceptions of market requirements, may outsource development of selected products or technologies or may accelerate development of certain products while deferring or canceling development of others. The completion of the development of new or enhanced products will involve significant expenditures without knowing whether such products will achieve the intended benefits of cost reductions and productivity gains or whether such products will receive market acceptance. For the years ended December 31, 1998, 1997 and 1996, total research and development expenditures were approximately $4.7 million, $4.8 million and $5.4 million, respectively, and represented 22.5%, 22.1% and 29.6% of revenues, respectively. The Company expects to continue to allocate significant resources to these efforts. There can be no assurance, however, that such research and development efforts will be successful. Any failure of the Company's OpenNet technology or other products under development, including other HCIS connectivity products, to achieve their intended benefits or market acceptance would have a material adverse effect on the Company's business, operating results and financial condition. BACKLOG The Company's backlog as of December 31, 1998, 1997 and 1996 was $1.1 million, $2.9 million and $2.0 million, respectively. Backlog consists of purchase orders for products deliverable within twelve months 6 8 and primarily represents orders from OEM customers. Purchase orders from the Company's OEM customers are generally cancelable at any time without penalty. The Company's backlog is not large enough to assure that its revenue targets for a particular quarter will be met. Therefore, the Company does not consider backlog to be a significant indication of future performance, and sales in any quarter are dependent on orders booked and shipped during that quarter and are not predictable with any degree of certainty. MANUFACTURING The Company's manufacturing operations consist primarily of final assembly and test and quality control of materials, components, subassemblies and systems. The Company relies on subcontractors for printed circuit board and component assembly. The Company obtained and maintains ISO 9001/EN 29001 certification and is required to operate under the Quality System Regulation (previously called the Good Manufacturing Practices) of the Food and Drug Administration ("FDA"). Some of the Company's products utilize components available in the short term from only a single or limited number of sources. Certain of these components, such as some devices manufactured by Burr-Brown Corporation, Motorola Semiconductor Products, Inc. and Maxim Integrated Products, Inc., have been available only on an allocation basis in the past and could be in scarce supply again in the future. In addition, from time to time, certain components, subassemblies and systems used by the Company are discontinued by manufacturers, requiring the Company to replace the component, subassembly or system with an equivalent product or if no such equivalent can be identified to modify and re-validate the product design. While such allocation restrictions and discontinuances have not had a significant adverse effect on the Company to date, any inability to obtain such components on a timely basis or at commercially reasonable prices or to redesign the product in a timely manner could have a material adverse effect on the Company's business, operating results and financial condition until alternative sources could be developed or design and manufacturing changes could be completed. The Company does not have long-term supply agreements with its component suppliers or subcontractors. The Company's manufacturing facility is located at its headquarters in Tustin, California. INTELLECTUAL PROPERTY The Company relies on a combination of copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect its proprietary rights. The Company seeks to protect its software, circuitry documentation and other written materials under trade secret and copyright laws, which afford only limited protection. The Company has one patent on certain aspects of the transmitter technology used in its products. Accucore, AccuLink, AccuNet, OpenNet, SiteLink, Vital Access, Enterprise-wide monitoring, Networked Monitoring and VitalCom are trademarks of the Company. The Company cannot assure that any of its proprietary products or technologies can be patented, that any issued patent will provide the Company with any competitive advantages or will not be challenged by third parties, or that the patents of others will not have an adverse effect on the Company's ability to do business. Certain of the Company's OEM products include 900 MHz transmission technology licensed pursuant to a fully paid, five-year agreement expiring January 1, 2001 with a third-party. Despite the Company's efforts to protect its proprietary rights, unauthorized parties might attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Restricting unauthorized use of the Company's products is difficult, and although the Company is unable to determine the extent to which unauthorized copying of its software products exists, such copying could be a potential problem. The Company believes, however, that it leads its competitors in certain technological developments, and that this lead affords it protection due in part to regulatory requirements related to technological advances. Nevertheless, the Company cannot assure that its protective measures for proprietary rights will be adequate or that the Company's competitors will not independently develop similar or superior technology, duplicate the Company's products or otherwise circumvent its intellectual property rights. COMPETITION The Company's Enterprise-wide monitoring systems compete with systems offered by a number of competitors, including Hewlett-Packard Company, SpaceLabs, Inc. and General Electric Company, substan- 7 9 tially all of which have significantly greater financial, technical, research and development and marketing resources than the Company. In addition, many of these competitors have long-standing relationships with acute care hospitals and IHDNs. Furthermore, consolidation in the healthcare industry and the emergence of IHDNs has resulted in larger healthcare providers that consolidate their purchasing with a small number of preferred vendors with whom they have had long-standing relationships. There can be no assurance that the Company will be able to sell to such hospitals or IHDNs or that the Company will be able to compete successfully with such vendors, and any inability to do so would have a material adverse effect on the Company's business, operating results and financial condition. The Company's OpenNet connections will face significant competition in the future from HCIS providers, patient monitoring companies, life support device companies and general purpose data network providers. Such potential competitors may elect to enter this market and compete with the Company using significantly greater financial, technical, research and development and marketing resources than are available to the Company. In addition, the Company's success in selling its multi-parameter OpenNet connections to hospitals and IHDNs will depend to a large extent on its ability to interface with patient monitoring and life support devices of other vendors. Any action on the part of such other vendors to make such interfacing more difficult or impossible could have a material adverse effect on the Company's business, operating results and financial condition. The market for the Company's OEM products is also intensely competitive. The Company's OEM customers are patient monitoring and life support device companies, many of which have significantly greater financial, technical, research and development and marketing resources than the Company. There can be no assurance that current OEM customers will not elect to design and manufacture patient monitoring and system components currently supplied by the Company or elect to contract with other OEM suppliers. Any such election by one or more of such companies would have a material adverse effect on the Company's business, operating results and financial condition. In addition, the Company may in the future elect to incorporate in its OEM products the hardware and software for larger networks and expand the number of OEM customers with the hardware and software required for real-time redistribution of information to Remote Viewing Stations for use in specialty departments of hospitals for which the Company's OEM customers design and sell their products. Although the Company believes that its OEM customers would not compete with its Enterprise-wide monitoring systems because the Enterprise-wide monitoring systems are sold to hospitals and IHDNs who elect to install larger, more dispersed systems, the Company could face competition with its OEM customers to the extent hospitals forego purchasing the Company's facility-wide Enterprise-wide monitoring systems for the smaller departmental systems of its OEM customers. The Company believes that the principal competitive factors in its markets are system features, product reliability, customer service and support, FDA regulatory compliance expertise, existing relationships with hospitals and IHDNs, company reputation, price and effectiveness of sales and marketing efforts. In addition, the Company believes that the ability to identify the evolving needs of the healthcare industry and the ability to develop innovative products to meet such needs, are important competitive factors. The Company believes that it competes favorably with respect to these factors but there can be no assurance that the Company will continue to compete favorably. GOVERNMENT REGULATION Certain of the Company's products are regulated in the United States as medical devices by the FDA under the Federal Food, Drug, and Cosmetic Act ("FDC Act") and implementing regulations and require premarket clearance or approval by the FDA prior to commercialization. In addition, certain material changes or modifications to the intended use, labeling or manufacturing of cleared or approved medical devices are also subject to FDA clearance or approval. Pursuant to the FDC Act, the FDA regulates the development, testing, safety, labeling, storage, record keeping, advertising, production and distribution of medical devices in the United States. Noncompliance with applicable requirements can result in civil or criminal penalties, recall or seizure of products, or total or partial suspension of production. 8 10 Generally, before a new medical device can be introduced into the market in the United States, the manufacturer or distributor must obtain FDA clearance by filing a 510(k) premarket notification or obtaining approval of a premarket approval ("PMA") application. If a medical device manufacturer or distributor can establish that a device is "substantially equivalent" to a legally marketed device for which the FDA has not called for PMA's, the manufacturer or distributor may seek clearance from the FDA to market the device by filing a 510(k) premarket notification. The 510(k) premarket notification may need to be supported by appropriate data establishing the claim of substantial equivalence to the satisfaction of the FDA. If a manufacturer or distributor of a medical device cannot establish substantial equivalence, the proposed device must be approved through a PMA application, which must be supported by statistical analysis of clinical data. The PMA application approval process can be expensive, uncertain and lengthy. To date the Company has received clearance on all of its products under the 510(k) process and has not been required to file a PMA application. The FDA has published a proposed rule that would require over forty devices, including those using arrhythmia software produced by the Company and its competitors, following a notice period, to receive PMA approvals or be discontinued for sale. A petition has been filed by some industry participants, including the Company, in response to the notice, to formally request that the FDA reclassify arrhythmia software devices from Class III devices to Class II devices. This petition is currently under FDA review. If the FDA reclassifies arrhythmia software devices to Class II, the Company's products will not require any additional clearances if a PMA application is not filed and approved within a specified time frame. However, if the FDA does not reclassify the arrhythmia software devices and publishes its final rule, such software devices would be subject to the lengthy and expensive PMA process, which could interrupt or terminate the sales of the Company's or its competitors' arrhythmia software devices. Any such interruption or termination could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is required to adhere to applicable FDA regulations including the new Quality System Regulation (previously called the Good Manufacturing Practices), which include testing, control, and documentation requirements and the Medical Device Reporting Regulation. Failure to receive or delays in receipt of FDA clearance or approvals, including the need for extensive clinical trials or additional data as a prerequisite to clearance or approval, would have a material adverse effect on the Company's business, operating results and financial condition. Changes in existing regulations or adoption of new governmental regulations or policies could prevent or delay required regulatory approvals of the Company's products. The Company's RF transmitter devices are subject to regulation by the Federal Communication Commission ("FCC"), and applicable approvals must be obtained before shipment of such products. The Company believes that all of its products designated for sale in the United States meet applicable Federal Communications Commission (FCC) regulations, including US FCC Part 15 for electromagnetic emissions. The FCC approval process starts with the collection of test data that demonstrates that a product meets the requirements stated in Part 15 of the FCC regulations. This data is then included as part of a report and application that is submitted to the FCC requesting approval. The FCC may grant or request additional information or withhold approval. Any failure of the Company's products to conform to governmental regulations or any delay or failure to obtain required FCC approvals in the future, if any, could cause the delay or loss of sales of the Company's products and therefore have a material adverse effect on the Company's business, financial condition and result of operations. The Company's proprietary communication products transmit real-time physiologic information from the patient to the central surveillance station. These communication products currently operate in three radio bands: VHF (174 MHz to 216 MHz, shared with TV channels 7 - 13); UHF (450 MHz to 470 MHz, shared with land mobile users); and the 900 MHz radio band (902 MHz to 928 MHz licensed for Spread Spectrum operation). The majority of the Company's RF products use the vacant television frequencies in the VHF band. The FCC is requiring all television stations to implement digital broadcasting transmission for High Definition Television (HDTV). Major metropolitan areas were required to implement HDTV by December 31, 1998 and other markets will be required to implement by December 31, 2006. In order to implement HDTV the FCC has granted each TV channel an additional 6 MHz channel for digital broadcasting until the transition period ends, at which time the broadcaster would return one of the two channels. As TV stations use the additional 6 MHz channel for the digital broadcasting transition, which may take years, they may overlap 9 11 into the radio spectrum which has been used for medical RF applications. Customers of the Company's lower power RF communication products may begin seeing more interference in the future. This interference may result in the Company's hospital biomedical personnel having to re-tune the Company's RF transmitters to other channels in order to reduce interference. In the event of high interference the Company's customers may need to purchase equipment to transmit in the UHF frequency range. In 1998 the FCC expanded the usable UHF frequencies for medical RF from the licensed 450 MHz to 470 MHz band to the previously unlicensed 470 MHz to 668 MHz frequency range. With VHF frequency ranges available for medical RF use potentially becoming more limited and the UHF frequency ranges expanding, the Company's competitors who have historically focused their RF products in what was the more limited UHF band, may now have a competitive advantage as compared to the Company, until such time as the Company expands its UHF RF product offerings. Any such competitive advantage of the Company's competitors and any additional development costs associated with expanding the Company's UHF RF product offerings could have a material adverse effect on the Company's business, operating results and financial condition. Additionally, future regulatory changes could significantly affect the Company's operations by diverting the Company's development efforts, making current products obsolete or increasing the opportunity for additional competition which could have a material adverse effect on the Company's business, operating results and financial condition. During 1998 the Company joined a task force created by the American Hospital Association (AHA) and the FDA called the Medical Telemetry Task Force (the "Task Force") along with other medical RF users, organizations, and vendors, including its competitors. The purpose of the Task Force is to respond to potential interference problems from HDTV, land mobile users and low power television to wireless patient monitoring devices. The Task Force's mission is to identify protected spectrum candidates for future medical telemetry use, evaluate use and make recommendations to the FCC. As such the Task Force will petition the FCC to license the UHF 608 MHz to 614 MHz band, currently reserved for radio astronomy, for medical use. It is anticipated that the Task Force will submit its petition during the first half of 1999, with proposed rule making and public commentary to follow. The Task Force will ask the FCC to expedite licensing for medical RF applications in the 608 MHz to 614 MHz band. In the event the FCC approves this license, which the Company believes is probable, the Company may be at a disadvantage in the marketplace if one or some of its competitors develop and introduce RF products in this new band before the Company introduces products in the new band, resulting in lost or delayed revenues. In addition, the costs of developing RF transmitter and receiver products in this new band could be expensive or divert research and development resources from other projects resulting in higher costs and delayed projects. Any such competitive advantage of the Company's competitors and any additional development costs associated with expanding the Company's UHF RF product offerings could have a material adverse effect on the Company's business, operating results and financial condition. Additionally, future regulatory changes could significantly affect the Company's operations by diverting the Company's development efforts, making current products obsolete or increasing the opportunity for additional competition which could have a material adverse effect on the Company's business, operating results and financial condition. If the Company were to attempt to market its products and components in Europe and certain other foreign jurisdictions, the Company and its distributors and agents would have to obtain required regulatory approvals and clearances and otherwise comply with extensive regulations regarding safety and manufacturing processes and quality. These regulations, including the requirements for approvals or clearance to market and the time required for regulatory review vary from country to country. EMPLOYEES As of December 31, 1998, the Company had approximately 139 full-time employees, of which 35 were in customer service, marketing and sales, 34 were in research and development, 56 were in manufacturing, quality assurance and regulatory affairs and 14 were in administration. None of the Company's employees is covered by a collective bargaining agreement, the Company has experienced no work stoppages and VitalCom believes that its relationship with its employees is good. 10 12 ITEM 2. PROPERTIES PROPERTIES The Company occupies approximately 37,000 square feet of space at its headquarters in Tustin, California under a lease expiring in October 2001, with an option to extend through October 2006. The Company believes that this facility will be adequate to satisfy its anticipated business requirements. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market and Market Price for Common Stock. VitalCom Inc. common stock, $0.0001 par value per share, is traded over the counter under the symbol VCOM and is an authorized security for quotation on the Nasdaq National Market ("Nasdaq"). The market prices of a share of VitalCom Inc. common stock are set forth below. The prices reflect the high and low trading prices for each quarter and the year ended December 31, 1998, since the Company's initial public offering in February 1996, as reported by Nasdaq.
THREE MONTHS ENDED YEAR ENDED YEAR ENDED YEAR ENDED ----------------------------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 1996 1997 1998 -------- ------- ------------ ----------- ------------ ------------ ------------ 1996 High.................... $20.000 $23.250 $16.813 $6.000 $23.250 Low..................... 12.625 12.875 4.375 5.125 4.375 1997 High.................... 5.750 5.625 5.063 5.563 $5.750 Low..................... 4.375 4.500 4.000 3.875 3.875 1998 High.................... 5.000 4.500 4.000 3.063 $5.000 Low..................... 4.063 3.000 2.375 1.500 1.500 1999 High (through 3/19/99).............. 3.000 Low (through 3/19/99)... 1.500
Holders. The approximate number of holders of record of VitalCom Inc. common stock, as recorded on the books of VitalCom's Registrar and Transfer Agent, as of March 19, 1999 was 42. Dividends. VitalCom has not paid cash dividends on its common stock and does not currently have any plans to pay such dividends in the foreseeable future. The dividend policy of VitalCom is reviewed from time to time by the Company's Board of Directors in light of its earnings and financial condition and such other business considerations as the Board of Directors considers relevant. UNREGISTERED SALES OF THE REGISTRANT'S EQUITY SECURITIES DURING LAST FISCAL YEAR The Note Purchase Agreement. In July 1998, the Company issued an aggregate of 10,000 shares of its Common Stock, $.0001 par value, to a consultant of the Company for a purchase price of $3.06 per share. The aggregate purchase price was paid in cash in the amount of $10 with the balance of $30,600 paid through the issuance of a non-recourse promissory note secured by a pledge of the shares to the Company. The issuance of 11 13 the shares was deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act as a transaction by an issuer not involving any public offering. In addition, the recipient of the shares in the transaction represented their intention to acquire the shares for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificate issued in the transaction. Common Stock Contributions to 401(k) Plan. On the last day of each quarter in 1998, the Company issued 18,535, 21,328, and 33,609 shares of Common Stock to employees as a matching contribution to the 401(k) plan. At December 31, 1998 the Company was obligated to issue 27,057 shares of Common Stock to employees as a matching contribution to the 401(k) Plan for the fourth quarter of 1998. This stock match was made in the first quarter of 1999. 12 14 ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data set forth below for the periods and the dates indicated and summary consolidated financial data are derived from the audited financial statements of the Company. The statement of operations data for each of the three fiscal years to the period ended December 31, 1998, and the balance sheet data at December 31, 1997 and 1998, are derived from the audited financial statements and notes thereto, which are included elsewhere in this report, and are qualified by reference to such financial statements and notes related thereto. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and Notes thereto included elsewhere in this report. SELECTED FINANCIAL DATA The following information should be read in conjunction with the financial statements and related notes.
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1994 1995 1996 1997 1998 ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenue.................................... $17,092 $23,964 $18,372 $21,794 $20,859 ------- ------- ------- ------- ------- Cost of sales.............................. 7,956 10,299 9,680 11,477 9,561 ------- ------- ------- ------- ------- Gross profit............................... 9,136 13,665 8,692 10,317 11,297 ------- ------- ------- ------- ------- Operating expenses: Sales and marketing..................... 3,643 6,442 9,515 8,562 6,794 Research and development................ 1,852 2,673 5,434 4,816 4,698 General and administrative.............. 1,072 1,644 2,507 2,536 2,159 Restructuring charges................... 481 ------- ------- ------- ------- ------- Total operating expenses........... 6,567 10,759 17,937 15,914 13,651 ------- ------- ------- ------- ------- Operating income (loss)...................... 2,569 2,906 (9,245) (5,597) (2,353) ------- ------- ------- ------- ------- Other income (expense), net.................. (174) (130) 975 973 890 ------- ------- ------- ------- ------- Income (loss) before provision (benefit) for income taxes............................... 2,395 2,776 (8,270) (4,624) (1,463) Provision (benefit) for income taxes......... 971 1,193 (1,902) 26 25 ------- ------- ------- ------- ------- Net income (loss)............................ $ 1,424 $ 1,583 $(6,368) $(4,650) $(1,488) ======= ======= ======= ======= ======= Net income (loss) per basic common share(1)................................... $ 0.30 $ (0.90) $ (0.58) $ (0.18) ======= ======= ======= ======= Net income (loss) per diluted common share(1)................................... $ 0.28 $ (0.90) $ (0.58) $ (0.18) ======= ======= ======= ======= Weighted average basic common shares(1)...... 5,313 7,084 8,001 8,148 ------- ------- ------- ------- Weighted average diluted common shares(1).... 5,671 7,084 8,001 8,148 ======= ======= ======= =======
DECEMBER 31, ----------------------------------------------- 1994 1995 1996 1997 1998 ------- ------- ------- ------- ------- (IN THOUSANDS) BALANCE SHEET DATA: Cash equivalents and short-term investments............................. $ 1,223 $ 2,164 $20,120 $18,157 $15,830 Working capital............................ 3,009 6,236 23,980 19,965 19,249 Total assets............................... 7,998 13,353 31,921 26,708 24,223 Long-term debt, excluding current portion................................. 1,542 1,042 82 60 32 Total stockholders' equity (deficit)....... (3,606) (2,973) 26,973 22,521 21,462
- --------------- (1) See Note 1 of the Notes to the Financial Statements for a description of shares used in calculating net income (loss) per share. 13 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements contained in this Annual Report on Form 10-K, including the information set forth in Part I, Item 1 -- Business, this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Report constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may vary substantially from these forward-looking statements for many reasons, including but not limited to those set forth in "Management's Discussion and Analysis of Financial Condition and Result of Operations -- Risk Factors". Additional information is available in the Company's reports and other documents filed with the Securities and Exchange Commission. GENERAL VitalCom provides computer networks and related radio communications products that acquire, interpret and distribute real-time monitoring information. The Company's radio and computer networks acquire physiologic data generated by its own proprietary ECG monitors and other manufacturers' bedside equipment located throughout a healthcare facility. The Company's products are sold through a direct sales force to acute care hospitals and integrated healthcare delivery networks ("IHDNs") and on an Original Equipment Manufacturer ("OEM") basis to patient monitoring equipment manufacturers. Revenues from sales of Enterprise-wide monitoring systems sold by the Company's direct sales force are recognized upon shipment. The sales cycle for Enterprise-wide monitoring systems has typically been from nine to 18 months. The Company has experienced seasonal variations in sales of its Enterprise-wide monitoring systems, with sales in the first quarter typically lower than the preceding fourth quarter's sales due to customer budget cycles and sales remaining relatively flat during the third quarter. Furthermore, a large percentage of a particular quarter's shipments of Enterprise-wide monitoring systems has historically been booked in the last weeks of the quarter. Revenues from sales of OEM products are recognized upon shipment. The selling cycle for OEM products varies depending upon product mix and the extent to which the Company develops customized operating software for a particular OEM customer. In addition, the Company has experienced seasonal variations in sales of its departmental products, with sales in the first quarter typically lower than the preceding fourth quarter's sales and third quarter sales of OEM products generally being lower than other quarters. The Company's products are generally shipped as orders are received and, accordingly, the Company typically operates with limited backlog. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter. To date, the Company has not capitalized software development expenses. However, the development of new products or the enhancement of existing products may require capitalization of such expenses in the future. See Note 1 of the Notes to the Financial Statements. 14 16 ANNUAL RESULTS OF OPERATIONS The following table sets forth the percentage of total revenues represented by certain statements of operations data for the periods indicated:
YEAR ENDED DECEMBER 31, ----------------------- 1996 1997 1998 ----- ----- ----- Revenue............................................. 100.0% 100.0% 100.0% ----- ----- ----- Cost of sales....................................... 52.7 52.7 45.8 ----- ----- ----- Gross profit........................................ 47.3 47.3 54.2 ----- ----- ----- Operating expenses: Sales and marketing............................... 51.8 39.3 32.6 Research and development.......................... 29.6 22.1 22.5 General and administrative........................ 13.6 11.6 10.3 Restructuring charges............................. 2.6 -- -- ----- ----- ----- Total operating expenses.................. 97.6 73.0 65.4 ----- ----- ----- Operating loss...................................... (50.3) (25.7) (11.3) Other income, net................................... 5.3 4.5 4.3 ----- ----- ----- Loss before provision (benefit) for income taxes.... (45.0) (21.2) (7.0) Provision (benefit) for income taxes................ (10.4) 0.01 0.01 ----- ----- ----- Net loss............................................ (34.6)% (21.3)% (7.1)% ===== ===== =====
COMPARISON OF THE YEARS ENDED 1998, 1997 AND 1996 Total Revenues. Total revenues consist of revenue from sales of Enterprise-wide monitoring systems and OEM products, together with fees for installation and servicing of products. Total revenues decreased 4.3% to $20.9 million in 1998 from $21.8 million in 1997. Total revenues increased 18.6% to $21.8 million in 1997 from $18.4 million in 1996. Revenues from Enterprise-wide monitoring systems sales decreased 5.0% to $8.8 million in 1998 from $9.3 million in 1997. Revenues from Enterprise-wide monitoring systems sales increased 12.8% to $9.3 million in 1997 from $8.2 million in 1996. Revenues from OEM product sales decreased 3.7% to $12.1 million in 1998 from $12.5 million in 1997. Revenues from OEM product sales increased 19.6% to $12.5 million in 1997 from $10.2 million in 1996. The decrease in Enterprise-wide monitoring systems sales in 1998 was due to the continued difficulty the Company has experienced rebuilding its sales force and funnel of potential new business from the 1996 direct sales business development restructuring. Since the Enterprise-wide sales cycle can extend up to 18 months, the development of a mature and dependable funnel of new business takes time to develop, thus the Company was reliant upon its existing customer base for the majority of its 1998 Enterprise-wide monitoring systems revenues. The increase in sales of Enterprise-wide monitoring systems in 1997 reflects increases in sales from the Company's installed base who expanded their systems. The decrease in OEM product sales in 1998 reflects the reduction in sales to the Company's largest OEM customer, due to weaker demand in their departmental monitoring market. In 1997, OEM product sales increased from 1996 due to the increased market demand for central monitoring system solutions sold by the Company's two largest OEM customers. Gross Margins. Cost of goods sold generally includes material, direct labor, overhead and, for Enterprise-wide monitoring systems, installation expenses. Cost of sales decreased 16.7% to $9.6 million from $11.5 million in 1997, on a 4.3% decrease in revenues in 1998. Cost of sales increased 18.6% to $11.5 million in 1997 from $9.7 million in 1996, on a 18.6% revenue increase in 1997. Gross margins were 54.2%, 47.3% and 47.3% in 1998, 1997 and 1996, respectively. The increase in gross margin in 1998 as compared to 1997 was due to price decreases in material costs for personal computer and RF board assembly materials and reduced overhead costs for overtime, product liability insurance and warranty costs. Gross margin in 1997 was identical to 1996 as the absorption of fixed costs remained consistent from year to year. Sales and Marketing Expenses. Sales and marketing expenses include payroll, commissions and related personnel costs attributable to Enterprise-wide monitoring systems and OEM sales and marketing personnel, 15 17 travel and entertainment expenses, and other promotional expenses. Sales and marketing expenses decreased 20.7%, to $6.8 million in 1998 from $8.6 million in 1997. Sales and marketing expenses decreased 10.0% to $8.6 million in 1997 from $9.5 million in 1996. The decrease in sales and marketing expenses in 1998 from 1997 was due to lower salaries and commission expenses associated with the reduction in sales personnel, lower travel expenses and a reduction in marketing and promotion costs. The decrease in sales and marketing expenses in 1997 was primarily attributable to a decrease in customer relations expenses as 1996 expenses included voluntary upgrades to selected Enterprise-wide monitoring systems customers to provide an upgrade path for future expansion and sales to these customers. Research and Development Expenses. Research and development expenses include payroll and related costs attributable to research and development personnel, prototyping expenses and other costs. Research and development expenses decreased 2.4% to $4.7 million in 1998 from $4.8 million in 1997. Research and development expenses decreased 11.4% to $4.8 million in 1997 from $5.4 million in 1996. Research and development expenses decreased in 1998 from 1997 due to lower salary expenses associated with the lower headcount in 1998. Research and development expenses decreased in 1997 from 1996 due primarily to a lower number of research and development personnel and reduced spending for prototype and test equipment. General and Administrative Expenses. General and administrative expenses include accounting, finance, MIS, human resources, general administration, executive officers and professional fee expenses. General and administrative expenses decreased 14.9% to $2.2 million in 1998 from $2.5 million in 1997. General and administrative expenses increased 1.1% to $2.5 million in 1997 from $2.5 million in 1996. The decrease in spending in 1998 in comparison to 1997 was primarily due to the reduction in legal and professional fees. The slight increase in spending in 1997 as compared to 1996 is attributable to headcount increases and related recruiting and relocation expenses. Other Income, Net. Other income, net consists primarily of interest income earned on proceeds from the Company's initial public offering, net of payments made in respect of outstanding indebtedness. Other income, net, in 1998 decreased to $889,621 in income as compared to income of $972,968 in 1997. This decrease was due to lower income derived from the short-term investments in comparison to the prior year. Other income, net in 1997 decreased slightly to $972,968 in income as compared to income of $975,341 in 1996. Provision (Benefit) for Income Taxes. The Company paid minimal state taxes in 1998 and 1997 due to its net loss position. In 1996 the Company recognized a benefit for the amount of refundable federal taxes of $2.7 million as a result of the carryback of its net operating loss, offset by the establishment of a valuation allowance of $748,000 against previously deferred tax assets, for a net tax benefit of $1.9 million. The Company's utilization of its credit carryforwards depends upon future income and may be subject to an annual limitation, required by the Internal Revenue Code of 1986 and similar state provisions (see Note 9 of the Notes to the Financial Statements). LIQUIDITY AND CAPITAL RESOURCES The Company has financed its operations (including capital expenditures) through net proceeds from the Company's February 1996 initial public offering, cash and cash equivalent balances, a bank line of credit and long-term debt. During the year ended December 31, 1996 the Company issued 2,300,000 shares of common stock in its February 1996 initial public offering, raising $25.6 million, net of expenses. At December 31, 1998, the Company had $15.8 million in cash, cash equivalents and short-term investments as compared to $18.2 million at December 31, 1997. The Company used $2.2 million of cash for operating activities in 1998, compared to $1.7 million and $5.0 million in 1997 and 1996, respectively to fund the net losses in 1998, 1997 and 1996 of $1.5 million, $4.6 million and $6.4 million, respectively. Of the net cash used in operating activities in 1998, $842,163 was used for the increase in account receivables, $620,857 was used to pay down accrued liabilities, $393,168 was used for payroll and related costs and $210,797 was attributable to the reduction in the accrued warranty reserve. During 1998, uses of cash were partially offset by the $735,338 in non-cash adjustments provided by depreciation and amortization of fixed assets and intangible assets, $420,600 was provided by the reduction in inventories, and $259,985 in the non-cash adjustment provided by the equity contribution to the 401(k) plan. 16 18 The 1997 net loss of $4.6 million and the $1.6 million increase in accounts receivable was partially offset by decreases in inventories and income tax receivable of $1.4 million and $2.9 million, respectively. The 1996 use of cash was due to a net loss of $6.4 million, a $2.9 million increase in income tax receivable and the $1.7 million increase in inventories was partially offset by the $4.4 million decrease in account receivables, $751,127 decrease in deferred income taxes and $699,676 increase in accrued liabilities. The Company provided $347,293 in investing activities in 1998 of which $630,787 was cash provided by short-term investments, compared to $6.4 million and $1.4 million in cash used in investing activities in 1997 and 1996, respectively. Cash used for investing activities in 1998 and 1997 was for the purchase of capital expenditures and net purchases of short-term investments. Cash used in 1996 was primarily for purchases of capital expenditures. The Company generated $144,949 of cash from financial activities in 1998, $176,691 in 1997, and $24.4 million in 1996. The primary source of cash from financing activities in 1998 and 1997 was the net proceeds of cash from the issuance of common stock and its employee stock purchase plan in the amounts of $169,813 and $198,189, respectively. The primary source of cash from financing activities in 1996 was the sale of 2,300,000 shares of common stock in the Company's initial public offering which the Company received approximately $25.6 million in net proceeds. At December 31, 1998, the Company's principal sources of liquidity consisted of $15.8 million of cash, cash equivalents and short-term investments, and $5.0 million of available credit facilities. In December 1998, the Company renewed a secured lending arrangement (the "Agreement") with Silicon Valley Bank, providing for a $5.0 million revolving line of credit agreement bearing interest at either the bank's prime rate or LIBOR interbank market rate, as selected by the Company. The bank does not have security interest in any of the Company's assets until the Company is borrowing under the line of credit. The Agreement expires in December 1999. At December 31, 1998, there were no borrowings outstanding under the Agreement and the Company was in compliance with all covenants. The financial covenants requires that the Company maintain a quick assets ratio of not less than 1.75 to 1, maintain tangible net worth of not less than $18,000,000, maintain a ratio of total liabilities to tangible net worth of not more than .75 to 1 and not incur a net loss (after taxes) for the fiscal year ending December 31, 1998 in excess of $3,250,000; nor incur a net loss (after taxes) for the fiscal year ending December 31, 1999 in excess of $2,000,000. As such, the bank held no security interest in any of the Company's assets (see Note 3 of the Notes to the Financial Statements). The Company's principal commitment at December 31, 1998 consisted of a lease on its office and manufacturing facility. The Company expects to spend approximately $1.0 million for capital expenditures during 1999. The Company believes that existing cash resources, cash flows from operations, if any, and line of credit facilities will be sufficient to fund the Company's operations for at least the next twelve months. Year 2000 Computer Systems Compliance. Many computer systems, software, and electronic equipment accept only two-digit entries in the date code field. Therefore "00" for the year 2000 could be interpreted to be the year 1900, resulting in an invalid date. These systems will need to be changed to distinguish 21st century dates. In addition, certain systems and products do not correctly process "leap year" dates. As a result, in the next 12 months, computer systems, software ("IT Systems"), and other equipment, such as elevators, phones, office equipment, and manufacturing equipment used by many companies may need to be upgraded, repaired, or replaced to comply with "Year 2000" and "leap year" requirements. The Company's Enterprise-wide monitoring systems and OEM central stations use a personal computer (PC) platform and include operating system, display, clinical analysis and networking software. The Company's research and development department has evaluated all Company Enterprise-wide monitoring products built and shipped on or after January 1, 1990. Test procedures included testing for (a) transition dates of December 31, 1999 to January 1, 2000 and December 31, 2000 to January 1, 2001; (b) leap year transition dates of February 28, 2000 to February 29, 2000 and February 29, 2000 to March 1, 2000; (c) a powered-down rollover test; (d) a powered-up rollover test; (e) a check of the date and time of history events and full disclosure on monitor displays; (f) alarms set and check for correct functioning after the transition dates and times and (f) verification for printouts for a three month period during the transition dates. The 17 19 Company tested a total of 111 hardware and software combinations. All products the Company is currently selling and installing are Y2K compliant. Of the 111 product combinations tested 40 combinations are compliant and Y2K certified, 35 are compliant with a simple workaround such as a power-down and power-up, 32 are not fully compliant, but which have relatively simple workarounds to provide a solution for the product to make it compliant, and 4 that are not compliant and have no workaround. All of the Company's Enterprise-wide monitoring customers have received a technical bulletin explaining the status of the Company's Y2K compliance requirements and applicable workarounds, if necessary. Recently the Company expanded its testing beyond the generally accepted Y2K criteria enumerated above to include testing for dates of January 1, 2001 and beyond. Preliminary tests indicate the Company's 486 based personal computer products that printed reports display an invalid date or a date two days prior to the actual date or event. The Company has just recently learned of this information and as such is continuing to test hardware and software combinations to determine the extent of year 2001 and beyond printing anomalies. The Company believes that it does not have any contractual obligation to update or replace any software or equipment for its customers at no charge. The Company's OEM customers are responsible for Y2K compliance and support for their end user customers. All of the Company's transmitters, receivers (RF products) and display monitors are year 2000 Compliant based on the fact that none of these devices contain a real time clock that would pose a Year 2000 date compliance issue. The Company has conducted an internal review of most of its internal systems, including inventory, manufacturing, planning, finance, human resources, payroll, automation, laboratory, and research systems. The systems affected by the Year 2000 problem are divided into eight categories including the Company's Enterprise-wide monitoring systems and OEM central stations discussed above. Business Computer Systems comprise any mainframe, midrange, or PC based computer system used in corporate operations. These systems generally involve application code provided by third-party vendors supported by internal staff. Technical Infrastructure are specific computer and process control software systems. End User Computing comprise the PC and server based office automation. Suppliers, Agents, and Service Providers comprise the software formulated by our suppliers, banks, utilities, and other suppliers. Manufacturing, Warehousing, Servicing Equipment comprise the equipment on our factory floor and warehouse areas that may be date dependent, especially micro-processor controlled devices. Environmental Operations in Plant, Offices and Other Sites comprise the Company's HVAC, security/access system, elevators, PBX, fire and alarm systems, and other systems of this nature. Dedicated Research and Development Test Facilities comprise controllers, devices, instruments etc. in the Company's test facilities. As part of the Company's review to assure compliance with Year 2000, the Company has formed a task force (the "Task Force") to oversee Year 2000 and leap year issues. The Task Force has reviewed all IT Systems and Non-IT Systems that have been determined not to be Year 2000 and leap year compliant and has identified and begun implementation of solutions to ensure such compliance. The Company has prioritized the remediation effort to fix critical business systems first, non-critical systems second, and cosmetic changes to reports and displays last. Key critical business systems, such as Financials (General Ledger, Purchasing, Accounts Payable, Accounts Receivable and Fixed Assets) and Material Requirements Planning, are currently 100% compliant. Remaining critical and non-critical business systems are expected to be completed by mid-1999 and cosmetic changes to reports and displays are anticipated to be completed in the fourth quarter of 1999. As part of contingency planning, the Company is developing procedures for those areas that are critical to its business. These plans will be designed to mitigate serious disruptions to the business beyond the end of 1999. The major efforts in contingency planning occurred in the last quarter of 1998 with the expectation that contingency plans will be in place by the end of the second quarter of 1999. Based on current plans and efforts to date, the Company does not anticipate that Year 2000 problems will have a material adverse effect on results of operations or financial condition. The Company has contacted its major customers, vendors, and service suppliers whose systems failures potentially could have a significant impact on the Company's operations to verify their Year 2000 readiness to determine potential exposure to Year 2000 issues. The Company has been informed by 75 percent of its major customers, vendors, and service suppliers that such suppliers will be Year 2000 compliant by the Year 2000. Failure of these third parties systems to timely achieve Year 2000 compliance could have a material adverse effect on the business, financial condition, results of operations and prospects of the Company. Year 2000 18 20 problems could affect many of the Company's production, distribution, plant equipment, financial and administrative operations. Systems critical to the business which have been identified as non-Year 2000 compliant are either being replaced or corrected through programming modifications. Remediation of problems discovered will be corrected through internal efforts, vendor upgrades, replacement, or decommissioning of obsolete systems and equipment. External and internal costs associated with these efforts are currently expected to be approximately $200,000. As of December 31, 1998, the Company had spent less than $20,000 on costs associated with the Year 2000 effort. The Company does not expect the costs relating to Year 2000 remediation to have a material effect on results of operations or financial condition. The Company has not determined the state of compliance of certain third-party suppliers of services such as phone companies, long distance carriers, financial institutions and electric companies. The failure of any one could severely disrupt the Company's ability to carry on its business as will as disrupt the business of the Company's customers. Failure to provide Year 2000 and leap year compliant business solutions to customers or to receive such business solutions from its suppliers could result in liability to the Company or otherwise have a material adverse effect on the Company's business, results of operations or financial condition. The Company could be affected through disruptions in the operation of the enterprises with which the Company interacts or from general widespread problems or an economic crisis resulting from non-compliant Year 2000 systems. Despite the Company's efforts to address the Year 2000 effect on its internal systems and business operations, such effect could result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. Recent Accounting Pronouncements -- In June 1997, the FASB issued Statement of Financial Accounting Standard No. 130 (SFAS 130), Reporting Comprehensive Income, and No. 131 (SFAS 131), Disclosures About Segments of an Enterprise and Related Information. These statements are effective for fiscal years commencing after December 15, 1997. SFAS 130 establishes standards for the reporting and disclosure of comprehensive income (revenues, expenses, gains and losses) in a full set of general purpose financial statements. SFAS 131 establishes standards for the reporting of information about operating segments of a business and is reported in Note 5 of the Notes to the Financial Statements. In June 1998, the FASB released Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for derivatives used for hedging activities. It requires that all derivatives be recognized either as an asset or liability, and measures them at fair value. SFAS 133 is effective for all fiscal quarters for fiscal years beginning after June 15, 1999. The Company believes that the application of SFAS 133 will not have a material impact on the Company's financial statements. In October 1997, the American Institute of Certified Public Accountants issued SOP 97-2, Software Revenue Recognition, which supercedes SOP 91-1 and is effective for transactions entered into for fiscal years beginning after December 15, 1997. While some principles remain the same, there are several key differences between the two pronouncements, including accounting for multiple element arrangements. SOP 97-2 addresses revenue recognition from a conceptual level and does not specifically provide implementation guidance. Management believes the implementation of SOP 97-2 did not have a material effect on the Company's financial position or results of operations. In March 1998, the American Institute of Certified Public Accountants issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 provides guidance on accounting for the costs of computer software, developed or obtained for internal use and requires costs incurred in the application development stage (whether internal or external) to be capitalized. This SOP is applicable to all financial statements for fiscal years beginning after December 15, 1998. Management does not believe the implementation of SOP 98-1 will have a material effect on the Company's financial position or results of operations. 19 21 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's financial instruments include cash and long-term debt. At December 31, 1998, the carrying values of the Company's financial instruments approximated their fair values based on current market prices and rates. It is the Company's policy not to enter into derivative financial instruments. The Company does not currently have any foreign currency exposure since it does not transact business in foreign currencies. Due to this, the Company does not have significant overall currency exposure at December 31, 1998. EUROPEAN MONETARY UNION Within Europe, the European Economic and Monetary Union (the "EMU") introduced a new currency, the euro, on January 1, 1999. The new currency is in response to the EMU's policy of economic convergence to harmonize trade policy, eliminate business costs associated with currency exchange and to promote the free flow of capital, goods and services. On January 1, 1999, the participating countries adopted the euro as their local currency, initially available for currency trading on currency exchanges and non-cash transactions such as banking. The existing local currencies, or legacy currencies, will remain legal tender through January 1, 2002. Beginning on January 1, 2002, euro-denominated bills and coins will be issued for cash transactions. For a period of up to six months from this date, both legacy currencies and the euro will be legal tender. On or before July 1, 2002, the participating countries will withdraw all legacy currencies and exclusively use the euro. The Company's transactions are recorded in U.S. Dollars and the Company does not currently anticipate future transactions being recorded in the euro. Based on the lack of transactions recorded in the euro, the Company does not believe that the euro will have a material effect on the financial position, results of operations or cash flows of the Company. In addition, the Company has not incurred and does not expect to incur any significant costs from the continued implementation of the euro, including any currency risk, which could materially affect the Company's business, financial condition or results of operations. The Company has not experienced any significant operational disruptions to date and does not currently expect the continued implementation of the euro to cause any significant operational disruptions. 20 22 FORWARD LOOKING STATEMENTS Certain statements contained in this Annual Report on Form 10-K, including the information set forth in Part I, Item 1 -- Business, this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Report constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include those regarding the Company's ability to shorten stays in costly intensive care (ICU) and cardiac care (CCU) units, increase medical staff productivity, reduce costly patient transfers, leverage the use of existing equipment, improve facility utilization, healthcare providers changing operations and increasingly focusing on controlling the cost of delivering care, facilitating the implementation of telemedicine with the Company's SiteLink application, the Company's possible election in the future to incorporate in its OEM products the hardware and software for larger networks and expand to other OEM customers the ability for real-time redistribution of information to remote viewing stations, the Company's intention to expand its OpenNet application with interfaces to additional patient monitoring or ventilator devices, the Company's intent to make additional connections between its Enterprise-wide monitoring systems and other HCIS products and computerized patient records, the outcome of any regulatory development, the probable FCC licensing of a new band for medical telemetry and the Company's intent to develop RF products to operate in this new band, potential new products, rebuilding of the Company's funnel of potential new Enterprise-wide monitoring systems sales, sequential growth in Enterprise- wide monitoring systems sales, the Company's working capital position, the Company's estimated expenditures for Year 2000 compliance, the expected effect of Year 2000 compliance on the Company and the effect and timing of Year 2000 compliance on the Company's customers. Actual results may vary substantially from these foward-looking statements for many reasons, including but not limited to those set forth in "Management's Discussion and Analysis of Financial Condition and Result of Operations -- Risk Factors." RISK FACTORS Dependence on Increased Market Acceptance of Enterprise-wide Monitoring Systems. In 1998, sales of the Company's Enterprise-wide systems decreased 5.0% to $8.8 million from $9.3 million in 1997. In 1997, sales of the Company's Enterprise-wide monitoring systems increased 12.8% to $9.3 million from $8.2 million in 1996. In 1996, sales of the Company's Enterprise-wide monitoring systems decreased 37.9% to $8.2 million from $13.1 million in 1995. Since 1995, the Company's sales levels for its Enterprise-wide monitoring systems has been lower than expected, which, together with investments and expense levels that are incurred based on the expectation of higher sales, has resulted in net losses in each year since 1995 and have had a material adverse effect on the Company's business, operating results and financial condition. If the Company is not successful in increasing sales levels of its Enterprise-wide monitoring systems in future periods, the Company's business, operating results and financial condition will continue to be materially adversely affected. In addition, although the Company's Enterprise-wide monitoring products have been installed in more than 100 hospitals, there is no assurance that the Company's products will achieve the hospital penetration necessary to increase sales. Fluctuations in Quarterly Results. The Company's quarterly operating results have fluctuated in the past and may fluctuate significantly from quarter to quarter in the future as a result of a number of factors, including, but not limited to the size and timing of orders; the length of the sales cycle; the Company's success in expanding its sales and marketing programs and the effects of changes in sales force alignment; the ability of the Company's customers to obtain budget allocations for the purchase of the Company's products; changes in pricing policies or price reductions by the Company or its competitors; mix of sales between Enterprise-wide monitoring systems and OEM products; the timing of new product announcements and introductions by the Company or its competitors; deferrals of customer orders in anticipation of new products or product enhancements; the Company's ability to develop, introduce and market new products and product enhancements; market acceptance of new products or product enhancements; the Company's ability to control costs; the availability of components; costs associated with responding to software "bugs" or errors; regulatory compliance and timing of regulatory clearances; changes in government regulations and other regulatory developments; and general economic factors. 21 23 The Company's products are generally shipped as orders are received and, accordingly, the Company has historically operated with limited backlog. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter and are not predictable with any degree of certainty. Further, a large percentage of any quarter's shipments have historically been booked in the last weeks of the quarter. In addition, a significant portion of the Company's expenses are relatively fixed, and the amount and timing of increases in such expenses are based in large part on the Company's expectations for future revenues. If revenues are below expectations in any given quarter, the adverse effect may be magnified by the Company's inability to maintain gross margins and to decrease spending to compensate for the revenue shortfall. This dynamic has contributed to the Company's net losses in the past. Further, the Company has sometimes experienced seasonal variations in operating results, with sales in the first quarter being lower than in the preceding fourth quarter's sales due to customer budget cycles and sales remaining relatively flat during the third quarter. Lengthy Sales Cycle. The decision by a healthcare provider to replace or substantially upgrade its clinical information systems typically involves a major commitment of capital and an extended review and approval process, and this review and approval process is becoming more complex, more financially oriented and increasingly subject to overall integration into the hospital's information systems planning. The sales cycle for the Company's Enterprise-wide monitoring systems has typically been nine to 18 months from initial contact to receipt of a purchase order. During this period, the Company expends substantial time, effort and funds preparing a contract proposal and negotiating a purchase order without any guarantee that the Company will complete the transaction. Any significant or ongoing failure to reach definitive agreements with customers has in the past and may in the future have a material adverse effect on the Company's business, operating results and financial condition. Possible Delisting of Securities from the Nasdaq National Market. The Company's Common Stock trades on the Nasdaq National Market. The Nasdaq National Market's continued listing standards require the Company to have (i) 750,000 share publicly held; (ii) a market value of publicly held shares of $5 million; (iii) net tangible assets of at least $4 million; (iv) 400 shareholders of round lots; and (v) a minimum bid price of at least $1 per share. The Company believes that it currently does not meet item (ii) above, and it is possible that the Company could fall below other criteria in the future, particularly item (v) above. Accordingly, the Company may be subject to possible delisting procedures in the future from the Nasdaq National Market and this would adversely affect the ability or willingness of investors to purchase the Company's securities and therefore would severely adversely affect the market liquidity for the Company's securities. Competition. The Company's Enterprise-wide monitoring systems compete with systems offered by a number of competitors, including Hewlett-Packard Company, SpaceLabs, Inc. and General Electric Company, all of which have significantly greater financial, technical, research and development and marketing resources than the Company. In addition, many of these competitors have longstanding relationships with acute care hospitals and IHDNs. There can be no assurance that the Company will be able to sell to such hospitals or IHDNs or that the Company will be able to compete successfully with such vendors, and any inability to do so could have a material adverse effect on the Company's business, operating results and financial condition. While the Company is not aware of any competitive open system multi-parameter Enterprise-wide monitoring systems currently available, the Company's OpenNet applications may face significant competition in the future from HCIS providers, patient monitoring companies, life support device companies and general purpose data network providers. Such potential competitors may elect to enter this market and compete with the Company using significantly greater financial, technical, research and development and marketing resources than are available to the Company. In addition, the Company's success in selling its multi-parameter OpenNet networks to hospitals and IHDNs will depend to a large extent on its ability to interface with patient monitoring and life support devices of other vendors. Any action on the part of such other vendors to make such interfacing more difficult or impossible could have a material adverse effect on the Company's business, operating results and financial condition. The market for the Company's OEM products is also intensely competitive. The Company sells to a range of patient monitoring and life support device companies, many of which have significantly greater financial, technical, research and development and marketing resources than the Company. There can be no assurance that current OEM customers will not elect 22 24 to design and manufacture patient monitoring and system components currently supplied by the Company or elect to contract with other OEM suppliers. Any such election by one or more of such companies could have a material adverse effect on the Company's business, operating results and financial condition. In addition, the Company may in the future elect to incorporate in its OEM products the hardware and software for larger networks and expand the number of OEM customers with the hardware and software required for real-time redistribution of information to Remote Viewing Stations for use in specialty departments of hospitals for which the Company's OEM customers design and sell their products. Although the Company believes that its OEM customers would not compete with its Enterprise-wide monitoring systems because the Enterprise-wide monitoring systems are sold to hospitals and IHDNs who elect to install larger, more dispersed systems, the Company could face competition with its OEM customers to the extent hospitals forego purchasing the Company's facility-wide Enterprise-wide monitoring systems for the smaller departmental systems of its OEM customers. Customer Concentration; Dependence on Departmental Products. The Company's OEM product sales, which represented approximately 55.6%, 53.7% and 57.9% of the Company's total net revenues in 1996, 1997 and 1998, respectively, have historically been to a small number of OEM customers. In 1997, Quinton Instrument Company ("Quinton") and Datascope Corporation ("Datascope") accounted for approximately 12.2% and 25.0%, respectively, of the Company's total revenues and in 1998 Quinton and Datascope accounted for approximately 19.7% and 22.6%, respectively, of the Company's total revenues. The loss of, or a reduction in sales to, any such OEM customer would have a material adverse effect on the Company's business, operating results and financial condition. Technological Change; Need to Develop New Products. Many aspects of the medical equipment industry are undergoing rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards. Historically, the Company derived substantially all of its revenue from sales of its Enterprise-wide monitoring systems and OEM products. The Company believes that as the market for these products matures, VitalCom's future success will depend upon its ability to develop and introduce on a timely basis new products and product enhancements that keep pace with technological developments and that address the increasingly sophisticated needs of acute care hospitals and IHDNs. In addition, the introduction of competing products embodying new technologies and the emergence of new industry standards could render the Company's existing products unmarketable or obsolete. If the Company is unable to develop and introduce product enhancements and new products in a timely and cost-effective manner in response to changing market conditions or customer requirements, or if the Company's new products or product enhancements, such as SiteLink, do not achieve market acceptance, the Company's business, operating results and financial condition will be materially adversely affected. Uncertainty and Consolidation in Healthcare Industry. The healthcare industry is subject to changing political, economic and regulatory influences that may affect the procurement practices and operation of healthcare providers. Many healthcare providers are consolidating to create larger hospitals and IHDNs. This consolidation reduces the number of potential customers for the Company's products, and the increased bargaining power of these organizations could lead to reductions in the amounts paid for the Company's products. These larger hospitals and IHDNs may concentrate their purchases on a small number of preferred vendors with whom they have had longstanding relationships. There can be no assurance that the Company will be able to sell to such hospitals or IHDNs or that the Company will be able to compete successfully with such vendors. The impact of these developments in the healthcare industry is difficult to predict and could have a material adverse effect on the Company's business, operating results and financial condition. Government Regulation. The manufacture and sale of medical devices, including the Company's products, is subject to extensive regulation by numerous governmental authorities. In the United States, the Company's products are regulated as medical devices and are subject to the Food and Drug Administration's pre-clearance or approval requirements. The Company has received clearance from the FDA to market its current products through the 510(k) premarket notification process. There can be no assurance that a similar 510(k) clearance for any future product or enhancement of an existing product will be granted or that the process will not be lengthy. If the Company cannot establish that a product is "substantially equivalent" to 23 25 certain legally marketed devices, or if FDA regulatory changes currently under consideration with respect to arrhythmia software are adopted, the 510(k) clearance procedure will be unavailable and Company will be required to utilize the longer and more expensive premarket approval ("PMA") process. Failure to receive or delays in receipt of FDA clearances or approvals, including the need for extensive clinical trials or additional data as a prerequisite to clearance or approval, could have a material adverse effect on the Company's business, operating results and financial condition. Sales of medical devices and components outside of the United States are subject to international regulatory requirements that vary from country to country. There can be no assurance that the Company will be able to obtain further clearance or approvals for its products or components on a timely basis or at all, and delays in receipt of, loss of or failure to receive such approvals or clearances could have a material adverse effect on the Company's business, operating results and financial condition. The Company's radio frequency transmitter devices are subject to regulation by the Federal Communication Commission ("FCC"), and applicable approvals must be obtained before shipment of such products. The Company believes that all of its products designated for sale in the United States meet applicable Federal Communications Commission (FCC) regulations, including US FCC Part 15 for electromagnetic emissions. The FCC approval process starts with the collection of test data that demonstrates that a product meets the requirements stated in Part 15 of the FCC regulations. This data is then included as part of a report and application that is submitted to the FCC requesting approval. The FCC may grant or request additional information or withhold approval. Any failure of the Company's products to conform to governmental regulations or any delay or failure to obtain required FCC approvals in the future, if any, could cause the delay or loss of sales of the Company's products and therefore have a material adverse effect on the Company's business, financial condition and result of operations. The Company's proprietary radio frequency (RF) communication products transmit real-time physiologic information from the patient to the central surveillance station. These communication products currently operate in three radio bands: VHF (174 MHz to 216 MHz, shared with TV channels 7 - 13); UHF (450 MHz to 470 MHz, shared with land mobile users); and the 900 MHz radio band (902 MHz to 928 MHz licensed for Spread Spectrum operation). The majority of the Company's RF products use the vacant television frequencies in the VHF band. The FCC is requiring all television stations to implement digital broadcasting transmission for High Definition Television (HDTV). Major metropolitan areas were required to implement HDTV by December 31, 1998 and other markets will be required to implement by December 31, 2006. In order to implement HDTV the FCC has granted each TV channel an additional 6 MHz channel for digital broadcasting until the transition period ends, at which time the broadcaster would return one of the two channels. As TV stations use the additional 6 MHz channel for the digital broadcasting transition, which may take years, they may overlap into the radio spectrum which has been used for medical RF applications. Customers of the Company's lower power RF communication products may begin seeing more interference in the future. This interference may result in the Company's hospital biomedical personnel having to re-tune the Company's RF transmitters to other channels in order to reduce interference. In the event of high interference the Company's customers may need to purchase equipment to transmit in the UHF frequency range. In 1998 the FCC expanded the usable UHF frequencies for medical RF from the licensed 450 MHz to 470 MHz band to the previously unlicensed 470 MHz to 668 MHz frequency range. With VHF frequency ranges available for medical RF use potentially becoming more limited and the UHF frequency ranges expanding, the Company's competitors who have historically focused their RF products in what was the more limited UHF band, may now have a competitive advantage as compared to the Company, until such time as the Company expands its UHF RF product offerings. Any such competitive advantage of the Company's competitors and any additional development costs associated with expanding the Company's UHF RF product offerings could have a material adverse effect on the Company's business, operating results and financial condition. During 1998 the Company joined a task force created by the American Hospital Association (AHA) and the FDA called the Spectrum selection Workgroup Medical Telemetry Task Force (the "Task Force") along with several other medical RF users, including its competitors. The purpose of the Task Force is to respond to potential interference problems from HDTV, land mobile users and low power television to wireless patient monitoring devices. The Task Force's mission is to identify spectrum candidates for future medical telemetry 24 26 use, evaluate use and make recommendations to the FCC. As such the Task Force has petitioned the FCC to license the UHF 608 MHz to 614 MHz band, currently reserved for radio astronomy, for medical use. It is anticipated that the Task Force will submit its petition during the first half of 1999, with proposed rule making and public commentary to follow. The Task Force will ask the FCC to expedite licensing for medical RF applications in the 608 MHz to 614 MHz band. In the event the FCC approves this license, which the Company believes is probable, the Company may be at a disadvantage in the marketplace if one or some of its competitors develop and introduce RF products in this new band before the Company introduces products in the new band, resulting in lost or delayed revenues. In addition, the costs of developing RF transmitter and receiver products in this new band could be expensive or divert research and development resources from other projects resulting in higher costs and delayed projects. Any such competitive advantage of the Company's competitors and any additional development costs associated with expanding the Company's UHF RF product offerings could have a material adverse effect on the Company's business, operating results and financial condition. Additionally, future regulatory changes could significantly affect the Company's operations by diverting the Company's development efforts, making current products obsolete or increasing the opportunity for additional competition which could have a material adverse effect on the Company's business, operating results and financial condition. Limited Intellectual Property Protection. The Company relies on a combination of copyright, trade secret and trademark laws, confidentiality procedures and contractual provisions to protect its intellectual property. The Company seeks to protect its software, circuitry documentation and other written materials under trade secret and copyright laws, which afford only limited protection. The Company cannot assure that its protective measures for proprietary rights will be adequate or that the Company's competitors will not independently develop similar or superior technology, duplicate the Company's products or otherwise circumvent its intellectual property rights. Although the Company has never received a claim that its products infringe a third party's intellectual property rights, there can be no assurance that third parties will not in the future claim infringement by the Company with respect to current or future products or proprietary rights. Any such claims, regardless of their merit, could be time consuming, result in costly litigation, delay or prevent product shipments or require the Company to enter into costly royalty or licensing agreements. The impact of any of these developments could have a material adverse effect on the Company's business, operating results and financial condition. Risk of Product Liability Claims. Certain of the Company's products provide applications that relate to patient physiologic status or other clinically critical information. Any failure by the Company's products to provide accurate and timely information could result in product liability and warranty claims against the Company by its customers or their patients. The Company maintains insurance against claims associated with the use of its products, but there can be no assurance that its insurance coverage would adequately cover any claim asserted against the Company. A successful claim brought against the Company in excess of its insurance coverage or outside the scope of the Company's insurance coverage could have a material adverse effect on the Company's business, operating results and financial condition. The Company in the past had to incur warranty expenditures for upgrades that had adverse expenses to the periods. Even unsuccessful claims could result in the expenditure of funds in litigation and diversion of management time and resources. Year 2000 Computer Systems Compliance. Many computer systems, software, and electronic equipment accept only two-digit entries in the date code field. Therefore "00" for the year 2000 could be interpreted to be the year 1900, resulting in an invalid date. These systems will need to be changed to distinguish 21st century dates. In addition, certain systems and products do not correctly process "leap year" dates. As a result, in the next 12 months, computer systems, software ("IT Systems"), and other equipment, such as elevators, phones, office equipment, and manufacturing equipment used by many companies may need to be upgraded, repaired, or replaced to comply with "Year 2000" and "leap year" requirements. The Company's Enterprise-wide monitoring systems and OEM central stations use a personal computer (PC) platform and include operating system, display, clinical analysis and networking software. The Company's research and development department has evaluated all Company Enterprise-wide monitoring products built and shipped on or after January 1, 1990. Test procedures included testing for (a) transition dates of December 31, 1999 to January 1, 2000 and December 31, 2000 to January 1, 2001; (b) leap year 25 27 transition dates of February 28, 2000 to February 29, 2000 and February 29, 2000 to March 1, 2000; (c) a powered-down rollover test; (d) a powered-up rollover test; (e) a check of the date and time of history events and full disclosure on monitor displays; (f) alarms set and check for correct functioning after the transition dates and times and (f) verification for printouts for a three month period during the transition dates. The Company tested a total of 111 hardware and software combinations. All products the Company is currently selling and installing are Y2K compliant. Of the 111 product combinations tested 40 combinations are compliant and Y2K certified, 35 are compliant with a simple workaround such as a power-down and power-up, 32 are not fully compliant, but which have relatively simple workarounds to provide a solution for the product to make it compliant, and 4 that are not compliant and have no workaround. All of the Company's Enterprise-wide monitoring customers have received a technical bulletin explaining the status of the Company's Y2K compliance requirements and applicable workarounds, if necessary. Recently the Company expanded its testing beyond the generally accepted Y2K criteria enumerated above to include testing for dates of January 1, 2001 and beyond. Preliminary tests indicate the Company's 486 based personal computer products that printed reports display an invalid date or a date two days prior to the actual date or event. The Company has just recently learned of this information and as such is continuing to test hardware and software combinations to determine the extent of year 2001 and beyond printing anomalies. The Company believes that it does not have any contractual obligation to update or replace any software or equipment for its customers at no charge. The Company's OEM customers are responsible for Y2K compliance and support for their end user customers. All of the Company's transmitters, receivers (RF products) and display monitors are year 2000 Compliant based on the fact that none of these devices contain a real time clock that would pose a Year 2000 date compliance issue. The Company has conducted an internal review of most of its internal systems, including inventory, manufacturing, planning, finance, human resources, payroll, automation, laboratory, and research systems. The systems affected by the Year 2000 problem are divided into eight categories including the Company's Enterprise-wide monitoring systems and OEM central stations discussed above. Business Computer Systems comprise any mainframe, midrange, or PC based computer system used in corporate operations. These systems generally involve application code provided by third-party vendors supported by internal staff. Technical Infrastructure are specific computer and process control software systems. End User Computing comprise the PC and server based office automation. Suppliers, Agents, and Service Providers comprise the software formulated by our suppliers, banks, utilities, and other suppliers. Manufacturing, Warehousing, Servicing Equipment comprise the equipment on our factory floor and warehouse areas that may be date dependent, especially micro-processor controlled devices. Environmental Operations in Plant, Offices and Other Sites comprise the Company's HVAC, security/access system, elevators, PBX, fire and alarm systems, and other systems of this nature. Dedicated Research and Development Test Facilities comprise controllers, devices, instruments etc. in the Company's test facilities. As part of the Company's review to assure compliance with Year 2000, the Company has formed a task force (the "Task Force") to oversee Year 2000 and leap year issues. The Task Force has reviewed all IT Systems and Non-IT Systems that have been determined not to be Year 2000 and leap year compliant and has identified and begun implementation of solutions to ensure such compliance. The Company has prioritized the remediation effort to fix critical business systems first, non-critical systems second, and cosmetic changes to reports and displays last. Key critical business systems, such as Financials (General Ledger, Purchasing, Accounts Payable, Accounts Receivable and Fixed Assets) and Material Requirements Planning, are currently 100% compliant. Remaining critical and non-critical business systems are expected to be completed by mid-1999 and cosmetic changes to reports and displays are anticipated to be completed in the fourth quarter of 1999. As part of contingency planning, the Company is developing procedures for those areas that are critical to its business. These plans will be designed to mitigate serious disruptions to the business beyond the end of 1999. The major efforts in contingency planning occurred in the last quarter of 1998 with the expectation that contingency plans will be in place by the end of the second quarter of 1999. Based on current plans and efforts to date, the Company does not anticipate that Year 2000 problems will have a material adverse effect on results of operations or financial condition. The Company has contacted its major customers, vendors, and service suppliers whose systems failures potentially could have a significant impact on the Company's operations to verify their Year 2000 readiness to 26 28 determine potential exposure to Year 2000 issues. The Company has been informed by 75 percent of its major customers, vendors, and service suppliers that such suppliers will be Year 2000 compliant by the Year 2000. Failure of these third parties systems to timely achieve Year 2000 compliance could have a material adverse effect on the business, financial condition, results of operations and prospects of the Company. Year 2000 problems could affect many of the Company's production, distribution, plant equipment, financial and administrative operations. Systems critical to the business which have been identified as non-Year 2000 compliant are either being replaced or corrected through programming modifications. Remediation of problems discovered will be corrected through internal efforts, vendor upgrades, replacement, or decommissioning of obsolete systems and equipment. External and internal costs associated with these efforts are currently expected to be approximately $200,000. As of December 31, 1998, the Company had spent less than $20,000 on costs associated with the Year 2000 effort. The Company does not expect the costs relating to Year 2000 remediation to have a material effect on results of operations or financial condition. The Company has not determined the state of compliance of certain third-party suppliers of services such as phone companies, long distance carriers, financial institutions and electric companies. The failure of any one could severely disrupt the Company's ability to carry on its business as will as disrupt the business of the Company's customers. Failure to provide Year 2000 and leap year compliant business solutions to customers or to receive such business solutions from its suppliers could result in liability to the Company or otherwise have a material adverse effect on the Company's business, results of operations or financial condition. The Company could be affected through disruptions in the operation of the enterprises with which the Company interacts or from general widespread problems or an economic crisis resulting from non-compliant Year 2000 systems. Despite the Company's efforts to address the Year 2000 effect on its internal systems and business operations, such effect could result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. Dependence on Sole Source Components; Component, Assembly & Systems Obsolescence. Certain of the Company's products utilize components that are available in the short term only from a single or a limited number of sources, have been available only on an allocation basis in the past and could be in scarce supply again in the future. Any inability to obtain components in the amounts needed on a timely basis or at commercially reasonable prices could result in delays in product introductions, interruption in product shipments or increases in product costs, which could have a material adverse effect on the Company's business, operating results and financial condition until alternative sources could be developed or design and manufacturing changes could be completed. In addition, from time to time, certain components, subassemblies and systems used by the Company are discontinued by manufacturers, requiring the Company to replace the components, subassembly or system with an equivalent product or if no such equivalent can be identified to modify and re-validate the product design. Any inability to obtain such components on a timely basis or at commercially reasonable prices or to redesign the product in a timely manner could have a material adverse effect on the Company's business, operating results and financial condition until alternative sources could be developed or design and manufacturing changes could be completed. Risks Associated With Recent Management Changes. During 1997 and 1998, the Company has had a number of changes in its management team. Effective January 1, 1997, David L. Schlotterbeck stepped down as the Company's Chief Executive Officer, and Donald J. Judson, the Company's Chairman of the Board, assumed such responsibilities. In March 1997, the Company hired a new Vice President, Direct Sales and in July 1997 hired a new Vice President, Research and Development. In October 1997, the Company hired Frank T. Sample as its new President and Chief Executive Officer, with Mr. Judson stepping down as such. In July 1998, Stan Reese stepped down as the Company's Vice President, Research and Development and was replaced by Stephen Hannah in December 1998. In August 1998 David Clare stepped down as the Company's Vice President, Direct Sales and was replaced by Patric Wiesmann in March 1999. The addition of new senior management has involved increased salary levels which the Company anticipates will result in increased administrative expenses in future periods. Such management changes can also involve disruptions in the 27 29 Company's day-to-day operations, can interrupt continuity in customer relationships and create delays in sales cycles or product release schedules. Although the Company believes that its new senior management will be successful in improving the Company's business, operating results and financial condition, there can be no assurance that such changes will not have a material adverse effect on the Company's business, operating results and financial condition in future periods. Dependence on Key Personnel. The Company's success depends to a large extent on its ability to attract and retain key personnel. The loss of the services, either temporarily or permanently, of any of the members of senior management or other key employees, particularly in sales and marketing and research and development, could have a material adverse effect on the Company's business, operating results and financial condition. In addition, the Company's future success depends to a large extent on its ability to attract and retain additional key management, sales and marketing and research and development personnel. Competition for such personnel is intense. There can be no assurance that the Company will be successful in attracting and retaining such personnel, and the failure to do so could have a material adverse effect on the Company's business, operating results and financial condition. Quantitative and Qualitative Disclosures About Market Risk. The Company's financial instruments include cash and long-term debt. At December 31, 1998, the carrying values of the Company's financial instruments approximated their fair values based on current market prices and rates. It is the Company's policy not to enter into derivative financial instruments. The Company does not currently have any significant foreign currency exposure since it does not transact business in foreign currencies. Due to this, the Company does not have significant overall currency exposure at December 31, 1998. The Company's market risk disclosures are not material and are therefore not required. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements are filed herewith and are listed under Item 14 of Part IV of this report. 28 30 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of VitalCom Inc., We have audited the accompanying balance sheets of VitalCom Inc. the "Company" as of December 31, 1997 and 1998, and the related statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in Item 14a. 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 in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of VitalCom Inc. at December 31, 1997 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. DELOITTE & TOUCHE LLP Costa Mesa, California February 12, 1999 29 31 VITALCOM INC. BALANCE SHEETS ASSETS
DECEMBER 31, ---------------------------- 1997 1998 ------------ ------------ Current assets: Cash and cash equivalents................................. $ 12,157,160 $ 10,460,810 Short-term investments.................................... 6,000,000 5,369,213 Accounts receivable, net of allowance for doubtful accounts and returns of $270,213 and $350,147 in 1997 and 1998............................................... 3,853,066 4,615,295 Inventories (Note 2)...................................... 1,812,499 1,391,899 Prepaid expenses.......................................... 269,462 140,647 ------------ ------------ Total current assets.............................. 24,092,187 21,977,864 Property: Machinery and equipment................................... 1,464,903 1,503,905 Office furniture and computer equipment................... 2,044,083 2,200,732 Leasehold improvements.................................... 87,351 173,883 ------------ ------------ 3,596,337 3,878,520 Less accumulated amortization and depreciation............ (1,659,939) (2,223,301) ------------ ------------ Property, net..................................... 1,936,398 1,655,219 Other assets (Note 1)....................................... 51,935 133,894 Goodwill, net (Note 1)...................................... 627,549 455,573 ------------ ------------ Total assets...................................... $ 26,708,069 $ 24,222,550 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 585,744 $ 429,987 Accrued payroll and related costs......................... 1,198,055 804,887 Accrued warranty costs.................................... 968,245 757,448 Accrued liabilities (Notes 6 and 7)....................... 1,353,675 711,255 Current portion of capital lease obligations (Note 4)..... 21,120 24,990 ------------ ------------ Total current liabilities......................... 4,126,839 2,728,567 Capital lease obligations, less current portion (Note 4).... 60,296 31,552 Commitments and contingencies (Note 4) Redeemable preferred stock, $0.001 par value, 5,000,000 shares authorized; no shares issued and outstanding at December 31, 1997 and 1998 Stockholders' equity (Notes 6 and 8): Common stock, including paid-in capital, $0.0001 par value; 25,000,000 shares authorized; 8,038,547 shares and 8,162,972 shares issued and outstanding at December 31, 1997 and 1998, respectively........................ 37,226,125 37,491,563 Note receivable for common stock sales.................... (194,960) (30,590) Accumulated deficit....................................... (14,510,231) (15,998,542) ------------ ------------ Total stockholders' equity........................ 22,520,934 21,462,431 ------------ ------------ Total liabilities and stockholders' equity........ $ 26,708,069 $ 24,222,550 ============ ============
See notes to financial statements. 30 32 VITALCOM INC. STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Revenues................................................ $18,372,415 $21,793,555 $20,858,926 Cost of sales........................................... 9,680,394 11,476,974 9,561,471 ----------- ----------- ----------- Gross profit............................................ 8,692,021 10,316,581 11,297,455 Operating expenses: Sales and marketing................................... 9,515,482 8,562,095 6,793,879 Research and development.............................. 5,433,738 4,815,543 4,697,750 General and administrative............................ 2,506,980 2,535,586 2,158,558 Restructuring charges (Note 10)....................... 480,996 ----------- ----------- ----------- Total operating expenses...................... 17,937,196 15,913,224 13,650,187 ----------- ----------- ----------- Operating loss.......................................... (9,245,175) (5,596,643) (2,352,732) Other income, net....................................... 975,341 972,968 889,621 ----------- ----------- ----------- Loss before (benefit) provision for income taxes........ (8,269,834) (4,623,675) (1,463,111) (Benefit) provision for income taxes.................... (1,901,995) 26,190 25,200 ----------- ----------- ----------- Net loss................................................ $(6,367,839) $(4,649,865) $(1,488,311) =========== =========== =========== Net loss per basic and diluted common share............. $ (0.90) $ (0.58) $ (0.18) =========== =========== =========== Weighted average basic and diluted common shares........ 7,084,397 8,000,982 8,148,085 =========== =========== ===========
See notes to financial statements. 31 33 VITALCOM INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
COMMON STOCK NOTE TOTAL ----------------------- ACCUMULATED RECEIVABLE FOR STOCKHOLDERS' SHARES AMOUNT DEFICIT STOCK SALES EQUITY (DEFICIT) --------- ----------- ------------ -------------- ---------------- Balances, January 1, 1996....... 1,155,994 $ 519,603 $ (3,492,527) $(2,972,924) Conversion of Series C and D preferred stock to common stock...................... 4,419,629 10,348,486 10,348,486 Stock issued to the public, net (Note 6)............... 2,300,000 25,633,607 25,633,607 Stock options exercised....... 34,250 27,690 27,690 Tax benefit related to stock options.................... 150,140 150,140 Stock issued pursuant to employee stock purchase plan....................... 32,815 153,410 153,410 Net loss...................... (6,367,839) (6,367,839) --------- ----------- ------------ --------- ----------- Balances, December 31, 1996..... 7,942,688 36,832,936 (9,860,366) 26,972,570 Stock options exercised......... 8,500 6,971 6,971 Note receivable for stock sales......................... 40,000 195,000 (195,000) Cash collections on note receivable.................... 40 40 Stock issued pursuant to employee stock purchase plan.......................... 47,359 191,218 191,218 Net loss........................ (4,649,865) (4,649,865) --------- ----------- ------------ --------- ----------- Balances, December 31, 1997..... 8,038,547 37,226,125 (14,510,231) (194,960) 22,520,934 Stock options exercised......... 28,250 24,549 24,549 Note receivable for stock sales......................... 10,000 30,600 (30,600) Cash collections on note receivable.................... 10 10 Cancellation of note receivable for stock..................... (40,000) (194,960) 194,960 Stock issued pursuant to employee stock purchase plan.......................... 52,703 145,264 145,264 Stock issued pursuant to 401(k) plan employer match........... 73,472 259,985 259,985 Net loss........................ (1,488,311) (1,488,311) --------- ----------- ------------ --------- ----------- Balances, December 31, 1998..... 8,162,972 $37,491,563 $(15,998,542) $ (30,590) $21,462,431 ========= =========== ============ ========= ===========
See notes to financial statements. 32 34 VITALCOM INC. STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Cash flows used in operating activities: Net loss.............................................. $(6,367,839) $(4,649,865) $(1,488,311) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization...................... 553,754 776,807 735,338 Provision for doubtful accounts and sales returns.......................................... (330,123) 34,647 79,934 Deferred income taxes.............................. 751,127 Common stock contribution to 401(k) plan........... 259,985 Loss on disposal of property....................... 10,878 35,078 1,311 Changes in operating assets and liabilities: Accounts receivable................................ 4,429,984 (1,588,353) (842,163) Inventories........................................ (1,711,122) 1,378,544 420,600 Income tax receivable.............................. (2,874,276) 2,874,276 Prepaid expenses................................... (188,175) 91,810 128,815 Other assets....................................... 128,600 88,166 (81,959) Accounts payable................................... 116,622 (500,228) (155,757) Accrued payroll and related costs.................. (465,696) 322,711 (393,168) Accrued warranty costs............................. 349,019 16,864 (210,797) Income taxes payable............................... (312,127) 228,294 (21,563) Accrued marketing commitments...................... 198,451 (309,377) Accrued liabilities................................ 699,676 (497,897) (620,857) ----------- ----------- ----------- Net cash used in operating activities.............. (5,011,247) (1,698,523) (2,188,592) Cash flows from investing activities: Purchases of property and equipment................ (1,434,608) (441,661) (283,494) Purchases of short-term investments................ (6,000,000) Proceeds from sale of short-term investments....... 630,787 Proceeds from sale of property..................... 3,550 450 ----------- ----------- ----------- Net cash (used in) provided by investing activities.................................. (1,431,058) (6,441,211) 347,293 Cash flows from financing activities: Repayment of long-term debt........................ (1,565,984) (21,538) (24,874) Cash collections on note receivable................ 40 10 Net proceeds from issuance of preferred and common stock............................................ 25,814,707 198,189 169,813 Tax benefit related to stock options............... 150,140 ----------- ----------- ----------- Net cash provided by financing activities..... 24,398,863 176,691 144,949 Net increase (decrease) in cash and cash equivalents.... 17,956,558 (7,963,043) (1,696,350) Cash and cash equivalents, beginning of year............ 2,163,645 20,120,203 12,157,160 ----------- ----------- ----------- Cash and cash equivalents, end of year.................. $20,120,203 $12,157,160 $10,460,810 =========== =========== =========== Supplemental disclosures of cash flow information: Interest paid......................................... $ 69,259 $ 31,382 $ 12,136 =========== =========== =========== Income taxes paid..................................... $ 360,326 $ 33,025 $ 19,861 =========== =========== =========== Supplemental schedule of noncash transactions: Notes receivable for stock sales...................... $ 195,000 $ 30,600 Cancellation of note receivable for stock............. $ 194,460
See notes to financial statements. 33 35 VITALCOM INC. NOTES TO FINANCIAL STATEMENTS 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General and Nature of Operations -- VitalCom Inc. (the Company) provides radio communications products and computer networks that acquire, interpret and distribute real-time patient monitoring information. The Company's radio and computer networks acquire physiologic data generated by its own proprietary ECG monitors and other manufacturers' bedside equipment located throughout a healthcare facility. The Company's products are sold through a direct sales force to acute care hospitals and integrated healthcare delivery networks ("IHDNs") and on an Original Equipment Manufacturer ("OEM") basis to patient monitoring equipment manufacturers. During the 1994 year, New PCI, Inc. changed its name to ACCUCORE, Inc. and in January 1996, changed its name to VitalCom Inc. Consolidation -- In December 1995, the Company and its wholly owned subsidiary merged. The merger has been treated as a reorganization of entities under common control and accounted for in a manner similar to that of a pooling of interests. The Company's financial statements have been restated accordingly. Fair Value of Financial Instruments -- The Company's balance sheets include the following financial instruments: cash, accounts receivable, accounts payable, and accrued liabilities. The Company considers the carrying value of cash, accounts receivable, accounts payable, and accrued liabilities in the financial statements to approximate fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. Cash Equivalents -- Cash equivalents generally represent highly liquid investments purchased with an original maturity date of three months or less. Short-Term Investments -- The Company accounts for investments in debt and equity securities in accordance with Statement of Financial Accounting Standards No. 115 (SFAS 115), Accounting for Certain Investments in Debt and Equity Securities. SFAS 115 requires investment securities to be classified as trading, available for sale, or held to maturity. Management determines the appropriate classification of its investments at the time of purchase and reevaluates the classification at each balance sheet date. As of December 31, 1998, all investments in the short-term investment portfolio are classified as available for sale. Investments classified as available for sale are required to be recorded at fair value and any temporary difference between an investment's cost and its fair value is recorded as a separate component of stockholders' equity. As of December 31, 1998, the fair value of investments approximates investment cost. Inventories -- Inventories are stated at the lower of weighted average cost or market. Property -- Property is stated at cost. Depreciation is provided using the straight-line method and the double declining balance method over the estimated useful lives of the related assets, generally three to eight years. Leasehold improvements are amortized over the lesser of the estimated useful lives of the related improvements or the related lease term. Goodwill -- Goodwill represents the excess purchase cost over the net assets acquired and is amortized over 20 years using the straight-line method. The Company periodically evaluates the recoverability of goodwill based on a profitability analysis related to its product sales and has determined that there was no impairment of goodwill at December 31, 1998. Long-Lived Assets -- The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards No. 121 (SFAS 121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed. In accordance with SFAS No. 121, long-lived assets to be held are reviewed for events or changes in circumstances which indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of long- 34 36 lived assets to determine whether or not an impairment to such value has occurred and has determined that there was no impairment at December 31, 1998. Revenue Recognition -- Revenues from both Enterprise-wide monitoring(TM) systems and OEM products, which consist of both hardware and software, are recognized upon shipment if no significant vendor obligations remain and collection of the related receivable is probable. The Company accounts for insignificant vendor obligations and post-contract support at the time of product delivery by accruing such costs and recognizing them ratably on completion of performance. There is no right of return on sales. Revenues related to service contracts with customers, which are insignificant, are deferred and amortized over the terms of the contracts, generally one year. Software Development Costs -- Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. Because the Company believes that its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs are capitalized as of December 31, 1997 or 1998. Income Taxes -- The Company accounts for income taxes in accordance with Statement of Financial Accounting Standard No. 109 (SFAS No. 109), Accounting for Income Taxes. This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in the Company's financial statements or tax returns. Measurement of the deferred items is based on enacted tax laws. Net Loss Per Share -- In February 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, Earnings Per Share (SFAS No. 128). This statement is effective for periods ending after December 15, 1997 and requires restatement of all prior periods. The Statement redefines earnings per share (EPS) under generally accepted accounting principles, making EPS comparable to international standards. SFAS 128 requires dual presentation of Basic and Diluted EPS by entities with complex capital structures, replacing Primary and Fully diluted EPS under APB Opinion No. 15. Basic EPS excludes dilution from common stock equivalents and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from common stock equivalents, similar to fully diluted EPS, but uses only the average stock price during the period as part of the computation. The Company has adopted the provisions of SFAS 128 in the accompanying financial statements. Upon adoption of SFAS 128, the Company's basic loss per share for the years ended December 31, 1996 and 1997 were $(0.90) and $(0.58) respectively. Common stock equivalents are excluded from the calculation of diluted EPS in loss years, as the impact is antidilutive. Net Loss Applicable to Common Stockholders -- Net loss applicable to common stockholders represents net loss less preferred dividends and accretion attributable to preferred stock redemption value. See Note 6 of Notes to Financial Statements. Recent Accounting Pronouncements -- In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive Income, and No. 131 (SFAS 131), Disclosures About Segments of an Enterprise and Related Information. These statements are effective for fiscal years commencing after December 15, 1997. SFAS 130 establishes standards for the reporting and disclosure of comprehensive income (revenues, expenses, gains and losses) in a full set of general purpose financial statements. For the year ended December 31, 1998, there was no difference between comprehensive income and amounts currently reported in the Company's financial statements. SFAS 131 establishes standards for the reporting of information about operating segments of a business and is reported in Note 5 of Notes to Financial Statements. 35 37 In October 1997, the American Institute of Certified Public Accountants issued SOP 97-2, Software Revenue Recognition, which supercedes SOP 91-1 and is effective for transactions entered into for fiscal years beginning after December 15, 1997. While some principles remain the same, there are several key differences between the two pronouncements, including accounting for multiple element arrangements. SOP 97-2 addresses revenue recognition from a conceptual level and does not specifically provide implementation guidance. Management believes the implementation of SOP 97-2 did not have a material effect on the Company's financial position or results of operations. In March 1998, the American Institute of Certified Public Accountants issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use and requires costs incurred in the application development stage (whether internal or external) to be capitalized. This SOP is applicable to all financial statements for fiscal years beginning after December 15, 1998. Management does not believe the implementation of SOP 98-1 will have a material effect on the Company's financial position or results of operations. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Significant Concentrations. Customer Concentrations -- The Company's OEM revenues, which represented 55.6%, 53.7% and 57.9% of the Company's total revenues in 1996, 1997 and 1998 respectively, have historically been concentrated in a small number of OEM customers. Approximately 41.7%, 45.6% and 46.0% of 1996, 1997 and 1998 total revenues, respectively, were to three customers. The loss of, or a reduction in sales to, any such OEM customers would have a material adverse effect on the Company's business, operating results and financial condition. Further, sales of the Company's OEM products are dependent to a large extent upon the Company's OEM customers selling patient monitoring devices that include the Company's OEM products as necessary components. Any inability of such OEM customers to sell such systems, or any election by such OEM customers not to include the Company's products as components therein, could have a material adverse effect on the Company's business, operating results and financial condition. Supplier Concentration -- Certain of the Company's products utilize components that are available in the short term only from a single or a limited number of sources. Certain of these components, such as semiconductor devices, have been available only on an allocation basis in the past and could be in scarce supply again in the future. Any inability to obtain components in the amounts needed on a timely basis or at commercially reasonable prices could result in delays in product introductions or interruption in product shipments or increases in product costs, which could have a material adverse effect on the Company's business, operating results and financial condition until alternative sources could be developed or design and manufacturing changes could be completed. Any such design or manufacturing changes or increased costs could result in delayed shipments and significant expenses in a particular quarter and therefore could materially adversely affect operating results for any such quarter or other period. 36 38 2. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out method) or market and consist of the following at December 31:
1997 1998 ---------- ---------- Raw materials....................................... $1,125,209 $ 895,145 Work-in-process..................................... 110,227 47,156 Finished goods...................................... 577,063 449,598 ---------- ---------- $1,812,499 $1,391,899 ========== ==========
3. REVOLVING LINE OF CREDIT In December 1998, the Company renewed a secured lending arrangement (the "Agreement") with Silicon Valley Bank, providing for a $5.0 million revolving line of credit agreement bearing interest at either the bank's prime rate or LIBOR interbank market rate, as selected by the Company. The bank does not have security interest in any of the Company's assets until the Company is borrowing under the line of credit. The Agreement expires in December 1999. At December 31, 1998, there were no borrowings outstanding under the Agreement and the Company was in compliance with all covenants. The financial covenants require that the Company maintain a quick assets ratio of not less than 1.75 to 1, maintain tangible net worth of not less than $18,000,000, maintain a ratio of total liabilities to tangible net worth of not more than .75 to 1 and not incur a net loss (after taxes) for the fiscal year ended December 31, 1998 in excess of $3,250,000; nor incur a net loss (after taxes) for the fiscal year ending December 31, 1999 in excess of $2,000,000. As such, the bank held no security interest in any of the Company's assets. 4. COMMITMENTS AND CONTINGENCIES The Company leases its facilities and certain equipment under a noncancelable operating lease and a capital lease that expires at various dates through 2003. Future minimum rent under such leases is as follows:
CAPITAL OPERATING YEAR ENDING DECEMBER 31 LEASE LEASE ----------------------- -------- --------- 1999................................................... $ 31,815 $265,860 2000................................................... 29,163 265,860 2001................................................... 180,600 2002................................................... 10,000 Thereafter............................................. 7,560 -------- -------- 60,978 $729,880 ======== Less amount representing interest...................... (4,436) -------- Present value of minimum lease payments................ 56,542 Less current portion................................... (24,990) -------- Capital lease obligations due after one year........... $ 31,552 ========
Capital leases included in property at December 31, 1997 and 1998, net of accumulated depreciation, were approximately $93,548 and $74,687, respectively. The Company's rent expense was $340,127, $356,265 and $349,832 for the years ended December 31, 1996, 1997 and 1998, respectively. 5. SEGMENT REPORTING Utilizing the management approach, the Company has broken down its business based upon sales through its two distribution channels. The Company does not allocate operating expenses to these segments, 37 39 nor does it allocate specific assets to these segments. Therefore, segment information reported includes only net sales. Selected information regarding the Company's product sectors is as follows:
OEM ENTERPRISE-WIDE PRODUCTS PRODUCTS ----------- --------------- Year ended December 31, 1996 Net Sales...................................... $10,209,199 $8,163,216 Year ended December 31, 1997 Net Sales...................................... $12,540,632 $9,252,923 Year ended December 31, 1998 Net Sales...................................... $12,071,380 $8,787,546
6. STOCKHOLDERS' EQUITY During the year ended December 31, 1996, the Company issued 2,300,000 shares of common stock in its initial public offering, raising approximately $25,633,607, net of expenses. Effective with the initial public offering, all 3,055,328 shares of the Company's Series C preferred stock and all 1,364,301 shares of Series D preferred stock converted to one share each of the Company's common stock. In addition, during the year ended December 31, 1996, the Company issued 32,815 shares of its common stock under its Employee Stock Purchase Plan and 34,250 shares of its common stock for exercises of stock options under the 1993 Stock Option Plan, for net proceeds of $153,410 and $27,690, respectively. During the year ended December 31, 1997, the Company issued 47,359 shares of its common stock under its Employee Stock Purchase Plan for net proceeds of $191,218, and 8,500 shares of its common stock for exercises of stock options under the 1993 Stock Option Plan for net proceeds of $6,971. The Company also issued 40,000 shares of its common stock, under interest bearing, non-recourse notes in the amount of $195,000 and received net proceeds of $40. During the year ended December 31, 1998, the Company issued 52,703 shares of its common stock under its Employee Stock Purchase Plan for net proceeds of $145,264; 73,472 shares of its common stock issued under the VitalCom Employee Stock 401(k) and Profit Sharing Plan for the employer match valued at $259,985 and 28,250 shares of its common stock for exercises of stock options under the 1993 Stock Option Plan for net proceeds of $24,549. During the year ended December 31, 1998, the Company also cancelled 40,000 shares of its common stock that were issued during 1997 under interest bearing, non-recourse notes for $195,000. The cancellations were due to the purchasers' forfeiting their right to purchase the shares. In addition, the Company also issued 10,000 shares of its common stock, under an interest-bearing, nonrecourse note in the amount of $30,600 and received net proceeds of $10 during 1998. 7. 401(K) AND PROFIT-SHARING PLAN The Company has a contributory profit-sharing plan which covers substantially all of its employees. Effective July 1, 1993, the Company amended its profit-sharing plan to include a 401(k) provision (the "401(k) Plan"). The 401(k) provisions in the 401(k) Plan allow eligible employees to contribute up to 15% of their income on a tax-deferred basis, subject to IRS discrimination and maximum dollar deferral rules. The Company, at its sole election, may make matching contributions to the 401(k) Plan. The Board of Directors approved a discretionary employer matching contribution of $0.50 for each $1.00 the employee contributes on the first 12% of compensation deposited as elective contributions, subject to 401(k) Plan limitations and IRS regulations, for calendar years 1996, 1997 and 1998. The Company's matching contributions vest to employees at 25% per year for each full year of continuous service. The Company's 401(k) matching expense was $300,006, $255,016 and $356,006 for the years ended December 31, 1996, 1997 and 1998, respectively. For the years ended December 31, 1996 and 1997 the Company's employer matching contribution was made in cash. For the year ended December 31, 1998 the Company's employer matching contribution was made in the Company's common stock at the end of each calendar quarter (see Note 6 of Notes to Financial Statements). The employer matching contribution was made in fractional shares, carried to two decimal places, by dividing 38 40 the employee's employer match by the fair market value of the Company's common stock as determined by the closing price on NASDAQ on the last trading day of each calendar quarter. The 401(k) Plan provides for an annual contribution to a self-directed employee trust in an amount to be determined by the Board of Directors, but limited to the amount allowable for income tax purposes. Employees may make annual contributions to the 401(k) Plan of not more than 10% of their annual compensation. The Company's contributions vest to the employees at 20% for the first two years and 20% per year for years three through six for each full year of continuous service, and are allocated based on employee compensation. The Company had no profit-sharing expense for the years ended December 31, 1996, 1997 and 1998. 8. STOCK BASED COMPENSATION PLANS At December 31, 1998 the Company had three stock options plans and an employee stock purchase plan, which are described below. The Company accounts for these plans in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations (APB 25). In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation. As permitted by SFAS 123, the Company has chosen to continue to account for its stock-based compensation plans under APB 25 and provide the expanded disclosures specified in SFAS 123. No compensation expense has been recognized for its stock-based compensation plans. Had compensation cost been determined using the provisions of SFAS 123, the Company's net loss and loss per share would have been increased to the pro forma amounts indicated below:
1996 1997 1998 ----------- ----------- ----------- Net loss As reported............................. $(6,367,838) $(4,649,865) $(1,488,311) Pro forma............................... (6,567,038) (5,109,243) (2,728,095) Net loss per basic and diluted share As reported............................. $ (0.90) $ (0.58) $ (0.18) Pro forma............................... $ (0.93) $ (0.64) $ (0.33)
For purposes of estimating the compensation cost of the Company's option grants and employee stock purchase plan in accordance with SFAS 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in the years 1996, 1997 and 1998, respectively: expected volatility of 67%, 52% and 80%; risk free interest rate of 6.25%; and expected lives of 10 years for the 1993 Stock Option Plan and the 1996 Stock Option Plan. Effective September 22, 1993, the Company adopted the 1993 Stock Option Plan (the "Option Plan"), as amended, to permit the Company's personnel and directors of the Company to participate in ownership of the Company. The Option Plan is administered by a committee consisting of two or more non-employee directors of the Company. Each option agreement includes a provision requiring the optionee to consent to the terms of the Agreement. The Option Plan provides for the grant of incentive stock options under the applicable provisions of the Internal Revenue Code or nonqualified options. In October 1996, the Board of Directors approved non-officer employees holding outstanding options to purchase 45,400 Common Shares of the Company at exercise prices equal to or in excess of $12.87 to exchange such options for new options at $6.00 per share, with the new options having a vesting schedule that re-started on the date of the new option exchange grant. In November 1998, the Company's Board of Directors approved a proposal allowing the Company's employees and officers to surrender for cancellation any existing stock option grants and have a new stock option issued for the equivalent number of shares with one half at a new exercise price of $3.00 per share and the other half at a new exercise price of $4.00 per share. The new options vest over the Company's standard four year vesting period, with the vesting period starting six months later than the vesting commencement date of the surrendered option. A six month blackout period in which none of the new options could be exercised was also instituted. Mr. Sample, the Company's President and Chief Executive Officer is 39 41 under a nine-month blackout period. A total of 447,763 options were cancelled with exercise prices ranging from $4.00 to $6.00 per share. Up to 2,339,885 shares of the Company's common stock were reserved for issuance under the Option Plan. The following table summarizes activity under the 1993 Option Plan, as amended.
NUMBER OF NUMBER OF WEIGHTED AVERAGE OPTIONS SHARES PRICE PER SHARE EXERCISE PRICE EXERCISABLE ---------- -------------------- ---------------- ----------- Balance, January 1, 1996....... 652,723 $ 0.60 - $ 5.72 $ 4.74 Granted...................... 131,109 6.00 - 15.75 11.22 Exercised.................... (34,250) 0.60 - 1.28 0.81 Canceled..................... (89,358) 0.60 - 15.75 9.09 ---------- Balance, December 31, 1996..... 660,224 0.60 - 15.75 5.64 232,035 Granted...................... 1,263,937 3.875 - 5.50 4.64 Exercised.................... (8,500) 0.60 - 1.28 0.82 Canceled..................... (310,808) 1.28 - 15.75 6.33 ---------- Balance, December 31, 1997..... 1,604,853 0.60 - 15.75 4.74 292,017 Granted...................... 1,597,070 2.625 - 4.438 3.66 Exercised.................... (28,250) 0.60 - 1.41 0.87 Canceled..................... (1,733,633) 1.28 - 6.00 4.60 ---------- Balance, December 31, 1998..... 1,440,040 $ 0.60 - $ 4.00 $ 3.46 325,958 ==========
At December 31, 1998, 777,268 options were available for grant under the 1993 Option Plan. The Company has reserved an aggregate of 100,000 shares of Common Stock for issuance under its 1996 Stock Option Plan (the "1996 Plan") to permit employees and consultants to the Company to participate in ownership of the Company. The 1996 Plan was adopted by the Board of Directors in October 1996. The 1996 Plan is administered by a committee consisting of two or more non-employee directors of the Company. Each option agreement includes a provision requiring the optionee to consent to the terms of the 1996 Plan. The Option Plan provides for the grant of nonqualified options. The following table summarizes activity under the 1996 Plan.
NUMBER OF NUMBER OF WEIGHTED AVERAGE OPTIONS SHARES PRICE PER SHARE EXERCISE PRICE EXERCISABLE --------- --------------- ---------------- ----------- Balance, January 1, 1996 Granted...................... 60,800 $5.50 - $6.00 $5.98 Exercised Canceled..................... (5,200) 5.50 - 6.00 6.00 ------- Balance, December 31, 1996..... 55,600 5.50 - 6.00 5.98 Granted...................... 35,500 4.97 4.97 Exercised Canceled..................... (21,775) 4.97 - 6.00 5.77 ------- Balance, December 31, 1997..... 69,325 4.97 - 6.00 5.52 9,675 Granted...................... 45,900 3.00 - 4.00 3.70 Exercised Canceled..................... (67,168) 4.97 - 6.00 4.70 ------- Balance, December 31, 1998..... 48,057 $3.00 - $4.00 $3.46 17,816 =======
At December 31, 1998, 51,943 options were available for grant under the 1996 Plan. The weighted average fair market value of options granted under the 1993 Stock Option Plan and the 1996 Stock Option Plan in 1996, 1997 and 1998 was $14.77, $4.78 and $3.49 respectively. 40 42 The following table summarizes information about stock options outstanding under the 1993 Stock Option Plan and the 1996 Stock Option Plan at December 31, 1998:
OPTIONS OUTSTANDING --------------------------------------------------- OPTIONS EXERCISABLE WEIGHTED AVERAGE ------------------------------- NUMBER REMAINING WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ------------------------ ----------- ---------------- ---------------- ----------- ---------------- $0.60 - $2.63......... 44,000 6.0 years $0.92 37,500 $0.91 $3.00 - $4.00......... 1,399,784 9.2 years 3.38 264,287 3.50 $4.75 - $6.00......... 44,313 9.0 years 5.47 41,987 5.50 --------- ------- 1,488,097 9.1 years $3.49 343,774 $3.46 ========= =======
The Company has reserved an aggregate of 300,000 shares of Common Stock for issuance under its 1996 Employee Stock Purchase Plan (the "ESPP"). The ESPP was adopted by the Board of Directors in January 1996 and approved by the Company's stockholders prior to the consummation of the Company's initial public offering in February 1996. The ESPP is intended to qualify under Section 423 of the Internal Revenue Code of 1986, as amended, and permits eligible employees of the Company to purchase Common Stock through payroll deductions of up to 10% of their compensation provided that no employee may purchase more than $25,000 worth of stock in any calendar year. The ESPP was implemented by an offering period commencing on February 14, 1996 and ending on the last business day in the period ending October 31, 1996. Each subsequent offering period (an "Offering Period") commences on the day following the end of the prior Offering Period and has a duration of six months. The price of Common Stock purchased under the ESPP will be 85% of the lower of the fair market value of the Common Stock on the first or last day of each offering period. The ESPP will expire in the year 2006. In the years ended December 31, 1996, 1997 and 1998 the Company issued 32,815, 47,359 and 52,703 shares of Common Stock, respectively under the ESPP for $153,410, $191,218 and $145,264 respectively. At December 31, 1998, $23,396 had been withheld from employee earnings for stock purchases under the ESPP. For purposes of estimating the compensation cost of employees' rights under the ESPP in accordance with SFAS 123, the fair value of the purchase rights has been estimated using the Black-Scholes model with the following assumptions used for 1998; expected volatility of 113%; risk free interest rate of 6.25%; expected life of six months. The weighted-average fair value of those purchase rights granted in 1998 was $0.77. The Company has reserved an aggregate of 60,000 shares of Common Stock for issuance under its 1996 Director Option Plan (the "Director Plan"). The Director Plan was adopted by the Board of Directors in February 1996. The Director Plan provides for the grant of an option to purchase a number of shares of Common Stock (the "First Option") to be determined by the incumbent Board of Directors to each non-employee director who first becomes a non-employee director after the effective date of the Director Plan. Annually, each outside director shall automatically be granted an option to purchase 4,000 shares (a "Subsequent Option"), provided he or she is then a non-employee director and, as of such date, he or she shall have served on the Board for at least the preceding six months. Each non-employee director will be eligible to receive a Subsequent Option, regardless of whether such non-employee director was eligible to receive a First Option. First Options and each Subsequent Option will have a term of ten years. One-quarter of the shares subject to a First Option will vest one year after their date of grant and an additional one-quarter will vest at the end of each year thereafter, provided that the optionee continues to serve as a director on such dates. Similarly, one-quarter of the shares subject to a Subsequent Option will vest one year after the date of the option grant and an additional one-quarter will vest at the end of each year thereafter, provided that the optionee continues to serve as a director on such date. The exercise prices of the First Option and each Subsequent Option will be 100% of the fair market value per share of the Company's Common Stock on the date of the grant of the option. There was no activity in the Director Plan during the year ended December 31, 1996. At December 31, 1997 and 1998 there were no options outstanding and 60,000 shares available for issuance. 41 43 9. INCOME TAXES The (benefit) provision for income taxes is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Current: Federal........................... $(2,710,593) $ $ State............................. 31,904 26,190 25,200 ----------- ----------- ----------- (2,678,689) 26,190 25,200 =========== =========== =========== Deferred: Federal........................... 31,804 (1,861,315) (804,805) State............................. (782,931) 256,150 (304,624) ----------- ----------- ----------- (751,127) (1,605,165) (1,109,429) ----------- ----------- ----------- Change in valuation allowance....... 1,527,821 1,605,165 1,109,429 ----------- ----------- ----------- $(1,901,995) $ 26,190 $ 25,200 =========== =========== ===========
A reconciliation of the (benefit) provision for income taxes to the amount of income tax expense that would result from applying the federal statutory rate (35%) to income before provision for income taxes is as follows:
YEAR ENDED DECEMBER 31, ----------------------- 1996 1997 1998 ----- ----- ----- Income tax expense at statutory rate................ (35.0)% (35.0)% (35.0)% State tax expense, net of federal benefit........... 1.4 .6 1.1 Research and development credits.................... (2.6) Change in valuation allowance....................... 11.0 32.5 32.5 Other............................................... 2.2 2.5 3.1 ----- ----- ----- (23.0)% 0.6% 1.7% ===== ===== =====
Deferred tax assets and liabilities at December 31 are as follows:
1996 1997 1998 ----------- ----------- ----------- Current: Accrued compensation and related costs.......................... $ 212,923 $ 219,189 $ 161,281 Warranty reserves................. 411,948 414,796 324,491 Sales returns and bad debt allowance...................... 102,000 115,759 127,298 Inventory reserves................ 252,577 312,191 294,622 Other............................. (323,552) (227,556) (331,465) ----------- ----------- ----------- 655,896 834,379 576,227 Long-term: Amortization and depreciation..... (108,693) (82,569) (170,558) Net operating loss carryforward... 558,567 1,760,657 2,591,947 Tax credit carryforward........... 422,051 620,519 1,244,799 ----------- ----------- ----------- 871,925 2,298,607 3,666,188 ----------- ----------- ----------- Valuation allowance................. $(1,527,821) $(3,132,986) $(4,242,415) ----------- ----------- ----------- $ $ $ =========== =========== ===========
As of December 31, 1998, a valuation allowance of $4,242,415 has been provided based upon the Company's assessment of the future realizability of certain deferred tax assets, as it is more likely than not that sufficient taxable income will not be generated to realize these temporary differences. 42 44 At December 31, 1998, the Company had federal and state net operating loss carryforwards of approximately $6.6 million and $3.9 million, respectively, which will begin expiring in the years 2013 and 2002, respectively. At December 31, 1998, the Company had tax credit carryforwards for federal and state purposes of $738,210 and $506,589 respectively, which will begin expiring in the years 2009 and 2012, respectively. 10. RESTRUCTURING CHARGES Restructuring charges of approximately $461,000 resulted from the Company's November 1996 restructuring of operations which include severance and other employee termination costs. The restructuring costs were all paid by September 24, 1997. 43 45 VITALCOM INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND END DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD ----------- ---------- ---------- ---------- --------- Provision for Doubtful Accounts and Sales Returns: December 31, 1996............................ $565,689 $(330,123) $235,566 December 31, 1997............................ 235,566 34,647 270,213 December 31, 1998............................ $270,213 $ 79,934 $350,147
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in or disagreements with accountants on accounting or financial disclosure matters during the Company's two most recent fiscal years. PART III Pursuant to Paragraph G(3) of the General Instructions to Form 10-K, portions of the information required by Part III of Form 10-K are incorporated by reference from the Company's Proxy Statement to be filed with the Securities and Exchange Commission in connection with the 1998 Annual Meeting of Stockholders (the "Proxy Statement"). ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning the directors of the Company appears in the Company's Proxy Statement under the caption "Election of Directors" and is incorporated herein by this reference EXECUTIVE OFFICERS Set forth below is certain information as of February 27, 1999 with respect to each person who is an executive officer of the Company:
NAME AGE POSITION ---- --- -------- Frank T. Sample 53 President & Chief Executive Officer, Chairman of the Board Warren J. Cawley 58 Vice President, Business Development John R. Graham 53 Vice President, Corporate Alliances Steve Hannah 40 Vice President, Research & Development Cheryl Isen 38 Vice President, Corporate Communications Shelley B. Thunen 46 Vice President, Finance, Chief Financial Officer and Corporate Secretary Patric Wiesmann 37 Vice President, Sales
Frank T. Sample, President and Chief Executive Officer, Chairman of the Board -- Mr. Sample has served as a Director of the Company and also has served as its President and Chief Executive Officer since October 1997. In February 1998, Mr. Sample was appointed Chairman of the Board. From August 1997 to October 1997, Mr. Sample served as Executive Vice President at IDX Systems Corporation, a leading provider of information technology to the healthcare industry. From December 1990 to July 1997, when PHAMIS, Inc. was merged into IDX Systems Corporation, he was President and Chief Executive Officer at PHAMIS, Inc., a provider of patient-centered medical record information systems. He is currently a Director 44 46 of IDX Systems Corporation. Mr. Sample holds a B.B.A. in Business Administration from Cleveland State University. Warren J. Cawley, Vice President Business Development -- Mr. Cawley has served as Vice President, Business Development since July 1996. From 1989 through June 1996, Mr. Cawley served as Vice President, Direct Sales for the Company. From 1985 through 1989, Mr. Cawley served as Vice President, OEM Sales for the Company. Prior to 1985, Mr. Cawley served in various sales and management capacities at several medical device companies. Mr. Cawley holds an M.B.A. degree and a B.S. degree from the University of Southern California. John R. Graham, Vice President Corporate Alliances -- Mr. Graham has served as Vice President, Corporate Alliances since January 1999 and Vice President, OEM Sales of the Company from 1989 through 1998. Prior to joining the Company in 1989, he acted as a consultant and held various positions at a number of healthcare organizations and technology-based companies, including serving as President and Chief Executive Officer of a medical device company. Mr. Graham holds an M.S. degree in Bioengineering from Columbia University and a B.S.E.E. degree from Northeastern University. Steve Hannah, Vice President, Research and Development -- Mr. Hannah joined the Company in December 1998 as Vice President, Research and Development. Prior to joining the Company, Mr. Hannah led Product Development, Systems Engineering at Sony Trans Com Inc. Prior to Sony, Mr. Hannah developed hardware and software products and managed large development projects at Hughes Aircraft Company. Mr. Hannah holds a B.S. degree in Computer Engineering from the University of Michigan. Cheryl Isen, Vice President, Corporate Communications -- Ms. Isen joined the Company in January 1998 as Senior Director of Corporate Communications and was promoted to Vice President in January 1999. Prior to joining the Company, Ms. Isen served as Senior Director of Corporate Communications at PHAMIS, Inc., which merged with IDX Systems in 1997, where she was responsible for company-wide communications. Prior to PHAMIS, Inc., Ms. Isen was Manager of Marketing Communications for the Target Marketing Services division of TRW. Ms. Isen holds a B.A. degree in Journalism and Marketing from San Diego State University. Shelley B. Thunen, Vice President, Finance, Chief Financial Officer and Corporate Secretary -- Ms. Thunen has served as Vice President, Finance and Chief Financial Officer of the Company since August 1992. Prior to joining the Company, Ms. Thunen served as the Vice President -- Finance of Hybrid Designs, Inc., a manufacturer of hybrid microelectronic circuits, from August 1990 to August 1992 and concurrently from January 1992 through August 1992 served as General Manager of a related company. Prior to August 1990, Ms. Thunen was a financial consultant specializing in company turnarounds and served in various financial management capacities at several technology-based companies, including as Chief Financial Officer of a publicly traded computer company. Ms. Thunen holds an M.B.A. degree and a B.A. degree in Economics from the University of California at Irvine. Patric Wiesmann, Vice President, Sales -- Mr. Wiesmann joined VitalCom in March 1999 as Vice President, Sales. Prior to joining the Company, Mr. Wiesmann served as Vice President of Sales and Marketing/Business Development at Mackie Designs, Inc where Mr. Wiesmann managed worldwide sales and marketing, product management and sales administration. Prior to Mackie, Mr. Wiesmann was Vice President of Sales and Marketing at Lang Manufacturing Company and Baxter Healthcare Corporation. Mr. Wiesmann holds a B.A. degree in Biology and Economics from the University of Puget Sound in Tacoma, Washington. 45 47 ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation appears in the Company's Proxy Statement under the caption "Executive Compensation" and is incorporated herein by this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning the security ownership of certain beneficial owners and management appears in the Company's Proxy Statement under the caption "Election of Directors" and is incorporated herein by this reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning certain relationships and related transactions appears in the Company's Proxy Statement under "Election of Directors" and is incorporated herein by this reference. 46 48 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Form 10-K: (1) Financial Statements. The following Financial Statements of VitalCom Inc. and Independent Auditors' Report are filed as part of this report. Independent Auditors' Report Balance Sheets at December 31, 1997 and 1998 Statements of Operations for the years ended December 31, 1996, 1997 and 1998 Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1996, 1997 and 1998 Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998 Notes to Financial Statements (2) Financial Statement Schedules. The following financial statement schedule of VitalCom Inc. are filed as part of this report and should be read in conjunction with the Financial Statements of VitalCom Inc. Schedule II -- Valuation and Qualifying Accounts Schedules not filed herein are omitted because of the absence of conditions under which they are required or because the information called for is shown in the financial statements or notes thereto. (b) Reports on Form 8-K: None 47 49 (c) Exhibits
EXHIBIT NO. DESCRIPTION OF EXHIBIT ------- ---------------------- 3.1 Amended and Restated Certificate of Incorporation of the Registrant, as currently in effect.(1) 3.2 Amended and Restated Bylaws of the Registrant, as currently in effect.(1) 4.1 Specimen Common Stock Certificate.(1) 4.2 Form of Voting Agreement among the Registrant, Warburg, Pincus Ventures, L.P., ABS Capital Partners, L.P. and Donald W. Judson.(1) 10.1 Registrant's 1993 Stock Option Plan, as amended, and forms of agreement thereunder.(6) 10.2 Registrant's 1996 Employee Stock Purchase Plan.(7) 10.3 Lease dated July 28, 1995 between Catellus Development Corporation as Landlord and Registrant as Tenant.(1) 10.4 Warburg Securities Purchase Agreement dated as of June 1, 1995 by and among the Registrant, Warburg, Pincus Ventures, L.P., ABS Capital Partners, L.P., Vertical Fund Associates, L.P., Vertical Partners, L.P. and BT Capital Partners, Inc.(1) 10.5 Form of Indemnification Agreement between the Registrant and its executive officers and directors.(1) 10.6 Form of Employment Agreement between the Registrant and certain of its executive officers.(1) 10.7 Form of Employee Severance Agreement with certain of the Registrant executive officers.(1) 10.8 Registrant's 1996 Director Option Plan.(1) 10.9 Registrant's 1996 Stock Option Plan and related agreements.(8) 10.10 Promissory Note Secured by Deed of Trust dated October 17, 1996 of David L. Schlotterbeck in favor of the Registrant.(2) 10.11 Loan Agreement between the Registrant and Silicon Valley Bank dated February 26, 1993, as amended through August 6, 1996.(1) 10.12 Common Stock Purchase Agreement dated July 14, 1998 between the Registrant and Irwin & Browning, Inc. 10.13 Silicon Valley Bank Amendment to Loan Agreement 23.1 Independent Auditors' Consent. 24.1 Power of Attorney (Included on page 45 hereof). 27 Financial Data Schedule
- --------------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (File No. 333-00268-LA) in the form in which it was declared effective on February 13, 1997. (2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. (4) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (5) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. (6) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-47173). (7) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-67109). (8) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-33901). 48 50 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. VitalCom Inc. By: /s/ FRANK T. SAMPLE ------------------------------------ Frank T. Sample President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Frank T. Sample and Shelley B. Thunen and each of them, jointly and severally, his or her attorneys-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign any and all amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant on March 30, 1999 in the capacities indicated.
SIGNATURE TITLE --------- ----- /s/ FRANK T. SAMPLE Chairman of the Board, - --------------------------------------------- President and Chief Executive Officer Frank T. Sample (Principal Executive Officer) /s/ SHELLEY B. THUNEN Vice President -- Finance - --------------------------------------------- and Chief Financial Officer Shelley B. Thunen (Principal Financial and Accounting Officer) /s/ PATRICK T. HACKETT Director - --------------------------------------------- Patrick T. Hackett /s/ JACK W. LASERSOHN Director - --------------------------------------------- Jack W. Lasersohn /s/ TIMOTHY T. WEGLICKI Director - --------------------------------------------- Timothy T. Weglicki
49 51 EXHIBIT INDEX
SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION OF EXHIBIT PAGES ------- ---------------------- ------------ 3.1 Amended and Restated Certificate of Incorporation of the Registrant, as currently in effect(1)....................... 3.2 Amended and Restated Bylaws of the Registrant, as currently in effect(1)................................................ 4.1 Specimen Common Stock Certificate(1) 4.2 Form of Voting Agreement among the Registrant, Warburg, Pincus Ventures, L.P., ABS Capital Partners, L.P. and Donald W. Judson(1)................................................ 10.1 Registrant's 1993 Stock Option Plan, as amended, and forms of agreement thereunder(6).................................. 10.2 Registrant's 1996 Employee Stock Purchase Plan(7)........... 10.3 Lease dated July 28, 1995 between Catellus Development Corporation as Landlord and Registrant as Tenant(1)......... 10.4 Warburg Securities Purchase Agreement dated as of June 1, 1995 by and among the Registrant, Warburg, Pincus Ventures, L.P., ABS Capital Partners, L.P., Vertical Fund Associates, L.P., Vertical Partners, L.P. and BT Capital Partners, Inc(1)...................................................... 10.5 Form of Indemnification Agreement between the Registrant and its executive officers and directors(1)..................... 10.6 Form of Employment Agreement between the Registrant and certain of its executive officers(1)........................ 10.7 Form of Employee Severance Agreement with certain of the Registrant executive officers(1)............................ 10.8 Registrant's 1996 Director Option Plan(1)................... 10.9 Registrant's 1996 Stock Option Plan and related agreements(8)............................................... 10.10 Promissory Note Secured by Deed of Trust dated October 17, 1996 of David L. Schlotterbeck in favor of the Registrant(2)............................................... 10.11 Loan Agreement between the Registrant and Silicon Valley Bank dated February 26, 1993, as amended through August 6, 1996(1)..................................................... 10.12 Common Stock Purchase Agreement dated July 14, 1998 between the Registrant and Irwin & Browning, Inc. .................. 10.13 Silicon Valley Bank Amendment to Loan Agreement............. 23.1 Independent Auditors' Consent............................... 24.1 Power of Attorney (Included on page 45 hereof).............. 27 Financial Data Schedule.....................................
- --------------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (File No. 333-00268-LA) in the form in which it was declared effective on February 13, 1997. (2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. (4) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. 52 (5) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. (6) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-47173). (7) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-67109). (8) Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 333-33901). EX-10.12 2 COMMON STOCK PURCHASE AGREEMENT 1 EXHIBIT 10.12 VITALCOM INC. COMMON STOCK PURCHASE AGREEMENT THIS AGREEMENT is made as of July 14, 1998, between VitalCom Inc., a Delaware corporation (the "Company"), and Irwin & Browning, Inc., a Georgia corporation ("Purchaser"). WHEREAS, Purchaser's continued affiliation with the Company is considered to be important for the Company's growth; and WHEREAS in order to provide Purchaser an opportunity to acquire an equity interest in the Company as an incentive for Purchaser to continue to participate in the training of Company personnel and management organization consulting to the Company, the Company is willing to sell to Purchaser and Purchaser desires to purchase shares of Common Stock according to the terms and conditions hereof; THEREFORE, the parties agree as follows: 1. PURCHASE AND SALE OF STOCK. Subject to the terms and conditions of this Agreement, the Company hereby agrees to sell to Purchaser and Purchaser agrees to purchase from the Company 10,000 shares of the Company's Common Stock (the "Stock") at a price of $3.06 per share, for an aggregate purchase price of $30,600.00. Payment of the aggregate purchase price shall be by check in the amount of $10.00 and a non-recourse promissory note in the amount of $30,600.00 (the "Note") in the form attached hereto as Exhibit A. The Note shall bear interest at a rate no less than the "prime rate" at time of purchase, and shall be secured by a pledge of the Stock purchased by the Note pursuant to a Security Agreement in the form attached hereto as Exhibit B (the "Security Agreement") accompanied by executed stock powers in the form attached hereto as Exhibit C. Upon such payment, the Company shall issue a duly executed certificate evidencing the Stock in the name of Purchaser; said certificate to be held by the Secretary of the Company subject to the terms and conditions of the Security Agreement. 2. RESTRICTIVE LEGENDS AND STOP-TRANSFER ORDERS. (a) Legends. The share certificate evidencing the Stock issued hereunder shall be endorsed with the following legends (in addition to any legends required under applicable state securities laws): THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISPOSITION MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN 2 OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933. THE SHARES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO THE TERMS AND CONDITIONS OF A COMMON STOCK PURCHASE AGREEMENT, DATED AS JULY 14,1998 BETWEEN THE COMPANY AND PURCHASER. COPIES OF SUCH AGREEMENT MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS CERTIFICATE TO THE COMPANY. (b) STOP-TRANSFER NOTICES. Purchaser agrees that, in order to ensure compliance with the restrictions referred to herein, the Company may issue appropriate "stop transfer" instructions to its transfer agent, if any, and that, if the Company transfers its own securities, it may make appropriate notations to the same effect in its own records. 3. PURCHASER'S REPRESENTATIONS AND COVENANTS. In connection with the purchase of the Stock, Purchaser hereby represents and warrants to the Company as follows: (a) INVESTMENT INTENT; CAPACITY TO PROTECT INTERESTS. Purchaser is purchasing the Stock solely for Purchaser's own account for investment and not with a view to or for sale in connection with any distribution of the Stock or any portion thereof and not with any present intention of selling, offering to sell or otherwise disposing of or distributing the Stock or any portion thereof. Purchaser also represents that the entire legal and beneficial interest of the Stock is being purchased, and will be held, for Purchaser's account only, and neither in whole or in part for any other person. Purchaser either (i) has a pre-existing business or personal relationship with the Company or at least one of its officers, directors or controlling persons, or (ii) by reason of Purchaser's business or financial experience (or the business or financial experience of Purchaser's professional advisors who are unaffiliated with and who are not compensated by the Company or any affiliate or selling agent of the Company, directly or indirectly), can be reasonably assumed to have the capacity to evaluate the merits and risks of an investment in the Company and to protect Purchaser's own interests in connection with this transaction. (b) RESIDENCE. Purchaser's principal business location is within the State of Georgia and is located at the address indicated beneath Purchaser's signature below. (c) INFORMATION CONCERNING COMPANY. Purchaser has discussed the Company and its plans, operations and financial condition with the Company's officers and has received all such information as Purchaser has deemed necessary and appropriate to enable Purchaser to evaluate the financial risk inherent in making an investment in the Stock. Purchaser has received satisfactory and complete information concerning the business and financial condition of the Company in response to all inquiries in respect thereof. 3 (d) ECONOMIC RISK. Purchaser realizes that the purchase of the Stock involves a high degree of risk. Purchaser is able, without impairing Purchaser's financial condition, to hold the Stock for an indefinite period of time and to suffer a complete loss on Purchaser's investment. (e) RESTRICTED SECURITIES. Purchaser understands and acknowledges that: (i) The Stock has not been registered under the Securities Act of 1933, as amended, in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of Purchaser's investment intent as expressed herein. In this connection, Purchaser understands that, in the view of the Securities and Exchange Commission ("SEC"), the statutory basis for such exemption may be unavailable if Purchaser's representation was predicated solely upon a present intention to hold the Stock for the minimum capital gains period specified under tax statutes, for a deferred sale, for or until an increase or decrease in the market price of the Stock, or for a period of one year or any other fixed period in the future. (ii) The Stock must be held indefinitely unless it is subsequently registered under the Securities Act or unless an exemption from such registration is otherwise available. Purchaser further acknowledges and understands that, except as contemplated by Section 4 of this Agreement, the Company is under no obligation to register the Stock. In addition, Purchaser understands that the certificate evidencing the Stock will be imprinted with a legend which prohibits the transfer of the Stock unless it is registered or such registration is not required in the opinion of counsel satisfactory to the Company. (f) DISPOSITION UNDER RULE 144. Purchaser understands that: (i) The shares of Stock are restricted securities within the meaning of Rule 144 promulgated under the Securities Act; that the exemption from registration under Rule 144 will not be available in any event for at least one (1) year from the date of purchase and payment of the Stock, and then will be available only if (i) a public trading market then exists for the Common Stock of the Company, (ii) adequate information concerning the Company is then available to the public, and (iii) other terms and conditions of Rule 144 are complied with; and that any sale of the Stock may be made only in limited amounts in accordance with such terms and conditions of Rule 144; (ii) That at the time Purchaser wishes to sell the Stock there may be no public market upon which to make such a sale; that, even if such a public market then exists, the Company may not be satisfying the current public information requirements of Rule 144; and that, in such event, Purchaser would be precluded from selling the Stock under Rule 144 even if the one (1) year minimum holding period had been satisfied; and (iii) In the event all of the requirements of Rule 144 are not satisfied, registration under the Securities Act or compliance with Regulation A or another registration exemption will be required; that, notwithstanding the fact that Rule 144 is not exclusive, the 4 Staff of the SEC has expressed its opinion that persons proposing to sell private placement securities other than in a registered offering or pursuant to Rule 144 will have a substantial burden of proof in establishing that an exemption from registration is available for such offers or sales; and that such persons and their respective brokers who participate in such transactions do so at their own risk. (g) FURTHER LIMITATIONS ON DISPOSITION. Without in any way limiting Purchaser's representations set forth above, Purchaser further agrees that Purchaser shall in no event make any disposition of all or any portion of the Stock unless and until: (i) Either: (A) there is then in effect a Registration Statement under the Securities Act covering such proposed disposition, and such disposition is made in accordance with said Registration Statement; or (B) Purchaser may sell the stock pursuant to Rule 144; or (C) (1) Purchaser shall have notified the Company of the proposed disposition and shall have furnished the Company with a detailed statement of the circumstances surrounding the proposed disposition; and (2) Purchaser shall have furnished the Company with an opinion of Purchaser's counsel, satisfactory to the Company, to the effect that such disposition will not require registration of such shares under the Securities Act. 4. TERMINATION. This Agreement shall terminate upon payment in full of the Note, except as to paragraphs 2, 3, 5, 6(d), 6(e), 6(g). 5. GOVERNING LAW. This Agreement shall be governed and construed by the laws of the State of California. 6. MISCELLANEOUS. (a) FURTHER ASSURANCES. The parties agree to execute such further instruments and to take such further action as may reasonably be necessary to carry out the intent of this Agreement. (b) NOTICES. Any notice required or permitted hereunder shall be given in writing and shall be deemed effectively given upon personal delivery (including by express courier) or upon deposit in the United States Post Office, by First Class mail with postage and fees prepaid, addressed to Purchaser at his address shown on the Company's employment records and to the Company at the address of its principal corporate offices (attention: Secretary) or at such other address as such party may designate by ten (10) days advance written notice to the other party. (c) ASSIGNMENT. The Company may assign its rights and delegate its duties under this Agreement. This Agreement shall inure to the benefit of the successors 5 and assigns of the Company and, subject to the restrictions on transfer herein set forth, be binding upon Purchaser, his heirs, executors, administrators, successors and assigns. The rights of Purchaser under this Agreement may be assigned only with the prior written consent of the Company. (d) WAIVER. Either party's failure to enforce any provision or provisions of this Agreement shall not in any way be construed as a waiver of any such provision or provisions, nor prevent that party thereafter from enforcing each and every other provision of this Agreement. The rights granted both parties herein are cumulative and shall not constitute a waiver of either party's right to assert all other legal remedies available to it under the circumstances. (e) ADVICE OF COUNSEL. Purchaser has reviewed this Agreement in its entirety, has had an opportunity to obtain the advice of counsel prior to executing this Agreement and fully understands all provisions hereof. (f) COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be an original and all of which together shall constitute one instrument. (g) ENTIRE AGREEMENT. This Agreement together with the Security Agreement and the Note represent the entire agreement between the parties with respect to the purchase of Common Stock by Purchaser, may be modified or amended only in writing signed by both parties, and satisfies all of the Company's obligations to Purchaser with regard to the issuance or sale of securities. 6 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written. VITALCOM INC. IRWIN & BROWNING, INC. a Delaware corporation a Georgia corporation By: s/ Frank T. Sample By: s/ Tim Irwin ----------------------------- ---------------------------- Title: CEO Title: President ---------------------------- ------------------------- 7 Exhibit A NON-RECOURSE PROMISSORY NOTE $30,600.00 Tustin, California July 14, 1998 FOR VALUE RECEIVED, the undersigned, Irwin & Browning, Inc., a Georgia corporation, promises to pay to VitalCom Inc., a Delaware corporation (the "Company"), or order, the principal sum of Thirty thousand six hundred dollars and no cents ($30,600.00), together with interest on the outstanding principal amount from the date hereof at the rate of 8.5% per annum. The principal amount hereof and all accrued and unpaid interest on the outstanding principal amount shall be due and payable to the holder hereof at 15222 Del Amo Avenue, Tustin, California 92780, or such other place as the holder hereof may designate. The principal amount, to the extent not sooner paid, shall be due and payable on July 14, 2001. All accrued and unpaid interest shall be due and payable on the first day of each fiscal quarter of the Company commencing on July 14, 1998. Should the undersigned fail to make full payment of principal or interest for a period of 30 days or more after the due date thereof, the whole unpaid balance on this Note of principal and interest shall become immediately due at the option of the holder of this Note. Payments of principal and interest shall be made in lawful money of the United States of America. The undersigned may at any time prepay all or any portion of the principal or interest owing hereunder. This Note is subject to the terms of the Common Stock Purchase Agreement, dated as of July 14, 1998. This Note is without recourse to the undersigned, provided that this Note is secured by a pledge of the Company's Common Stock under the terms of a Security Agreement of even date herewith (a copy of which is on file with the Secretary of the Company) and is subject to all the provisions thereof. The undersigned hereby waives presentment, protest, demand for payment, notice of dishonor and all other notices or demands in connection with the delivery, acceptance, performance, default or endorsement of this Note. In the event the Purchase Agreement dated July 14, 1998 between the undersigned and the Company shall be terminated pursuant to the terms of the Purchase Agreement, this Note shall, at the option of the Company, be accelerated, and the whole unpaid balance on this Note of principal and accrued interest shall be immediately due and payable. 8 The reasonable costs and attorneys' fees of the holder incurred in the collection of this Note shall be paid by the undersigned. This Note has been made and delivered in the State of California and shall be governed and construed in accordance with the laws of the State of California. IRWIN & BROWNING, INC., a Georgia corporation By: s/ Tim Irwin --------------------------- Title: President ----------------------- 9 Exhibit B SECURITY AGREEMENT This Security Agreement is made as of July 14, 1998 between VitalCom Inc., a Delaware corporation ("Pledgee"), and Irwin & Browning, Inc., a Georgia corporation ("Pledgor"). Recitals Pursuant to Pledgor's election to purchase Stock under the Stock Purchase Agreement dated July) 14, 1998 (the "Agreement") and Pledgor's election to pay for such shares with a promissory note (the "Note"), Pledgor has purchased 10,000 shares of Pledgee's Common Stock (the "Stock") at a price of 3.06 per share, for a total purchase price of $30,600.00. The Note and the obligations thereunder are as set forth in Exhibit A to the Agreement. NOW, THEREFORE, it is agreed as follows: 1. Creation and Description of Security Interest. In consideration of the transfer of the Stock to Pledgor under the Agreement, Pledgor, pursuant to the California Commercial Code, hereby pledges all of such Stock (herein sometimes referred to as the "Collateral") represented by certificate number _______, duly endorsed in blank or with executed stock powers, and herewith delivers said certificate to the Secretary of Pledgee ("Pledgeholder"), who shall hold said certificate subject to the terms and conditions of this Security Agreement. The pledged stock (together with an executed blank stock assignment for use in transferring all or a portion of the Stock to Pledgee if, as and when required pursuant to this Security Agreement) shall be held by the Pledgeholder as security for the repayment of the Note, and any extensions or renewals thereof, to be executed by Pledgor pursuant to the terms of the Agreement, and the Pledgeholder shall not encumber or dispose of such Stock except in accordance with the provisions of this Security Agreement. 2. Pledgor's Representations and Covenants. To induce Pledgee to enter into this Security Agreement, Pledgor represents and covenants to Pledgee, its successors and assigns, as follows: a. Payment of Indebtedness. Pledgor will pay the principal sum of the Note secured hereby, together with interest thereon, at the time and in the manner provided in the Note. 10 b. Encumbrances. The Stock is free of all other encumbrances, defenses and liens, and Pledgor will not further encumber the Stock without the prior written consent of Pledgee. c. Margin Regulations. In the event that Pledgee's Common Stock is now or later becomes margin-listed by the Federal Reserve Board and Pledgee is classified as a "lender" within the meaning of the regulations under Part 207 of Title 12 of the Code of Federal Regulations ("Regulation G"), Pledgor agrees to cooperate with Pledgee in making any amendments to the Note or providing any additional collateral as may be necessary to comply with such regulations. 3. Voting Rights. During the term of this pledge and so long as all payments of principal and interest are made as they become due under the terms of the Note, Pledgor shall have the right to vote all of the Stock pledged hereunder. 4. Stock Adjustments. In the event that during the term of the pledge any stock dividend, reclassification, readjustment or other changes are declared or made in the capital structure of Pledgee, all new, substituted and additional shares or other securities issued by reason of any such change shall be delivered to and held by the Pledgee under the terms of this Security Agreement in the same manner as the Stock originally pledged hereunder. In the event of substitution of such securities, Pledgor, Pledgee and Pledgeholder shall cooperate and execute such documents as are reasonable so as to provide for the substitution of such Collateral and, upon such substitution, references to "Stock" in this Security Agreement shall include the substituted shares of capital stock of Pledgor as a result thereof. 5. Options and Rights. In the event that, during the term of this pledge, subscription Options or other rights or options shall be issued in connection with the pledged Stock, such rights, Options and options shall be the property of Pledgor and, if exercised by Pledgor, all new stock or other securities so acquired by Pledgor as it relates to the pledged Stock then held by Pledgeholder shall be immediately delivered to Pledgeholder, to be held under the terms of this Security Agreement in the same manner as the Stock pledged. 6. Default. Pledgor shall be deemed to be in default of the Note and of this Security Agreement in the event: a. Payment of principal or interest on the Note shall be delinquent for a period of 30 days or more; b. Pledgor fails to perform any of the covenants set forth in the Agreement or contained in this Security Agreement for a period of 10 days after written notice thereof from Pledgee; or c. The purchase agreement dated July 14, 1998 between Pledgee and Pledgor shall be terminated for any reason. 11 In the case of an event of Default, as set forth above, Pledgee shall have the right to accelerate payment of the Note upon notice to Pledgor, and Pledgee shall thereafter be entitled to pursue its remedies under the California Commercial Code. 7. Release of Collateral. Subject to any applicable contrary rules under Regulation G, there shall be released from this pledge a portion of the pledged Stock held by Pledgeholder hereunder upon payments of the principal of the Note. The number of shares of the pledged Stock which shall be released shall be that number of shares of full Stock which bears the same proportion to the initial number of shares of Stock pledged hereunder as the payment of principal bears to the initial full principal amount of the Note. 8. Withdrawal or Substitution of Collateral. Pledgor shall not sell, withdraw, pledge, substitute or otherwise dispose of all or any part of the Collateral without the prior written consent of Pledgee. 9. Term. The within pledge of Stock shall continue until the payment of all indebtedness secured hereby, at which time the remaining pledged stock shall be promptly delivered to Pledgor, subject to the provisions for prior release of a portion of the Collateral as provided in paragraph 7 above. 10. Insolvency. Pledgor agrees that if a bankruptcy or insolvency proceeding is instituted by or against him, or if a receiver is appointed for the property of Pledgor, or if Pledgor makes an assignment for the benefit of creditors, the entire amount unpaid on the Note shall become immediately due and payable, and Pledgee may proceed as provided in the case of default. 11. Pledgeholder Liability. In the absence of willful or gross negligence, Pledgeholder shall not be liable to any party for any of his acts, or omissions to act, as Pledgeholder. 12. Invalidity of Particular Provisions. Pledgor and Pledgee agree that the enforceability or invalidity of any provision or provisions of this Security Agreement shall not render any other provision or provisions herein contained unenforceable or invalid. 13. Successors or Assigns. Pledgor and Pledgee agree that all of the terms of this Security Agreement shall be binding on their respective successors and assigns, and that the term "Pledgor" and the term "Pledgee" as used herein shall be deemed to include, for all purposes, the respective designees, successors, assigns, heirs, executors and administrators. 14. Governing Law. This Security Agreement shall be interpreted and governed under the laws of the State of California. 12 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. "PLEDGOR" IRWIN & BROWNING, INC., a Georgia corporation By: s/ Tim Irwin ----------------------------- Title: President -------------------------- 2900 Paces Ferry Rd., Bldg. B Atlanta, GA 30339 --------------------------------- Address "PLEDGEE" VITALCOM INC., a Delaware corporation By: s/ Frank T. Sample --------------------------------- Title: CEO --------------------------------- "PLEDGEHOLDER" s/ Shelley B. Thunen --------------------------------- Secretary of VitalCom Inc. 13 Exhibit C ASSIGNMENT SEPARATE FROM CERTIFICATE FOR VALUE RECEIVED and pursuant to that certain Security Agreement dated as of July 14, 1998 (the "Agreement"), Irwin & Browning, Inc. ("Purchaser") hereby sells, assigns and transfers unto __________________________________ (10, 000 ) shares of the Common Stock of VitalCom Inc., a Delaware corporation, standing in the undersigned's name on the books of said corporation represented by certificate no. _______ herewith, and does hereby irrevocably constitute and appoint ___________________ attorney to transfer the said stock on the books of the said corporation with full power of substitution in the premises. THIS ASSIGNMENT MAY ONLY BE USED AS AUTHORIZED BY THE AGREEMENT AND THE EXHIBITS THERETO. Dated: July 14, 1998 PURCHASER IRWIN & BROWNING, INC., a Georgia corporation By: s/ Tim Irwin ----------------------------- Title: President ----------------------------- INSTRUCTION: PLEASE DO NOT FILL IN ANY BLANKS OTHER THAN THE SIGNATURE LINE. THE PURPOSE OF THIS ASSIGNMENT IS TO ENABLE THE CORPORATION TO ACQUIRE THE SHARES UPON DEFAULT UNDER PURCHASER'S NOTE WITHOUT REQUIRING ADDITIONAL SIGNATURES ON THE PART OF THE PURCHASER. EX-10.13 3 AMENDMENT TO LOAN AGREEMENT 1 EXHIBIT 10.13 SILICON VALLEY BANK AMENDMENT TO LOAN AGREEMENT BORROWER: VITALCOM INC., A DELAWARE CORPORATION ADDRESS: 15222 DEL AMO AVENUE TUSTIN, CA 92780 DATE: DECEMBER 31, 1998 THIS AMENDMENT TO LOAN AGREEMENT is entered into between SILICON VALLEY BANK ("Silicon") and the. borrower named above (the "Borrower"). The Parties agree to amend the Loan and Security Agreement between them dated February 26, 1993, as amended by that Amendment to Loan Agreement dated December 21, 1993, as amended by that Amendment to Loan Agreement dated April 27, 1994, as amended by that Amendment to Loan Agreement dated May 5, 1995, as amended by that Amendment to Loan Agreement dated May 30, 1995, as amended by that Amendment to Loan Agreement dated December 27, 1995, as amended by that Amendment to Loan Agreement dated August 6, 1996, as amended by that Amendment to Loan Agreement dated September 25, 1996, as amended by that Amendment to Loan Agreement dated August 6, 1997 (the "August 1997 Amendment"), and as otherwise amended from time to time (the "Loan Agreement"; terms defined in the Loan Agreement are used herein as therein defined), as follows, effective as of the date hereof. The Maturity Date set forth in the August 1997 Amendment was August 5, 1998, and effective upon such date the Loan Agreement was terminated. Effective as of the date hereof, the Loan Agreement is considered to be revived and in full force and effect. 1. AMENDED SCHEDULE. The Schedule to the Loan Agreement is amended, effective as of the date hereof to read as set forth on the Amended Schedule attached hereto. 2. MODIFIED SECTION 2.2. Section 2.2 of the Loan Agreement is hereby deleted in its entirety and replaced with the following: "2.2 CONDITIONAL GRANT OF SECURITY INTEREST IN COLLATERAL. Upon the making of any Loans, the following shall be considered to be immediately and fully effective, without any further action on the part of Silicon or Borrower: Borrower hereby grants Silicon a continuing security interest in all of Borrower's interest in the Collateral (as defined below in Section 2.2A) as security for all Obligations (such grant of a security interest is referred to herein as the "Grant"). Notwithstanding the foregoing, no Loans shall be made unless and until Silicon has acquired a perfected security interest in the Collateral, including but not limited to the filing of any UCC-1 financing statements as required by Silicon in its discretion. Borrower agrees to take such actions and execute such documentation as Silicon determines is necessary or desirable in order to allow Silicon to perfect its security interest in the Collateral at such time as the Grant becomes effective. 2 2.2A COLLATERAL. The following is referred to as the "Collateral": (a) All accounts, contract rights, chattel paper, letters of credit, documents, securities, money, and instruments, and all other obligations now or in the future owing to the Borrower; (b) All inventory, goods, merchandise, materials, raw materials, work in process, finished goods, farm products, advertising, packaging and shipping materials, supplies, and all other tangible personal property which is held for sale or lease or furnished under contracts of service or consumed in the Borrower's business, and all warehouse receipts and other documents; *All books and records, whether stored on computers or otherwise maintained; and **All substitutions, additions and accessions to any of the foregoing, and all products, proceeds and insurance proceeds of the foregoing, and all guaranties of and security for the foregoing; and all books and records relating to any of the foregoing. * (c) ** (d) 3. SECTION 3.7 OF THE LOAN AGREEMENT. Section 3.7 of the Loan Agreement is hereby amended in its entirety to read as follows: "3.7 FINANCIAL CONDITION AND STATEMENTS. All financial statements now or in the future delivered to Silicon have been, and will be, prepared in conformity with generally accepted accounting principles and now and in the future will completely and accurately reflect the financial condition of the Borrower, at the times and for the periods therein stated subject to normal year-end adjustments. Since the last date covered by any such statement, there has been no material adverse change in the financial condition or business of the Borrower. The Borrower is now and will continue to be solvent. The Borrower will provide Silicon: (i) Within 30 days after the end of each calendar month in which, as of the end of such month, Borrower's Liquidity (as defined below). is less than $8,000,000, a monthly financial statement prepared by Borrower and a Compliance Certificate in such form as Silicon shall reasonably specify, signed by the Chief Financial Officer of the Borrower, certifying that throughout such month the Borrower was in full compliance with all of the terms and conditions of this Agreement, and setting forth calculations showing compliance with the financial covenants set forth on the Schedule and such other information as Silicon shall reasonably request (a "Compliance Certificate"); (ii) Within 10 days after the earlier of the date the report l0-Q is filed or is required to be filed with the Securities and Exchange Commission ("SEC") with respect to Borrower, such l0-Q report, a quarterly financial statement prepared by Borrower, and a Compliance Certificate for such quarter; (iii) within 10 days after the earlier of the date the report l0-K is filed or is required to be filed with the Securities and Exchange Commission with respect to Borrower, such 10-K report, complete annual financial statements, certified by Deloitte & Touche or other independent certified public accountants acceptable to Silicon, and a Compliance Certificate for the quarter then ended; provided, however, with respect to the 10-Q and 10-K reports referred to above, if (x) Borrower applies for and obtains an extension from the SEC for the delivery of such reports to the SEC, (y) Borrower provides Silicon with evidence of the SEC's grant of such extension, and (z) such extension is not 30 days beyond the regular submission date for such reports, then the required dates for the submission of financial information and reports set forth in this Section 3.7 shall be deemed to be modified to the date of the extension so granted by the SEC*. As used herein, "Liquidity" means the sum of (i) 3 Borrower's cash and marketable securities, plus (ii) the amount available for Borrower to borrow under this Agreement. * ; AND WITHIN 20 DAYS AFTER THE END OF EACH CALENDAR MONTH IN WHICH, AT ANY TIME DURING SUCH MONTH THERE WERE ANY OBLIGATIONS OUTSTANDING, (a) A BORROWING BASE CERTIFICATE SIGNED BY THE CHIEF EXECUTIVE OFFICER, PRESIDENT, CHIEF FINANCIAL OFFICER OR CONTROLLER OF BORROWER IN FORM AND SUBSTANCE ACCEPTABLE TO SILICON, (b) AN ACCOUNTS RECEIVABLE AGING FOR SUCH MONTH, AGED BY INVOICE DATE, (c) AN ACCOUNTS PAYABLE AGING FOR SUCH MONTH, AGED BY INVOICE DATE, AND (d) OUTSTANDING OR HELD CHECK REGISTERS, IF ANY, WITH RESPECT TO SUCH MONTH" 4. SECTION 4.5 OF THE LOAN AGREEMENT. Section 4.5 of the Loan Agreement hereby amended in its entirety to read as follows: "4.5 ACCESS TO COLLATERAL, BOOKS AND RECORDS. At all reasonable times, and upon * notice, Silicon, or its agents, shall have the right to inspect the Collateral, and the right to audit and copy the Borrower's accounting books and records and Borrower's books and records relating to the Collateral. Silicon shall take reasonable steps to keep confidential all information obtained in any such inspection or audit, but Silicon shall have the right to disclose any such information to its auditors, regulatory agencies, and attorneys, and pursuant to any subpoena or other legal process. **foregoing audits shall be ***. Notwithstanding the foregoing, after the occurrence of an Event of Default, all audits shall be at the Borrower's expense **** * THREE BUSINESS DAYS' ** ALL COSTS OF THE *** PAID EQUALLY BY BORROWER AND SILICON, AND SILICON MAY CHARGE BORROWER'S PORTION THEREOF TO ANY ACCOUNT OF BORROWER MAINTAINED WITH SILICON, PROVIDED THAT SUCH AUDITS SHALL ONLY BE CONDUCTED IF THERE HAVE BEEN ANY LOANS MADE AT ANY TIME HEREUNDER, AND THE FIRST SUCH AUDIT SHALL BE CONDUCTED WITHIN 90 DAYS OF THE MAKING OF THE FIRST LOAN HERE UNDER. **** AND MAY BE PERFORMED ON ONE BUSINESS DAY'S NOTICE." 5. MODIFICATION TO SECTION 4.6. Section 4.6 of the Loan Agreement is hereby amended in its entirety to read as follows: "4.6 NEGATIVE COVENANTS. Except as may be permitted in the Schedule hereto, the Borrower shall not, without Silicon's prior written consent, do any of the following: (i) acquire any assets outside the ordinary course of business for an aggregate purchase price exceeding 25% of Borrower's Tangible Net Worth (as defined in the Schedule) as of the end of the month prior to the effective date of the acquisition; (ii) enter into any other transaction outside the ordinary course of business (except as permitted by the other provisions of this Section); (iii) sell or transfer any Collateral, except for the sale of finished inventory in the ordinary course of the Borrower's business, and except for the sale of obsolete or unneeded equipment in the ordinary course of business * ; (iv) make any loans of any money or any other assets; (v) incur any debts, outside the ordinary course of business, which would have a material, adverse effect on the Borrower or on the prospect of repayment of the Obligations; (vi) guarantee or otherwise become liable with respect to the obligations of another party or entity; (vii) pay or declare any dividends on the Borrowers stock (except for dividends payable solely in stock of the Borrower); (viii) redeem, retire, purchase or otherwise acquire, directly or indirectly, any of the Borrowers stock; (ix) make any change in the Borrowers capital structure which has a material 4 adverse effect on the Borrower or on the prospect of repayment of the Obligations; or (x) dissolve or elect to dissolve. Transactions permitted by the foregoing provisions of this Section are only permitted if no Event of Default and no event which (with notice or passage of time or both) would constitute an Event of Default would occur as a result of such transaction. ** * OR LICENSE TECHNOLOGY OR PRODUCTS IN THE ORDINARY COURSE OF BORROWER'S BUSINESS ** NOTWITHSTANDING ANYTHING TO THE CONTRARY CONTAINED IN THIS AGREEMENT, BORROWER MAY MERGE OR CONSOLIDATE WITH ANOTHER CORPORATION IF AND ONLY IF (I) BORROWER IS THE SURVIVING CORPORATION, AND (II) NO EVENT OF DEFAULT, NOR ANY EVENT OR CONDITION WHICH (WITH NOTICE OR PASSAGE OF TIME OR BOTH) WOULD CONSTITUTE AND EVENT OF DEFAULT, EXISTS IMMEDIATELY PRIOR TO, OR WOULD EXIST IMMEDIATELY SUBSEQUENT TO, SUCH TRANSACTION. 6. REFERENCES IN LOAN AGREEMENT. Until such time as the Grant has become effective, Borrower and Silicon hereby agree that all references to the security interest or lien of Silicon in the Collateral are deemed not to be in effect; provided that, upon the effectiveness of the Grant, such provisions and such references shall immediately be deemed to be in full force and effect, without any further action or notice by Silicon or Borrower. 7. NEGATIVE PLEDGE AGREEMENT. Concurrently herewith, Borrower shall execute Silicon's form of Negative Pledge Agreement, pursuant to which Borrower agrees not to sell, transfer, assign, mortgage, pledge, lease, grant a security interest in, or encumber any of Borrower's assets other than the Collateral. 8. GENERAL PROVISIONS. This Amendment, the Loan Agreement, any prior written amendments to the Loan Agreement signed by Silicon and the Borrower, and the other written documents and agreements between Silicon and the Borrower set forth in full all of the representations and agreements of the parties with respect to the subject matter hereof and supersede all prior discussions, representations, agreements and understandings between the parties with respect to the subject hereof. Except as herein expressly amended, all of the terms and provisions of the Loan Agreement, and all other documents and agreements between Silicon and the Borrower shall continue in full force and effect and the same are hereby ratified and confirmed. This Amendment shall be controlling in the event of any conflicts between any prior written agreements and amendments between Silicon and the Borrower, on the one hand, and this Amendment. Borrower: Silicon: VITALCOM INC SILICON VALLEY BANK By s/ Frank T. Sample By s/ ------------------------------- -------------------------- President and CEO Title: Vice President By s/ Shelley B. Thunen ------------------------------- Secretary 5 INTEREST RATE SUPPLEMENT TO LOAN AGREEMENT This Interest Rate Supplement to Loan Agreement (this "Supplement") dated December ___ 1998, is a supplement to the Loan and Security Agreement (the "Loan Agreement") between Silicon Valley Bank ("Bank") and VitalCom Inc. ("Borrower") dated February 26 1993, as amended from time to time, including but not limited to that certain Amendment to Loan and Security Agreement dated approximately even date herewith. This Supplement forms a part of and is incorporated into the Loan Agreement. 1. Definitions. "Business Day" means a day of the year (a) that is not a Saturday, Sunday or other day on which banks in the State of California or the City of London, United Kingdom are authorized or required to close and (b) on which dealings are carried on in the interbank market in which Bank customarily participates. "Interest Period" means for each LIBOR Rate Advance, a penod of approximately one, two, three or six months, provided that the last day of an Interest Period for a LIBOR Rate Advance shall be determined in accordance with the practices of the LIBOR interbank market as from time to time in effect, provided, further, in all cases such period shall expire not later than the applicable Maturity Date. "Interest Rate" shall mean as to: (a) Prime Rate Advances, a rate equal to the Prime Rate; and (b) LIBOR Rate Advances, a rate of 2.75% per annum in excess of the LIBOR Rate (based on the LIBOR Rate applicable for the Interest Period selected by the Borrower). "LIBOR Base Rate" means, for any Interest Period for a LIBOR Rate Advance, the rate of interest per annum determined by Bank to be the per annum rate of interest as which deposits in United States Dollars are offered to Bank in the London interbank market in which Bank customarily participates at 11:00 A.M. (local time in such interbank market) two (2) Business Days before the first day of such Interest Period for a period approximately equal to such Interest Period and in an amount approximately equal to the amount of such Advance. "LIBOR Rate" shall mean, for any Interest Period for a LIBOR Rate Advance, a rate per annum (rounded upwards, if necessary, to the nearest 1/16 of 1%) equal to (i) the LIBOR Base Rate for such Interest Period divided by (ii) 1 minus the Reserve Requirement for such Interest Period. "LIBOR Rate Advances" means any Advances made or a portion thereof on which interest is payable based on the LIBOR Rate in accordance with the terms hereof. "Prime Rate" means the variable rate of interest per annum, most recently announced by Bank as its "prime rate," whether or not such announced rate is the lowest rate available from Bank. The interest rate applicable to the Prime Rate Advances shall change on each date there is a change in the Prime Rate. "Prime Rate Advances" means any Advances made or a portion thereof on which interest is payable based on the Prime Rate in accordance with the terms hereof. "Regulatory Change" means, with respect to Bank, any change on or after the date of this Loan Agreement in United States federal, state or foreign laws or regulations, including Regulation D, or the adoption or making on or after such date of any interpretations, directives or requests applying to a class of lenders including Bank of or under any United States federal or 6 state, or any foreign, laws or regulations (whether or not having the force of law) by any court or governmental or monetary authority charged with the interpretation or administration thereof. "Reserve Requirement" means, for any Interest Period, the average maximum rate at which reserves (including any marginal, supplemental or emergency reserves) are required to be maintained during such Interest Period under Regulation D against "Eurocurrency liabilities" (as such term is used in Regulation D) by member banks of the Federal Reserve System. Without limiting the effect of the foregoing, the Reserve Requirement shall reflect any other reserves required to be maintained by Bank by reason of any Regulatory Change against (i) any category of liabilities which includes deposits by reference to which the LIBOR Rate is to be determined as provided in the definition of "LIBOR Base Rate" or (ii) any category of extensions of credit or other assets which include Advances. 2. Requests for Advances; Confirmation of Initial Advances. Each LIBOR Rate Advance shall be made upon the irrevocable written request of Borrower received by Bank not later than 11:00 a.m. (Santa Clara, California time) on the Business Day three (3) Business Days prior to the date such Advance is to be made. Each such notice shall specify the date such Advance is to be made, which day shall be a Business Day; the amount of such Advance, the Interest Period for such Advance, and comply with such other requirements as Bank determines are reasonable or desirable in connection therewith. The amount of a LIBOR Rate Advance shall be $500,000 or such greater amount which is an integral multiple of $50,000. Each written request for a LIBOR Rate Advance shall be in the form of a LIBOR Rate Advance Borrowing Certificate as set forth on Exhibit A, which shall be duly executed by the Borrower. Each Prime Rate Advance shall be made upon the irrevocable written request of Borrower received by Bank not later than 3 p.m. (Santa Clara, California time) on the Business Day such Advance is to be made. Each such notice shall specify the date such Advance is to be made, which day shall be a Business Day and the amount of such Advance, and comply with such other requirements as Bank determines are reasonable or desirable in connection therewith. 3. Conversion/Continuation of Advances. (a) Borrower may from time to time submit in writing a request that Prime Rate Advances be converted to LIBOR Rate Advances or that any existing LIBOR Rate Advances continue for an additional Interest Period. Such request shall specify the amount of the Prime Rate Advances which will constitute LIBOR Rate Advances (subject to the limits set forth below) and the Interest Period to be applicable to such LIBOR Rate Advances. Each written request for a conversion to a LIBOR Rate Advance or a continuation of a LIBOR Rate Advance shall be substantially in the form of a LIBOR Rate Conversion/Continuation Certificate as set forth on Exhibit B, which shall be duly executed by the Borrower. Subject to the terms and conditions contained herein, three (3) Business Days after Bank's receipt of such a request from Borrower, such Prime Rate Advances shall be converted to LIBOR Rate Advances or such LIBOR Rate Advances shall continue, as the case may be provided that: (i) No Event of Default or event which with notice or passage of time or both would constitute an Event of Default exists; (ii) No party hereto shall have sent any notice of termination of this Supplement or of the Loan Agreement; 7 (iii) Borrower shall have complied with such customary procedures as Bank has established from time to time for Borrower's requests for LIBOR Rate Advances; (iv) The amount of a LIBOR Rate Advance shall be $500,000 or such greater amount which is an integral multiple of $50,000; and (v) Bank shall have determined that the Interest Period or LIBOR Rate is available to Bank which can be readily determined as of the date of the request for such LIBOR Rate Advance. Any request by Borrower to convert Prime Rate Advances to LIBOR Rate Advances or continue any existing LIBOR Rate Advances shall be irrevocable. Notwithstanding anything to the contrary contained herein, Bank shall not be required to purchase United States Dollar deposits in the London interbank market or other applicable LIBOR Rate market to fund any LIBOR Rate Advances, but the provisions hereof shall be deemed to apply as if Bank had purchased such deposits to fund the LIBOR Rate Advances. (b) Any LIBOR Rate Advances shall automatically convert to Prime Rate Advances upon the last day of the applicable Interest Period, unless Bank has received and approved a complete and proper request to continue such LIBOR Rate Advance at least three (3) Business Days prior to such last day in accordance with the terms hereof. Any LIBOR Rate Advances shall, at Bank's option, convert to Prime Rate Advances in the event that (i) an Event of Default, or event which with the notice or passage of time or both would constitute an Event of Default, shall exist, (ii) this Supplement or the Loan Agreement shall terminate, or (iii) the aggregate principal amount of the Prime Rate Advances which have previously been converted to LIBOR Rate Advances, or the aggregate principal amount of existing LIBOR Rate Advances continued, as the case may be, at the beginning of an Interest Period shall at any time during such Interest Period exceeds the Committed Revolving Line. Borrower agrees to pay to Bank, upon demand by Bank (or Bank may, at its option, charge Borrower's loan account) any amounts required to compensate Bank for any loss (including loss of anticipated profits), cost or expense incurred by such person, as a result of the conversion of LIBOR Rate Advances to Prime Rate Advances pursuant to any of the foregoing. (c) On all Advances, interest shall be payable by Borrower to Bank monthly in arrears not later than the first day of each calendar month at the applicable Interest Rate, or on such other day of the month as Bank may notify Borrower from time to time. 4. Additional Requirements/Provisions Regarding LIBOR Rate Advances; Etc. (a) If for any reason (including voluntary or mandatory prepayment or acceleration), Bank receives all or part of the principal amount of a LIBOR Rate Advance prior to the last day of the Interest Period for such Advance, Borrower shall immediately notify Borrower's account officer at Bank and, on demand by Bank, pay Bank the amount (if any) by which (i) the additional interest which would have been payable on the amount so received had it not been received until the last day of such Interest Period exceeds (ii) the interest which would have been recoverable by Bank by placing the amount so received on deposit in the certificate of deposit markets or the offshore currency interbank markets or United States Treasury investment products, as the case may be, for a period starting on the date on which it was so received and ending on the last day of such Interest Period at the interest rate determined by Bank in its reasonable discretion. Bank's determination as to such amount shall be conclusive absent manifest error. (b) Borrower shall pay to Bank, upon demand by Bank, from time to time such amounts as Bank may reasonably determine to be necessary to compensate it for any reasonable costs incurred by Bank that Bank determines are attributable to its making or maintaining of any amount receivable by Bank hereunder in respect of any Advances relating thereto (such increases in costs and 8 reductions in amounts receivable being herein called "Additional Costs"), in each case resulting from any Regulatory Change which: (i) Changes the basis of taxation of any amounts payable to Bank under this Supplement in respect of any Advances (other than changes which affect taxes measured by or imposed on the overall net income of Bank by the jurisdiction in which such Bank has its principal office); or (ii) Imposes or modifies any reserve, special deposit or similar requirements relating to any extensions of credit or other assets of, or any deposits with or other liabilities of Bank (including any Advances or any deposits referred to in the definition of "LIBOR Base Rate"); or (iii) Imposes any other condition affecting this Supplement (or any of such extensions of credit or liabilities). Bank will notify Borrower of any event occurring after the date of the Loan Agreement which will entitle Bank to compensation pursuant to this section as promptly as practicable after it obtains knowledge thereof and determines to request such compensation. Bank will furnish Borrower with a statement setting forth the basis and amount of each request by Bank for compensation under this Section 4. Determinations and allocations by Bank for purposes of this Section 4 of the effect of any Regulatory Change on its costs of maintaining its obligations to make Advances or of making or maintaining Advances or on amounts receivable by it in respect of Advances, and of the additional amounts required to compensate Bank in respect of any Additional Costs, shall be conclusive absent manifest error, subject to subsequent verification by the Borrower at the Borrower's sole cost and expense, after the payment thereof by the Borrower. (c) Borrower shall pay to Bank, upon the request of Bank, such amount or amounts as shall be sufficient (in the sole good faith opinion of such Bank) to compensate it for any loss, costs or expense incurred by it as a result of any failure by Borrower to borrow an Advance on the date for such borrowing specified in the relevant notice of borrowing hereunder. (d) If Bank shall determine that the adoption or implementation of any applicable law, rule, regulation or treaty regarding capital adequacy, or any change therein, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by Bank (or its applicable lending office) with any respect or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on capital of Bank or any person or entity controlling Bank (a "Parent") as a consequence of its obligations hereunder to a level below that which Bank (or its Parent) could have achieved but for such adoption, change or compliance (taking into consideration its policies with respect to capital adequacy) by an amount reasonably deemed by Bank to be material, then from time to time, within 15 days after demand by Bank, Borrower shall pay to Bank such additional amount or amounts as will compensate Bank for such reduction. A statement of Bank claiming compensation under this Section and setting forth the additional amount or amounts to be paid to it hereunder shall be conclusive absent manifest error, subject to subsequent verification by the Borrower at the Borrower's sole cost and expense, after the payment thereof by the Borrower. (e) If at any time Bank, in its sole and absolute discretion, determines that: (i) the amount of the LIBOR Rate Advances for periods equal to the corresponding Interest Periods are not available to Bank in the offshore currency interbank markets, or (ii) the LIBOR Rate does not accurately reflect the cost to Bank of lending the LIBOR Rate Advance, then Bank shall promptly give notice thereof to Borrower, and upon the giving of such notice Bank's obligation 9 to make the LIBOR Rate Advances shall terminate, unless Bank and the Borrower agree in writing to a different interest rate Advances shall terminate, unless Bank and the Borrower agree in writing to a different interest rate applicable to LIBOR Rate Advances. If it shall become unlawful for Bank to continue to fund or maintain any Advances, or to perform its obligations hereunder, upon demand by Bank, Borrower shall prepay the Advances in full with accrued interest thereon and all other amounts payable by Borrower hereunder (including, without limitation, any amount payable in connection with such prepayment pursuant to Section 4(a)). IN WITNESS WHEREOF, the parties hereto have caused this Supplement to be executed as of the date first above written. VitalCom Inc. By: s/ Frank T. Sample -------------------------------------- Title: Chief Executive Officer By: s/ Shelley B. Thunen -------------------------------------- Title: Chief Financial Officer 10 EXHIBIT A LIBOR RATE ADVANCE BORROWING CERTIFICATE The undersigned hereby certify as follows: We, _______________________ and _________________________, are the duly elected and Acting ______________________ and _______________________, respectively, of VitalCom Inc. ("Borrower"). This certificate is delivered pursuant to Section 2 of that certain Interest Rate Supplement to Agreement together with the Loan and Security Agreement by and between Borrower and Silicon Valley Bank ("Bank") (the "Loan Agreement"). The terms used in this Borrowing Certificate which are defined in the Loan Agreement have the same meaning herein as ascribed to them therein. Borrower hereby requests on _____________________________ a LIBOR Rate Advance (the "Advance") as follows: (a) The date on which the Advance is to be made is __________________. (b) The amount of the Advance is to be _______________($____________) for an Interest Period of [one] [two] [three] [six] month[s]. All representations and warranties of Borrower stated in the Loan Agreement are true, correct and complete in all material respects as of the date of this request for an Advance; provided, however, that those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date. IN WITNESS WHEREOF, this Borrowing Base Certificate is executed by undersigned as of this ____ day of __________________________________. VitalCom Inc. By: -------------------------- Title: ----------------------- By: -------------------------- Title: -----------------------
FOR INTERNAL BANK USE ONLY LIBOR PRICING DATE LIBOR RATE LIBOR RATE VARIANCE MATURITY DATE - ------------------ ---------- ------------------- ------------- % - ------------------ ----------- ------------ --------------
11 EXHIBIT B LIBOR RATE CONVERSION/CONTINUATION CERTIFICATE The undersigned hereby certify as follows: We, _______________________ and _________________________ are the duly elected and Acting ______________________ and ________________________, respectively, of VitalCom Inc. ("Borrower"). This certificate is delivered pursuant to Section 2 of that certain Interest Rate Supplement to the Loan and Security Agreement by and between Borrower and Silicon Valley Bank ("Bank") (the "Loan Agreement"). The terms used in this LIBOR Rate Conversion/Continuation Certificate which are defined in the Loan Agreement have the same meaning herein as ascribed to them therein. Borrower hereby requests on ______________, a LIBOR Rate Advance ("the "Advance") as follows: (a) _____ (i) A rate conversion of an existing Prime Rate Advance from a Prime Rate a LIBOR Rate Advance; or _____ (ii) A continuation of an existing LIBOR Rate Advance as a LIBOR Rate Advance; [Check (i) or (ii) above] (b) The date on which the Advance is to be made is ____________________. (c) The amount of the Advance is to be ________________ ($___________), for an Interest Period of [one] [two] [three] [six] month[s]. All representations and warranties of Borrower stated in the Loan Agreement are true, correct and complete in all material respects as of the date of this request for a loan; provided, however, that those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date. IN WITNESS WHEREOF, this LIBOR Rate Conversion/Continuation Certificate is executed by the undersigned as of this _____ day of ________________________. VitalCom Inc. By: -------------------------- Title: ----------------------- By: -------------------------- Title: -----------------------
FOR INTERNAL BANK USE ONLY LIBOR PRICING DATE LIBOR RATE LIBOR RATE VARIANCE MATURITY DATE - ------------------ ---------- ------------------- ------------- < % - ----------------- ----------- ------------- -------------
12 SILICON VALLEY BANK AMENDED SCHEDULE TO LOAN AND SECURITY AGREEMENT BORROWER: VITALCOM INC., A DELAWARE CORPORATION ADDRESS: 15222 DEL AMO AVENUE TUSTIN, CA 92780 DATE: DECEMBER 31, 1998 CREDIT LIMIT (Section 1.1): An amount not to exceed the lesser of: (1) $5,000,000 AT any one time outstanding; or (2) the sum of: (a) Loans (the "Formula Loans") in an amount not to exceed 75% of the Net Amount of Borrower's accounts, which Silicon in its discretion deems eligible for borrowing; plus (b) Loans other than Formula Loans (the "Non-Formula Loans"), provided that no Non-Formula Loans may be outstanding unless the sum of Borrower's cash and marketable securities equals or exceeds the greater of (i) $3,000,000, or (ii) 150% of the outstanding amount of Non-Formula Loans. If at any time the outstanding Non- Formula Loans exceed the greater of (i) or (ii) in the preceding sentence, Borrower shall repay such excess to Silicon immediately, without demand. "Net Amount" of an account means the gross amount of the account, minus all applicable sales, use, excise and other similar taxes and minus all discounts, credits and allowances of any nature granted or claimed. Without limiting the fact that the determination of which accounts are eligible for borrowing is a matter of Silicon's discretion, the following will not be deemed eligible for borrowing: accounts outstanding for more than 90 days from the invoice date, accounts subject to any contingencies, accounts owing from any government agency, accounts owing from an account debtor outside the United States (unless pre-approved by Silicon in its discretion, or backed by a letter of credit satisfactory to Silicon, or FCJA insured satisfactory to Silicon), accounts owing from one account debtor to the extent they exceed 25%* of the total eligible accounts outstanding, accounts owing from an affiliate of Borrower, and accounts 13 owing from an account debtor to whom Borrower is or may be liable for goods purchased from such account debtor or otherwise. In addition, if more than 50% of the accounts owing from an account debtor are outstanding more than 90 days from the invoice date or are otherwise not eligible accounts, then all accounts owing from that account debtor will be deemed ineligible for borrowing. * provided that in the case of Datascope Instruments and Quinton Instrument Company as account debtors, this percentage figure shall be 40% No Loans shall be made to Borrower subsequent to December 31, 1999. Beginning January 1, 2000, and continuing on the first day of each succeeding calendar month, Borrower shall repay the principal amount of the Obligations outstanding on December 31, 1999, in forty eight consecutive installments, consisting of forty seven installments equal to one forty-eighth of such then-outstanding principal amount, and one final installment on December 1, 2003, in the amount of the entire unpaid balance of all Obligations. LETTERS OF CREDIT Silicon, in its reasonable discretion, will from time to time during the term of this Agreement issue letters of credit for the account of the Borrower ("Letters of Credit"), in an aggregate amount at any one time outstanding hot to exceed $500,000, upon the request of the Borrower, provided that, on the date the Letters of Credit are to be issued, Borrower has available to it Loans in an amount equal to or greater than the face amount of the Letters of Credit to be issued. Prior to the issuance of any Letters of Credit, Borrower shall execute and deliver to Silicon Applications for Letters of Credit and such other documentation as Silicon shall specify (the "Letter of Credit Documentation"). Fees for the Letters of Credit shall be as provided in the Letter of Credit Documentation. The Credit Limit set forth above and the Loans available under this Agreement at any time shall be reduced by the face amount of Letters of Credit from time to time outstanding. Interest Rate (Section 1.2): Interest on the Loans shall be paid at a rate equal to the "Interest Rate", as defined in, and pursuant to the terms of,the Interest Rate Supplement to Loan Agreement attached hereto, which is incorporated into and forms an integral part of this Agreement. Interest shall be calculated on the basis of a 360-day year for the actual number of days elapsed. UNUSED LINE FEE: In the event, in any fiscal quarter of Borrower (or portion thereof at the beginning and end of the term hereof), the average daily principal balance of the Loans outstanding during such fiscal quarter is less than the amount of the Credit Limit, Borrower shall pay Silicon an unused line fee in an amount equal to 0.25% per annum on the difference between 14 the amount of the Credit Limit and the average daily principal balance of the Loans outstanding during such fiscal quarter, which unused line fee shall be computed and paid quarterly, in arrears, on the first day of the following fiscal quarter. MATURITY DATE (Section 5.1): DECEMBER 1, 2003. PRIOR NAMES OF BORROWER (Section 3.2). ACCUCORE, INC., PACIFIC COMMUNICATIONS, INC. TRADE NAMES OF BORROWER (Section 3.2): ACCUCORE OTHER LOCATIONS AND ADDRESSES (Section 3.3): NONE MATERIAL ADVERSE LITIGATION (Section 3.10): NONE NEGATIVE COVENANTS-EXCEPTIONS (Section 4.6): Without Silicon's prior written consent, Borrower may do the following, provided that, after giving effect thereto, no Event of Default has occurred and no event has occurred which, with notice or passage of time or both, would constitute an Event of Default, and provided that the following are done in compliance with all applicable laws, rules and regulations: (i) repurchase shares of Borrower's stock, provided that the total amount paid by Borrower for such stock does not exceed $250,000 in any fiscal year. FINANCIAL COVENANTS (Section 4.1): Borrower shall comply with all of the following covenants. Compliance shall be determined as of the end of each calendar quarter, except as otherwise specifically provided below: QUICK ASSET RATIO: Borrower shall maintain a ratio of "Quick Assets" to current liabilities of not less than 1.75 to I. TANGIBLE NET WORTH: Borrower shall maintain a tangible net worth of not less than $18,000,000. DEBT TO TANGIBLE NET WORTH RATIO: Borrower shall maintain a ratio of total liabilities to tangible net worth of not more than 0.75 to 1. 15 PROFITABILITY: Borrower shall not incur a net loss (after taxes) for: (i) the fiscal year ending December 31, 1998, in excess of $3,250,000; nor (ii) the fiscal year ending December 31, 1999, in excess of $2,000,000. DEFINITIONS: "Current assets" and "current liabilities" shall have the meaning ascribed thereto in accordance with generally accepted accounting principles. "Tangible net worth" means the excess of total assets over total liabilities, determined in accordance with generally accepted accounting principles, excluding however all assets which would be classified as intangible assets under generally accepted accounting principles, including without limitation goodwill, licenses, patents, trademarks, trade names, copyrights, and franchises. "Quick Assets" means cash on hand or on deposit in banks, readily marketable securities issued by the United States, readily marketable commercial paper rated "A-1" by Standard & Poor's Corporation (or a similar rating by a similar rating organization), certificates of deposit and banker's acceptances, and accounts receivable (net of allowance for doubtful accounts). SUBORDINATED DEBT: "Liabilities(1)", for purposes of the foregoing covenants, do not include indebtedness which is subordinated to the indebtedness to Silicon under a subordination agreement in form specified by Silicon or by language in the instrument evidencing the indebtedness which is acceptable to Silicon." ACQUISITION-RELATED NON-CASH CHARGES: "Net loss", for purposes of the foregoing covenants, shall not include non-cash charges incurred in connection with any acquisition(s) by Borrower of another corporation or asset(s). OTHER COVENANTS (Section 4.1): Borrower shall at all times comply with all of the following additional covenants: 1. BANKING RELATIONSHIP. Borrower shall at all times maintain its primary operating banking relationship with Silicon. 2. INDEBTEDNESS. Without limiting any of the foregoing terms or provisions of this Agreement, Borrower shall not in the future incur indebtedness for borrowed money, except for (i) indebtedness to Silicon, and (ii) indebtedness incurred in the future for the purchase price of or lease of equipment. 16 3. UCC-1 FINANCING STATEMENTS. Borrower is concurrently delivering to Silicon UCC-l financing statements, and it is understood and agreed that such financing statements shall not be considered effective unless and until the first Grant is effective. At such time Silicon shall be permitted to file such financing statements immediately. 4. TERMINATION OF AGREEMENT. Borrower and Silicon hereby agree that this Agreement may be terminated by Borrower's written notice to Silicon when no Obligations are outstanding or otherwise have been paid and performed in full. BORROWER: VITALCOM INC. BY s/ FRANK T. SAMPLE ------------------------------- PRESIDENT AND CEO BY s/ SHELLEY B. THUNEN ------------------------------- SECRETARY SILICON: SILICON VALLEY BANK BY s/ GARY REAGAN ------------------------------- TITLE VICE PRESIDENT 17 NEGATIVE PLEDGE AGREEMENT This Negative Pledge Agreement is made as of December 31, 1998 by and between Vitalcom Inc. ("Borrower") and Silicon Valley Bank ("Silicon"). In connection with, among other documents, the Loan and Security Agreement between Borrower and Silicon dated February 26, 1993 (as amended, the "Loan Agreement; the Loan Agreement and all related instruments, documents and agreements may be collectively referred to herein as the "Loan Documents"), Borrower agrees as follows: 1. Borrower shall not sell, transfer, assign, mortgage, pledge, lease, grant a security interest in, or encumber any of Borrower's: a. Equipment, including without limitation all machinery, fixtures, trade fixtures, vehicles, furnishings, furniture, materials, tools, machine tools, office equipment, computers and peripheral devices, appliances, apparatus, parts, dies, and jigs; or b General intangibles, including, but not limited to, deposit accounts, goodwill, drawings, blueprints, customer lists, security deposits, loan commitment fees, federal, state and local tax refunds and claims, all rights in all litigation presently or hereafter pending for any cause or claim (whether in contract, tort or otherwise), and all judgments now or hereafter arising therefrom, all claims of Borrower against Silicon, all rights to purchase or sell real or personal property, all rights as a licensor or licensee of any kind, all royalties, licenses, processes, telephone numbers, proprietary information, purchase orders, and all insurance policies and claims (including without limitation credit, liability, property and other insurance), all other rights, privileges and franchises of every kind, and all intellectual property, including, without limitation, the following: i. Any and all copyright rights, copyright applications, copyright registrations and like protections in each work or authorship and derivative work thereof, whether published or unpublished and whether or not the same also constitutes a trade secret, now or hereafter existing, created, acquired or held; ii. Any and all trade secrets, and any and all intellectual property rights in computer software and computer software products now or hereafter existing, created, acquired or held; iii. Any and all design rights which may be available to Borrower now or hereafter existing, created, acquired or held; iv. All patents, patent applications and like protections including, without limitation, improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same, including without limitation the patents and patent applications; v. Any trademark and servicemark rights, whether registered or not, applications to register and registrations of the same and like protections, and the entire goodwill of the business of Borrower connected with and symbolized by such trademarks, including without limitation; 1 18 vi. Any and all claims for damages by way of past, present and future infringements of any of the rights included above, with the right, but not the obligation, to sue for and collect such damages for said use or infringement of the intellectual property rights identified above; vii. All licenses or other rights to use any of the Copyrights, Patents or Trademarks, and all license fees and royalties arising from such use to the extent permitted by such license or rights; and viii. All amendments, extensions, renewals and extensions of any of the Copyrights, Trademarks or Patents; and ix. All proceeds and products of the foregoing, including without limitation all payments under insurance or any indemnity or warranty payable in respect of any of the foregoing; 2. It shall be an event of default under the Loan Documents between Borrower and Silicon if there is a breach of any term of this Negative Pledge Agreement. 3. Capitalized terms used but not otherwise defined herein shall have the same meaning as in the Loan Documents. BORROWER: VITALCOM INC. By: s/ Shelley B. Thunen ---------------------------- Title: Chief Financial Officer ---------------------------- SILICON: SILICON VALLEY BANK By: s/ Gary Reagan --------------------------- Title: Vice President ------------------------ 2 19 SILICON VALLEY BANK CERTIFIED RESOLUTION BORROWER: VITALCOM INC., A CORPORATION ORGANIZED UNDER THE LAWS OF THE STATE OF DELAWARE ADDRESS: 15222 DEL AMO AVENUE TUSTIN, CA 92780 DATE: DECEMBER 31, 1998 I, the undersigned, Secretary or Assistant Secretary of the above-named borrower, a corporation organized under the laws of the state set forth above, do hereby certify that the following is a full, true and correct copy of resolutions duly and regularly adopted by the Board of Directors of said corporation as required by law, and by the by-laws of said corporation, and that said resolutions are still in full force and effect and have not been in any way modified, repealed, rescinded, amended or revoked. RESOLVED, that this corporation borrow from Silicon Valley Bank ("Silicon"), from time to time, such sum or sums of money as, in the judgment of the officer or officers hereinafter authorized hereby, this corporation may require. RESOLVED FURTHER, that any of the Chairman, President, Chief Executive Officer, Chief Financial Officer or Secretary of this corporation be, and he or she is hereby authorized, directed and empowered, in the name of this corporation, to execute and deliver to Silicon, and Silicon is requested to accept, the loan agreements, security agreements, notes, financing statements, and other documents and instruments providing for such loans and evidencing and/or securing such loans, with interest thereon, and said authorized officers are authorized from time to time to execute renewals, extensions and/or amendments of said loan agreements, security agreements, and other documents and instruments. RESOLVED FURTHER, that said authorized officers be and they are hereby authorized, directed and empowered, as security for any and all indebtedness of this corporation to Silicon, whether arising pursuant to this resolution or otherwise, to grant, transfer, pledge, mortgage, assign, or otherwise hypothecate to Silicon, or deed in trust for its benefit, any property of any and every kind, belonging to this corporation, including, but not limited to, any and all real property, accounts, inventory, equipment, general intangibles, instruments, documents, chattel paper, notes, money, deposit accounts, furniture, fixtures, goods, and other property of every kind, and to execute and deliver to Silicon any and all grants, transfers, trust receipts, loan or credit agreements, pledge agreements, mortgages, deeds of trust, financing statements, security agreements and other hypothecation agreements, which said instruments and the note or notes and other instruments referred to in the preceding paragraph may contain such provisions, covenants, recitals and agreements as Silicon may require and said authorized officers may approve, and the execution thereof by said authorized officers shall be conclusive evidence of such approval. 1 20 The undersigned further hereby certifies that the following persons are the duly elected and acting officers of the corporation named above as borrower and that the following are their actual signatures:
NAMES OFFICE(S) ACTUAL SIGNATURES Frank T. Sample Chairman of the Board, CEO s/ Frank T. Sample______ Shelley B. Thunen Chief Financial Officer, Secretary s/ Shelley B. Thunen____
IN WITNESS WHEREOF, I have hereunto set my hand as such Secretary or Assistant Secretary on the date set forth above. s/ Shelley B. Thunen ---------------------------- Secretary 2 21 THIS SPACE FOR USE OF FILING OFFICER FINANCING STATEMENT - FOLLOW INSTRUCTIONS CAREFULLY THIS FINANCING STATEMENT IS PRESENTED FOR FILING PURSUANT TO THE UNIFORM COMMERCIAL CODE AND WILL REMAIN EFFECTIVE, WITH CERTAIN EXCEPTIONS, FOR 5 YEARS FROM DATE OR FILING. A. NAME & TEL. # OF CONTACT AT FILER(OPTIONAL) B. FILING OFFICE ACOT. #(OPTIONAL) Wendy Huey 310471-3000 CA SOS
RETURN CORY TO: (NAME AND MAILING ADDRESS) Levy, Small & Lallas 815 Moraga Drive Los Angeles, CA 90049 Ann: Documentation Dept. C. OFTIONAL DESIGNATION (IF APPLICABLE): 1/2 LESSORILESSEE L CONSIGNOR/CONSIGNEE NON-UCC FIL'NG DEBTOR'S ENTITY'S NAME VITALCOM INC. 15222 DEL AMO AVENUE TUSTIN, CA 92780 USA SECURED PARTY'S ENTITY'S NAME SILICON VALLEY BANK 3003 TASMAN DRIVE, MAIL SORT NC-661 SANTA CLARA, CA 95054 USA THIS FINANCING STATEMENT COVERS THE FOLLOWING TYPES OR ITEMS OF PROPERTY: DEBTOR HEREBY GRANTS SECURED PARTY A SECURITY INTEREST IN ALL OF THE FOLLOWING, WHETHER NOW OWNED OR HEREAFTER ACQUIRED, AND WHEREVER LOCATED, AS COLLATERAL FOR THE PAYMENT AND PERFORMANCE OF ALL PRESENT AND FUTURE INDEBTEDNESS, LIABILITIES, GUARANTEES AND OBLIGATIONS OF DEBTOR TO SECURED PARTY: ALL "ACCOUNTS," AND "INVENTORY," AS SUCH TERMS ARE DEFINED IN DIVISION 9 OF THE CALIFORNIA UNIFORM COMMERCIAL CODE IN EFFECT ON THE DATE HEREOF, AND ALL OTHER TYPES OR ITEMS OF PROPERTY DESCRIBED ON EXHIBIT A HERETO (BUT THIS FINANCING STATEMENT SHALL BE FULLY EFFECTIVE NOTWITHSTANDING ANY LACK OF ANY EXHIBIT A). DEBTOR IS NOT AUTHORIZED TO SELL, TRANSFER, OR FURTHER ENCUMBER ANY OF THE FOREGOING COLLATERAL, EXCEPT FORT THE SALE OF FINISHED INVENTORY IN THE ORDINARY COURSE OF BUSINESS. VITALCOM INC. SILICON VALLEY BANK BY: S/SHELLEY B. THUNEN BY: S/GARY REAGAN --------------------------- ------------------------- CHIEF FINANCIAL OFFICER VICE PRESIDENT 22 EXHIBIT "A" TO FINANCING STATEMENT AND SECURITY AGREEMENT This FINANCING STATEMENT and SECURITY AGREEMENT covers the following types or items of property, and the undersigned, VITALCOM INC. ("Debtor") hereby grants SILICON VALLEY BANK ("Secured Party") a security interest therein as collateral for the payment and performance of all present and future indebtedness, liabilities, guarantees and obligations of Debtor to Secured Party. Debtor agrees that said security interest may be enforced by Secured Party in accordance with the terms and provisions of all security and other agreements between Secured Party and Debtor, the California Uniform Commercial Code, or both (but this document shall be fully effective as a security agreement, even if there is not other security or other agreement between Secured Party and Debtor): (a) All accounts, contract rights, chattel paper, letters of credit, documents, securities, securities accounts, investment property, money, and instruments, all other obligations now or in the future owing to the Debtor; and (b) All inventory, goods, merchandise, materials, raw materials, work in process, finished goods, farm products, advertising, packaging and shipping materials, supplies, and all other tangible personal property which is held for sale or lease or furnished under contracts of service or consumed in the Debtor's business, and all warehouse receipts and other documents; (c) All books and records, whether stored on computers or otherwise maintained; and (d) All substitutions, additions and accessions to any of the foregoing, and all products, proceeds and insurance proceeds of the foregoing, and all guaranties of and security for the foregoing; and all books and records relating to any of the foregoing. VITALCOM INC. By s/ Shelley B. Thunen ----------------------------- Title Chief Financial Officer EX-23.1 4 INDEPENDENT AUDITORS' CONSENT 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 333-47173, 333-67109 and 333-33901 on Form S-8 of our report dated February 12, 1999 appearing in this Annual Report on Form 10-K of VitalCom Inc. for the year ended December 31, 1998. Deloitte & Touche LLP Costa Mesa, California March 26, 1999 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 10,461 5,369 4,965 350 1,392 21,978 3,879 2,223 24,223 2,729 0 0 0 37,492 (16,029) 24,223 20,859 20,859 9,561 9,561 13,570 80 890 (1,463) 25 (1,488) 0 0 0 (1,488) (.18) (.18)
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