-----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, BmkM9c9pLFvsSG7WLEIsQ2g6Ax2nW47K9i+Hpf35heeBYMhPKQRjJb797x7Sw2Nu qopH1dQ6IGblTp7ekKLGNg== 0000883322-00-000003.txt : 20000331 0000883322-00-000003.hdr.sgml : 20000331 ACCESSION NUMBER: 0000883322-00-000003 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROTOCOL SYSTEMS INC/NEW CENTRAL INDEX KEY: 0000883322 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 930913130 STATE OF INCORPORATION: OR FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-19943 FILM NUMBER: 585954 BUSINESS ADDRESS: STREET 1: 8500 S W CREEKSIDE PLACE CITY: BEAVERTON STATE: OR ZIP: 97008 BUSINESS PHONE: 6126862500 MAIL ADDRESS: STREET 1: 8500 SW CREEKSIDE PLACE CITY: BEAVERTON STATE: OR ZIP: 97008 10-K405 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 Form 10-K (Mark One) [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 1999 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number: 0-19943 ------- PROTOCOL SYSTEMS, INC. (Exact name of registrant as specified in its charter) Oregon 93-0913130 - ------------------------------- ----------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8500 SW Creekside Place, Beaverton, OR 97008 -------------------------------------------- -------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (503) 526-8500 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 17, 2000 the aggregate market value of the voting stock held by non-affiliates of the registrant was $ 91,637,592. There were 8,179,442 shares of Common stock of the registrant outstanding at March 17, 2000. Documents Incorporated by Reference ----------------------------------- Part of Form 10-K Into Document Which Incorporated - --------------------------------------- ---------------------- Portions of the Proxy Statement for the 2000 Annual Meeting of Shareholders Part III PART I ITEM 1. BUSINESS GENERAL Protocol Systems, Inc. made its first commercial shipment of patient monitors in 1988. Since that date, the Company has sold over 55,000 vital signs monitors. The Company's stock trades on the Nasdaq Stock Market under the symbol PCOL. The Company designs, manufactures and markets patient monitoring instruments and systems utilizing innovative design, advanced software concepts and leading electronic technology. The Company's products are designed to address customers requirements for more efficient and flexible utilization of patient monitoring equipment and technology. The Company's Propaq family of monitors combine multiple physiologic measurement and display capabilities in a single lightweight, rugged instrument, permitting the use of the monitor in a variety of patient care applications. The Company's Acuity work station further increases monitoring flexibility by allowing a clinician to observe and control up to 60 Propaq monitors, Modem Propaqs, QuikSign-tm- monitors, and/or Protocol Cordless ECG telemetry transmitters from a dedicated Sun Microsystems UNIX-based workstation. The Company also markets vital signs technologies and subsystems on an OEM basis to medical device manufacturers under the Pryon-tm- label. Capnography (end-tidal CO2), the Company's first OEM technology, is the measurement and graphical display of carbon dioxide concentration present in a patient's airway. Since 1989, over 35,000 CO2 systems have been sold world-wide. The Company has recently expanded its OEM product offering with the introduction of an ECG/Respiration ASIC and a non-invasive blood pressure module. The Company operates in a single industry segment: the design, manufacture, sale and servicing of medical patient monitoring equipment, including instruments, systems and technologies. Sales of the Company's products by geographic region are shown in the notes to the consolidated financial statements. MARKET FOR PATIENT MONITORING EQUIPMENT The principal purchasers of patient monitoring equipment are hospitals; other customers include outpatient surgery centers, clinics, physician offices, emergency transportation units and military field applications. Patient monitoring products measure, display and document physiologic information obtained from sensors attached to the patient. Measured parameters include electrocardiogram (ECG), invasive and non-invasive blood pressure, pulse rate, pulse oximetry, body temperature, respiration rate, end- tidal CO2 and other specialized parameters. Products vary from specialized single-parameter instruments to monitors with the ability to measure multiple parameters and interface with other instruments. PATIENT MONITORING MARKET SEGMENTS The patient monitoring market may be divided into five market segments: transport monitors, portable bedside monitors, high-end systems, low-end systems and telemetry systems. Each segment is distinguished by the intensity and duration of the monitoring, the acuity of the patient's condition and the level of nursing attention devoted to each patient. TRANSPORT MONITORS. This market segment includes portable monitors used both inside and outside the hospital for transporting critically ill patients. Small size, light weight, ruggedness and long battery life are the distinguishing requirements of this segment. The Company is the world-wide leader in transport monitoring. PORTABLE BEDSIDE MONITORS. Portable monitors are freestanding and movable and typically measure multiple parameters. They are carried or wheeled with the patient, often while he or she is being transported to or within the hospital. They may also be left at the patient's bedside, providing continuous longer- term monitoring when the patient's condition warrants. When monitoring is no longer required, the monitor can be easily moved to a new location or patient. The Company has been a leader in the development of the portable bedside monitoring segment since its introduction of the highly portable, multiple- parameter Propaq monitor in 1988. HIGH-END SYSTEMS. High-end systems monitors are normally large, permanently located adjacent to a particular hospital bed and connected to a central monitoring station for observing multiple patients. They are used most often in intensive care units (ICU's) where hospitals care for their more acutely ill patients, maintain the highest nurse-to-patient ratios and provide for constant patient monitoring. The Propaq Encore and Propaq CS monitors and the Acuity central station allow the Company to compete in certain segments of the high-end systems market. The neonatal, impedance respiration and 5-lead ECG capabilities of the Company's monitors and the central monitoring capability of the Acuity central station provide a monitoring system which is suitable to neonatal, pediatric and adult respiratory ICU applications. LOW-END SYSTEMS. As medical monitoring manufacturers began to network their portable bedside monitors, the low-end systems market segment emerged. These systems allow for cost-effective, continuous monitoring of non-ICU patients. The Company's Acuity central station, with its central monitoring capability, is designed to meet the requirements of this market segment. Subsequent enhancements to the Acuity software, including arrhythmia detection, ST segment analysis, and 96-hour full disclosure capabilities, have expanded the potential applications for the Company's monitoring system. TELEMETRY SYSTEMS. A telemetry system typically consists of a small unit worn by the patient which transmits ECG data via telemetry to a central monitoring station. They are used in situations, such as post-coronary care, where the patient is allowed freedom of movement as part of the recovery process. The Company's Protocol Cordless-registered trademark- monitoring system provides such ECG telemetry monitoring for ambulating patients. PRODUCTS The Company believes that its products presently address a significant portion of the worldwide patient vital sign monitoring market. The Company's highly portable multiple-parameter monitors and ECG telemetry transmitters networked to Acuity central workstations allow hospitals to realize the benefits of Flexible Monitoring-tm-. Flexible Monitoring allows hospitals to constantly reconfigure their monitoring capability in order to match vital signs monitoring with patient acuity levels in the most cost-effective way without compromising the quality of patient care. PROPAQ MONITORS AND OPTIONS. The Company's principal product line, Propaq portable patient monitors, is used in hospitals, outpatient surgery centers, clinics, physician offices, emergency transportation units and military field applications to obtain and display current physiologic patient information. This information enables health care providers to continuously evaluate the patient's condition and to assist the clinician in determining the proper medication or treatment necessary to promote the patient's recovery. Propaq monitors lead the industry in terms of weight, durability and battery life for any comparably configured monitor. Propaq 100 Series monitors are available in multiple configurations and can measure ECG; blood pressure, both invasively and non-invasively; arterial blood oxygen saturation level (pulse oximetry); end-tidal CO2; and body temperature. The Propaq Encore retains all of the monitoring capabilities and portability of the Propaq 100 Series monitor. In addition, the Propaq Encore monitor provides a superior quality high resolution display, an enhanced user interface, respiration monitoring using impedance pneumography, diagnostic level 5-lead ECG monitoring capability and mainstream and/or sidestream Carbon Dioxide (CO2) monitoring. Propaq Encore monitors can be configured to monitor neonatal, pediatric or adult patients. The Company introduced the Modem Propaq monitor in 1997. This monitor provides all the functionality of the Propaq monitors and is able to transmit multiple patient vital signs data via a simple telephone modem to the Acuity central station. The Modem propaq gives the health care provider the flexibility to remotely monitor patients located both inside and outside the hospital from a central nursing station. In 1998, the Company introduced Smartcuf-tm- technology that further increases the Propaq's reliability and accuracy by filtering artifact for even more reliable non-invasive blood pressure (NIBP) measurements. The patented software synchronizes its NIBP readings with the patient's ECG which eliminates the "noise" affecting blood pressure measurement created by external stimuli such as patient motion or vibration, delivering more accurate blood pressure measurements. In September 1999, the Company introduced the Propaq CS monitor which offers a large, touch-zone color display capable of displaying up to four waveforms and two vectors of ECG. The Propaq CS monitor is available with all the same vital sign parameters and options available with the Propaq Encore monitor. The features of the Propaq CS are suited for bedside applications, including neonatal general and intensive care, pediatric wards, pediatric intensive care and pediatric outpatient and specialty areas, as well as gastrointestinal endoscopy, bronchoscopy, emergency departments, post anesthesia units, labor and delivery rooms, surgical and intensive care unit transport, outpatient surgery and respiratory and cardiac step-down units. FLEXIBLE MONITORING SYSTEM. The Flexible Monitoring System-tm- is the product of a co-development effort with Massachusetts General Hospital and was introduced by the Company in 1991. The Flexible Monitoring System combines networked Propaq monitors and Protocol Cordless transmitters with a Sun Microsystems, Inc. workstation and proprietary Protocol software to monitor the vital signs of up to 60 patients simultaneously. Individual workstations in various clinical departments can be linked together to provide an integrated, enterprise wide system. The Company's software controls the networked Propaq monitors and Protocol Cordless transmitters with an easy-to-understand graphical user interface display on a high-resolution color CRT screen. The Acuity central station utilizes a map to display the physical layout of the individual hospital floor. Remote diagnostic capabilities enable the Company's service and support personnel to evaluate system performance without user interruption and provide timely service response. Central station monitoring has been predominately used in intensive care environments in which bedside monitors are permanently wired to a central station. Flexible monitoring re-defines traditional central station monitoring by allowing portable monitors to be placed anywhere patient needs dictate and route vital signs information back to a workstation over low cost communication networks. Propaq monitors can easily be connected to the Acuity central station as the hospital's needs dictate through the use of a simple snap-in modular plug similar to a standard network jack. The portability of Propaq monitors and ease with which they may be connected to the system reduces the number of monitors the hospital would otherwise need to cover a large number of beds and reduces the cost of transporting patients to more traditional monitoring systems. Full disclosure, arrythmia and ST segment analysis options are available with the Flexible Monitoring System. The full disclosure software version for the Acuity central station provides the ability to capture and later retrieve each second of patient vital signs data for the previous 96-hour period. The arrhythmia detection software option enables the system to detect various types of ventricular and life-threatening arrhythmias in a patient, classify the detected arrhythmias by category and provide an alarm when appropriate. Arrhythmia detection is often used in areas of the hospital such as emergency departments, cardiac telemetry units, step-down units and intermediate or transitional care units. The ST Segment Analysis software option analyzes the ST Segment of a patient's ECG for changes that may indicate myocardial ischemia or injury. The Company introduced Networked Acuity patient monitoring systems in 1998. Networked Acuity systems operate as Vital Signs ServersTM, each capable of centrally monitoring local and remote groups of patients resident on multiple Networked Acuity systems. These systems, both inside and outside the hospital, connect smaller hospitals or clinics, or floors within a single hospital such as areas outside the ICU, providing a number of benefits to the user. Remote viewing and control of both real-time and historical full disclosure waveform information, for consultation on any patient's vital signs data, is easily accessible from any of the connected Acuity central stations. From admission to discharge, a seamless patient flow record is automatically generated as the patient moves from one Networked Acuity system to another. Furthermore, the Networked Acuity system configured with an additional review station can provide "mission critical" back-up capability to another Networked Acuity system within the enterprise in the event of a hardware or software failure. In November 1999, the Company introduced a low cost central monitoring station for networking Propaq portable patient monitors. The central station, manufactured by Vidco, Inc., networks up to eight Propaq monitors and simultaneously displays the monitors' vital signs data from a large color display. The central station displays all vital sign parameters provided by the Propaq patient monitors including heart rate, ECG, noninvasive blood pressure, invasive blood pressure, pulse oximetry, impedance respiration, temperature and capnography. In March 2000, the Company announced the FlexNet wireless patient monitoring network providing vital signs data and patient information from anywhere to anywhere, including secure access over the Internet. FlexNet seamlessly links multiple devices such as wireless portable monitors and ambulatory telemetry monitors to central surveillance workstations and/or to remote personal computers (PCs) via the Internet. FlexNet can facilitate the communication of multiple monitoring devices fully configured with a comprehensive complement of vital signs parameters including heart rate, ECG, pulse oximetry, noninvasive and invasive blood pressure, respiration and capnography among others. In addition, other devices gaining increasing use by clinicians such as Internet Protocol (IP) telephones, personal digital assistants (PDAs), and wireless PCs may also be seamlessly and simultaneously supported on the same wireless FlexNet network. FlexNet utilizes Symbol Technology's Spectrum24 - -registered trademark- radio module that operates in the 2.4 GHz band using spread-spectrum modulation. Utilizing this technology, FlexNet can not only support comprehensive and sophisticated patient monitoring networks, but can also do so while providing superior noise tolerance and communications integrity. The FlexNet Access Points can support both wireless portable monitors and ambulatory telemetry devices unlike other systems, which must layer two antenna systems in order to accommodate both types of monitoring devices. Clinicians can also remotely access the FlexNet's vital signs data via a variety of devices including PDAs, PCs, and IP telephones through common Internet browsers supported by Protocol's secure Vital Signs Server. The FlexNet wireless network can also be seamlessly integrated with existing hardwired patient monitoring systems from Protocol Systems. The Company expects FlexNet to be available for customer shipments in the fourth quarter of 2000 pending FDA market clearance. In March 2000, the Company announced the Micropaq-tm- ambulatory patient monitor, which combines the functionality and form of a patient worn telemetry monitor with the display, alarms and parameters of a standalone portable vital signs monitor. This monitor provides one or two channels of ECG, heart rate, pulse oximetry and nurse call capabilities. It is principally designed for use in cardiac care with ambulatory patients connected wirelessly to the Company's FlexNet-tm- network and the Acuity central workstation. The monitor is also appropriate for a number of monitoring applications outside of cardiac care because it provides a liquid crystal display of vital signs data and will operate standalone outside of the wireless network. The Company expects the first version of the Micropaq monitor, including ECG, heart rate, and pulse oximetry, to be available for customers shipments in the fourth quarter of 2000 pending FDA market clearance. A later version including a noninvasive blood pressure option featuring the Company's Smartcuf patient motion artifact resistant technology is expected the following year. PROTOCOL CORDLESS TELEMETRY SYSTEM. The telemetry option provides wireless communication of ECG signals by radio frequency (RF) waves from a portable transmitter, generally worn by an ambulating patient, to an Acuity central station and/or Propaq monitor. QUIKSIGNS MONITOR. In 1997, the Company entered into an agreement with Welch Allyn, Inc. under which Welch Allyn manufactures the QuikSigns monitor under the Company's name and provides the Company with U.S. hospital distribution and marketing rights. The QuikSigns product is a spot-check patient monitor that adds to the breadth of Protocol's product line, and is ideal for gathering routine and procedural vital signs data. The instrument quickly and non-invasively monitors blood pressure, blood oxygen and temperature, and features data storage and printing capabilities. OEM PRODUCTS. The Company manufactures solutions for CO2 monitoring applications that include mainstream and sidestream CO2 sensors for OEM applications as well as stand-alone monitors. The sidestream CO2 sensor and related hardware and software are used with non-intubated patients in applications such as post-ventilator patient assessment, conscious sedation, acute asthma assessment in the emergency room, assessment of patient conditions on BiPAP and other applications. The mainstream CO2 sensors and related hardware and software are used in hospital venues for intubated patients. The Company also manufactures a line of consumable products that are used in conjunction with its CO2 sensors. In November 1999, the Company introduced an ECG Application Specific Integrated Circuit (ASIC) monitoring subsystem. This new subsystem is small, requires low power and provides a high performance ECG monitoring front-end for integration into patient monitoring devices. The Company also introduced the LC101 sidestream CO2 monitoring subsystem for integration into patient monitoring devices providing noninvasive vital sign measurements of ETCO2, inspired carbon dioxide and breath rate using a simple nasal cannula. MARKETING AND DISTRIBUTION DOMESTIC. The Company markets its products domestically through both Company- employed sales representatives and independent distributors. The Company's domestic sales managers supervise its direct sales representatives and independent distributors, in a defined geographic area. The Company intends to continue to use a combination of direct sales representatives and independent distributors based on the most effective sales approach for each territory. The Company's primary market in the United States consists of approximately 6,000 hospitals, where its products are purchased for use in emergency departments, post-anesthesia care units, step-down intensive care units, special procedure rooms such as cardiac catheterization and gastrointestinal endoscopy, labor and delivery, general-care floors, and for transport of patients between departments. In 1990, the General Services Administration approved the Company's Propaq monitors for purchase by United States government agencies, including the armed forces and Veterans' Administration hospitals. The Company's products were added to the U.S. Government's international supply schedule in 1992. In 1995, the Company received approval from the U. S. Air Force for in-flight use of the 100 Series Propaq monitor. In 1997, the Propaq Encore was approved for use during all phases of flight on all U.S. Air Force aircraft. The Company's national accounts managers negotiate and manage the Company's group contracts with organizations such as MAGNET, MedEcon, University Hospital Consortium and Kaiser Permanente. In 1998, the Company signed an exclusive 3-year purchasing agreement with American Medical Response, the largest ambulance service and emergency physician practice manager in the U.S. In March 2000, the Company announced two additional group contracts, a two- year agreement with Amerinet for the portable patient monitoring category of Amerinet's Cardiovascular Clinical Service Program and a three-year agreement to provide portable patient monitoring equipment to Novation. The Company currently has group contracts which include more than 65% of the acute care hospitals in the U.S. The Company has developed a financial modeling tool called Proforma-tm- to help hospitals evaluate the financial impact of Flexible Monitoring on the institutions. Proforma facilitates sales of Flexible Monitoring systems by helping customers re-engineer their patient flow thereby helping the hospital lower patient care costs. INTERNATIONAL. The Company markets its products internationally through independent distributors covering all major European and Pacific Rim markets and has sold its products in over 90 countries. The agreements with these distributors generally provide the exclusive right to sell the Company's products in a specific geographic area or country subject to certain performance requirements. A team of international sales managers supervise, assist and train this network of international distributors. The Company believes that its ability to meet foreign regulatory requirements and provide monitors in nine languages is an important international marketing advantage. In February 1999, the Company entered into a four-year marketing and representation agreement with Medtronic Physio-Control ("Physio"), that gives Physio exclusive marketing, distribution and service rights for the Company's Propaq and Acuity patient monitoring instruments and systems in France and most of Germany. OEM. The Company's marketing strategy is to establish and develop OEM customer relationships with U.S. and international patient monitoring systems manufacturers. OEM subassemblies and accessories are sold directly to customers by a dedicated OEM sales and marketing group within the Company. OEM customers include Mallinckrodt, Spacelabs Medical, Datex-Ohmeda, Nihon Kohden, and Welch Allyn among others. CUSTOMER SUPPORT. The Company maintains a technical support group to provide clinical in-service, installation, repair and technical training services in support of both direct and distributor sales. Technical support offices are currently maintained in Beaverton, Oregon, the United Kingdom, and Asia/Pacific (New Zealand). The Company provides maintenance and repair classes for distributors and the biomedical engineering personnel of its hospital customers. In addition, Protocol has developed a "Partners in Care" program designed to provide clinical education and training to customers installing Flexible Monitoring systems. WARRANTIES. The Company warrants its products sold from one to three years depending on product category and geography (domestic vs. international). Optional extended warranty and service contracts are available for all Propaq products and the Acuity central stations. BACKLOG. Backlog generally consists of purchase orders for products deliverable within twelve months. Sales in any quarter are dependent on orders booked and shipped during that quarter. Accordingly, the Company does not consider backlog to be a significant indication of future performance. RESEARCH AND DEVELOPMENT The Company's research and development efforts focus on developing new products and expanding the capabilities of existing products. The Company's research and development staff consists of 57 individuals with collective expertise in analog and digital circuit design, software design, networking and communications, mechanical and packaging design, mathematics, medical and clinical sciences, and optics and display technology. During 1999, 1998, and 1997, research and development expenses, net of reimbursed expenditures, were $6.7 million, $8.3 million, and $8.7 million, respectively. MANUFACTURING The Company's manufacturing operations consist of procurement and inspection of components, final assembly of electronic components and extensive testing of finished products. The Company uses subcontractors for the fabrication and assembly of printed circuit boards. By using this approach, the Company reduces its capital and employee requirements and can more easily and rapidly adopt emerging manufacturing technologies. The Company currently procures most of its parts from outside suppliers and relies upon a number of single-source suppliers to provide certain parts for its products, including pulse oximetry, display subassemblies and certain circuit board assemblies. To date, the Company has been able to obtain the necessary parts to meet manufacturing requirements. There can be no assurance, however, that supply shortages or interruptions will not arise in the future, which could increase the cost or delay the shipment of the Company's products or cause the Company to incur costs to develop alternative sources, either of which could have a material adverse effect on the Company's results of operations. The Company typically purchases components pursuant to open purchase orders placed from time to time in the ordinary course of business. In order to reduce the risk of supply interruption, the Company maintains close working relationships with its suppliers and may choose to inventory selected components. Quality and reliability are emphasized in the design and manufacture of the Company's products. The Company believes it manufactures its products according to criteria that meet or exceed the requirements of all applicable domestic and foreign regulations and standards. The Company's products undergo thorough quality inspection and testing throughout the manufacturing process. In addition, the Company's quality assurance group inspects, operates and verifies calibration and conformance with the customer order of all products prior to shipment. The Company has received ISO 9001 and EN 46001 certifications in 1998. In September 1998, the Company successfully completed an unannounced Good Manufacturing Practices (GMP) audit by the FDA. The audit was completed with no adverse observations and without the issuance of Form 483. COMPETITION The patient monitoring market is intensely competitive and characterized by rapidly evolving technology. Selling its products in multiple market segments, the Company faces a broad range of competitors, many of which have financial, technical, research and development and marketing resources significantly greater than those of the Company. The Company's principal competitors are Datascope Corporation, Agilent Technologies, GE Marquette Medical Systems, Medical Data Electronics, Inc., Siemens Medical Electronics, and Spacelabs Medical, Inc. Principal OEM competitors include Novametrix and Oridion. In addition to the Company's existing competitors, other medical and electronic equipment companies could enter the markets in which the Company competes. The Company believes that the principal competitive factors in its market are product depth and breadth, individual product features, reliability, customer service, product reputation, price and effectiveness of marketing and sales efforts. In addition, the Company believes that the speed with which companies can identify medical needs and anticipate evolving standards of care, develop products to meet those needs and standards, and supply commercial quantities to the market are important competitive factors. The Company believes that it competes favorably with respect to these factors. PATENTS, TRADEMARKS AND COPYRIGHTS The Company owns or has rights to ten U.S. patents, and has ten U.S. patent applications pending related to the design and manufacture of patient monitoring instruments. The Company owns or has the rights to six foreign patents. The Company also owns thirteen U.S. registered trademarks, has one U.S. trademark registration application pending, and owns eight registered trademarks in various countries. In addition, the Company holds copyrights with respect to its proprietary software. Although the Company has such proprietary rights, it believes that its success depends more upon the innovative skills and technical competence of its management and employees in responding to customer needs and changing markets than upon ownership of such rights. GOVERNMENT REGULATION The manufacture and sale of the Company's products are subject to substantial regulation by numerous governmental authorities, principally the FDA and corresponding foreign agencies. The Company is subject to FDA regulations, standards and procedures with respect to registration of the Company's manufacturing facilities and the manufacture of its medical devices and to periodic FDA inspection for compliance therewith. The FDA also has broad regulatory powers with respect to pre-clinical and clinical testing of new medical devices and the manufacturing, marketing and advertising of medical devices. The Company is also subject to regulation in the foreign countries in which it markets its products. Many of the regulations applicable to the Company's products in such countries are similar to those of the FDA. However, certain foreign regulatory agencies establish product standards and qualification requirements for medical devices which are different from, and in some cases more stringent than, those in the United States. The Company has received certification that the Propaq family of monitors meet the essential requirements of the Medical Device Directive of the European Union. This certification authorizes the Company to display the CE mark on its monitors and to sell monitors in the various countries of the European Union. Prior to obtaining this certification, the Company was required to obtain product approvals from each of the pertinent regulatory agencies of the individual countries of the European Union. Federal and foreign regulations regarding manufacture and sale of products such as those of the Company, as well as regulations and practices regarding the reimbursement of hospitals and other health care providers for the cost of service rendered, are subject to change. Although the Company cannot predict what impact, if any, such changes might have on its business, it is possible that any such changes could adversely affect the Company's business. ITEM 2. PROPERTIES The Company's principal office is located in Beaverton, Oregon. The Company leases approximately 95,000 square feet at the Beaverton, Oregon location under a lease that expires in December 2005. The primary manufacturing, warehousing, research and development, sales, marketing and administrative activities of the Company are conducted from this facility which is nearly fully utilized and maintained in good condition. The Company believes that the properties subject to the lease and additional office space available under lease options will be sufficient to accommodate its operations for the near term. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1999. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock began trading on the Nasdaq Stock Market under the symbol PCOL on March 24, 1992 following the Company's initial public offering. As of March 17, 2000, there were 137 stockholders of record of Protocol common stock and approximately 3,000 beneficial owners of common stock. No cash dividends have been paid on the common stock and the Company does not anticipate paying any cash dividends in the foreseeable future. Following are the range of the high and low sales prices for the Company's common stock as reported by Nasdaq: 1999 -- QUARTER ENDED HIGH LOW - --------------------- ------ ------ December 31, 1999 $9.00 $6.00 September 30, 1999 9.13 6.88 June 30, 1999 9.50 5.88 March 31, 1999 8.75 6.00 1998 -- QUARTER ENDED HIGH LOW - --------------------- ----- ----- December 31, 1998 $8.50 $6.13 September 30, 1998 9.63 7.88 June 30, 1998 10.38 7.69 March 31, 1998 10.25 6.75 During the fourth quarter of 1999, the Company sold securities without registration under the Securities Act of 1933, as amended (the "Securities Act") upon the exercise of certain stock options granted under the Company's stock option plans. An aggregate of 91,357 shares of Common Stock were issued at exercise prices ranging from $1.32 to $7.00. These transactions were effected in reliance upon the exemption from registration under the Securities Act provided by Rule 701 promulgated by the Securities and Exchange Commission pursuant to authority granted under Section 3 (b) of the Securities Act. ITEM 6. SELECTED FINANCIAL DATA
(in thousands, except Years Ended December 31, per share amounts) 1999 1998 1997 1996 1995 - -------------------- ------ ------ ------ ------ ------ Operations Data Sales $66,317 $67,323 $64,094 $66,894 $59,602 Income from operations before special charges 5,515 3,252 3,316 7,377 6,010 Income (loss) from operations 5,515 (2,182) 3,316 5,005 6,010 Net income (loss) 6,291 (675) 3,356 4,078 5,398 Per Share Data Basic earnings (loss) per share .77 (.08) .38 .47 .64 Diluted earnings (loss) per share .76 (.08) .36 .44 .60 Weighted average number of shares used in the computation of earnings (loss) per share: Basic 8,176 8,487 8,859 8,672 8,460 Diluted 8,321 8,487 9,253 9,373 9,004 Dividends declared -- -- -- -- -- Balance Sheet Data Cash and investments $23,989 $18,748 $25,570 $22,703 $24,267 Working capital 36,651 39,296 42,475 43,783 30,853 Total assets 59,838 55,851 63,755 59,045 57,220 Long-term debt and capital lease obligations, excluding current maturities - -- -- -- 1,795 Shareholders' equity 51,951 47,746 55,678 51,309 46,793
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS Results of Operations 1999 Compared to 1998 - --------------------- SALES. Sales decreased 1.5% to $66.3 million in 1999 from $67.3 million in 1998. Domestic sales, excluding Original Equipment Manufacturer sales of Pryon Medical Device Technology (MDT) products and GenESA devices (OEM sales), decreased 2.9% to $43.7 million (65.8% of total sales) in 1999 from $45.0 million (66.8% of total sales) in 1998 primarily as a result of a decrease in the number of Acuity central stations and related monitors sold. This decrease was partially offset by a $787,000 increase in U.S. military revenues and sales of the new Propaq CS monitor of $825,000 in the fourth quarter of 1999. International sales, excluding international OEM sales, decreased 4.5% to $15.5 million (23.4% of total sales) in 1999 from $16.2 million (24.1% of total sales) in 1998. This decline in international sales was primarily due to a decline in the number of units sold in Asia reflecting soft international markets in that region, partially offset by sales of the new Propaq CS monitor of $277,000 in the fourth quarter of 1999. OEM sales increased 16.6% to $7.2 million (10.8% of total sales) in 1999 from $6.1 million (9.1% of total sales) in 1998 primarily due to a $1.5 million increase in MDT CO2 product shipments. This increase was partially offset by a $496,000 decrease in sales of GenESA devices to Gensia Automedics, Inc. GROSS PROFIT. Gross profit as a percentage of sales decreased to 49.1% in 1999 from 50.9% in 1998. The decrease in gross profit was primarily due to an increase in sales of products which carry a relatively low margin, such as OEM products and QuikSigns monitors, combined with slightly higher discounts on domestic sales. RESEARCH AND DEVELOPMENT. Research and development expenses decreased 19.1% to $6.7 million in 1999 compared to $8.3 million in 1998. This decrease was primarily the result of the relocation of the Pryon operations from Menomonee Falls, Wisconsin to the Company's Beaverton, Oregon facility in 1998 which resulted in a reduction in the total number of research and development employees. As a percentage of sales, research and development expenses were 10.1% in 1999 and 12.3% in 1998. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses decreased 10.5% to $20.3 million in 1999 from $22.7 million in 1998. This decrease resulted primarily from the closure of the Company's subsidiary offices and the direct sales organizations in Germany and France initiated at the end of 1998 and the reduction in the number of administrative employees as a result of the relocation of the Pryon operations in the third quarter of 1998. As a percentage of sales, selling, general and administrative expenses were 30.7% in 1999 and 33.8% in 1998. SPECIAL CHARGES. During 1998, the Company incurred special charges of $5.4 million which included $3.2 million related to the restructuring of the Company's worldwide operations and $2.2 million to relocate the operations of the Company's Pryon subsidiary from Wisconsin to Oregon. Cash payments during 1999 related to these special charges totaled $1,540,000 and consisted primarily of employee severance benefits and lease termination costs. As of December 31, 1999, special charges of $102,000, related primarily to certain contract terminations, had not been disbursed. The Company anticipates that these remaining balances will be expended by the end of 2000. No special charges were incurred in 1999. OTHER INCOME. Other income (net) increased to $2.6 million in 1999 from $982,000 in 1998 primarily due to the 1999 SICOR litigation settlement, partially offset by foreign exchange losses related to the liquidation of the Company's French and German subsidiaries. During 1999, the Company reached a settlement with SICOR, Inc. (formerly Gensia SICOR, Inc.) relating to litigation the Company commenced against Gensia SICOR, Inc. and Gensia Automedics in July 1998 alleging they breached a development and supply agreement to develop and supply a closed-loop drug delivery and monitoring device. Under terms of this settlement, SICOR, Inc. and Gensia Automedics have agreed to pay the Company a total of $3.7 million over the next two years. PROVISION FOR (BENEFIT FROM) INCOME TAXES. The provision for income taxes was $1.8 million in 1999 compared to a benefit from income taxes of $525,000 in 1998, producing annual effective tax rates of 22.3% and (43.7%), respectively. The difference in the effective taxes rates between 1999 and 1998 was primarily due to the significant change in pretax income (loss) caused by the special charges incurred in 1998, partially offset by benefits from utilization of net operating loss and research and experimentation tax credit carryovers in 1999. NET INCOME (LOSS). Net income in 1999 was $6.3 million or $0.76 per diluted share compared to net loss of $675,000 or $0.08 per diluted share in 1998. The increase in net income was primarily due to reduced operating expenses and special charges as a result of the relocation of the Pryon manufacturing facility and the worldwide restructuring in 1998, and increased 1999 other income primarily related to the SICOR litigation settlement. Excluding unusual items consisting of $1.6 million of SICOR settlement income and $125,000 of foreign exchange losses (net $1.1 million after tax, or $.13 per diluted share), net income for 1999 was $5.2 million, or $.63 per diluted share. Excluding unusual items consisting of $5.4 million of special charges associated with the worldwide restructuring and the relocation of Pryon (net $4.0 million after tax, or $0.47 per diluted share), net income for 1998 was $3.3 million, or $.39 per diluted share. Net income exclusive of unusual items is a non-GAAP measure, and investors should not rely on it as a substitute for GAAP measures. Because the 1999 SICOR settlement and the 1998 worldwide restructuring and relocation of the Pryon subsidiary were unusual in nature, management believes that a measure of net income excluding these items is meaningful and useful to investors as it provides an alternative basis with which management and investors can assess the profitability of the Company's core operations. 1998 Compared to 1997 - --------------------- SALES. Sales increased 5.0% to $67.3 million in 1998 from $64.1 million in 1997. Domestic sales, excluding Original Equipment Manufacturer sales of Pryon Medical Device Technology (MDT) products and GenESA devices (OEM sales), increased 17.6% to $45.0 million (66.8% of total sales) in 1998 from $38.2 million (59.6% of total sales) in 1997 primarily as a result of a $7.0 million increase in U.S. military revenues due to an increase in unit sales of Propaq Encore monitors. International sales, excluding international OEM sales, decreased 7.4% to $16.2 million (24.1% of total sales) in 1998 from $17.5 million (27.3% of total sales) in 1997. This decline in international sales was principally due to the continued strength of the U.S. dollar against foreign currencies and soft international markets, particularly in Europe and Asia. OEM sales decreased 26.5% to $6.1 million (9.1% of total sales) in 1998 from $8.4 million (13.1% of total sales) in 1997 primarily due to a $2.1 million decrease in sales to certain of the Company's MDT customers. Additionally, there was a slight decrease in sales of GenESA devices to Gensia Automedics. GROSS PROFIT. Gross profit as a percentage of sales decreased to 50.9% in 1998 from 51.3% in 1997. The decrease in gross profit as a percentage of sales was primarily due to manufacturing inefficiencies and production start up costs resulting from the relocation of the Pryon operations from Menomonee Falls, Wisconsin to the Company's Beaverton, Oregon facility in 1998. RESEARCH AND DEVELOPMENT. Research and development expenses decreased 4.3% to $8.3 million in 1998 compared to $8.7 million in 1997. This decrease was primarily the result of the relocation of the Pryon operations from Menomonee Falls, Wisconsin to the Company's Beaverton, Oregon facility in 1998 which resulted in a reduction in the total number of research and development employees. As a percentage of sales, research and development expenses were 12.3% in 1998 and 13.5% in 1997. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses increased 8.8% to $22.7 million in 1998 from $20.9 million in 1997. This increase resulted primarily from the establishment of direct sales organizations in Germany and France in 1998 and an increase in the number of direct sales representatives and clinical application specialists employed by the Company to expand the field sales and service operations. As a percentage of sales, selling, general and administrative expenses were 33.8% in 1998 and 32.6% in 1997. SPECIAL CHARGES. The Company incurred special charges of $5.4 million during 1998. These special charges included $3.2 million related to the restructuring of the Company's worldwide operations, which was comprised of a $1.6 million write-down of the Universal Defibrillator Module (UDM) purchased in 1995 as part of the acquisition of Omeara Limited, $933,000 costs related to the closure of the direct sales organizations in Germany and France which include termination costs for 16 employees, lease termination costs and write- down of assets of direct sales organizations to net realizable value, and $644,000 of severance costs for 14 terminated domestic employees and a severance package for the founder and Chief Technical Officer who resigned in 1998. Additionally, special charges of $2.2 million were incurred to relocate the operations of the Company's Pryon subsidiary from Wisconsin to Oregon. These costs include employee severance, write-off of assets that will not be utilized in Oregon, lease and other contract terminations, and costs to relocate key employees as well as inventory and equipment. The relocation resulted in a reduction of 56 employees from manufacturing, engineering and administrative functions. OTHER INCOME. Other income (net) decreased to $982,000 in 1998 from $1.1 million in 1997 primarily due to a reduction in the cash and investments balance as the Company utilized $8.9 million of its available cash to repurchase common stock in 1998. PROVISION FOR (BENEFIT FROM) INCOME TAXES. The benefit from income taxes was $525,000 in 1998 compared to a provision for income taxes of $1.0 million in 1997, producing annual effective tax rates of (43.7%) and 23.5%, respectively. The difference in the effective taxes rates between 1998 and 1997 was primarily due to the significant change in pretax income (loss) caused by the special charges incurred in 1998. NET INCOME (LOSS). The net loss in 1998 was $675,000 or $0.08 per diluted share compared to net income of $3.4 million or $0.36 per diluted share in 1997. Excluding unusual items consisting of special charges associated with the worldwide restructuring and the relocation of Pryon, net income for 1998 would have been $3.3 million or $0.39 per diluted share. Net income exclusive of unusual items is a non-GAAP measure, and investors should not rely on it as a substitute for GAAP measures. Because the worldwide restructuring and relocation of the Pryon subsidiary were unusual in nature, management believes that a measure of net income excluding these items is meaningful and useful to investors as it provides an alternative basis with which management and investors can assess the profitability of the Company's core operations. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1999, the Company had cash and investment balances totaling $24.0 million. Working capital balances decreased to $36.7 million at December 31, 1999 from $39.3 million at December 31, 1998 primarily due to a reduction in inventory and accounts receivable balances. The current ratio decreased slightly to 5.6:1 at December 31, 1999 from 5.9:1 at December 31, 1998. The Company's portfolio of long-term investments increased by $6.0 million in 1999. Operating activities generated positive cash flows of $10.1 million in 1999 primarily due to income from operations of $6.3 million as well as a decrease in inventory and accounts receivable balances. Cash of $1.9 million was used for the acquisition of property and equipment in 1999. During 1999, the Company repurchased 407,000 shares of common stock at a weighted average purchase price of $7.94 per share. Proceeds from stock option and stock purchase plans and related tax benefits were $1.1 million in 1999. No significant commitments for capital expenditures have been entered into as of December 31, 1999. However, management will continue to explore opportunities for strategic relationships with other companies and the possible acquisition of technologies or businesses, all of which may require significant future outlays of cash. Management believes that the combination of current cash and investment balances and cash flows from operations will be sufficient to meet the Company's liquidity and capital needs for 2000 and the foreseeable future. YEAR 2000 ISSUES Prior to December 31, 1999, the Company initiated and completed a comprehensive Year 2000 analysis. To date, the Company has not, nor to the Company's knowledge, have the Company's suppliers and third party vendors, experienced any material Year 2000-related problems. However, the Company cannot determine if it will be subject to Year 2000 problems in the future that have not been identified to date. FORWARD-LOOKING STATEMENTS This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of the Annual Report contain statements, that are forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the Company's business, management's beliefs and assumptions made by management. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. In addition, such statements could be affected by other factors discussed elsewhere in this Annual Report and from time to time in the Company's other Securities and Exchange Commission filings and reports, and by general industry and market conditions and growth rates, and general domestic and international economic conditions. Such forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Report. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect thereto or with respect to other forward-looking statements. The Company's quarterly operating results have fluctuated in the past and may continue to fluctuate in the future depending on factors such as increased competition, timing of new product announcements, pricing changes by the Company or its competitors, length of sales cycles, market acceptance or delays in the introduction of new products or enhanced versions of existing products, timing of significant orders, regulatory approval requirements, product mix and economic factors and conditions generally and in the market for the Company's products specifically. In particular, the Company's quarterly operating results have fluctuated as a result of the unpredictable size and timing of military patient monitoring equipment procurements, and seasonal or other changes in customer buying patterns. A substantial portion of the Company's revenue in each quarter results from orders booked in that quarter. Accordingly, revenue from quarter to quarter is difficult to forecast. The Company's expense levels are based, in part, on its expectations as to future revenue. If revenue levels are below expectations, operating results are likely to be adversely affected. In particular, net income may be disproportionately affected by a reduction in revenue because only a small portion of expenses vary with revenue. Results of operations in any period should not be considered indicative of the result to be expected for any future period, and fluctuations in operating results may also result in fluctuations in the price of the Company's common stock. No assurance can be given that the Company will be able to grow in future periods or that its operations will remain profitable. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 also requires that changes in the derivative's fair value be recognized currently in results of operations unless specific hedge accounting criteria are met. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. The Company does not expect SFAS No. 133 to have a material impact on its Consolidated Financial Statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to the impact of foreign currency fluctuations due to a small portion of its international sales. The Company minimizes its risk to foreign currency fluctuations as international sales through independent distributors are made in U.S. dollars which has helped reduce any foreign currency risk. As of December 31, 1999, the Company had an investment portfolio of fixed income securities, including those classified as cash and cash equivalents, short-term investments and long-term investments of $21.5 million. These securities are subject to interest rate fluctuations. An increase in interest rates could adversely affect the market value of the Company's fixed income securities. The Company does not use derivative financial instruments in its investment portfolio to manage interest rate risk. The Company does, however, limit its exposure to interest rate and credit risk by establishing and strictly monitoring clear policies and guidelines for its investment portfolio. The weighted average maturity of the investment portfolio may not exceed 360 days and no single investment may have a maturity date of greater than two years. The guidelines also establish credit quality standards and limit the exposure to one issue, issuer, or type of instrument. Due to these factors the exposure to market and credit risk is not expected to be material. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FINANCIAL STATEMENTS - -------------------- REPORT OF MANAGEMENT The management of Protocol Systems, Inc. is responsible for the accompanying consolidated financial statements. These consolidated financial statements were prepared by management in conformity with generally accepted accounting principles and necessarily include amounts which are based on management's best estimates and judgment. Management is also responsible for maintaining systems of internal control to provide reasonable assurance that assets are safeguarded, business activities are executed in accordance with management authorization and transactions are properly recorded. The Audit Committee of the Board of Directors is composed of two outside directors who are not officers or employees of the Company. These directors meet regularly with management and with the independent auditors to review matters related to accounting, financial reporting and the Company's systems of internal control. The independent auditors have free access to the Audit Committee, without management present, to discuss these matters. /s/Robert F. Adrion /s/Edward M. Kolasinski - ---------------------------- ----------------------------- Robert F. Adrion, Ph.D. Edward M. Kolasinski Chief Executive Officer, President Vice-President, Finance/Chief Financial Officer INDEPENDENT AUDITORS' REPORT To the Shareholders and Board of Directors of Protocol Systems, Inc.: We have audited the accompanying consolidated balance sheets of Protocol Systems, Inc. and subsidiaries as of December 31, 1999 and 1998 and the related consolidated statements of operations and comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Protocol Systems, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999 in conformity with generally accepted accounting principles. /s/ KPMG LLP Portland, Oregon January 21, 2000 PROTOCOL SYSTEMS, INC. Consolidated Statements of Operations and Comprehensive Income (in thousands except per share amounts)
Years ended December 31, ------------------------ 1999 1998 1997 ------ ------ ------ Sales $66,317 $67,323 $64,094 Cost of sales 33,733 33,029 31,212 ------ ------ ------ Gross profit 32,584 34,294 32,882 Operating expenses: Research and development expenses 6,722 8,304 8,675 Selling, general and administrative expenses 20,347 22,738 20,891 Special charges -- 5,434 -- ------ ------ ------ Total operating expense 27,069 36,476 29,566 ------ ------ ------ Income (loss) from operations 5,515 (2,182) 3,316 Other income (expense): Interest income 1,089 1,016 1,104 Other 1,496 (34) (32) ------ ------ ------ Total other income 2,585 982 1,072 ------ ------ ------ Income (loss) before income taxes 8,100 (1,200) 4,388 Provision for (benefit from) income taxes 1,809 (525) 1,032 ------ ------ ------ Net income (loss) 6,291 (675) 3,356 Other comprehensive income (loss), net of tax: Foreign currency translation adjustments (98) 87 (41) Unrealized holding gain (loss) arising during the period (119) 20 1 ------ ------ ------ Other comprehensive income (loss) (217) 107 (40) ------ ------ ------ Comprehensive income (loss) $6,074 ($568) $3,316 ------ ------ ------ Earnings (loss) per share: Basic $0.77 ($0.08) $0.38 ------ ------ ------ Diluted $0.76 ($0.08) $0.36 ------ ------ ------ Weighted average number of shares used in the computation of earnings (loss) per share: Basic 8,176 8,487 8,859 Diluted 8,321 8,487 9,253
See accompanying notes to consolidated financial statements. PROTOCOL SYSTEMS, INC. Consolidated Balance Sheets (in thousands)
December 31, ----------------------- 1999 1998 ------ ------ ASSETS Current assets: Cash and cash equivalents $10,470 $ 8,023 Short-term investments 3,487 6,680 Accounts receivable: Trade, less allowance for doubtful accounts of $450 and $420 at 1999 and 1998, respectively 16,615 17,654 Other 1,468 317 Inventories, net 10,080 12,218 Prepaid expenses and other current assets 2,418 2,469 ------- ------ Total current assets 44,538 47,361 Long-term investments 10,032 4,045 Property and equipment, net 3,912 4,041 Other assets 1,356 404 ------- ------ $59,838 $55,851 ------- ------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,750 $ 2,584 Accrued liabilities 5,057 5,383 Deferred revenue and customer deposits 80 98 ------ ------ Total current liabilities 7,887 8,065 Deferred income taxes -- 40 Commitments and contingencies Shareholders' equity: Preferred stock, $.01 par value. Authorized 10,000 shares; none issued and outstanding at 1999 and 1998 -- -- Common stock, $.01 par value. Authorized 30,000 shares; issued and outstanding 8,032 at 1999 and 8,207 at 1998 80 82 Additional paid-in capital 26,216 28,105 Unearned compensation (26) (48) Accumulated other comprehensive income(loss) (12) 205 Retained earnings 25,693 19,402 ------ ------ Total shareholders' equity 51,951 47,746 ------ ------ $59,838 $55,851 ------ ------
See accompanying notes to consolidated financial statements. PROTOCOL SYSTEMS, INC. Consolidated Statements of Shareholders' Equity (in thousands)
Accumulated Total Common stock Additional other share- ----------------- paid-in Unearned comprehensive Retained holders' Shares Par value capital compensation income(loss) earnings equity ------ --------- --------- ----------- -------- -------- ------- Balance at December 31, 1996 8,744 $87 $34,363 $-- $138 $16,721 $51,309 Common stock issued under stock purchase and stock option plans 191 2 879 -- -- -- 881 Tax benefit from stock option incentive plans -- -- 81 -- -- -- 81 Vesting of shares issued for purchase of subsidiary -- -- 91 -- -- -- 91 Other comprehensive loss -- -- -- -- (40) -- (40) Net income -- -- -- -- -- 3,356 3,356 ------ ------- ------- ------- ------- -------- ------- Balance at December 31, 1997 8,935 89 35,414 -- 98 20,077 55,678 Common stock issued under stock purchase and stock option plans 208 2 1,183 -- -- -- 1,185 Tax benefit from stock option incentive plans -- -- 147 -- -- -- 147 Repurchase of common stock (956) (9) (8,922) -- -- -- (8,931) Issuance of common stock under restricted stock award agreement 20 -- 192 (192) -- -- -- Amortization of unearned compensation -- -- -- 144 -- -- 144 Vesting of shares issued for purchase of subsidiary -- -- 91 -- -- -- 91 Other comprehensive income -- -- -- -- 107 -- 107 Net loss -- -- -- -- -- (675) (675) ------ ------- ------- ------- ------- -------- ------- Balance at December 31, 1998 8,207 82 28,105 (48) 205 19,402 47,746 Common stock issued under stock purchase and stock option plans 219 2 1,062 -- -- -- 1,064 Tax benefit from stock option incentive plans -- -- 82 -- -- -- 82 Repurchase of common stock (407) (4) (3,225) -- -- -- (3,229) Issuance of common stock under restricted stock award agreement 13 -- 101 (101) -- -- -- Amortization of unearned compensation -- -- -- 123 -- -- 123 Vesting of shares issued for purchase of subsidiary -- -- 91 -- -- -- 91 Other comprehensive loss -- -- -- -- (217) -- (217) Net income -- -- -- -- -- 6,291 6,291 ------ ------ ------- ------- ------- ------- -------- Balance at December 31, 1999 8,032 $80 $26,216 ($26) ($12) $25,693 $51,951 ------ ------ ------- ------- ------- ------- --------
See accompanying notes to consolidated financial statements. PROTOCOL SYSTEMS, INC. Consolidated Statements of Cash Flows (in thousands)
Year ended December 31, ------------------------------- 1999 1998 1997 ------------------------------- Cash flows from operating activities: Net income (loss) $6,291 $(675) $3,356 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 2,175 2,353 2,365 Asset impairment 50 2,466 -- Amortization of bond premium 133 186 312 Provision for deferred income taxes (413) (562) (250) Other non-cash items 129 144 -- Changes in operating assets and liabilities: Accounts receivable 273 (1,808) (653) Inventories 2,061 1,331 (1,098) Prepaid expenses and other assets (866) (120) (130) Accounts payable and accrued liabilities 307 (169) 569 Deferred revenue and customer deposits (17) (24) (20) ------ ------ ------ Net cash provided by operating activities 10,123 3,122 4,451 Cash flows from investing activities: Purchase of investments (15,534) (10,871) (14,539) Proceeds from maturity of investments 12,488 13,292 16,715 Acquisition of property and equipment (1,926) (2,090) (2,198) Expenditures for other assets (261) (264) (36) ------- ------ ------ Net cash provided by (used in) investing activities (5,233) 67 (58) Cash flows from financing activities: Proceeds from stock option and stock purchase plans and related tax benefits 1,146 1,332 962 Repurchase of common stock (3,229) (8,931) -- ------- ------- ------ Net cash provided by (used in) financing activities (2,083) (7,599) 962 Effect of exchange rates on cash and cash equivalents (360) 176 (1) ------- ------- ------ Net increase (decrease) in cash and cash equivalents 2,447 (4,234) 5,354 Cash and cash equivalents at beginning of year 8,023 12,257 6,903 ------- -------- ------ Cash and cash equivalents at end of year $10,470 $8,023 $12,257 ------- -------- ------ Supplemental disclosures of cash flow information: Cash paid for income taxes $1,485 $989 $933 Supplemental schedule of noncash financing activities: Increase in investment due to release of escrowed shares of common stock $91 $91 $91
See accompanying notes to consolidated financial statements. PROTOCOL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Protocol Systems, Inc. and its wholly owned subsidiaries (the "Company"). All material intercompany balances and transactions have been eliminated in consolidation. CASH AND CASH EQUIVALENTS For purposes of these consolidated financial statements, the Company considers all highly liquid securities purchased with an original or effective maturity of three months or less to be cash equivalents. INVESTMENTS In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities", all investments in marketable securities are classified as available-for-sale and are reported at their fair market value. Short-term investments consist of highly liquid securities with maturities of less than one year. Long-term investments consist of highly-rated notes and bonds from a variety of issuers with maturities of greater than one year and less than two years. At December 31, 1999, the fair market value of short-term and long-term investments was $13,519,000 while short-term and long-term investments stated at amortized cost were $13,585,000 resulting in an unrealized holding loss of $66,000. At December 31, 1998, the fair market value of short-term and long- term investments was $10,725,000 while short-term and long-term investments stated at amortized cost were $10,672,000 resulting in an unrealized holding gain of $53,000. Unrealized holding gains and losses on available-for-sale securities are reported as a separate component of shareholders' equity until realized. INVENTORIES Inventories consist of raw materials, work in process, finished goods and demonstration instruments and are valued at the lower of cost or market. Cost is determined on the first-in, first-out basis (FIFO). PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the various assets, generally three to five years. Leasehold improvements are amortized using the straight-line method over a period of five years or the life of the lease, whichever is shorter. Depreciation expense, including amortization of capital leases, totaled $1,986,000, $2,203,000, and $2,058,000, for 1999, 1998, and 1997, respectively. SOFTWARE DEVELOPMENT COSTS The Company capitalizes certain software development costs incurred in accordance with the provisions of SFAS No. 86 "Accounting for Software to be Sold, Leased, or Otherwise Marketed". These capitalized costs are amortized using the straight-line method over the estimated economic life of the software, which is not anticipated to exceed three years. The Company capitalized software development costs of $0, $190,000, and $26,000, in 1999, 1998, and 1997, respectively. Amortization expense related to capitalized software development costs of $129,000, $148,000, and $202,000 was recorded in 1999, 1998, and 1997. Amortization of capitalized software costs is included in cost of sales in the consolidated statements of operations. Accumulated amortization at December 31, 1999 and 1998 was $1,192,000 and $1,063,000, respectively. INTANGIBLE ASSETS Intangible assets, which are classified as other non-current assets, are stated at historical cost less accumulated amortization. The Company's intangible assets consist primarily of patents and technology rights. The patents are amortized using the straight-line method over their estimated economic lives of ten years. Amortization of the technology rights will commence upon the initial sale of the related product. FOREIGN CURRENCY TRANSLATION The functional currency of the Company's foreign subsidiaries is the local currency. Assets and liabilities of the foreign subsidiaries are translated into U.S. dollars at the current exchange rate as of the balance sheet date. Revenues and expenses are translated using a weighted average exchange rate for the period presented. Adjustments resulting from the translation of the financial statements of the active foreign subsidiaries are included as a separate component of consolidated shareholders' equity. Adjustments resulting from translation of the remaining balance sheets of the discontinued French and German subsidiary operations are reported as transaction gains and losses, included in other income (loss) in 1999. Cash flows from the foreign subsidiaries are calculated using its functional currency. As a result, changes in assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree to changes in the corresponding items on the consolidated balance sheets. The effect of exchange rate changes on cash balances held in foreign currencies is reported as a separate line item in the consolidated statements of cash flows. REVENUE RECOGNITION Revenue is recognized and all related costs, including warranty, are recorded upon transfer of title and risk of loss to the customer which generally occurs upon product shipment. BASIC AND DILUTED EARNINGS PER SHARE The Company reports earnings per share in accordance with SFAS No. 128, "Earnings per Share" which requires the presentation of both basic earnings per share and diluted earnings per share. Basic earnings per share is computed using the weighted average number of common shares outstanding and diluted earnings per share is computed using the weighted average number of common shares outstanding and dilutive potential common shares assumed to be outstanding during the period using the treasury stock method. Dilutive potential common shares consist of options to purchase common stock. FINANCIAL INSTRUMENTS The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term nature of these instruments. Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument when available. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. USE OF ESTIMATES These consolidated financial statements were prepared by management in conformity with generally accepted accounting principles and necessarily include amounts which are based on management's best estimates and judgment. Actual results could differ from those estimates. STOCK-BASED COMPENSATION PLANS The Company accounts for its stock plans in accordance with the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," which establishes a fair value method of accounting for stock plans. As allowed under SFAS No. 123, the Company has elected to continue to apply the provisions of Accounting Principles Board (APB) Opinion No. 25 to its plans covering employees and non- employee directors, and to provide pro-forma disclosures of the effects of SFAS No. 123 on net income (loss) and earnings (loss) per share. NOTE 2. BALANCE SHEET COMPONENTS (IN THOUSANDS) The components of inventories, net of reserve are as follows: December 31, 1999 1998 ------ ------ Raw materials $ 4,670 $ 4,939 Work in process 1,916 2,838 Finished goods 2,043 2,207 Demonstration instruments 1,451 2,234 ------- ------- Inventories, net $10,080 $12,218 ------- ------- The components of property and equipment are as follows: Equipment $13,622 $12,111 Furniture and fixtures 1,776 1,910 Leasehold improvements 487 551 ------ ------ 15,885 14,572 Less accumulated depreciation and amortization 11,973 10,531 ------ ------ Property and equipment, net $ 3,912 $ 4,041 ------ ------ The components of accrued liabilities are as follows: Accrued salaries, wages and related liabilities $2,827 $2,588 Accrual for special charges 102 1,642 Reserve for warranties 923 915 Income taxes payable 587 -- Other liabilities 618 238 ------ ------- Total accrued liabilities $5,057 $5,383 ------ ------- The components of accumulated other comprehensive income are as follows: Unrealized holding gain (loss) on investments ($66) $53 Foreign currency translation adjustment 54 152 ------ ------ Total accumulated other comprehensive income (loss) ($12) $205 ------ ------ NOTE 3. SHAREHOLDERS' EQUITY PREFERRED STOCK The Company is authorized to issue 10,000,000 shares of $.01 par value preferred stock. At December 31, 1999, no preferred shares were issued; however, 100,000 shares of Series D Junior Participating Preferred Stock had been designated and reserved. Additional series of preferred stock may be designated and the related rights and preferences fixed by action of the Board of Directors. COMMON STOCK OPTIONS Pursuant to the Company's 1998, 1992 and 1987 stock option plans, the Board of Directors has the authority to grant incentive stock options. The incentive stock options generally vest at a rate of 25% per year, with the Board having authority to accelerate the vesting schedules. The options expire ten years from the date of grant. The incentive stock option price is determined by the Board of Directors, but may not be less than the fair market value of the Company's common stock on the date of grant. Non-statutory stock options may also be granted pursuant to the 1998 and 1992 stock option plans. The option price for the non-statutory stock options is determined by the Board of Directors on the date of grant, but generally is not less than the fair market value of the Company's common stock on the grant date. The outstanding options vest at a rate of 25% per year, with the Board having authority to accelerate the vesting schedules. Non-statutory options expire ten years from the date of grant. On August 6, 1999, the Company's Board of Directors granted 152,944 non- statutory stock options to its President and Chief Executive Officer. These options were not pursuant to any of the Company's stock option plans. These options vest at a rate of 25% per year following the grant date and expire ten years from the date of grant. These options were issued at the fair market value of the Company's common stock on the date of grant. Under the Company's 1993 Stock Option Plan for Nonemployee Directors, each nonemployee director receives an initial option to purchase 20,000 shares of common stock immediately following the annual meeting of shareholders at which such director is first elected to the Board of Directors. The initial option grant vests ratably over a three year period. Following each subsequent annual meeting of shareholders, each nonemployee director receives an additional option, which is immediately exercisable, to purchase 3,000 shares of common stock. The option price for the non-statutory stock options granted pursuant to the plan may not be less than the fair market value of the Company's common stock at the date of grant. Each option expires ten years from the date of grant. As of December 31, 1999, there were 202,944, 115,064 and 0 stock options available under the 1998, 1992 and 1987 option plans, respectively and 217,000 non-statutory stock options available for grant under the 1993 option plan for nonemployee directors. The Company has reserved 2,294,890 shares of common stock for future issuance pursuant to these plans. SHAREHOLDER RIGHTS PLAN In March 1992, the Board of Directors approved a shareholder rights plan and declared a dividend of one preferred share purchase right for each outstanding common share. Each right represents the right to purchase one one-hundredth of a share of Series D Junior Participating Preferred Stock, par value $.01 per share, at an exercise price of $40, subject to adjustment. The rights are only exercisable ten days after a person or group acquires, or commences a tender or exchange offer to acquire, beneficial ownership of 20% or more of the Company's outstanding common shares. Subject to the terms of the shareholder rights plan and upon the occurrence of certain events, each right would entitle the holder to purchase common shares of the Company, or of an acquiring company in certain circumstances, having a market value of two times the exercise price of the right. The rights expire in March 2002, but may be redeemed by action of the Board of Directors prior to that time at $.01 per right. EMPLOYEE STOCK PURCHASE PLAN The 1994 Employee Stock Purchase Plan allows employees of the Company to accumulate funds of up to 10% of their cash compensation to purchase shares of the Company's common stock. Under the plan, 85,340, 101,289, and 91,736 shares of common stock were issued in 1999, 1998, and 1997, respectively. The Company has reserved 199,894 shares of common stock for future issuance under this plan. RESTRICTED STOCK AWARD On August 18, 1999, the Company's Board of Directors awarded a stock grant of 10,000 common shares with a fair value of $7.87 per share to the Chairman of the Board. This stock award is subject to vesting ratably over a six month period and other terms as specified at the time of issuance by a committee of the Board of Directors. Unearned compensation expense is recognized ratably over the vesting period. Stock grants of up to 60,000 common shares may be issued to the Chief Executive Officer in future years beginning in 2002 based on the attainment of certain performance criteria. STOCK REPURCHASE PLAN On May 19, 1999 and January 7, 1998, the Board of Directors authorized the repurchase of the Company's currently outstanding shares of common stock of up to 500,000 and 1,000,000 shares, respectively. The Company has repurchased 407,000 and 956,000 and shares of common stock in 1999 and 1998, respectively. NOTE 4. STOCK-BASED COMPENSATION At December 31, 1999, the Company had five plans providing for stock compensation; four fixed option plans under which options are granted to acquire company stock at exercise prices equal to 100% of the fair value of the stock as of the date the option is granted, and an employee stock purchase plan, which provides for six-month enrollment periods under which shares may be purchased at 85% of the lesser of the fair value at the beginning or end of the enrollment period. Additionally, the Company issued 152,944 options in 1999 and 80,000 options in 1998 that were not pursuant to any of the stock option plans. The Company applies APB No. 25 in accounting for these options and, accordingly, no compensation cost has been recognized with respect thereto. Had compensation cost for these options been determined consistent with SFAS No. 123, the Company's net income (loss) and basic and diluted earnings (loss) per share would have been reduced to the proforma amounts shown in the following table: 1999 1998 1997 ------ ------ ------ Net income (loss) (in thousands) As reported $ 6,291 ($ 675) $ 3,356 Pro-forma $ 4,750 ($ 2,420) $ 1,811 Basic earnings (loss) per share As reported $ 0.77 ($ 0.08) $ 0.38 Pro-forma $ 0.58 ($ 0.29) $ 0.20 Diluted earnings (loss) per share As reported $ 0.76 ($ 0.08) $ 0.36 Pro-forma $ 0.58 ($ 0.29) $ 0.20 The pro forma information presented above includes only the effects of applying SFAS No. 123 to options granted after 1994. Because options generally vest over a number of years and additional awards are made each year, the pro forma 1998 and 1997 amounts are not representative of the effect SFAS No. 123 would have had on net income (loss) and earnings (loss) per share had it been applied to options granted prior to 1995. Similarly, the resulting pro forma compensation costs may not be representative of that expected in future years. The fair value of compensation costs reflected in the above pro forma amounts were determined using the Black-Scholes option pricing model and the following weighted-average assumptions: Years ended December 31, ------------------------ 1999 1998 1997 ------ ------ ------ Risk-free interest rate 5.72% 5.19% 6.18% Expected dividend yield 0% 0% 0% Expected life (in years) 5 5 5 Expected volatility 62% 61% 60% Under the Black-Scholes option pricing model the weighted-average grant date fair value of options granted during 1999, 1998 and 1997 was $4.48, $4.91 and $4.80, respectively. Information with respect to the Company's options for 1999, 1998 and 1997 is provided below:
Weighted-average Number of shares exercise price per share ---------------- ------------------------ Balance at December 31, 1996 1,359,303 8.51 Granted 535,154 8.38 Exercised (108,408) 2.02 Cancelled (408,426) 12.93 --------- Balance at December 31, 1997 1,377,623 7.66 Granted 278,620 8.76 Exercised (112,083) 3.98 Cancelled (108,222) 8.66 --------- Balance at December 31, 1998 1,435,938 $ 8.09 Granted 609,490 7.74 Exercised (132,770) 3.71 Cancelled (152,776) 7.87 --------- Balance at December 31, 1999 1,759,882 $ 8.30 ---------
Additional information regarding options as of December 31, 1999 is as follows:
Options outstanding Options exercisable - ------------- ------------------------------------- ------------------------ Weighted- Weighted- Weighted- Range of average average average exercise Number remaining exercise Number exercise prices outstanding life price exercisable price - ------------- ------------------------------------- ------------------------ $ 0.35-$ 6.00 180,846 2.25 years $ 4.04 180,846 $ 4.04 6.13- 7.50 554,305 7.48 years 7.08 224,237 6.98 7.56- 8.50 469,061 9.35 years 8.14 54,768 8.03 8.63- 20.75 555,670 6.39 years 11.04 480,732 11.07 ----------- ----------- $ 0.35-$20.75 1,759,882 7.10 years $ 8.30 960,583 $ 8.53 ----------- -----------
NOTE 5. 401(K) RETIREMENT INVESTMENT PLAN The Company has a Retirement Investment Plan (the Plan) that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Plan, participating U.S. employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit. The Company currently matches 25% of eligible employee's contributions on the first 5% of employee's earnings deferred. Employer matching contributions vest over 5 years, 20% for each year of service completed. The Company's matching contributions to the Plan were $145,000, $169,000, and $170,000, for 1999, 1998, and 1997, respectively. NOTE 6. EARNINGS PER SHARE The following is a reconciliation of the denominators of the basic and diluted computations of earnings (loss) per share. There are no reconciling items for the numerators, which consist of net income (loss) for all periods presented.
For years ended December 31, ---------------------------- 1999 1998 1997 -------------- -------------- -------------- Per Per Per (in thousands except share share share per share amounts) Shares Amount Shares Amount Shares Amount ------ ------ ------ ------ ------ ------ Basic earnings (loss): 8,176 $0.77 8,487 ($0.08) 8,859 $0.38 Effect of dilutive stock options 145 -- 394 ----- ----- ----- Diluted earnings (loss): 8,321 $0.76 8,487 ($0.08) 9,253 $0.36 ----- ------ ----- ----- ----- -----
The number of options to purchase shares of common stock that were outstanding but were not included in the computation of diluted earnings per share were 827,000, 1,414,000, and 414,000, for 1999, 1998, and 1997, respectively. These options were not included in the diluted earnings per share calculation in 1999 and 1997 because the options' exercise prices were greater than the average market prices of the shares. These options were not included in the diluted loss per share calculation in 1998 because the Company incurred a net loss for the year. NOTE 7. SPECIAL CHARGES During the third quarter of 1998, the Company incurred special charges of $2,246,000 to relocate its wholly owned subsidiary, Pryon Corporation ("Pryon"), from Menomonee Falls, Wisconsin to the Company's Beaverton, Oregon facility in order to improve operating efficiencies. During the fourth quarter of 1998, the Company incurred additional special charges of $3,188,000 as it discontinued the development of its defibrillator project and restructured its worldwide operations. This restructuring included the closure of its subsidiary offices and direct sales organizations in France and Germany, elimination of 14 positions at the Company's headquarters in Beaverton, Oregon and the resignation of the founder and Chief Technical Officer. Cash payments during 1999 related to these special charges totaled $1,540,000 and consisted primarily of employee severance benefits and lease termination costs. As of December 31, 1999, special charges of $102,000, related primarily to certain contract terminations, had not been disbursed. The Company anticipates that these remaining balances will be expended by the end of 2000. NOTE 8. LITIGATION SETTLEMENT On August 2, 1999 the Company reached a settlement with SICOR, Inc. (formerly Gensia SICOR, Inc.) relating to litigation the Company commenced against Gensia SICOR, Inc. and Gensia Automedics in July 1998 alleging they breached a development and supply agreement to develop and supply a closed-loop drug delivery and monitoring device. Under terms of this settlement, SICOR, Inc. and Gensia Automedics have agreed to pay the Company a total of $3.7 million over the next two years. During 1999, the Company recognized in other income $1,611,000 related to this settlement. NOTE 9. LEASES The Company leases its primary office and manufacturing facilities in Beaverton, Oregon under a long-term operating lease which expires in December 2005. Other operating leases have been entered into in connection with the lease of additional office space and capital equipment. Minimum future rental payments under all operating leases are as follows: Years ending December 31, (in thousands) ------------- -------------- 2000 $ 986 2001 1,090 2002 1,076 2003 1,127 2004 1,136 Thereafter 1,204 ------- Total future minimum lease payments $6,619 ------- Total rental expense for all operating leases was $880,000, $886,000, and $767,000 for the years ended December 31, 1999, 1998, and 1997, respectively. NOTE 10. INCOME TAXES Domestic and foreign pre-tax income (loss) consists of the following:
For the years ended December 31, -------------------------------- (in thousands) 1999 1998 1997 - -------------- ------ ------ ------ Domestic $ 7,803 $ 1,786 $ 4,587 Foreign 297 (2,986) ( 199) ------- ------ ------ Total $ 8,100 ($ 1,200) $ 4,388 ------- ------ ------
The provision for income taxes consists of the following:
For the year ended December 31, ------------------------------- (in thousands) 1999 1998 1997 ----- ----- ----- Current: Federal $1,808 ($ 40) $1,080 Foreign 7 5 4 State 407 72 198 ------ ------ ------ 2,222 37 1,282 Deferred: Federal (344) (74) (156) Foreign (14) (482) (65) State (55) (6) (29) ------ ------ ------ (413) (562) (250) ------ ------ ------ Total $1,809 ($ 525) $1,032 ------ ------ ------
A reconciliation showing the reasons for the difference between the Company's effective tax rate and the statutory Federal income tax rate of 34% is as follows:
For the year ended December 31, ------------------------------- 1999 1998 1997 ----- ----- ----- Federal statutory rate 34.0 % (34.0%) 34.0 % State taxes, net of federal benefit 3.4 2.3 2.5 Research and experimentation credits (1.8) (27.5) (7.6) Tax benefit of foreign sales corporation (1.2) (3.1) (2.3) Tax benefit of exempt interest income (2.0) (18.8) (5.6) Increase (decrease) in valuation allowance (6.4) 34.4 -- Net operating loss carryovers utilized (4.0) -- -- Other, net 0.3 3.0 2.5 ------ ------ ------ Effective tax rate 22.3 % (43.7%) 23.5 % ------ ------ ------
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1999 and 1998 are presented below:
(in thousands) 1999 1998 ----- ----- Deferred tax assets: Inventory valuation adjustments $ 601 $ 513 Other non-deductible accruals 1,264 717 Net operating loss carryovers -- 322 Tax credit carryovers 456 632 Other 308 684 ------- ------- Gross deferred tax assets 2,629 2,868 Valuation allowance (591) (1,172) ------- ------- Deferred tax assets 2,038 1,696 Deferred tax liabilities: Depreciation -- (40) Intangible technology rights -- 55 Software development costs -- (84) ------ ------- Deferred tax liabilities -- (69) ------ ------- Net deferred taxes $ 2,038 $1,627 ------ -------
Net current deferred taxes - asset $ 1,889 $1,667 Net long-term deferred taxes - asset (liability) $ 149 ($ 40) The Company has established a valuation allowance for certain deferred tax assets of $591,000 at December 31, 1999. The valuation allowance was $1,172,000 and $987,000 at December 31, 1998 and 1997, respectively. The net decrease of $581,000 in 1999 was mainly due to recognition of the benefits of expected utilization of net operating loss and research & experimentation credit carryovers. Management believes that it is more likely than not that the results of future operations will generate sufficient income to realize the net deferred tax assets as of December 31, 1999. At December 31, 1999, the Company had available federal research & experimentation tax credit carryovers of $338,000, expiring in the years 2018 through 2019, and alternative minimum tax credit carryovers of $75,000 with no expiration date. NOTE 11. SEGMENT INFORMATION The Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" during 1998. In accordance with SFAS No. 131 the Company has identified a single operating segment: the design, manufacture, sale and servicing of medical instruments and systems. Sales are made primarily to hospitals and other health-care related customers. Credit risk with respect to accounts receivable is limited due to the large number and geographical dispersion (both domestically and internationally) of entities which comprise the Company's customer base. Sales to the U.S. Government were $11,195,000, $10,410,000, and $3,388,000, in 1999, 1998, and 1997, respectively. No other customer or country constituted more than 5% of total sales. Sales by geographic region were as follows for the years ended December 31:
(in thousands) 1999 1998 1997 ------- ------- ------- United States $48,491 $49,306 $45,365 International 17,826 18,017 18,729 ------- ------- ------- Total Sales $66,317 $67,323 $64,094 ------- ------- -------
SUPPLEMENTARY DATA - ------------------ QUARTERLY FINANCIAL SUMMARY (UNAUDITED DATA)
(in thousands except common stock Quarters ended prices and per share amounts) ------------------------------------------------ March 31 June 30 September 30 December 31 --------- -------- ------------ ------------ 1999 Sales $14,299 $16,753 $16,528 $18,737 Gross profit 6,955 8,049 8,280 9,300 Income from operations 705 1,535 1,498 1,777 Net income 725 1,323 2,428 1,815 Basic earnings per share .09 .16 .30 .23 Diluted earnings per share .09 .16 .29 .22 Weighted average number of shares used in the computation of earnings (loss) per share: Basic 8,241 8,314 8,214 8,023 Diluted 9,385 8,453 8,388 8,146 1998 Sales $14,920 $16,960 $17,530 $17,913 Gross profit 6,913 8,967 9,478 8,936 Income (loss) from operations 39 721 (1,041) (1,901) Net income (loss) 230 673 (557) (1,021) Basic earnings (loss) per share .03 .08 (.07) (.12) Diluted earnings (loss) per share .03 .08 (.07) (.12) Weighted average number of shares used in the computation of earnings per share: Basic 8,794 8,501 8,389 8,267 Diluted 9,134 8,845 8,389 8,267
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is included under the captions "Election of Directors", "Management" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement for the 2000 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is included under the caption "Executive Compensation" in the Company's Proxy Statement for the 2000 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is included under the caption "Stock Owned By Management and Principal Shareholders" in the Company's Proxy Statement for the 2000 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) The following documents are filed as part of this Form 10-K: (1) FINANCIAL STATEMENTS Report of Management Report of Independent Accountants for the fiscal years ended December 31, 1999 and 1998 Consolidated Statements of Operations and Comprehensive Income - Years ended December 31, 1999, 1998 and 1997 Consolidated Balance Sheets - As of December 31, 1999 and 1998 Consolidated Statements of Stockholders' Equity - Years ended December 31, 1999, 1998 and 1997 Consolidated Statements of Cash Flows - Years ended December 31, 1999, 1998 and 1997 (2) FINANCIAL STATEMENT SCHEDULE Schedule II - Valuation and Qualifying Accounts Report of Independent Accountants on Financial Statement Schedules Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is included in the Consolidated Financial Statements or notes thereto. (A) (3) EXHIBITS
Exhibit Number Description - ------- ----------- 3.1 Fourth Restated Articles of Incorporation of Protocol Systems, Inc. (1) 3.2 Restated Bylaws of Protocol Systems, Inc. (1) 4.0 Rights Agreement dated March 20, 1992 between Protocol Systems, Inc. and First Interstate Bank of Oregon, N.A. (1) 10.1 Original Equipment Manufacturer Agreement for Purchase and Sale of Pulse Oximeter Modules dated October 23, 1989 between Protocol Systems, Inc. and Nellcor, Incorporated, and addendum thereto dated January 21, 1992. (1) 10.2 Form of Indemnity Agreements between Protocol Systems, Inc. and its Executive Officers and Directors. (1) 10.3 Protocol Systems, Inc. 1987 Key Employee's Incentive Stock Option Plan, as amended on January 21, 1992. (1) 10.4 Protocol Systems, Inc. 1987 Non-Statutory Stock Option Plan, as amended on January 21, 1992. (1) 10.5 Protocol Systems, Inc. 1992 Stock Incentive Plan as amended on January 24, 1995 (3) 10.6 Business Park Lease dated October 26, 1990 By and Among Protocol Systems, Inc., Koll-Copley Partners and Petula Associates and amendments thereto dated October 16,1991 and November 6, 1991. (1) 10.7 Amendment to Business Park Lease between Protocol Systems, Inc., Koll-Copley Partners and Petula Associates dated October 6, 1993. (2) 10.8 Amendment to Original Equipment Manufacturer Agreement for Purchase and Sale of Pulse Oximeter Modules dated February 25, 1993 between Protocol Systems, Inc. and Nellcor, Incorporated. (2) 10.9 Protocol Systems, Inc. 1993 Stock Option Plan for Nonemployee Directors as amended February 10, 1999 (8) 10.10 Amendment to Business Park Lease between Protocol Systems, Inc., Koll-Copley Partners and Petula Associates dated December 24, 1997 (4) 10.11 Protocol Systems, Inc. 1994 Employee Stock Purchase Plan as amended on May 19,1999 (8) 10.12 Protocol Systems, Inc. 1998 Stock Incentive Plan as amended on May 19, 1999 (8) 10.13 Protocol Systems, Inc. Non-Qualified Stock Option Agreement dated March 6, 1998 (6) 10.14 Protocol Systems, Inc. Restricted Stock Award Agreement dated April 3, 1998 (5) 10.15 Executive Employment Agreement between Protocol Systems, Inc. and Allen L. Oyler dated July 1, 1998 (7) 10.16 Executive Employment Agreement between Protocol Systems, Inc. and Carl P. Hollstein dated July 1, 1998 (7) 10.17 Executive Employment Agreement between Protocol Systems, Inc. and James P. Fee dated July 1, 1998 (7) 10.18 Executive Employment Agreement between Protocol Systems, Inc. and James P. Welch dated July 1, 1998 (7) 10.19 Executive Employment Agreement between Protocol Systems, Inc. and Richard L. Roa dated July 1, 1998 (7) 10.20 Executive Employment Agreement between Protocol Systems, Inc. and Donald M. Abbey dated July 1, 1998 (7) 10.21 Amendment to Business Park Lease between Protocol Systems, Inc., Koll-Copley Partners and Petula Associates dated March 19, 1999 10.22 Protocol Systems, Inc. Non-Qualified Stock Option Agreement dated August 6, 1999 (9) 10.23 Executive Employment Agreement between Protocol Systems, Inc. and Robert F. Adrion dated August 1, 1999 (10) 22.0 Subsidiaries of the Registrant 23.0 Consent of Accountants 27.1 Financial Data Schedule for the year ended December 31, 1999 (1) Incorporated herein by reference to the Company's Registration Statement on Form S-1 dated January 22, 1992, File No. 33-45067. (2) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (3) Incorporated herein by reference to the Company's Registration Statement on Form S-4 dated April 9, 1996, File No. 333-03316. (4) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. (5) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999. (6) Incorporated herein by reference to the Company's Registration Statement on S-8 dated August 13, 1998, File No. 333-61415. (7) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. (8) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999. (9) Incorporated herein by reference to the Company's Registration Statement on S-8 dated October 19, 1999, File No. 333-89315. (10) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999.
(b) No reports on Form 8-K were filed during the quarter ended December 31, 1999. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROTOCOL SYSTEMS, INC. ----------------------- (Registrant) Date: March 30, 2000 By: /s/ Robert F. Adrion -------------- ----------------------- Robert F. Adrion, Ph.D. President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----- /s/ Robert F. Adrion President and Chief March 30, 2000 - --------------------------- Executive Officer (Principal -------------- Robert F. Adrion, Ph.D. Executive Officer) /s/ Edward M. Kolasinski Vice-President, Finance and Chief March 30, 2000 - --------------------------- Financial Officer -------------- Edward M. Kolasinski (Principal Financial and Accounting Officer) /s/ David F. Bolender Chairman of the Board of March 30, 2000 - --------------------------- Directors -------------- David F. Bolender /s/ Steven E. Wynne Director March 30, 2000 - -------------------------- -------------- Steven E. Wynne /s/ Ronald S. Newbower, Ph.D. Director March 30, 2000 - ------------------------------- -------------- Ronald S. Newbower, Ph.D. /s/ Frank E. Samuel, Jr. Director March 30, 2000 - --------------------------- -------------- Frank E. Samuel, Jr. /s/ Curtis M. Stevens Director March 30, 2000 - ---------------------------- -------------- Curtis M. Stevens
Additions Additions Balance at charged to charged to Balance at beginning costs and other end of Description period expenses accounts Deductions period ---------- ---------- --------- ---------- ---------- Year ended December 31, 1997: Allowance for doubtful accounts $ 252 $ 147 -- $ 41(1) $ 358 Allowance for sales returns 100 187 -- -- 287 Inventory obsolescence and valuation reserves 785 530 -- 313(2) 1,002 Reserve for warranties 985 1,177 -- 1,078(3) 1,084 Reserve for product upgrades 3 245 -- 56(4) 192 Year ended December 31, 1998: Allowance for doubtful accounts $ 358 $ 114 -- $ 52(1) $ 420 Allowance for sales returns 287 134 -- 181(5) 240 Inventory obsolescence and valuation reserves 1,002 329 -- 605(2) 726 Reserve for warranties 1,084 511 -- 680(3) 915 Reserve for product upgrades 192 (98) -- 68(4) 26 Year ended December 31, 1999: Allowance for doubtful accounts $ 420 $ 131 -- $ 101(1) $ 450 Allowance for sales returns 240 432 -- -- 672 Inventory obsolescence and valuation reserves 726 441 -- 92(2) 1,075 Reserve for warranties 915 902 -- 894(3) 923 Reserve for product upgrades 26 (5) -- 21(4) 0
(1) Deductions primarily represent write-offs of accounts receivable during the period. (2) Deductions primarily represent inventory scrapped, sold or upgraded during the period. (3) Deductions primarily represent inventory and labor costs incurred repairing products under warranty. (4) Deductions primarily represent inventory and labor costs incurred for product upgrades performed during the period. (5) Deductions primarily represent product returns and recognition of deferred revenue for upgrades performed during the period. INDEPENDENT AUDITORS' REPORT To the Shareholders and Board of Directors of Protocol Systems, Inc.: Under the date of January 21, 2000, we reported on the consolidated balance sheets of Protocol Systems, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations and comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999, which are included in the 1999 annual report to shareholders. These consolidated financial statements and our report thereon are included in the annual report on Form 10-K for the year 1999. In connection with our audit of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG LLP Portland, Oregon January 21, 2000 EX-10.21 2 SIXTH AMENDMENT TO LEASE DATE CHANGE/RENTAL ADJUSTMENT That certain Lease dated 10/16/90 by and between Koll Copley partners and Petula Associates, Ltd., assigned to Petula Associates Ltd., an Iowa corporation and Principal Mutual Life Insurance company, an Iowa corporation doing business as KC Creekside Phase I, assigned to PS Business Parks, L.P., Landlord, and Protocol Systems, Inc., Tenant, is amended this 19th day of March, 1999 solely as hereinafter described. 1.h. Term of Lease: 8500 SW Creekside Place Renewal Commencement Date: January 1, 2001 Expiration Date: December 31, 2005 8605 SW Creekside Place Commencement Date: April 1, 1999 Expiration Date: December 31, 2005 1.i. Base Monthly Rent: 8500 SW Creekside Place January 1, 2001 - December 31, 2003 $61,581 January 1, 2004 No rent, operating expenses only February 1, 2004 - December 31, 2005 $67,996 8605 SW Creekside Place April 1, 1999 - June 30, 1999 $10,220 and operating expenses on 14,000 s.f. July 1, 1999 - June 30, 2002 $29,279 July 1, 2002 No rent, operating expenses only August 1, 2002 - December 31, 2005 $32,329 All other terms and conditions of said Lease shall remain in full force and effect. IN WITNESS WHEREOF, Landlord and Tenant have executed this Amendment as of the date first written above. LANDLORD: PS Business Parks, L.P., a California limited Partnership By: Eileen Newkirk, Assistant Vice President By PS Business Parks, Inc., its general partner TENANT: Protocol Systems, Inc. EX-22.0 3 EXHIBIT 22.0 SUBSIDIARIES OF THE REGISTRANT Jurisdiction of Subsidiary Incorporation - ---------- ---------------- Protocol Medical Systems Limited Northern Ireland Protocol U.K. Limited Oregon Protocol Systems Foreign Sales Corporation Guam Protocol Systems, S.A.R.L. France Protocol Systems, GmbH Germany EX-23.0 4 Exhibit 23.0 Consent of Independent Accountants - -------------------------------------------- The Board of Directors Protocol Systems, Inc. We consent to incorporation by reference in the Registration Statements (Nos. 33-94912, 33-53992,33-66272, 33-74384, 33-81104, 333-17703, 333- 17705, 333-61423, 333-61419, 333-61415, 333-89309, 333-89313 and 333- 89315) on Form S-8 of Protocol Systems, Inc. of our reports dated January 21, 2000, relating to the consolidated balance sheets of Protocol Systems, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations and comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999, and all related financial statement schedules, which reports appear in the December 31, 1999 annual report on Form 10-K of Protocol Systems, Inc. /s/ KPMG LLP March 24, 2000 EX-27.1 5
5 This schedule contains summary financial information extracted from Protocol Systems, Inc. Consolidated Balance Sheet as of December 31, 1999 and Consolidated Statement of Operations and Comprehensive Income for the year ended December 31, 1999 and is qualified in its entirety by reference to such financial statements. 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 10,470 13,519 16,615 450 10,080 44,538 15,885 11,973 59,838 7,887 0 0 0 80 51,871 59,838 66,317 66,317 33,733 33,733 24,484 631 0 8,100 1,809 6,291 0 0 0 6,291 0.77 0.76 Net of allowance
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