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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, 2004
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
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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, 2004 there were 12,709,047 shares of Common Stock, no par
value, outstanding.
VITAL SIGNS, INC.
INDEX
Page
Number
------
PART I.
Financial information..................................................................... 1
Item 1. Financial Statements
Report of Independent Registered Public Accounting Firm................................... 2
Consolidated Balance Sheets as of June 30, 2004 (Unaudited) and September 30, 2003........ 3
Consolidated Statements of Income for the Three Months Ended June 30, 2004 and 2003 4
(Unaudited)............................................................................
Consolidated Statements of Income for the Nine Months Ended June 30, 2004 and 2003 5
(Unaudited)............................................................................
Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2004 and 2003 6
(Unaudited)............................................................................
Notes to Consolidated Financial Statements (Unaudited).................................... 7-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.....12-19
Item 3. Quantitative and Qualitative Disclosure About Market Risks................................ 20
Item 4. Controls and Procedures................................................................... 20
PART II.
Item 1. Legal Proceedings......................................................................... 21
Item 2. Changes in Securities and Use of Proceeds................................................. 22
Item 4. Submission of Matters to a Vote of Security Holders....................................... 22
Item 5. Other Items............................................................................... 22
Item 6. Exhibits and Reports on Form 8-K.......................................................... 23
Signatures................................................................................ 24
Exhibit 31.1..............................................................................
Exhibit 31.2 .............................................................................
Exhibit 32.1..............................................................................
Exhibit 32.2..............................................................................
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, 2003.
The results of operations for the interim periods presented herein are
not necessarily indicative of the results to be expected for the entire fiscal
year, or any other period.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2004 and the related consolidated
statements of income for the three months and nine months ended June 30, 2004
and 2003, and the consolidated statements of cash flows for the nine months
ended June 30, 2004 and 2003. These financial statements are the responsibility
of the Company's management.
We conducted our reviews in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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 the
standards of the Public Company Accounting Oversight Board, 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 U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the consolidated
balance sheet of Vital Signs, Inc. and Subsidiaries as of September 30, 2003 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 5, 2003, except for the fourth paragraph of Note 16, as to which the
date is December 26, 2003, 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, 2003 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
July 23, 2004
2
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, September 30,
2004 2003
---- ----
(In thousands of dollars)
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents .......................................... $ 72,530 $ 55,660
Accounts receivable, less allowance for rebates and doubtful
accounts of $8,792 and $7,075, respectively ...................... 27,043 29,436
Inventory .......................................................... 19,408 21,857
Prepaid expenses ................................................... 2,736 3,239
Other current assets ............................................... 1,718 4,129
Assets of discontinued business .................................... -- 2,104
-------- --------
Total Current Assets ........................................... 123,435 116,425
Property, plant and equipment--net ................................. 32,920 32,306
Goodwill ........................................................... 69,506 69,506
Deferred income taxes .............................................. 443 1,519
Other assets ....................................................... 2,637 3,322
-------- --------
Total Assets ................................................... $228,941 $223,078
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ................................................... $ 4,953 $ 6,072
Current portion of long-term debt .................................. -- 1,690
Accrued expenses ................................................... 6,203 6,071
Accrued income taxes ............................................... 3,997 3,392
Other current liabilities .......................................... 120 228
Liabilities of discontinued business ............................... -- 503
-------- --------
Total Current Liabilities ...................................... 15,273 17,956
-------- --------
Minority interest in subsidiary ......................................... 3,273 2,900
-------- --------
Commitments and contingencies
Stockholders' Equity
Common stock--no par value; authorized 40,000,000 shares, issued and
outstanding 12,709,047 and 12,915,566 shares, respectively ....... 23,946 30,467
Accumulated other comprehensive income ............................. 2,287 1,827
Retained earnings .................................................. 184,162 169,928
-------- --------
Stockholders' equity ............................................... 210,395 202,222
-------- --------
Total Liabilities and Stockholders' Equity ..................... $228,941 $223,078
======== ========
(See Notes to Consolidated Financial Statements)
3
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the Three
Months Ended
June 30,
----------------------
2004 2003
---- ----
In thousands, except
(per share amounts)
Net Revenues:
Net sales........................................................................... $ 37,355 $ 38,900
Service revenue..................................................................... 8,316 9,271
--------- ---------
45,671 48,171
--------- ---------
Cost of goods sold and services performed:
Cost of goods sold.................................................................. 17,141 19,511
Cost of services performed.......................................................... 4,666 4,877
--------- ---------
21,807 24,388
--------- ---------
Gross profit............................................................................. 23,864 23,783
--------- ---------
Operating expenses:
Selling, general and administrative................................................. 12,300 13,083
Research and development............................................................ 1,868 1,462
Other expense--net................................................................... 260 67
--------- ---------
Total operating expenses........................................................ 14,428 14,612
--------- ---------
Operating Income......................................................................... 9,436 9,171
--------- ---------
Other (income) expense...................................................................
Interest (income)................................................................... (189) (211)
Interest expense.................................................................... -- 147
--------- ---------
Total other (income) .................................................................... (189) (64)
--------- ---------
Income from continuing operations before provision for income taxes and minority 9,625 9,235
interest in income of consolidated subsidiary.........................................
Provision for income taxes............................................................... 3,477 3,750
--------- ---------
Income from continuing operations before minority interest in income of consolidated 6,148 5,485
subsidiary............................................................................
Minority interest in income of consolidated subsidiary................................... 119 107
--------- ---------
Income from continuing operations........................................................ 6,029 5,378
Discontinued Operations:
Income (loss) from operations of Vital Pharma, net of income taxes (benefit) of $38 and
($1,300).............................................................................. 69 (1,590)
--------- ---------
Net income............................................................................... $ 6,098 $ 3,788
========= =========
Earnings per Common Share:
Basic
Income per share from continuing operations......................................... $ 0.47 $ 0.42
Income (loss) per share from discontinued operations................................ $ 0.01 $ (0.12)
--------- ---------
Net earnings per share ............................................................. $ 0.48 $ 0.30
========= =========
Diluted
Income per share from continuing operations......................................... $ 0.47 $ 0.41
Income (loss) per share from discontinued operations................................ $ 0.01 $ (0.12)
--------- ---------
Net earnings per share.............................................................. $ 0.48 $ 0.29
========= =========
Basic weighted average number of shares outstanding...................................... 12,739 12,922
Diluted weighted average number of shares outstanding.................................... 12,830 12,990
Dividends paid per share................................................................. $ 0.06 $ 0.05
(See Notes to Consolidated Financial Statements)
4
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the Nine
Months Ended
June 30,
----------------------
2004 2003
---- ----
In thousands, except
(per share amounts)
Net Revenues:
Net sales.......................................................................... $ 111,833 $ 106,992
Service revenue.................................................................... 24,323 28,000
--------- ---------
136,156 134,992
Cost of goods sold and services performed:
Cost of goods sold................................................................. 53,579 53,303
Cost of services performed......................................................... 13,461 14,977
--------- ---------
67,040 68,280
--------- ---------
Gross profit............................................................................ 69,116 66,712
--------- ---------
Operating expenses:
Selling, general and administrative................................................ 37,370 37,718
Research and development........................................................... 5,407 4,383
Impairment charge for China operations............................................. -- 553
Other expense--net................................................................. 481 653
--------- ---------
Total operating expenses....................................................... 43,258 43,307
--------- ---------
Operating Income........................................................................ 25,858 23,405
--------- ---------
Other (income) expense..................................................................
Interest (income).................................................................. (574) (500)
Interest expense................................................................... 25 874
--------- ---------
Total other (income) expense............................................................ (549) 374
--------- ---------
Income from continuing operations before provision for income taxes and minority
interest in income of consolidated subsidiary........................................ 26,407 23,031
Provision for income taxes.............................................................. 9,367 9,522
--------- ---------
Income from continuing operations before minority interest in income of consolidated
subsidiary........................................................................... 17,040 13,509
Minority interest in income of consolidated subsidiary.................................. 373 236
Income from continuing operations....................................................... 16,667 13,273
Discontinued Operations:
Loss from operations of Vital Pharma, net of income tax benefit of ($54) and ($2,503)... (102) (4,502)
--------- ---------
Net income.............................................................................. $ 16,565 $ 8,771
========= =========
Earnings (loss) per Common Share:
Basic
Income per share from continuing operations........................................ $ 1.30 $ 1.03
Loss per share from discontinued operations........................................ $ (0.01) $ (0.35)
--------- ---------
Net earnings per share............................................................. $ 1.29 $ 0.68
========== ==========
Diluted
Income per share from continuing operations........................................ $ 1.29 $ 1.02
Loss per share from discontinued operations........................................ $ (0.01) $ (0.35)
--------- ---------
Net earnings per share............................................................. $ 1.28 $ 0.67
========== ==========
Basic weighted average number of shares outstanding..................................... 12,822 12,910
Diluted weighted average number of shares outstanding................................... 12,946 12,991
Dividends paid per share................................................................ $ 0.18 $ 0.14
(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,
-----------------------
2004 2003
---- ----
(In thousands of dollars)
Cash Flows from Operating Activities:
Net income ...................................................... $ 16,565 $ 8,771
Add loss from discontinued operations ........................... 102 4,502
-------- --------
Income from continuing operations ............................... 16,667 13,273
Adjustments to reconcile income from continuing operations to
net cash provided by continuing operations
Depreciation and amortization ................................... 3,368 3,310
Deferred income taxes ........................................... 1,076 136
Minority interest in income of consolidated subsidiary .......... 373 236
Non cash loss on write off of China receivable .................. -- 553
Increase in rebate allowance .................................... -- 3,300
Changes in operating assets and liabilities:
Decrease in accounts receivable ................................. 2,688 2,434
Decrease in inventory ........................................... 2,866 59
Decrease in prepaid expenses and other current assets ........... 2,984 619
Decrease (increase) in other assets ............................. 686 (308)
(Decrease) increase in accounts payable ......................... (1,698) 586
(Decrease) in accrued expenses .................................. (4) (678)
Increase in accrued income taxes ................................ 605 5,190
Increase in other liabilities ................................... 99 308
-------- --------
Net cash provided by continuing operations ........................... 29,710 29,018
Net cash used in discontinued operations ............................. (140) (1,801)
-------- --------
Net cash provided by operating activities ............................ 29,570 27,217
-------- --------
Cash flows from investing activities:
Net proceeds from sales of assets of Vital Pharma ............... 417 --
Net proceeds from sale of Vital Pharma real estate .............. 1,222 --
Acquisition of property, plant and equipment .................... (3,186) (2,269)
Capitalized software costs ...................................... (421) (369)
Capitalized patent costs ........................................ (86) (353)
Proceeds from sales of available for sale securities ............ -- 82
-------- --------
Net cash used in investing activities ................................ (2,054) (2,909)
-------- --------
Cash flows from financing activities:
Dividends paid .................................................. (2,330) (1,833)
Proceeds from exercise of stock options ......................... 1,099 501
Purchase of common stock ........................................ (7,620) (2,312)
Principal payments on long-term debt and notes payable .......... (1,690) (249)
-------- --------
Net cash used in financing activities ................................ (10,541) (3,893)
-------- --------
Effect of foreign currency translation ............................... (105) 1,491
-------- --------
Net increase in cash and cash equivalents ............................ 16,870 21,906
Cash and cash equivalents at beginning of period ..................... 55,660 29,303
-------- --------
Cash and cash equivalents at end of period ........................... $ 72,530 $ 51,209
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the nine months for:
Interest........................................................ $ 65 $ 138
Income taxes.................................................... $ 5,614 $ 3,698
(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, 2004, the consolidated
statements of income for the three and nine months ended June 30, 2004 and 2003,
and the consolidated statements of cash flows for the nine months ended June 30,
2004 and 2003, 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, 2004 and the results of operations for the three months and
nine months ended June 30, 2004 and 2003, and the cash flows for the nine months
ended June 30, 2004 and 2003, have been made.
2. See the Company's Annual Report on Form 10-K for the year ended
September 30, 2003 (the "Form 10-K") for additional disclosures relating to the
Company's consolidated financial statements.
3. At June 30, 2004, the Company's inventory was comprised of raw
materials of $11,333,000 and finished goods of $8,075,000. At September 30,
2003, the Company's inventory was comprised of raw materials of $12,570,000 and
finished goods of $9,287,000.
4. For Details of Legal Proceedings, see Part II, Item 1, "Legal
Proceedings".
5. Net revenues consist of product sales and service revenues. For
substantially all product sales, revenue is recognized in the same period as
title to the product passes to the customer. For service revenue, revenue is
recorded when the service is performed. A component of product sales is a
deduction for rebates due on sales to distributors (see Footnote 13). A
reconciliation of gross to net sales is provided below:
Three Months Ended Nine Months Ended
June 30, June 30,
----------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
(In thousands of dollars)
Gross sales....................... $ 50,786 $ 50,520 $ 150,035 $ 143,538
--------- --------- ---------- -----------
Rebates........................... (12,445) (10,911) (35,199) (33,436)
Other deductions.................. (986) (709) (3,003) (3,110)
--------- --------- ---------- -----------
Net sales......................... 37,355 38,900 111,833 106,992
Service revenues.................. 8,316 9,271 24,323 28,000
--------- --------- ---------- -----------
Total net revenues............. $ 45,671 $ 48,171 $ 136,156 $ 134,992
========= ========= ========== ===========
Other deductions consist of discounts, returns and allowances for
credits.
6. 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:
7
VITAL SIGNS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Respiratory/ Pharmaceutical
Critical Technology
Anesthesia Care Sleep Services Other* Consolidated
---------- ---- ----- -------- ----- ------------
(In thousands of dollars)
For the Three Months Ended
June 30, 2004
Net revenues....................... $ 20,716 $ 10,132 $ 10,976 $ 3,847 $ -- $ 45,671
Gross profit....................... 11,670 5,573 5,194 1,427 -- 23,864
Operating income................... 5,813 2,843 428 352 -- 9,436
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
For the Nine Months Ended
June 30, 2004
Net revenues....................... $ 58,715 $ 31,919 $ 34,152 $ 11,370 -- $ 136,156
Gross profit....................... 31,724 17,396 15,563 4,433 -- 69,116
Operating income................... 14,939 8,121 1,819 979 -- 25,858
Total assets....................... 112,917 61,385 36,227 18,412 -- 228,941
Capital expenditures............... 1,407 765 1,075 446 -- 3,693
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
- --------------
* "Other" relates to an adjustment for the allowance for rebates in the three
and nine months ended June 30, 2003 in the anesthesia and respiratory/critical
care business segments.
--------------
7. Other comprehensive income for the three months and nine months ended
June 30, 2004 and 2003 consisted of:
Three Months Ended Nine Months Ended
June 30, June 30,
----------------------- -----------------------
2004 2003 2004 2003
---- ---- ---- ----
(In thousands of dollars)
Net income ..............................$ 6,098 $ 3,788 $ 16,565 $ 8,771
Foreign currency translation............. 62 1,584 460 2,484
Other.................................... -- (35) -- (33)
---------- --------- --------- ---------
Comprehensive income.....................$ 6,160 $ 5,337 $ 17,025 $ 11,222
========== ========= ========= =========
8
VITAL SIGNS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
8. During the third quarter of fiscal 2004, the Company charged to other
expense $197,000 of costs related to a failed acquisition attempt. These
expenses were allocated to the Anesthesia and Respiratory/Critical Care
segments.
9. During the second quarter of fiscal 2004, the Company's Breas
subsidiary expensed $175,000 of discontinued product inventory, $94,000 of
estimated costs for a field upgrade, and $94,000 to increase the reserve for
service stock inventory. These expenses were allocated to the Company's Sleep
segment.
10. During the first quarter of fiscal 2004, included in selling, general
and administrative expenses are $235,000 of expenses related to a special review
performed by the Company's Audit Committee, and $139,000 of unamortized cost
related to the prepayment of the Company's Industrial Revenue Bond of
$1,500,000. These expenses were allocated to the Anesthesia and
Respiratory/Critical Care segments.
11. During the third quarter of fiscal 2003, the Company wrote-off
certain inventory amounting to $647,000. 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.
12. During the third quarter of fiscal 2003 accounting and legal expenses
of $262,000 were incurred in connection with the Audit Committee review a
complaint filed against the Company and two of its officers and related
proceedings. At the request of management, the Company's Audit Committee hired
outside independent accountants and legal counsel to review the matters alleged
by the plaintiff, a former CFO of the Company. These expenses were included in
selling, general and administrative expenses and were allocated (on a net sales
basis) to the Anesthesia and Respiratory/Critical Care segments.
13. During the second quarter of fiscal 2003, the Company reviewed and
adjusted its estimate for rebates due to distributors. As background, the
Company's sales to distributors in the domestic anesthesia and
respiratory/critical care business segments, which represented 25.6% of the
Company's net sales during the third quarter of fiscal 2004, are made at the
Company's established distributor price. Since the end-user (i.e., a hospital)
is typically entitled, on a case by case basis, to a price lower than our
established price, the distributor is due a rebate (the difference between the
established price and the lower price to which the end-user is entitled) when
shipment is made to the end user. In order to properly reflect sales to
distributors, the Company records the gross sale (at our established price),
less the amount of expected rebate to arrive at net sales. This net sale is the
amount the Company expects to receive in cash from the distributor on the sale.
On a monthly basis, each distributor provides the Company with
documentation of shipments to particular end-users and computes a rebate claim
on such shipments. Once the distributor has provided us with this claim, they
will deduct the computed rebate from their net remittance.
The amount of estimated rebate that has not yet been claimed by the
distributor through the reduction of a payment is included in the allowance for
rebates, which reduces the accounts receivable on the Company's balance sheet.
This allowance is calculated by adding (1) the amount of rebates the
distributors have documented is due but not yet claimed and (2) an estimate of
the amount of future rebates due on any inventory the distributors are holding
at the end of each period.
For several years, the Company utilized an historical moving average
calculation (comparing rebates to sales to distributors) in order to estimate
the amount of rebate expense that should be recorded against gross sales in each
period. Based upon a review conducted in connection with the filing of our
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, the Company
concluded that our estimated allowance as calculated in the previous paragraph
was greater than previously calculated. As a result of its review of the rebate
allowance, we recorded an additional allowance for rebates of $3,300,000 in the
second quarter of fiscal 2003. We have continued to monitor the recorded
allowance for rebates as well as the payments made against this estimate and
believe we are providing a better estimate of the ultimate rebate our
distributors are entitled to.
14. During the third quarter of fiscal 2003, as a result of a review of
the Company's tax returns, certain state tax returns for prior periods were
amended, resulting in an incremental tax expense of $500,000, and interest
expense
9
VITAL SIGNS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
of $70,000 during the third quarter of fiscal 2003. The Internal Revenue
Service (IRS) had 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. On October 6, 2003, the Company
finalized the IRS tax audit for the years 1997, 1998 and 1999.
15. During the second quarter of fiscal 2003, the Company concluded that
it would be unable to collect its remaining receivable under normal terms from
its China distributor, and provided a reserve against the receivable balance of
$553,000. In May 2003, the Company retained counsel in China to commence certain
legal actions against its distributor in China to collect its receivable. This
charge related to the Company's Anesthesia and Respiratory/Critical Care
segments.
16. In the second quarter of fiscal 2003, income from continuing
operations included $322,000 of expenses relating to costs for a public offering
that was discontinued due to market conditions.
17. During the second quarter of fiscal 2003, the Company had received
several non-binding bids for its Vital Pharma business. Based on the non-binding
bids received, the Company reduced the amount of its investment in Vital Pharma,
which is included in discontinued operations, and expensed $3,300,000 in the
second quarter of fiscal 2003, and subsequently in the third quarter of fiscal
2003 expensed an additional $2,033,000. In October 2003, the Company sold Vital
Pharma to ProClinical, Inc. for $500,000 in cash and a three-year note
receivable from ProClinical for $2,000,000. The note is secured by a first lien
against all of the assets sold. No gain or further loss was recorded on the
sale. On December 29, 2003 the Company sold certain related real estate. The
Company has accounted for these sales on a cost recovery basis. In the quarter
ended June 30, 2004 the Company received $107,000 of interest income from Pro
Clinical, which was recorded as a net gain from discontinued operations (after
income tax effect) of $69,000.
18. 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, 2004 and 2003 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,
--------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income--as reported.............................. $ 6,098 $ 3,788 $ 16,565 $ 8,771
Net income--Pro forma................................ 5,759 3,688 15,727 8,471
Basic net income per common share--as reported....... .48 .30 1.29 .68
Diluted net income per common share--as reported..... .48 .29 1.28 .67
Basic net income per common share--Pro forma......... .45 .29 1.23 .66
Diluted net income per common share--Pro forma....... .44 .28 1.22 .65
10
VITAL SIGNS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
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, 2004 and
2003, respectively: expected volatility of 50% and 50%, respectively, risk-free
interest rate of 3.7% and 4.2%, respectively, dividend yield rate of .7% and
..7%, respectively, and all options have expected lives of 5 years.
19. 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.
11
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, 2003 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.
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 from Increase from
Prior Period Prior Period
Three Months Ended Nine Months Ended
June 30, 2004 June 30, 2004
Compared with Compared with
Three Months Ended Nine Months Ended
June 30, 2003 June 30, 2003
------------------ -----------------
Consolidated Statement of Operations Data:
Net revenues......................................... (5.2%) 0.9%
Gross profit......................................... 0.3% 3.6%
Total operating expenses............................. (1.3%) (0.1)%
Income from continuing operations.................... 12.1% 25.6%
Net income........................................... 61.0% 88.9%
Comparison of Results for the Three-Month Period Ended June 30, 2004 to the
Three-Month Period Ended June 30, 2003.
Net Revenue. Net revenues for the three months ended June 30, 2004
decreased by 5.2% (a decrease of 6.1% excluding the favorable effect of foreign
exchange) to $45.7 million as compared to $48.2 million in the comparable period
last year. Of our total revenues, $34.5 million, or 75.5%, were derived from
domestic sales and $11.2 million, or 24.5%, were derived from international
sales. The following are the net revenues by business segment for the three
months ended June 30, 2004 compared to the three months ended June 30, 2003.
12
REVENUE BY BUSINESS SEGMENT
For the Quarter
Ended June 30,
---------------------- Percent
2004 2003 Change
---- ---- ------
(Dollars in thousands)
Anesthesia................................ $ 20,716 $ 19,498 6.2%
Respiratory/Critical Care................. 10,132 12,373 (18.1%)
Sleep..................................... 10,976 11,810 (7.1%)
Pharmaceutical Technology Services........ 3,847 4,490 (14.3%)
-------- -------- ----
$ 45,671 $ 48,171 (5.2%)
======== ======== ====
Sales of anesthesia products increased 6.2% from $19.5 million for the
three months ended June 30, 2003 to $20.7 million for the three months ended
June 30, 2004. The increase is due to a 65.0% increase in sales of Limb-O(TM),
our patented anesthesia circuit, to $2,259,000, a 12.5% increase in sales of
traditional anesthesia circuits to $6,502,000, and a 25.0% increase in sales by
the Company's Thomas Medical subsidiary to $5,521,000. Domestic sales of
anesthesia products increased 7.4%, from $17,682,000 for the three months ended
June 30, 2003 to $18,984,000 for the three months ended June 30, 2004.
International sales of anesthesia products decreased 4.7%, from $1,817,000 for
the three months ended June 30, 2003 to $1,732,000 for the three months ended
June 30, 2004.
Sales of respiratory/critical care products decreased 18.1%, from $12.4
million for the three months ended June 30, 2003 to $10.1 million for the three
months ended June 30, 2004. Domestic sales of respiratory/critical care products
decreased 14.9% from $8,437,000 for the three months ended June 30, 2003 to
$7,182,000 for the three months ended June 30, 2004, primarily due to lower
pricing resulting from price concessions offered to continue our partnership
with the Premier Group Purchasing Organization. Our ongoing cost reduction
programs have allowed us to offset these price concessions without eroding
margins. International sales of respiratory/critical care products decreased
25.1%, from $3,936,000 for the three months ended June 30, 2003 to $2,950,000
for the three months ended June 30, 2004 resulting principally from a decrease
of 26.9% in the quarter in our Arterial Blood Gas ("ABG") business to two large
international OEM customers. However, the international sales of ABG's have
increased by 2.3% for the fiscal year to date as compared to the same period in
the prior year.
Net revenues in the Sleep segment decreased 7.1% (a decrease of 10.4%
excluding foreign exchange) from $11.8 million for the three months ended June
30, 2003 to $11.0 million for the three months ended June 30, 2004. The Net
revenues at Sleep Services of America (SSA), the Company's domestic sleep
disorder diagnostic business, decreased 6.5% as a result of closing certain
sleep labs that had not returned the appropriate margins. SSA has experienced a
16.8% sales increase in the continuing sleep centers over the same period of
last year. Also in this segment, revenues for Breas, our European manufacturer
of personal ventilators and CPAP devices, decreased 7.4% (a decline of 12.8%
excluding foreign exchange). The current Breas designs for CPAP and home
ventilators do not meet the German H&H reimbursement requirements. Breas is
preparing for the launch of its new family of products, which is scheduled in
early fiscal 2005.
Service revenues in the Pharmaceutical Technology Services segment
decreased 14.3%, from $4.5 million for the three months ended June 30, 2004 to
$3.8 million for the three months ended June 30, 2004, as our larger
pharmaceutical customers had, in the beginning of the current fiscal year,
reduced their external resource usage with regards to 21 CFR Part 11 FDA
regulatory compliance needs. Sales in this segment have leveled off to
approximately $3.7 to $3.8 million in each of the last three quarters.
Cost of Goods Sold and Services Performed. Cost of goods sold and
services performed decreased 10.6% from $24.4 million for the three months ended
June 30, 2003 to $21.8 million for the three months ended June 30, 2004.
Cost of goods sold decreased $2.4 million, or 12.1%, from $19.5 million
for the three months ended June 30, 2003 to $17.1 million for the three months
ended June 30, 2004. Included in Cost of Goods Sold for the three months ended
June 30, 2003 were charges of $647,000 for the write-down of certain inventory
located at our Colorado and Breas locations, and a $243,000 charge representing
a twelve-month contractual volume related
13
expense adjustment from a supplier. The balance of the decrease from the quarter
ended June 30, 2003 to the quarter ended June 30, 2004 reflects the sales volume
decrease at Breas, (leading to approximately $910,000 in cost reduction, offset
by $255,000 of foreign exchange related increases in costs), and the planned
reduction of costs at our New Jersey, Colorado and California plants of
approximately $650,000.
Cost of services performed decreased 4.3%, from $4.9 million for the
three months ended June 30, 2003 to $4.7 million for the three months ended June
30, 2004, resulting primarily from reduced sales volumes in our Pharmaceutical
Technology Services segment and at Sleep Services of America, our sleep disorder
diagnostic company, where the business continues to close sleep labs that were
not returning the appropriate margin.
Gross Profit. Our gross profit increased 0.3%; from $23.8 million for the
three months ended June 30, 2003 to $23.9 million for the three months ended
June 30, 2004. Our overall gross profit margin was 52.3% for the three months
ended June 30, 2004; an increase from the 49.4% achieved in the three months
ended June 30, 2003. The three months ended June 30, 2003 were effected by the
inventory write-downs ($647,000) and supplier charge ($243,000) discussed above.
Foreign exchange from our European subsidiary, Breas, increased gross profit by
$180,000 and cost improvement programs at our plants, as described above,
improved gross profits by approximately $1.1 million. These improvements were
offset by sales decreases in our Respiratory/Critical Care, Sleep and
Pharmaceutical Technology segments, as described above, of approximately
$600,000 and sales rate declines (principally resulting from increased rebates
of $1.5 million). For gross profit information related to our four segments,
refer to Footnote 6 of the Notes to Consolidated Financial Statements.
Operating Expenses
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased 6.0%; from $13.1 million for the three months
ended June 30, 2003 to $12.3 million for the three months ended June 30, 2004.
The $800,000 decrease consists primarily of reduced legal expenses of $362,000
(primarily related to the audit committee investigation during the third quarter
of fiscal 2003), $186,000 for data processing charges incurred during the third
quarter of fiscal 2003 and net cost reductions (primarily at our Breas and
Stelex subsidiaries) of approximately $379,000, offset by an increase from
foreign exchange at Breas of approximately $127,000.
Research and Development Expenses. Research and development expenses
increased by approximately $406,000, or 27.8%, from $1.5 million for the three
months ended June 30, 2003 to $1.9 million for the three months ended June 30,
2004 relating to the development of the new Breas family of Sleep CPAP and
ventilation equipment and patient interfaces.
Other (Income) Expense--Net. Other expense included in operating
expenses, increased by $193,000 from $67,000 for the three months ended June 30,
2003 to $260,000 for the three months ended June 30, 2004. Included in the three
months ended June 30, 2004 was $197,000 of costs related to a failed acquisition
attempt.
Other Items
Interest Income and Expense. Interest income decreased $22,000, or 10.4%,
from $211,000 for the three months ended June 30, 2003 to $189,000 during the
three months ended June 30, 2004. Interest expense decreased 100% from $147,000
for the three months ended June 30, 2003, as the Company had paid down its
Industrial Revenue Bond in the first quarter of fiscal 2004. Refer to Footnote
10 of the Notes to Consolidated Financial Statements. Also included in Interest
expense during the three months ended June 30, 2003 was interest related to the
examination by the Internal Revenue Service of the Company's 1997, 1998 and 1999
Federal income tax returns. Refer to Footnote 14 of the Notes to Consolidated
Financial Statements.
Provision for Income Taxes. The provision for income tax expense for the
three months ended June 30, 2004 and 2003 was $3.5 million and $3.75 million,
respectively, reflecting effective tax rates of 36.1% and 40.6% for these
periods, respectively. Included in the provision for the three months ended June
30, 2003 is an additional provision of $500,000 resulting from the amending of
certain state returns subsequent to the examination by the Internal Revenue
Service of the Company's 1997, 1998 and 1999 Federal income tax returns. Refer
to Footnote 14 of the Notes to Consolidated Financial Statements.
Discontinued Operations. The net gain (after applying the taxes) from
discontinued operation was approximately $69,000 for the three months ended June
30, 2004 and approximately $1,590,000 for the three
14
months ended June 30, 2003. In the quarter ended June 30, 2004 the Company
received $107,000 of interest income from the purchaser, Pro Clinical. Refer to
Footnote 17 of the Notes to Consolidated Financial Statements.
Comparison of Results for the Nine-Month Period Ended June 30, 2004 to the
Nine-Month Period Ended June 30, 2003.
Net Revenue. Net revenues for the nine months ended June 30, 2004
increased by 0.9% (a decrease of 1.3% excluding the favorable effect of foreign
exchange) to $136.2 million as compared to $135.0 million in the comparable
period last year. Of our total revenues, $100.4 million (or 73.7%) were derived
from domestic sales and $35.8 million (or 26.3%) were derived from international
sales. Following are the net revenues by business segment for the nine months
ended June 30, 2004 compared to the nine months ended June 30, 2003.
REVENUE BY BUSINESS SEGMENT
For the Nine-Months
Ended June 30,
------------------------ Percent
2004 2003 Change
---- ---- ------
Anesthesia.................................... $ 58,715 $ 54,010 8.7%
Respiratory/Critical Care..................... 31,919 34,975 (8.7%)
Sleep......................................... 34,152 34,950 (2.3%)
Pharmaceutical Technology Services ........... 11,370 14,357 (20.8%)
Rebate allowance adjustment. ................. -- (3,300) N/A
-------- -------- -----
$136,156 $134,992 0.9%
======== ======== =====
The rebate allowance of $3.3 million relates to our anesthesia and
respiratory/critical care segments. Refer to Footnote 13 of the Notes to
Consolidated Financial Statements for a description of the rebate allowance.
Sales of anesthesia products increased 8.7% from $54.0 million for the
nine months ended June 30, 2003 to $58.7 million for the nine months ended June
30, 2004. This increase was due to volume growth in anesthesia circuits
including our Limb-O(TM), our patented anesthesia circuit, which increased 67.9%
to $5.8 million, a 9.9% increase in traditional anesthesia circuits to $18.3
million and volume increases in our Thomas Medical Products subsidiary, which
increased 26.9% to $14.7 million. Domestic sales of anesthesia products
increased 8.4%, from $49.6 million to $53.8 million. International sales of
anesthesia products increased 11.7%, from $4.4 million to $4.9 million.
Sales of respiratory/critical care products decreased 8.7%, from $35.0
million for the nine months ended June 30, 2003 to $31.9 million for the nine
months ended June 30, 2004. Domestic sales declined 13.4%, from $25.7 million to
$22.3 million resulting from increased competition within the segment.
International sales of respiratory/critical care products increased 4.2% from
$9.3 million for the nine months ended June 30, 2003 to $9.7 million for the
nine months ended June 30, 2004 reflecting higher sales volumes through our
distributor arrangement in Europe with Rusch.
Our sleep segment revenues decreased 2.3% (a decrease of 10.0%
excluding favorable foreign exchange), from $35.0 million for the nine months
ended June 30, 2003 to $34.2 million for the nine months ended June 30, 2004.
Sleep Services of America's revenues decreased 5.1% from $13.6 million for the
nine months ended June 30, 2003 to $13.0 million for the nine months ended June
30, 2004 as the Company has closed 14 sleep labs that had not returned the
appropriate margins. The Company has opened 9 new sleep labs in fiscal 2004. In
the continuing sleep labs, revenue increased 16.8%. Pre-tax margins in our SSA
business improved to 15.4% in the nine-month period ended June 30, 2004, as
compared to 9.4% in the comparable period last year. Revenues at our Breas
subsidiary decreased 0.5% (a decrease of 12.8% excluding favorable foreign
exchange) from $21.3 million for the nine months ended June 30, 2003 to $21.2
million for the nine months ended June 30, 2004. The current Breas designs for
CPAP and home ventilators do not meet the German H&H reimbursement requirements.
Breas is preparing for the launch of its new family of products, which is
scheduled to begin in early fiscal 2005.
Service revenues in the Pharmaceutical Technology Services segment
decreased 20.8%, from $14.4 million for the nine months ended June 30, 2003 to
$11.4 million for the nine months ended June 30, 2004. Our larger
15
pharmaceutical customers have reduced their external resource usage with regards
to 21 CFR Part 11 FDA regulatory compliance needs. Revenues in the
Pharmaceutical Technology Services segment have leveled off to approximately
$3.7 to $3.8 million in each of the last three quarters.
Cost of Goods Sold and Services Performed. Cost of goods sold and
services performed decreased 1.8% from $68.3 million for the nine months ended
June 30, 2003 to $67.0 million for the nine months ended June 30, 2004.
Cost of goods sold increased $300,000, or 0.5%, from $53.3 million for
the nine months ended June 30, 2003 to $53.6 million for the nine months ended
June 30, 2004. The increase resulted from sales volume increases of
approximately $900,000 in our anesthesia and respiratory/critical care segments
and approximately $1.7 million related to foreign exchange at our European
subsidiary, Breas, (offset by approximately $1.4 million related to Breas sales
volume declines). These increases were offset by the planned reduction of costs
at our New Jersey, Colorado, Minnesota and California of approximately $900,000.
Cost of services performed decreased 10.1%, from $15.0 million for the
nine months ended June 30, 2003 to $13.5 million for the nine months ended June
30, 2004, resulting primarily from reduced sales volumes in our Pharmaceutical
Technology Services segment and at Sleep Services of America, our sleep
diagnostics company, where the business has closed 14 sleep labs that had not
returned the appropriate margins.
Gross Profit. Our gross profit increased 3.6%; from $66.7 million for the
nine months ended June 30, 2003 to $69.1 million for the nine months ended June
30, 2004. Our overall gross profit margin was 50.8% for the nine months ended
June 30, 2004 and 49.4% for the nine months ended June 30, 2003 The nine months
ended June 30, 2003 were effected by the inventory write-downs ($647,000) and
supplier charge ($243,000) discussed above. Foreign exchange at our European
subsidiary, Breas, increased gross profits $1.3 million and the continuing cost
improvement programs at our plants and sleep centers, as described above,
improved gross profits by approximately $2.6 million. These improvements were
offset by sales volume decreases in our Respiratory/Critical Care, Sleep and
Pharmaceutical Technology segments (of approximately $600,000) and sales rate
declines (principally resulting from a $1.8 million increase in rebates). For
gross profit information related to our four segments, refer to Footnote 6 of
the Notes to Consolidated Financial Statements.
Operating Expenses
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased 0.9%, from $37.7 million for the nine months
ended June 30, 2003 to $37.4 million for the nine months ended June 30, 2004.
The $300,000 decrease consists primarily of net cost reductions (primarily at
our Breas and Stelex subsidiaries) of approximately $331,000 and a reduction of
$186,000 for data processing charges, offset by the write off of $139,000 of
debt acquisition costs relating to the pay-off of the $1.5 million Industrial
Revenue Bond. (See Footnote 10 of the Notes to Consolidated Financial
Statements).
Research and Development Expenses. Research and development expenses
increased by approximately $1.0 million or 23.4%, from $4.4 million for the nine
months ended June 30, 2003 to $5.4 million for the nine months ended June 30,
2004 relating to the development of new Sleep CPAP, ventilation equipment
and interfaces for our Breas subsidiary.
Impairment Charge for China Operations. As described in Footnote 15 of
the Notes to Consolidated Financial Statements, during the second quarter of
fiscal 2003, the Company concluded that it would be unable to collect its
remaining receivable under normal terms from its China distributor, and provided
a reserve against the receivable balance of $553,000.
Other Expense--Net. Other net expense included in operating expense
decreased $172,000 from $653,000 for the nine months ended June 30, 2003 to
$481,000 for the nine months ended June 30, 2004. Included in the nine months
ended June 30, 2003 were costs of $322,000 for the costs of a public offering
that was discontinued due to market conditions, $205,000 for the closing cost
for several European sales offices, $59,000 for severance costs and $59,000 for
the closing of redundant Stelex offices. Included in the nine months ended June
30, 2004 were costs of $197,000 related to a failed acquisition attempt,
$197,000 for severance costs and $87,000 of net other expense.
Other Items
Interest Income and Expense. Interest income increased 14.8%; from
$500,000 for the nine months ended June 30, 2003 to $574,000 during the nine
months ended June 30, 2004, resulting from the increase in the level of
16
cash and cash equivalents being invested. Interest expense decreased $849,000
from $874,000 for the nine months ended June 30, 2003 to $25,000 during the nine
months ended June 30, 2004. Interest expense for the nine months ended June 30,
2003 included $760,000 of interest relating to past taxes due resulting from an
Internal Revenue Service examination and interest of $100,000 on our IRB loan,
which was paid off in December 2003. (See Footnote 14 of the Notes to
Consolidated Financial Statements).
Provision for Income Taxes. The provision for income tax expense for the
nine months ended June 30, 2004 and 2003 was $9.4 million and $9.5 million,
respectively, reflecting effective tax rates of 35.5% and 41.3% 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 by the Internal Revenue Service of the Company's 1997, 1998 and 1999
Federal income tax returns and $500,000 resulting from the amending of certain
state tax returns for prior periods. (See Footnote 14 of the Notes to
Consolidated Financial Statements).
Discontinued Operations. On October 30, 2003 the Company sold the assets
of its Vital Pharma subsidiary to Pro Clinical, Inc. The Company received
$500,000 in cash and a three-year note receivable from ProClinical for
$2,000,000. The note is secured by a first lien against all of the assets sold.
No gain or further loss was recorded on the sale. On December 29, 2003 the
Company sold certain related real estate. The Company has accounted for these
sales on a cost recovery basis. The net loss (after applying the tax benefit)
from discontinued operation was approximately $102,000 for the nine months ended
June 30, 2004 and approximately $4,502,000 for the nine months ended June 30,
2003. (See Footnote 17 of the Notes to Consolidated Financial Statements).
Liquidity and Capital Resources
Historically, our primary liquidity requirements have been to support
operations. We have funded these requirements principally through internally
generated cash flow. At June 30, 2004, we had cash and cash equivalents of
approximately $72.5 million and we had no long-term debt. 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, 2004.
Vital Signs continues to generate cash flows from its operations. During
the nine months ended June 30, 2004, cash and cash equivalents increased by
$16.9 million. Operating activities provided $29.2 million net cash, of which
$29.4 million was provided from continuing operations and $140,000 was used by
our discontinued operation at Vital Pharma. Investing activities provided
$400,000 of net proceeds from the sale of Vital Pharma's assets and $1.2 million
net proceeds on the sale of Vital Pharma's real estate which was offset by $3.3
million used for capital expenditures. Financing activities used $10.5 million,
consisting of $7.6 million for the repurchase of common stock, $1.5 million used
to pay down an Industrial Revenue Bond, and $2.3 million paid for dividends,
offset by $1.1 million of cash received from the exercise of stock options.
Cash and cash equivalents were $72.5 million at June 30, 2004 as compared
to $55.7 million at September 30, 2003. At June 30, 2004 our working capital was
$108.1 million as compared to $98.5 million at September 30, 2003. At June 30,
2004 the current ratio was 8.1 to 1, as compared to 6.5 to 1 at September 30,
2003.
Capital expenditures for the nine month period ended June 30, 2004 were
approximately $3.7 million, and included expenditures for equipment used as part
of cost improvement projects at our New Jersey facility ($600,000), Colorado
facility ($750,000), California facility ($90,000) and Thomas Medical Products
facility ($240,000), machinery and equipment and tooling at Breas ($873,000),
new laboratory equipment ($190,000) for the sleep labs at SSA, computer hardware
and software to upgrade MIS systems ($443,000) and the capitalized costs of
software development ($421,000) and patents ($86,000). We expect that our total
capital expenditures for fiscal 2004 should not exceed our total capital
spending of $4.6 million in fiscal 2003. This statement represents a
forward-looking statement under the Reform Act. Actual results may differ from
this statement for a number of reasons, including the possibility that the
Company determines that its business requires new equipment in order to meet
competitive and/or technological challenges.
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.
17
Our Board of Directors has authorized the expenditure of up to $20
million for the repurchase of Vital Signs' stock. In fiscal 2003 and for the
nine months ended June 30, 2004, we had repurchased 358,700 shares for $10.2
million, at an average price of $28.43. 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 $2.3 million in dividends (amounting
to $.18 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. 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. We state these accounting policies in the notes to our
consolidated financial statements and at relevant places in this discussion and
analysis. 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 June 30, 2004 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 $600,000 at June 30, 2004 and $919,000 at
September 30, 2003. 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 U.S. distributors are made at our established distributor
price. Since the end-user (i.e., a hospital) is typically entitled, on
a case by case basis, to a price lower than our established price, the
distributor is due a rebate -- the difference between the established
price and the lower price to which the end-user is entitled -- when
shipment is made to the end user. In order to properly reflect our
sales to distributors, we record the gross sale (at our established
price), less the amount of expected rebate to arrive at net sales.
This net sale is the amount we expect to receive in cash from the
distributor on the sale.
On a monthly basis, each distributor provides us with documentation of
shipment to particular end-users and computes a rebate on such
shipments. Once the distributor has provided us with this information,
they will deduct the computed rebate from their next remittance.
The amount of estimated rebate that has not yet been claimed by the
distributor through the reduction of a payment is included in the
allowance for rebates, which reduces the accounts receivable on our
balance sheet. This allowance is calculated by adding (1) the amount
of rebates the distributors have documented is due but not yet claimed
and (2) an estimate of the amount of future rebates due on any
inventory the distributors are holding at the end of each period.
For several years, we utilized an historical moving average
calculation (comparing rebates to sales to distributors) in order to
estimate the amount of rebate expense that should be recorded against
gross sales in each period. Based upon a review conducted in
connection with the filing of our Quarterly
18
Report on Form 10-Q for the quarter ended March 31, 2003, we concluded
that our estimated allowance as calculated in the previous paragraph
was greater than previously calculated. As a result of its review of
the rebate allowance, we recorded an additional allowance for rebates
of $3,300,000 in the second quarter of fiscal 2003. We have continued
to monitor the recorded allowance for rebates as well as the payments
made against this estimate and believe we are providing a better
estimate of the ultimate rebate our distributors are entitled to. The
allowance for rebates was $8,192,000 and $6,156,000 at June 30, 2004
and September 30, 2003, respectively. Rebate expense was $12,445,000
and $10,911,000 for the three months ended June 30, 2004 and June 30,
2003, and was $35,199,000 and $33,436,000 for the nine months ended
June 30, 2004 and June 30, 2003.
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
quarter ended June 30, 2004, the Company wrote-off certain Breas
inventory amounting to $363,000. Our inventory allowance for
obsolescence was $965,000 at June 30, 2004 and $981,000 at September
30, 2003.
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.
19
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 26.3% of our total
net revenues. Our Breas subsidiary, located in Sweden, represents 59.3% 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 instrument transactions (i.e.
foreign exchange forward or option contracts) as of June 30, 2004.
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 Interim 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.
20
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings:
(a) On December 8, 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. In August 2000, the court ordered the plaintiff to submit their
claims to binding arbitration and stayed all other proceedings pending the
outcome of the arbitration. The arbitration hearing commenced on January 26,
2004. The hearing is being held on an intermittent schedule and the presentation
of testimony is expected to be concluded during the fourth quarter of the
current fiscal year.
(b) On May 7, 2003 a complaint was filed against the Company and two of
its officers by Joseph Bourgart, a former chief financial officer of the
Company. A detailed description of this litigation is set forth in Item 3, Legal
Proceedings, of the Company's Annual Report on Form 10-K for the year ended
September 30, 2003. The Company strongly denies all of Plaintiff's substantive
allegations. On June 23, 2004 the Company announced that the litigation had been
settled. Monetary terms of the settlement were not disclosed. However, the
settlement was immaterial to the financial results of the Company and were fully
reimbursed by the Company's insurance carrier.
(c) A first amended complaint was filed against the Company's Vital
Pharma subsidiary on September 8, 2003 in the U.S. District Court for the
Northern District of California related to the packaging services it provides to
Lifecore Biomedical, Inc. ("Lifecore"). The complaint also names Lifecore and
Ethicon, Inc. (a subsidiary of Johnson and Johnson) as defendants. A detailed
description of this litigation is set forth in Item 3, Legal Proceedings, of the
Company's Annual Report on Form 10-K for the year ended September 30, 2003. The
Company's insurance carrier has responded and has also notified Lifecore of its
obligation under its agreement with Vital Pharma to indemnify it for complaints
related to product defects.
On January 28, 2004 plaintiff filed a nearly identical lawsuit in
California state court on her own behalf and on behalf of the general public
alleging violation of the California Business and Professions Code based upon
the facts underlying the federal court action. Our insurance carrier has denied
coverage for this matter. The Company has notified Lifecore of its obligations
to defend and indemnify the Company for these claims.
(d) On May 16, 2003 the Company was served with a complaint by a former
Belgian distributor for breach of contract. The distributor and the Company have
entered into a settlement agreement. The settlement amount is within the reserve
amount established by the Company for the litigation.
(e) A detailed description of litigation involving the Company is set
forth in Item 3, Legal Proceedings, of the Company's Annual Report on Form 10-K
for the year ended September 30, 2003. 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.
21
Item 2. Changes in Securities and Use of Proceeds:
The following table provides information about purchases made by the
Company of its common stock during the quarter ended June 30, 2004:
(c)(1)
Total Number of (d)(1)
Shares Purchased Maximum Dollar
(a) as Part of Amount that
Total (b) Publicly May Yet be
Number of Average Announced Purchased
Shares Price Paid Plans or Under the
Period Purchased Per Share Programs Plans or Programs
------ --------- --------- -------- -----------------
4/1/2004-4/30/2004.................... -- -- -- $13,633,564
5/1/2004-5/31/2004.................... 38,500 $27.45 38,500 $12,575,183
6/1/2004-6/30/2004.................... 102,600 $27.14 102,600 $9,786,708
------- ------ ------- ----------
Total............................ 141,100 $27.22 141,100 $9,786,708
======= ====== ======= ==========
- --------------
(1) In May 2003, our Board of Directors authorized the expenditure of up to
$20 million for the repurchase of Vital Signs' stock. During the nine
months ended June 30, 2004, we had repurchased 258,400 shares for $7.6
million, including commissions of $10,336, at an average price of $29.53.
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.
Item 3 (Not applicable)
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of our shareholders was held on April 9, 2004. At that
meeting, each of the nominees for election to the Board, as identified in our
proxy statement, was elected. The Board of Directors nominated 3 directors whose
terms will expire in 2007. The following number of shares was voted for and
against each nominee:
Authority
Nominee Votes For Withheld
------- --------- --------
David H. MacCallum.................... 11,442,437 314,666
Richard L. Robbins.................... 11,394,222 362,281
George A. Schapiro.................... 11,473,271 283,232
Item 5. Other Information
Mr. Joseph J. Thomas, a Director of the Company and President of Thomas Medical
Products, a subsidiary of the Company, has announced his intention to retire
from the Company and as a Director effective October 1, 2004.
Item 6. Reports on Form 8-K (excluding reports furnished to, but not deemed
filed with, the Commission) A Current Report on Form 8-K was filed on May 11,
2004, disclosing (under Item 5) the resignation as of May 10, 2004 of Frederick
A. Schiff as Chief Financial Officer of the Company.
22
EXHIBIT INDEX
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 Interim 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 Interim Chief Financial Officer Pursuant
to [p] U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
23
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/ RICHARD T. FEIGEL
--------------------------------------
Richard T. Feigel
Corporate Controller and
Interim Chief Financial Officer
Date: August 13, 2004
24
STATEMENT OF DIFFERENCES
------------------------
The trademark symbol shall be expressed as ............................... 'TM'
The paragraph symbol shall be expressed as ............................... [p]