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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark one)
[X] Quarterly report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30, 2003 or
[ ] Transition report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the transition period from ___________ to
___________
Commission file number: 0-18793
----------
VITAL SIGNS, INC.
(Exact name of registrant as specified in its charter)
New Jersey 11-2279807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 Campus Road
Totowa, New Jersey 07512
(Address of principal executive office, including zip code)
973-790-1330
(Registrant's telephone number, including area code)
________________________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
At August 12, 2003 there were 12,907,498 shares of Common Stock, no
par value, outstanding.
VITAL SIGNS, INC.
INDEX
PAGE
NUMBER
PART I.
Financial information................................................................................. 1
Item 1. Financial Statements
Independent Accountant's Report....................................................................... 2
Consolidated Balance Sheets as of June 30, 2003 (Unaudited) and September 30, 2002.................... 3
Consolidated Statements of Income for the Three Months ended June 30, 2003 and 2002 (Unaudited)....... 4
Consolidated Statements of Income for the Nine Months ended June 30, 2003 and 2002 (Unaudited)........ 5
Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2003 and 2002 (Unaudited).... 6
Notes to Consolidated Financial Statements (Unaudited)................................................ 7 - 11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................. 11 - 21
Item 3. Quantitative and Qualitative Disclosure About Market Risks............................................ 21 - 22
Item 4. Controls and Procedures............................................................................... 22
PART II.
Item 1. Legal Proceedings..................................................................................... 23 - 24
Item 6. Exhibits and Reports on Form 8-K...................................................................... 24
Signatures............................................................................................ 26
Exhibit 31.1.......................................................................................... 27
Exhibit 31.2.......................................................................................... 28
Exhibit 32.1.......................................................................................... 29
Exhibit 32.2.......................................................................................... 30
PART I.
Financial Information
Item 1.
Financial Statements
Certain information and footnote disclosures required under generally
accepted accounting principles have been condensed or omitted from the following
consolidated financial statements pursuant to the rules and regulations of the
Securities and Exchange Commission. Vital Signs, Inc. (the "registrant", the
"Company", "Vital Signs", "we", "us", or "our") believes that the disclosures
are adequate to assure that the information presented is not misleading in any
material respect. It is suggested that the following consolidated financial
statements be read in conjunction with the year-end consolidated financial
statements and notes thereto included in the registrant's Annual Report on Form
10-K for the year ended September 30, 2002.
The results of operations for the interim period presented herein are
not necessarily indicative of the results to be expected for the entire fiscal
year, or any other period.
1
INDEPENDENT ACCOUNTANT'S REPORT
To the Board of Directors
Vital Signs, Inc.
We have reviewed the accompanying consolidated balance sheet of Vital Signs,
Inc. and Subsidiaries as of June 30, 2003 and the related consolidated
statements of income for the three months and nine months ended June 30,
2003 and 2002, and the consolidated statements of cash flows for the nine months
ended June 30, 2003 and 2002. These financial statements are the responsibility
of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures and
making inquiries of persons responsible for financial and accounting matters. It
is substantially less in scope than an audit conducted in accordance with
generally accepted auditing standards, the objective of which is the expression
of an opinion regarding the consolidated financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Vital Signs, Inc. and Subsidiaries as of September 30, 2002 and the related
consolidated statements of income, stockholders' equity and cash flows for the
year then ended (not presented herein); and in our report dated November 22,
2002, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
consolidated balance sheet as of September 30, 2002, is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
GOLDSTEIN GOLUB KESSLER LLP
New York, New York
August 1, 2003
2
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, SEPTEMBER 30,
2003 2002
----------- -------------
(IN THOUSANDS OF DOLLARS)
ASSETS
(Unaudited)
Current Assets:
Cash and cash equivalents ............................................................ $ 51,209 $ 29,303
Accounts receivable, less allowance for rebates and doubtful accounts of $6,787 and
$4,661 respectively ............................................................... 30,443 35,392
Inventory ............................................................................ 22,171 21,024
Prepaid expenses and other current assets ............................................ 8,389 6,085
Assets of discontinued business ...................................................... 2,500 7,846
-------- --------
Total Current Assets .............................................................. 114,712 99,650
Property, plant and equipment - net .................................................. 31,466 30,867
Marketable securities ................................................................ 104 186
Goodwill ............................................................................. 69,684 69,516
Deferred income taxes ................................................................ 1,715 1,851
Other assets ......................................................................... 3,780 3,007
-------- --------
Total Assets ...................................................................... $221,461 $205,077
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ..................................................................... $ 6,383 $ 3,940
Current portion of long-term debt .................................................... 401 395
Accrued other expenses ............................................................... 6,626 6,980
Accrued income taxes ................................................................. 5,190 --
Other current liabilities ............................................................ 1,393 1,015
Liabilities of discontinued business ................................................. 578 720
-------- --------
Total Current Liabilities ......................................................... 20,571 13,050
Long term debt .......................................................................... 1,305 1,560
-------- --------
Total Liabilities ................................................................. 21,876 14,610
Minority interest in subsidiary ......................................................... 2,888 2,652
Commitments and contingencies
Stockholders' Equity
Common stock - no par value; authorized 40,000,000 shares, issued and outstanding
12,908,600 and 12,938,002 shares, respectively .................................... 30,306 30,812
Accumulated other comprehensive income (loss) ........................................ 1,262 (1,189)
Retained earnings .................................................................... 165,129 158,192
-------- --------
Stockholders' equity ................................................................. 196,697 187,815
-------- --------
Total Liabilities and Stockholders' Equity ........................................ $221,461 $205,077
======== ========
(See Notes to Consolidated Financial Statements)
3
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
FOR THE THREE MONTHS ENDED
JUNE 30,
----------------------------------------
2003 2002
------- -------
(In Thousands, Except Per Share Amounts)
----------------------------------------
Net Revenues:
Net sales ................................................................... $38,900 $36,009
Service revenue ............................................................. 9,271 8,952
------- -------
48,171 44,961
Cost of goods sold and services performed:
Cost of goods sold .......................................................... 19,511 16,145
Cost of services performed .................................................. 4,877 5,339
------- -------
24,388 21,484
Gross profit ................................................................... 23,783 23,477
Operating expenses:
Selling, general and administrative ......................................... 13,083 11,575
Research and development .................................................... 1,462 1,631
Impairment charge for China operations ...................................... -- 1,578
Other expense - net ......................................................... 67 251
------- -------
Total operating expenses ................................................. 14,612 15,035
Operating Income ............................................................... 9,171 8,442
Other (income) expense
Interest (income) ........................................................... (211) (137)
Interest expense ............................................................ 147 125
------- -------
Total other (income) expense ................................................... (64) (12)
Income from continuing operations before provision for income taxes and minority
interest in income of consolidated subsidiary ............................... 9,235 8,454
Provision for income taxes ..................................................... 3,750 2,797
------- -------
Income from continuing operations before minority interest in income of
consolidated subsidiary ..................................................... 5,485 5,657
Minority interest in income of consolidated subsidiary ......................... 107 191
------- -------
Income from continuing operations .............................................. 5,378 5,466
Discontinued Operations:
Loss from operations of Vital Pharma, net of income tax benefit of ($1,300)
and ($6) .................................................................... (1,590) (16)
------- -------
Net income ..................................................................... $ 3,788 $ 5,450
======= =======
Earnings (loss) per Common Share:
Basic
Income per share from continuing operations ................................. $ 0.42 $ 0.42
Loss per share from discontinued operations ................................. $ (0.12) $ 0.00
Net earnings ................................................................ $ 0.30 $ 0.42
Diluted
Income per share from continuing operations ................................. $ 0.41 $ 0.42
Loss per share from discontinued operations ................................. $ (0.12) $ 0.00
Net earnings ................................................................ $ 0.29 $ 0.42
Basic weighted average number of shares outstanding ............................ 12,922 12,879
Diluted weighted average number of shares outstanding .......................... 12,990 13,049
Dividends paid per share ....................................................... $ 0.05 $ 0.04
(see Notes to Consolidated Financial Statements)
4
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
FOR THE NINE MONTHS ENDED
JUNE 30,
----------------------------------------
2003 2002
-------- ---------
(In Thousands, Except Per Share Amounts)
----------------------------------------
Net Revenues:
Net sales ................................................................... $106,992 $108,501
Service revenue ............................................................. 28,000 19,887
-------- --------
134,992 128,388
Cost of goods sold and services performed:
Cost of goods sold .......................................................... 53,303 50,590
Cost of services performed .................................................. 14,977 12,639
-------- --------
68,280 63,229
Gross profit ................................................................... 66,712 65,159
Operating expenses:
Selling, general and administrative ......................................... 37,718 32,745
Research and development .................................................... 4,383 4,820
Impairment charge for China operations ...................................... 553 1,578
Reversal of litigation accrual .............................................. -- (5,006)
Other expense - net ......................................................... 653 393
-------- --------
Total operating expenses ................................................. 43,307 34,530
Operating Income ............................................................... 23,405 30,629
Other (income) expense
Interest (income) ........................................................... (500) (522)
Interest expense ............................................................ 874 184
-------- --------
Total other (income) expense ................................................... 374 (338)
Income from continuing operations before provision for income taxes and minority
interest in income of consolidated subsidiary ............................... 23,031 30,967
Provision for income taxes ..................................................... 9,522 10,417
-------- --------
Income from continuing operations before minority interest in income of
consolidated subsidiary ..................................................... 13,509 20,550
Minority interest in income of consolidated subsidiary ......................... 236 345
-------- --------
Income from continuing operations .............................................. 13,273 20,205
Discontinued Operations:
Loss from operations of Vital Pharma, net of income tax benefit of ($2,503)
and ($261) .................................................................. (4,502) (498)
-------- --------
Net income ..................................................................... $ 8,771 $ 19,707
======== ========
Earnings (loss) per Common Share:
Basic
Income per share from continuing operations ................................. $ 1.03 $ 1.57
Loss per share from discontinued operations ................................. $ (0.35) $ (0.04)
Net earnings ................................................................ $ 0.68 $ 1.53
Diluted
Income per share from continuing operations ................................. $ 1.02 $ 1.55
Loss per share from discontinued operations ................................. $ (0.35) $ (0.04)
Net earnings ................................................................ $ 0.67 $ 1.51
Basic weighted average number of shares outstanding ............................ 12,910 12,893
Diluted weighted average number of shares outstanding .......................... 12,991 13,040
Dividends paid per share ....................................................... $ 0.14 $ 0.12
(see Notes to Consolidated Financial Statements)
5
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
FOR THE NINE MONTHS ENDED
JUNE 30,
-------------------------
2003 2002
------- --------
(IN THOUSANDS OF DOLLARS)
-------------------------
Cash Flows from Operating Activities:
Net income .................................................................. $ 8,771 $ 19,707
Add loss from discontinued operations ....................................... 4,502 498
------- --------
Income from continuing operations ........................................... 13,273 20,205
Adjustments to reconcile income from continuing operations to net cash provided
by continuing operations
Depreciation and amortization ............................................ 3,310 2,943
Deferred income taxes .................................................... 136 2,106
Minority interest in income of consolidated subsidiary ................... 236 345
Non cash loss on write off of China receivable ........................... 553 1,578
Non cash gain on litigation accrual reversal ............................. -- (5,006)
Changes in operating assets and liabilities:
Decrease in accounts receivable .......................................... 2,434 832
Increase in rebate allowance ............................................. 3,300 --
Decrease in inventory .................................................... 59 641
Decrease in prepaid expenses and other current assets .................... 619 5,934
(Increase) decrease in other assets ...................................... (308) 785
Increase in accounts payable ............................................. 586 3
Decrease in accrued expenses ............................................. (678) (572)
Increase in accrued income taxes ......................................... 5,190 --
Increase (decrease) in other liabilities ................................. 308 (1,449)
------- --------
Net cash provided by continuing operations ..................................... 29,018 28,345
------- --------
Net cash used in discontinued operations ....................................... (1,801) (1,012)
------- --------
Net cash provided by operating activities ...................................... 27,217 27,333
Cash flows from investing activities:
Acquisition of property, plant and equipment ............................. (2,269) (3,103)
Capitalized software costs ............................................... (369) --
Capitalized patent costs ................................................. (353) (132)
Acquisition of subsidiaries, net of cash acquired ........................ -- (21,796)
Proceeds from sales of available for sale securities ..................... 82 76
------- --------
Net cash used in investing activities .......................................... (2,909) (24,955)
Cash flows from financing activities:
Dividends paid ........................................................... (1,833) (1,553)
Proceeds from exercise of stock options .................................. 501 810
Purchase of treasury stock, net of cost................................... (2,312) (2,265)
Issuance of treasury stock ............................................... -- 191
Principal payments on long-term debt and notes payable ................... (249) (5,622)
------- --------
Net cash used in financing activities .......................................... (3,893) (8,439)
Effect of foreign currency translation ......................................... 1,491 (231)
------- --------
Net increase (decrease) in cash and cash equivalents ........................... 21,906 (6,292)
Cash and cash equivalents at beginning of period ............................... 29,303 31,029
------- --------
Cash and cash equivalents at end of period ..................................... $51,209 $ 24,737
======= ========
Supplemental disclosures of cash flow information:
Cash paid during the nine months for:
Interest ................................................................. $ 138 $ 157
Income taxes ............................................................. $ 3,698 $ 455
(See Notes to Consolidated Financial Statements)
6
VITAL SIGNS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The consolidated balance sheet as of June 30, 2003, the consolidated
statements of operations for the three and nine months ended June 30, 2003
and 2002, and the consolidated statements of cash flows for the nine months
ended June 30, 2003 and 2002, have been prepared by Vital Signs, Inc. (the
"registrant", the "Company", "Vital Signs", "we", "us", or "our") and are
unaudited. In the opinion of management, all adjustments necessary to
present fairly the financial position at June 30, 2003 and the results of
operations for the three months and nine months ended June 30, 2003 and
2002, and the cash flows for the nine months ended June 30, 2003 and 2002,
have been made.
2. See the Company's Annual Report on Form 10-K for the year ended September
30, 2002 (the "Form 10-K") for additional disclosures relating to the
Company's consolidated financial statements.
3. At June 30, 2003, the Company's inventory was comprised of raw materials of
$12,745,000, and finished goods of $9,426,000. At September 30, 2002, the
Company's inventory was comprised of raw materials of $12,095,000 and
finished goods of $8,929,000.
4. For Details of Legal Proceedings, see Part II, Item 1, "Legal Proceedings".
5. The Company has aggregated its business units into four reportable
segments, anesthesia, respiratory/critical care, sleep and pharmaceutical
technology services. There are no material intersegment sales. Anesthesia
and Respiratory/Critical Care share certain manufacturing, sales and
administration costs; therefore the operating profit, total assets, and
capital expenditures are not specifically identifiable. However the Company
has allocated these shared costs on a net sales basis to arrive at
operating profit for the anesthesia and respiratory/critical care segments.
Total assets and capital expenditures for anesthesia and
respiratory/critical care have also been allocated on a net sales basis.
Management evaluates performance on the basis of the gross profits and
operating results of the four business segments. Summarized financial
information concerning the Company's reportable segments is shown in the
following table:
RESPIRATORY/ PHARMACEUTICAL
CRITICAL TECHNOLOGY
ANESTHESIA CARE SLEEP SERVICES OTHER CONSOLIDATED
---------- ------------ ------- -------------- ----- ------------
(IN THOUSANDS OF DOLLARS)
---------------------------------------------------------------------------
FOR THE THREE MONTHS
ENDED JUNE 30,
2003
Net revenues $19,498 $12,373 $11,810 $4,490 $-- $48,171
Gross profit 10,027 6,348 5,265 2,143 -- 23,783
Operating income 5,009 2,473 1,027 662 -- 9,171
2002
Net revenues $17,598 $11,776 $10,639 $4,948 $-- $44,961
Gross profit 10,288 6,406 4,863 1,920 -- 23,477
Operating income 4,174 2,793 620 855 -- 8,442
7
RESPIRATORY/ PHARMACEUTICAL
CRITICAL TECHNOLOGY
ANESTHESIA CARE SLEEP SERVICES OTHER * CONSOLIDATED
---------- ------------ ------- -------------- ------- ------------
(IN THOUSANDS OF DOLLARS)
-----------------------------------------------------------------------------
FOR THE NINE MONTHS
ENDED JUNE 30,
2003
Net revenues $54,010 $34,975 $34,950 $14,357 $(3,300) $134,992
Gross profit 28,727 18,804 15,683 6,798 (3,300) 66,712
Operating income 13,426 7,983 2,901 2,395 (3,300) 23,405
Total assets 99,877 64,677 37,254 19,653 -- 221,461
Capital expenditures 1,514 981 121 375 -- 2,991
2002
Net revenues $51,708 $36,417 $29,050 $ 9,574 $ 1,639 $128,388
Gross profit 27,752 19,957 12,802 3,209 1,439 65,159
Operating income 12,263 14,656 1,032 1,239 1,439 30,629
Total assets 88,872 60,668 33,200 18,897 -- 201,637
Capital expenditures 1,823 1,244 138 30 -- 3,235
(*) "Other" relates to an adjustment for the allowance for rebates in the nine
months ended June 30, 2003 in the anesthesia and respiratory/critical care
business segments, and one-time licensing revenue recorded in the nine
month period ended June 30, 2002 in the anesthesia business segment.
6. Other comprehensive income for the three months and nine months ended June
30, 2003 and 2002 consisted of:
THREE MONTHS NINE MONTHS
(IN THOUSANDS OF DOLLARS) ENDED JUNE 30, ENDED JUNE 30,
---------------------------- --------------- -----------------
2003 2002 2003 2002
------ ------ ------- -------
Net income $3,788 $5,450 $ 8,771 $19,707
Foreign currency translation 1,584 1,172 2,484 1,165
Other (35) 40 (33) 36
------ ------ ------- -------
Comprehensive income $5,337 $6,662 $11,222 $20,908
====== ====== ======= =======
7. As part of the Company's continuing evaluation of its inventory, the
Company wrote-off certain inventory amounting to $647,000 in the third
quarter of fiscal 2003. A total of $397,000 related to the
Respiratory/Critical Care segment of the Company's business and $250,000
related to the Company's Breas subsidiary, a part of the Company's sleep
segment. Also, in the third quarter of fiscal 2003, the Company expensed to
cost of goods sold, $243,000 for a twelve-month volume related expense
adjustment from a supplier, which was also allocated to the anesthesia and
respiratory/critical care segments.
8. On May 7, 2003 a complaint was filed against the Company and two of its
officers. At the request of management, the Company's Audit Committee has
hired outside independent accountants and legal
8
counsel to review the matters alleged by the plaintiff, a former CFO of the
Company. Accounting and legal expenses of $262,000 included in selling,
general and administrative expenses, were incurred during the third quarter
of fiscal 2003 in connection with the Audit Committee review and related
proceedings. These expenses were allocated (on a net sales basis) to the
anesthesia and respiratory/critical segments.
9. During the second quarter of fiscal 2003, the Company reviewed and adjusted
its estimate for rebates due to distributors. These rebates apply to the
Company's anesthesia and respiratory/critical care segments. As background,
the Company's sales to distributors, which represented 24.8% of the
Company's net sales during the third quarter of fiscal 2003, are made at
the Company's established price. Each distributor subsequently provides the
Company with documentation that the Company's products have been shipped to
particular end-users (i.e. particular hospitals). In general, the end-user
is entitled, on a case by case basis, to a price lower than the Company's
established price. Accordingly, the Company owes the distributor a rebate -
the difference between the established price and the lower price to which
the end user is entitled - upon the Company's receipt of applicable
documentation from the distributor. At the time that the distributor remits
payment to the Company for the products purchased, the distributor deducts
an amount for the related rebates.
The allowance for rebates is recorded at the time the Company records the
revenue for the product shipped to the distributor. The rebate is recorded
as a sales allowance, reducing gross revenue. The allowance for rebates was
$6,235,000 and $4,023,000 at June 30, 2003 and September 30, 2002,
respectively. Rebates amounted to $33,437,000 and $27,616,000 for the
nine months ended June 30, 2003 and June 30, 2002 and $10,911,000 and
$9,964,000 for the three months ended June 30, 2003 and June 30, 2002.
The Company has, for several years, utilized a historical moving average to
estimate the allowance for rebates. Based on the Company's recent review,
the Company has concluded that the moving average estimate does not
necessarily result in the appropriate liability due to distributors.
Accordingly, the Company has changed its method of estimating rebate claims
to record the allowance for rebates based upon the documentation provided
by the distributor of the shipments to the end-user, as well as estimates
for inventory not yet sold by the distributor, adjusting from estimate to
actual at the time of remittance. As a result of its review of the rebate
allowance, the Company recorded an additional allowance for rebates of
$3,300,000 in the second quarter of fiscal 2003 to assure that it has
established an appropriate reserve for rebate claims.
10. As a result of the continuing review of the Company's tax returns, certain
state tax returns for prior periods are in the process of being re-filed,
resulting in an incremental tax expense of $500,000, and interest expense
of $70,000 during the third quarter of fiscal 2003.
The Internal Revenue Service (IRS) has been performing, in their normal
course, an examination of the Company's 1997, 1998 and 1999 Federal tax
returns. As a result of views expressed by the IRS, the Company increased
its tax provision in the second quarter of fiscal 2003 by $1,081,000, and
increased interest expense by $650,000 for the related interest due. An
additional $40,000 was charged to interest expense in the third quarter of
fiscal 2003. The Company expects the Internal Revenue Service to complete
its examination in the fourth quarter of fiscal 2003. While the Company
believes it has recorded the appropriate tax liability and tax provision,
the Company may be subject to other audit adjustments arising from that
review.
11. During the third quarter of fiscal 2002, the Company recognized an
impairment charge of $1,578,000 related principally to its Chinese
business. While the Company continues to sell products in China
9
and the business relationship continues on a limited basis, disputes remain
over certain receivables and other charges. During the second quarter of
fiscal 2003, the Company concluded that it would be unable to collect its
receivable under normal terms, and provided a reserve against the remaining
receivable balance for $553,000 before taxes. This expense has been
allocated to the respiratory/critical care segment.
12. In the second quarter of fiscal 2003, income from continuing operations
included $322,000 of pretax expenses relating to costs for a public
offering that was discontinued due to market conditions. This expense has
been allocated (on a net sales basis) between the anesthesia and
respiratory/critical care segment.
13. In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS
No. 123". SFAS No. 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 "Accounting for Stock-Based
Compensation", to require prominent disclosures in annual and interim
financial statements about the method of accounting for stock-based
employee compensation and the effect in measuring compensation expense. The
disclosure requirements of SFAS No. 148 are effective for periods beginning
after December 15, 2002.
The Company has elected, in accordance with the provisions of SFAS No. 123,
as amended by SFAS No. 148, to apply the current accounting rules under APB
Opinion No. 25 and related interpretations in accounting for its stock
options and, accordingly, has presented the disclosure-only information as
required by SFAS No. 123. If the Company had elected to recognize
compensation cost based on the fair value of the options granted at the
grant date as prescribed by SFAS No. 123, the Company's net income and net
income per common share for the three months and nine months ended June 30,
2003 and 2002 (pro forma effect has been adjusted for income taxes) would
approximate the pro forma amounts indicated in the table below (dollars in
thousands):
THREE MONTH PERIOD NINE MONTH PERIOD
ENDED JUNE 30, ENDED JUNE 30,
------------------ -----------------
2003 2002 2003 2002
------ ------ ------ -------
Net income - as reported ............................... $3,788 $5,450 $8,771 $19,707
Net income- pro forma .................................. 3,688 5,309 8,471 19,285
Basic net income per common share - as reported ........ .30 .42 .68 1.53
Diluted net income per common share - as reported ..... .29 .42 .67 1.51
Basic net income per common share - Pro forma .......... .29 .41 .66 1.50
Diluted net income per common share - Pro forma ....... .28 .41 .65 1.48
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for the three months and nine months ended June 30, 2003
and 2002, respectively: expected volatility of 50% and 50%, respectively,
risk-free interest rate of 5.2% and 5.2%, respectively, dividend yield rate
of .5% and .5%, respectively, and all options have expected lives of 5
years.
14. In May, 2003 the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity".
This Statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset
10
in some circumstances). The Company does not believe that SFAS 150 will
have a material effect on the Company's financial position or results of
operation.
In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under
FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities". The Company does not believe that SFAS 149 will have a
material effect on the Company's financial position or results of
operation.
In November 2002, the Emerging Issues Task Force ("EITF") issued EITF
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
This consensus provides guidance in determining when a revenue arrangement
with multiple deliverables should be divided into separate units of
accounting, and, if separation is appropriate, how the arrangement
consideration should be allocated to the identified accounting units. The
provisions of EITF 00-21 are effective for revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. The Company will
evaluate multiple element arrangements in accordance with EITF 00-21.
The Company does not believe that any recently issued but not yet effective
accounting standards will have a material effect on the Company's financial
position or results of operations.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
Forward Looking Statements
This Quarterly Report on Form 10-Q contains, and from time to time we
expect to make, certain forward-looking statements regarding our business,
financial condition and results of operations. The forward-looking statements
are typically identified by the words "anticipates", "believes", "expects",
"intends", "forecasts", "plans", "future", "strategy", or words of similar
import. In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 (the "Reform Act"), we intend to
caution investors that there are important factors that could cause our actual
results to differ materially from those projected in our forward-looking
statements, whether written or oral, made herein or that may be made from time
to time by or on behalf of us. Investors are cautioned that such forward-looking
statements are only predictions and that actual events or results may differ
materially from such statements. We undertake no obligation to publicly release
the results of any revisions to our forward-looking statements to reflect
subsequent events or circumstances or to reflect the occurrence of unanticipated
events.
We wish to ensure that any forward-looking statements are accompanied
by meaningful cautionary statements in order to comply with the terms of the
safe harbor provided by the Reform Act. Accordingly, we have set forth in
Exhibit 99.1 to our Annual Report on Form 10-K for the year ended September 30,
2002 a list of important factors, certain of which are outside of management's
control, that could cause our actual results to differ materially from those
expressed in forward-looking statements or predictions made herein and from time
to time by us. Reference is made to such Exhibit 99.1 for a list of such risk
factors.
11
Results of Operations
The following table sets forth, for the periods indicated, the
percentage increase or decrease of certain items included in the Company's
consolidated statement of income.
INCREASE/(DECREASE) INCREASE/(DECREASE)
FROM PRIOR PERIOD FROM PRIOR PERIOD
THREE MONTH'S ENDED NINE MONTH'S ENDED
JUNE 30, 2003 JUNE 30, 2003
COMPARED WITH COMPARED WITH
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2002
------------------- -------------------
Consolidated Statement of Operations Data:
Net revenues..................................... 7.1% 5.1%
Gross profit..................................... 1.3% 2.4%
Total operating expenses......................... (2.8)% 25.4%
Income from continuing operations................ (1.6%) (34.3%)
Net income....................................... (30.5%) (55.5%)
12
Comparison of Results for the Three-Month Period Ended June 30, 2003 to the
Three-Month Period Ended June 30, 2002.
Net Revenue. Net revenues for the three months ended June 30, 2003
increased by 7.1% (an increase of 4.1% excluding the favorable effect of foreign
exchange) to $48.2 million as compared to $45.0 million in the comparable period
last year. Of our total revenues, $35.6 million (or 73.9%) were derived from
domestic sales and $12.6 million (or 26.1%) were derived from international
sales. Following are the net revenues by business segment for the three months
ended June 30, 2003 compared to the three months ended June 30, 2002.
REVENUE BY BUSINESS SEGMENT
FOR THE QUARTER ENDED
JUNE 30
--------------------- PERCENT
2003 2002 CHANGE
------- ------- -------
Anesthesia $19,498 $17,598 10.8%
Respiratory/Critical Care 12,373 11,776 5.1%
Sleep 11,810 10,639 11.0%
Pharmaceutical Technology Services 4,490 4,948 (9.3%)
------- ------- ----
$48,171 $44,961 7.1%
Sales of anesthesia products for the three months ended June 30, 2003,
increased 10.8% from $17.6 million for the three months ended June 30, 2002 to
$19.5 million for the three months ended June 30, 2003. This increase was due
primarily to volume growth in anesthesia circuits, including our Limb'TM', a
patented anesthesia circuit, which increased 74.6% to $1.4 million, and growth
at our Thomas Medical Products subsidiary, which increased 40.5% to $4.4
million. Domestic sales of anesthesia products increased 7.9%, from $16.4
million to $17.7 million. International sales of anesthesia products increased
50.0%, from $1.2 million to $1.8 million.
Sales of respiratory/critical care products increased 5.1%, from $11.8
million for the three months ended June 30, 2002 to $12.4 million for the three
months ended June 30, 2003, primarily due to higher overseas revenue. Domestic
sales of respiratory/critical care products decreased 3.4%, from $8.7 million to
$8.4 million primarily due to volume declines. International sales of
respiratory/critical care products increased 25.8%, from $3.1 million to $3.9
million which resulted from increased volume levels.
Our sleep segment increased revenues 11.0% (a decrease of 1.2%
excluding favorable foreign exchange), from $10.3 million for the three months
ended June 30, 2002 to $11.8 million for the three months ended June 30, 2003.
The growth in our sleep segment, which includes sleep diagnostic services and
therapy products, was due primarily to increased revenue of 15.2% in our Breas
subsidiary, our sleep ventilation business, resulting principally from favorable
exchange rates. Excluding the effect of favorable exchange rates, Breas revenues
declined 5.3%,. This decrease is due to the phase out of certain distributed
product lines, as Breas focuses its strategy on self-manufactured equipment.
Also included in this segment is Sleep Services of America, our sleep
diagnostics and therapy company, whose revenues increased by 5.4%, primarily due
to increased patient utilization.
Service revenues in the Pharmaceutical Technology Services segment
decreased 9.3%, from $4.9 million for the three months ended June 30, 2002 to
$4.5 million for the three months ended June 30, 2003, as customers have
deferred projects awaiting FDA guidance on 21 CFR Part 11.
13
Cost of Goods Sold and Services Performed. Cost of goods sold and
services performed increased 13.5% from $21.5 million for the three months ended
June 30, 2002 to $24.4 million for the three months ended June 30, 2003.
Cost of goods sold increased 21.1%, from $16.1 million for the three
months ended June 30, 2002 to $19.5 million for the three months ended June 30,
2003. The $3.0 million increase results primarily from the corresponding
increase in sales volume in our anesthesia and respiratory/critical care
segments, resulting in an increase in cost of goods sold of approximately $1.4
million, an increase in cost of goods sold of approximately $700,000 at our
Breas subsidiary due to foreign exchange rate changes, the write-off of certain
inventory amounting to $647,000 resulting from our continuing evaluation of
inventory and $243,000 representing a twelve-month volume related expense
adjustment from a supplier.
Cost of services performed decreased 7.5%, from $5.3 million for the
three months ended June 30, 2002 to $4.9 million for the three months ended June
30, 2003, resulting primarily from reduced sales volumes in our Pharmaceutical
Technology Services segment, as customers have deferred projects awaiting FDA
guidance on 21 CFR Part 11. This decrease was partially offset by increased
volumes at Sleep Services of America, our sleep diagnostics company.
Gross Profit. Our gross profit increased 1.3%, from $23.5 million for
the three months ended June 30, 2002 to $23.8 million for the three months ended
June 30, 2003. Our overall gross profit margin was 49.4% for the three months
ended June 30, 2003, a decrease from the 52.2% achieved in the three months
ended June 30, 2002. The decline in gross profit percentage reflects the lower
gross margin realized from a change in mix attributable to the increase in
revenues of our sleep segment which operates at a lower gross margin, as well as
the above mentioned charges for the write down of inventory and the twelve month
volume adjustment. For gross profit information related to our four segments,
refer to Footnote 5 to our financial statements.
Operating Expenses
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 12.9%, from $11.6 million for the three months
ended June 30, 2002 to $13.1 million for the three months ended June 30, 2002.
The $1.5 million increase was primarily due to an increase of $530,000 in legal
and accounting expense (including $262,000 for accounting and legal expenses
applicable to a complaint filed against the company by a former Chief Financial
Officer of the Company and related matters (see Footnote 8)); increased business
insurance costs of $220,000; an increase of approximately $400,000 at our Breas
subsidiary due to foreign exchange rate changes; $186,000 for data processing
charges for the past year; and increased other expense of approximately
$200,000, primarily relating to compensation expense.
Research and Development Expenses. Research and development expenses
declined by approximately $169,000, or 10.4%, from $1.63 million for the three
months ended June 30, 2001 to $1.46 million for the three months ended June 30,
2002.
Impairment charge for China operations. During the third quarter of
fiscal 2002, the Company recognized an impairment charge of $1,578,000 related
principally to its Chinese distributor based on an evaluation of its business in
China. At that time, the Company believed that it would be able to renegotiate
its agreement with its Chinese distributor to preserve some of its business in
that country. During the second quarter of fiscal 2003, the Company concluded
that it would be unable to renegotiate its agreement with its Chinese
distributor, and as a result the Company has expensed its remaining investment
in China, primarily a receivable from its distributor, of $553,000. See Footnote
11.
14
Other (Income) Expense--Net. Other expense included in operating
income, decreased by $184,000 from $251,000 for the three months ended June 30,
2002 to $67,000 for the three months ended June 30, 2003, resulting primarily
from reduced levels of donations of products to charitable organizations.
Other Items
Interest Income and Expense. Interest income increased 54.0%, from
$137,000 for the three months ended June 30, 2002 to $211,000 during the three
months ended June 30, 2003, resulting from the increase in the level of cash and
cash equivalents being invested. Interest expense increased 17.6%, from $125,000
for the three months ended June 30, 2002 to $147,000 during the three months
ended June 30, 2003, due to a $70,000 charge resulting from the refiling of
certain state income tax returns and an additional $40,000 charge related to the
IRS audit in the third quarter of fiscal 2003 (see Footnote 10), offset by
decreased levels of debt.
Provision for Income Taxes. The provision for income tax expense for
the three months ended June 30, 2003 and 2002 was $3.8 million and $2.8 million,
respectively, reflecting effective tax rates of 40.6% and 33.1% for these
periods, respectively. Included in the provision for the three months ended June
30, 2003 is an additional incremental tax expense of $500,000 for certain state
tax returns for prior periods which are in the process of being re-filed. The
effective tax rate for the three month period before the $500,000 expense was
35.2% See Footnote 10.
Discontinued Operations. In September 2002, we decided to sell our
Vital Pharma, Inc. subsidiary, a fully integrated contract manufacturer that
utilizes blow-fill-seal technology. Accordingly, effective September 2002 the
results for Vital Pharma have been reclassified for all periods presented. Based
upon an appraisal of Vital Pharma's assets and several non-binding bids received
for its Vital Pharma business, the Company has lowered its investment in Vital
Pharma to $2,500,000 and has expensed in the third quarter of fiscal 2003 an
additional $2,033,000 ($1,220,000 after tax) which is included in discontinued
operations. Consequently, the loss from operations, net of tax benefits, of
Vital Pharma for the three months ended June 30, 2003 was $1,590,000, which
represents an additional loss of $1,574,000 over the loss from operations of
Vital Pharma of $16,000 experienced in the three months ended June 30, 2002.
15
Comparison of Results for the Nine-month Period Ended June 30, 2003 to the
Nine-month Period Ended June 30, 2002
Net Revenue. Total net revenue increased 5.1%, from $128.4 million for
the nine months ended June 30, 2002 to $135.0 million for the nine months ended
June 30, 2003. Of the 5.1% increase, approximately 2.6% is attributable to
favorable foreign exchange rates. Increased sales volume was partially offset by
a $3.3 million adjustment recorded in the second quarter to the rebate allowance
(see Footnote 9). Of our total revenues, $100.7 million (or 74.6%) were derived
from domestic sales and $34.3 million (or 25.4%) were derived from international
sales. Domestic revenues increased 1.8%, from $98.9 million for the nine months
ended June 30, 2002 to $100.7 million for the nine months ended June 30, 2003.
International revenues increased 16.5%, from $29.5 million for the nine months
ended June 30, 2002 to $34.3 million for the nine months ended June 30, 2003.
Following are the net revenues by business segment for the nine months ended
June 30, 2003 compared to the nine months ended June 30, 2002.
REVENUE BY BUSINESS SEGMENT
FOR THE NINE ENDED
JUNE 30
------------------- PERCENT
2003 2002 CHANGE
-------- -------- -------
Anesthesia $ 54,010 $ 51,708 4.5%
Respiratory/Critical Care 34,975 36,417 (4.0%)
Sleep 34,950 29,050 20.3%
Pharmaceutical Technology Services 14,357 9,574 50.0%
Rebate allowance adjustment* (3,300) -- N/A
Other* -- 1,639 N/A
-------- -------- ----
$134,992 $128,388 5.1%
*"Other" relates primarily to one-time licensing revenue recorded in
the nine month period ended June 30, 2002 in the anesthesia business
segment. The rebate allowance of $3.3 million relates to our
anesthesia and respiratory/critical care segments. Refer to Footnote 9
of the Notes to Consolidated Financial Statements for a description of
the rebate allowance.
Sales of anesthesia products increased 4.5% from $51.7 million for the
nine months ended June 30, 2002 to $54.0 million for the nine months ended June
30, 2003. This increase was due to volume growth in anesthesia circuits
including our Limb'TM', a patented anesthesia circuit, which increased 86% to
$3.4 million and revenue increases in our Thomas Medical Products. Domestic
sales of anesthesia products increased 3.1%, from $48.1 million to $49.6
million. International sales of anesthesia products increased 22.2%, from $3.6
million to $4.4 million.
Sales of respiratory/critical care products decreased 4.0%, from $36.4
million for the nine months ended June 30, 2002 to $35.0 million for the nine
months ended June 30, 2003. This was due primarily to lower domestic sales
volumes which declined 5.2%, from $27.1 million to $25.7 million. International
sales of respiratory/critical care products were $9.3 million for both the nine
months ended June 30, 2003 and 2002.
Our sleep segment increased revenues 20.3% (an increase of 8.2%
excluding favorable foreign exchange), from $29.1 million for the nine months
ended June 30, 2002 to $35.0 million for the nine months ended June 30, 2003.
Sleep Services of America's revenues increased 15.3% from $11.8 million for the
nine months ended June 30, 2002 to $13.6 million for the nine months ended June
30, 2003. This growth was
16
due primarily to the merger of our National Sleep Technologies subsidiary with a
subsidiary of Johns Hopkins Health System in the second quarter of fiscal 2002.
Our Breas subsidiary increased revenues 24.7% (an increase of 4.2% excluding
favorable foreign exchange) from $16.6 million for the nine months ended June
30, 2002 to $20.7 million for the nine months ended June 30, 2003.
Service revenues in the Pharmaceutical Technology Services segment
increased 50.0%, from $9.6 million for the nine months ended June 30, 2002 to
$14.4 million for the nine months ended June 30, 2003, primarily due to the
acquisition of Stelex Inc, in the second quarter of fiscal 2002.
Cost of Goods Sold and Services Performed. Cost of goods sold and
services performed increased 8.1% from $63.2 million for the nine months ended
June 30, 2002 to $68.3 million for the nine months ended June 30, 2003.
Cost of goods sold increased 5.3%, from $50.6 million for the nine
months ended June 30, 2002 to $53.3 million for the nine months ended June 30,
2003. The $2.7 million increase results primarily from an increase of
approximately $1.8 million at our Breas subsidiary due to foreign exchange rate
changes; the write-off of certain inventory amounting to $647,000 resulting from
our continuing evaluation of inventory; and $243,000 representing a twelve-month
volume related expense adjustment from a supplier.
Cost of services performed increased 19.0%, from $12.6 million for the
nine months ended June 30, 2002 to $15.0 million for the nine months ended June
30, 2003, reflecting the increased pharmaceutical technology outsourcing
services achieved with the acquisition of Stelex Inc. in the second quarter of
fiscal 2002 and the increased volume in sleep services revenue resulting from
the merger in the second quarter of fiscal 2002 of our National Sleep
Technologies subsidiary with the Johns Hopkins Health System subsidiary.
Gross Profit. Our gross profit increased 2.4%, from $65.2 million for
the nine months ended June 30, 2002 to $66.7 million for the nine months ended
June 30, 2003. Our overall gross profit margin was 49.4% for the nine months
ended June 30, 2003 and 50.8% for the nine months ended June 30, 2002. The
decrease in gross margin percentage primarily reflects the increase in rebate
expense (see Footnote 9) and, to a lesser extent, the lower gross margin
realized from a change in mix attributable to the increase in revenues of our
Sleep and Pharmaceutical Technology Services segments, which operate at a lower
gross margin, and charges for the write down of inventory (see Footnote 7). For
gross profit information related to our four segments, refer to Footnote 5 to
our financial statements.
Operating Expenses
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 15.0%, from $32.7 million for the nine months
ended June 30, 2002 to $37.7 million for the nine months ended June 30, 2003.
The $5.0 million increase primarily reflects $2.4 million associated with
additional employee levels and other expense resulting from the acquisition of
Stelex, Inc; an increase of approximately $1.0 million in selling, general and
administrative expenses at our Breas subsidiary due to foreign exchange rate
changes; increases of $520,000 in business insurance costs; $500,000 in
accounting and legal expenses (including $262,000 for accounting and legal
expenses applicable to a complaint filed against the Company by a former Chief
Financial Officer of the Company and related matters (see Footnote 8); a
$186,000 charge for data processing charges for the past year; and increased
other expense of approximately $400,000, primarily relating to compensation
expense.
17
Research and Development Expenses. Research and development expenses
decreased by approximately $435,000, or 9.1%, from $4.8 million for the nine
months ended June 30, 2002 to $4.4 million for the nine months ended June 30,
2003.
Impairment charge for China operations. During the third quarter of
fiscal 2002, the Company recognized an impairment charge of $1,578,000 related
principally to its Chinese distributor based on an evaluation of its business in
China. At that time, the Company believed that it would be able to renegotiate
its agreement with its Chinese distributor to preserve some of its business in
that country. During the second quarter of fiscal 2003, the Company concluded
that it would be unable to renegotiate its agreement with its Chinese
distributor, and as a result the Company has expensed its remaining investment
in China, primarily a receivable from its distributor, of $553,000. See Footnote
11.
Reversal of litigation accrual. In September 1996, a patent
infringement action was filed in Japan against an OEM medical device distributor
in connection with the sale in Japan of Marquest Medical Products, Inc.'s ABG
syringe product line. In July 1999 the Court indicated at a hearing that, based
on one exhibit submitted by the plaintiff, the Marquest ABG syringe products
appeared to infringe the plaintiff's patent, and requested that the plaintiff
submit an updated proof of damages. In July 1999, plaintiff filed an updated
proof of damages of approximately $6.5 million, plus interest and costs. On June
23, 2000 the Court entered a judgment against the Company's distributor for Yen
336,872,689 ($2,887,645) plus five- percent annual interest. The distributor
(which has patent indemnification protection from the Company's Marquest
subsidiary) appealed the judgement to the Tokyo Supreme Court. On March 28,
2002, the appellate court ruled in favor of the distributor, thereby ending the
litigation and ending the Company's exposure with respect to this proceeding.
The Company reversed the $5,006,000 accrual associated with this litigation
during the nine months ended June 30, 2002.
Other (Income) Expense--Net. Other (income) expense increased $260,000
from $393,000 for the nine months ended June 30, 2002 to $653,000 for the nine
months ended June 30, 2003. This was primarily due to a $322,000 charge relating
to the costs for a discontinued public offering (see Footnote 12) and $151,000
of shut down expenses for Breas sales offices, offset by other net reductions
of $213,000.
Other Items
Interest Income and Expense. Interest income decreased 4.2%, from
$522,000 for the nine months ended June 30, 2002 to $500,000 during the nine
months ended June 30, 2003, resulting from the decrease in available interest
rates. Interest expense increased $690,000, from $184,000 for the nine months
ended June 30, 2002 to $874,000 during the nine months ended June 30, 2003. This
was primarily due to $690,000 of interest charges resulting from the IRS
examination of the Company's 1997, 1998 and 1999 Federal Income Tax returns and
$70,000 for the refiling of certain state income tax returns (see Footnote 10).
These increases were partially offset by reduced interest relating to decreased
levels of debt.
Provision for Income Taxes. The provision for income tax expense for
the nine months ended June 30, 2003 and 2002 was $9.6 million and $10.4 million,
reflecting effective tax rates of 41.3% and 33.6% for these periods,
respectively. Included in the provision for the nine months ended June 30, 2003
is an additional provision of $1.1 million resulting from an examination, in the
Internal Revenue Service's normal course, of the Company's 1997, 1998 and 1999
Federal income tax returns and an additional incremental tax expense of $297,000
for certain state tax returns for prior periods which are in the process of
being re-filed. The effective tax rate excluding these two items was 35.2%. The
Company expects the Internal Revenue Service to complete its examination in the
fourth quarter of fiscal 2003. While the Company believes it has
18
recorded the appropriate tax liability and tax provision, the Company may be
subject to other audit adjustments arising from that review. See Footnote 10.
Discontinued Operations. In September 2002, we decided to sell our
Vital Pharma, Inc. subsidiary, a fully integrated contract manufacturer that
utilizes blow-fill-seal technology. Accordingly, effective September 2002 the
results for Vital Pharma have been reclassified for all periods presented. Based
upon an appraisal of Vital Pharma's assets and several non-binding bids received
for its Vital Pharma business, the Company has lowered its investment in Vital
Pharma to $2,500,000 and has expensed an additional $5,333,000 ($3,402,000 after
tax) which is included in discontinued operations. Consequently, the loss from
operations, net of tax benefits, of Vital Pharma for the nine months ended June
30, 2003 was $4,502,000, which represents an additional loss of $4,004,000 over
the loss from operations of Vital Pharma of $498,000 experienced in the nine
months ended June 30, 2002.
Liquidity and Capital Resources
Historically, our primary liquidity requirements have been to finance
business acquisitions and to support operations. We have funded these
requirements principally through internally generated cash flow. At June 30,
2003, we had cash and cash equivalents of $51.2 million and we had long-term
debt of $1.3 million, representing industrial revenue bonds payable in varying
installments through 2009. We have a $20 million line of credit with JP Morgan
Chase Bank. There were no amounts outstanding on the JP Morgan Chase Bank line
of credit at June 30, 2003.
Vital Signs continues to generate cash flows from its operations.
During the nine months ended June 30, 2003, cash and cash equivalents increased
by $21.9 million. Operating activities provided $27.2 million net cash, of which
$29.0 million was provided from continuing operations, offset by $1.8 million
used in our discontinued operation at Vital Pharma. Investing activities used
approximately $2.9 million for capital expenditures. Financing activities used
$3.9 million, consisting of $2.3 million for the repurchase of common stock;
$249,000 used to pay down long term debt; and $1.8 million paid for dividends,
offset by $501,000 of cash received from the exercise of stock options.
Cash and cash equivalents were $51.2 million at June 30, 2003 as
compared to $29.3 million at September 30, 2002. At June 30, 2003 our working
capital was $94.3 million as compared to $86.6 million at September 30, 2002. At
June 30, 2003 the current ratio was 5.6 to 1, as compared to 7.6 to 1 at
September 30, 2002.
Our capital investments vary from year to year, based in part on
capital demands of newly acquired businesses. Capital expenditures for the nine
month period ended June 30, 2002 were approximately $2.9 million, and included
expenditures for equipment used as part of cost improvement projects at our New
Jersey facility ($1.2 million), Colorado facility ($530,000), California
facility ($300,000) and Thomas Medical Products facility ($200,000), and the
capitalized costs of software development ($369,000) and patents ($353,000).
Our current policy is to retain working capital and earnings for use
in our business, subject to the payment of certain cash dividends. Such funds
may be used for business acquisitions, product acquisitions, and product
development, among other things. We regularly evaluate and negotiate with
domestic and foreign medical device companies regarding potential business or
product line acquisitions, licensing arrangements and strategic alliances.
Our Board of Directors has authorized the expenditure of up to $20
million for the repurchase of Vital Signs' stock. Through June 30, 2003, we had
repurchased 90,600 shares for $2,316,000, including
19
commissions of $4,000, at an average price of $25.52. Any purchases under Vital
Signs' stock repurchase program may be made from time-to-time in the open
market, through block trades or otherwise. Depending on market conditions and
other factors, these purchases may be commenced or suspended at any time or from
time-to-time without prior notice.
Our Board of Directors has approved $1.8 million in dividends
(amounting to $.14 per share) in the current fiscal year.
Critical Accounting Principles and Estimates
We have identified the following critical accounting principles that
affect the more significant judgments and estimates used in the preparation of
our consolidated financial statements. The preparation of our consolidated
financial statements in conformity with generally accepted accounting principles
requires us to make estimates and judgments that affect our reported amounts of
assets and liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to asset impairment, revenue recognition,
allowance for doubtful accounts, and contingencies and litigation. We state
these accounting policies in the notes to our consolidated financial statements
and at relevant places in this discussion and analysis. These estimates are
based on the information that is currently available to us and on various other
assumptions that we believe to be reasonable under the circumstances. Actual
results could vary from these estimates under different assumptions or
conditions.
We believe that the following critical accounting principles affect
the more significant judgments and estimates used in the preparation of our
consolidated financial statements:
o Through September 30, 2001, we amortized goodwill and intangibles
on a straight-line basis over their estimated lives. Upon our
adoption of SFAS No. 142 on October 1, 2001, we ceased amortizing
goodwill and we perform an annual impairment analysis based upon
discounted cash flows to assess the recoverability of the
goodwill, in accordance with the provisions of SFAS No. 142. We
completed this impairment test during the three month period
ended March 31, 2003 and found no impairment. If we are required
to record impairment charges in the future, it would have an
adverse impact on our results of operations and financial
condition.
o We maintain an allowance for doubtful accounts for estimated
losses resulting from the inability of our customers to make
required payments, which results in bad debt expense. Our
allowance for doubtful accounts was $552,000 at June 30, 2003 and
$638,000 at September 30, 2002. We determine the adequacy of this
allowance by evaluating individual customer receivables,
considering the customer's financial condition and credit history
and analyzing current economic conditions. If the financial
condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional
allowances may be required.
o Our sales to distributors are made at our established price. Each
distributor subsequently provides us with documentation that our
products have been shipped to particular end-users (i.e..
particular hospitals). In general, the end-user is entitled, on a
case by case basis, to a price lower than our established price.
Accordingly, we owe the distributor a rebate - the difference
between the established price and the lower price to which the
end-user is entitled - upon our receipt of the documentation from
the distributor. At the time that the distributor remits payment
to us for the products purchased, the distributor deducts an
amount for the related rebates.
20
The allowance for rebates is recorded at the time we record the
revenue for the product shipped to the distributor. The rebate is
recorded as sales allowance reducing gross revenue.
We have, for several years, utilized an historical moving average
to estimate the allowance for rebates. Based upon our recent
review, we have concluded that the moving average estimate does
not necessarily result in the appropriate liability due to the
distributor. Accordingly, we have changed our method of
estimating rebate claims to record the allowance for rebates
based upon the documentation provided by the distributor of the
shipments to the end-user as well as estimates for inventory not
yet sold by the distributor, adjusting from estimate to actual at
the time of remittance.
o We are subject to various claims and legal actions in the
ordinary course of our business. These matters frequently arise
in disputes regarding the rights to intellectual property, where
it is difficult to assess the likelihood of success and even more
difficult to assess the probable ranges of recovery. Although we
currently are not aware of any legal proceeding that is
reasonably likely to have a material adverse effect on our
financial position and results of operations, if we become aware
of any such claims against us, we will evaluate the probability
of an adverse outcome and provide accruals for such contingencies
as necessary.
o We have established an allowance for inventory obsolescence. The
allowance was determined by performing an aging analysis of the
inventory; based upon this review, inventory is stated at the
lower of cost (first in, first out method) or its net realizable
value. In the third quarter of fiscal 2003, the Company wrote-off
certain inventory amounting to $647,000. Our inventory allowance
for obsolescence was $1,127,000 at June 30, 2003 and $438,000 at
September 30, 2002.
Accounting Principles. For information regarding new accounting
principles, see Note 12 of our notes to consolidated financial statements.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks, including the impact of material price
changes and changes in the market value of our investments and, to a lesser
extent, interest rate changes and foreign currency fluctuations. In the normal
course of business as described below, we employ policies and procedures with
the objective of limiting the impact of market risks on earnings and cash flows
and to lower our overall borrowing costs.
The impact of interest rate changes is not material to our financial
condition. We do not enter into interest rate transactions for speculative
purposes.
Our international net revenue represents approximately 25.4% of our
total net revenues. Our Breas subsidiary, located in Sweden, represents 60.2% of
our total international net revenues. We do not enter into any derivative
transactions, including foreign currency transactions, for speculative purposes.
The Company has not entered into any derivative instruments (i.e. foreign
exchange forward or option contracts) as of June 30, 2003.
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Our risk involving price changes relate to raw materials used in our
operations. We are exposed to changes in the prices of resins and latex for the
manufacture of our products. We do not enter into commodity futures or
derivative instrument transactions. Except with respect to our single source of
supply for facemasks, it is our policy to maintain commercial relations with
multiple suppliers and when prices for raw materials rise to attempt to source
alternative supplies.
ITEM 4.
CONTROLS AND PROCEDURES
(a) Disclosure controls and procedures. As of the end of the Company's
most recently completed fiscal quarter covered by this report, the Company
carried out an evaluation, with the participation of the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the Company's disclosure controls and procedures pursuant
to Securities Exchange Act Rule 13a-15. Based upon that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective in ensuring that
information required to be disclosed by the Company in the reports that it files
or submits under the Securities Exchange Act is recorded, processed, summarized
and reported, within the time periods specified in the SEC's rules and forms.
(b) Changes in internal controls over financial reporting. There have
been no changes in the Company's internal controls over financial reporting that
occurred during the Company's last fiscal quarter to which this report relates
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
22
PART II.
Other Information
ITEM 1.
Legal Proceedings:
(a) Reference is made to Item 3 of our Annual Report on Form 10-K for the year
ended September 30, 2002.
(b) On December 6, 1999, a complaint was filed against us on behalf of the
former shareholders of our Vital Pharma subsidiary alleging breach of
contract for failure to pay earnout payments allegedly due under the stock
purchase agreement executed in connection with our purchase of Vital Pharma
in December 1995. We have answered the complaint, filed counter-claims and
moved to transfer the case to arbitration. In August 2000, the court
ordered the plaintiff to submit such claims to binding arbitration and
stayed all other proceedings pending the outcome of the arbitration. The
parties are in the final stages of discovery in the arbitration proceeding.
Arbitration proceedings had been scheduled to begin in the fourth quarter
of fiscal 2003. It is currently anticipated that the hearing will begin in
the first quarter of fiscal 2004.
(c) On May 7, 2003 a complaint was filed against the Company and two of its
officers by Joseph Bourgart, a former chief financial officer for the
period January 11, 2002 to November 2002. Plaintiff alleges that he was a
"whistleblower" within the meaning of the New Jersey Conscientious Employee
Protection Act, based on allegations of improper accounting practices.
Plaintiff asserts these allegations notwithstanding the fact that, in
connection with the filing of the Company's report on Form 10-Q for the
Company's third quarter of fiscal 2002 (the period ended June 30, 2002), he
had executed a certification pursuant to the Sarbanes-Oxley Act certifying
that the Quarterly Report on Form 10-Q for that period "fully complies with
the requirements of Section 13(a) of the Securities and Exchange Act of
1934" and that "The information contained in the Report fairly presents, in
all material respects, the consolidated financial condition of the
Company...". Furthermore, as the Company's chief financial officer,
Plaintiff signed the Company's quarterly reports on Form 10-Q for the first
quarter and second quarter of fiscal 2002 (ended December 31, 2001 and
March 31, 2002, respectively). Less than one month before Plaintiff's
resignation, he participated in a meeting with the Company's worldwide
management team to review the accuracy of the Company's Annual Report on
form 10-K for the 2002 fiscal year. At that meeting he voiced no objections
to the 10-K, nor did he say that the report contained any untrue statements
or omit to state any material fact. Of the items enumerated in the
complaint, most had already been reviewed with the Company's independent
accountants and the Company's Audit Committee prior to the Company's filing
of its quarterly report for the third quarter of fiscal 2002. The Company
believes that the filing of the complaint is a retaliatory action by
Plaintiff who voluntarily resigned without any severance payment after
being confronted with evidence of certain unethical and possibly illegal
conduct. Nevertheless, in accordance with the Sarbanes-Oxley Act, the
issues raised in the complaint have been referred to the Audit Committee,
which has commenced its own independent analysis of those matters.
On July 28, 2003 the defendants filed a motion for summary judgement to
dismiss the lawsuit. The motion asserts that Plaintiff resigned after being
confronted with proof of his unethical and possibly illegal conduct; that
the Plaintiff is not a "whistleblower"; and that the Plaintiff has no basis
for his assertion of impropriety as he repeatedly represented in writing to
the Securities and Exchange
23
Commission and the Company's auditors that the Company's public filings
were true and accurate in all material respects. Inasmuch as Plaintiff
approved and certified the accuracy of the Company's financial statements
to the investing public under penalty of criminal prosecution, the Company
has asserted that no reasonable jury could believe that Plaintiff had
reason to believe that the Company engaged in improper accounting
practices. The Company strongly denies that it had engaged in improper
conduct both as regards its accounting practices and with regard to its
treatment of the Plaintiff.
(d) We are also involved in other legal proceedings arising in the ordinary
course of business. We cannot predict the outcome of our legal proceedings
with certainty. However, based upon our review of pending legal
proceedings, we do not believe the ultimate disposition of our pending
legal proceedings will be material to our financial condition. Predictions
regarding the impact of pending legal proceedings constitute
forward-looking statements. The actual results and impact of such
proceedings could differ materially from the impact anticipated, primarily
as a result of uncertainties involved in the proof of facts in legal
proceedings.
ITEM 2 THROUGH 5
Not applicable.
ITEM 6.
Reports on Form 8-K
A Current Report on Form 8-K was filed on May 8, 2003, disclosing (under
Items 7 and 12) Vital Signs' press release regarding results for the three
and six months ended March 31, 2003.
24
Exhibits
31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer Pursuant to [p] U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
32.2 Certification of the Chief Financial Officer Pursuant to [p] U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
25
Signatures
Pursuant to the requirements 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.
VITAL SIGNS, INC.
By: /s/ Frederick S. Schiff
----------------------------
Frederick S. Schiff
Executive Vice President and
Chief Financial Officer
Date: August 13, 2003
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STATEMENT OF DIFFERENCES
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The trademark symbol shall be expressed as............................. 'TM'
The paragraph symbol shall be expressed as............................. [p]