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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004.
[_] 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)
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New Jersey 11-2279807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
20 Campus Road, Totowa, New Jersey 07512; (973) 790-1330
(Address and telephone number, including area code,
of registrant's principal executive office)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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Common Stock, no par value
Indicate by checkmark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [_] No
Indicate by checkmark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Indicate by checkmark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) [X] Yes [_] No
Aggregate market value of voting stock held by non-affiliates as of
December 9, 2004 was approximately $541,933,413.
Number of shares of Common Stock outstanding as of December 9, 2004:
14,156,004
Documents incorporated by reference: None.
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VITAL SIGNS, INC.
TABLE OF CONTENTS
Page
----
PART I
Item 1 Business ...................................................... 2
Item 2 Properties .................................................... 17
Item 3 Legal Proceedings ............................................. 18
Item 4A Executive Officers of the Registrant........................... 19
PART II
Item 5 Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securites............................................ 20
Item 6 Selected Financial Data........................................ 22
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 23
Item 7A Quantitative and Qualitative Disclosures About Market Risk..... 34
Item 8 Financial Statements and Supplementary Data.................... 34
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................... F-22
Item 9A Controls and Procedures........................................ F-22
Item 9B Other Information..............................................
PART III
Item 10 Directors of the Registrant.................................... 35
Item 11 Executive Compensation ........................................ 35
Item 12 Security Ownership of Certain Beneficial Owners
and Management.............................................. 35
Item 13 Certain Relationships and Related Transactions ............... 35
Item 14 Principal Accounting Fees and Services ........................ 35
PART IV
Item 15 Exhibits, Financial Statement Schedules........................ 36
1
PART 1
Item 1. Business
Introduction
Vital Signs, Inc. was initially incorporated in New York in 1972 and
reincorporated in New Jersey in 1988. Unless otherwise indicated, references in
this Annual Report to "Vital Signs, Inc.", "Vital Signs", "Company", "we", "us"
and "our" refer to Vital Signs, Inc., and its consolidated subsidiaries. Vital
Signs' principal executive offices are located at 20 Campus Road, Totowa, New
Jersey 07512; its telephone number at that location is (973) 790-1330.
Vital Signs designs, manufactures and markets medical products for the
anesthesia, respiratory, critical care, neonatal, sleep therapy and emergency
markets. A number of single-patient use products are increasing their share of
the medical products market primarily because of their cost advantages and
improved patient care features, including reducing the potential of transmitting
infections from one patient to another. With the acquisition of Breas Medical AB
("Breas") from 1997 to 2002, National Sleep Technologies, Inc. in 2000 (see
below), and the merger of HSI Medical Services Corporation in 2002, we have
expanded our focus into the sleep therapy and personal ventilation markets.
We pioneered the development and introduction of a variety of
single-patient use products. In 1975, we commenced the marketing of clear,
non-conductive anesthesia breathing circuits. The first clear plastic,
single-use air-filled cushion facemask for anesthesia delivery and resuscitation
was launched by us in 1981. We were the first organization to introduce a
single-patient use manual resuscitator in 1984. The first single-patient use
laryngoscope system for use in the anesthesia and critical care arenas was
developed and launched by us in 1988. We have also developed a general
anesthesia kit, which can combine over 20 disposable items in one convenient,
cost-effective package. The first single-patient use infant resuscitation
circuit with an adjustable pressure limiting valve, used to protect the infant's
lung from injury due to over pressurization.
We offer products and services for the sleep disorder/personal ventilation
markets, which builds upon our airway management expertise. Our products are
used in the treatment of obstructive sleep apnea, a condition caused by the
narrowing of the airway, usually the result of the soft tissue in the rear of
the throat collapsing during sleep. We operate a number of sleep diagnosis
centers which test for the presence of sleep apnea, and tailor specific products
for individual patients.
We also deliver regulatory compliance services to FDA regulated companies,
primarily to pharmaceutical, medical device, diagnostic and biotechnology
companies.
Acquisitions--1999 to Present
Through several transactions from 1997 to 1999, we acquired 53% of Breas
Medical, AB ("Breas"), a manufacturer of CPAP (continuous positive airway
pressure) machines and personal ventilators, based in Sweden. In May 2001 we
purchased another 41%. At that time substantially all of the minority interest
was held by Breas' management. In April of 2002 we purchased the remaining
minority shares, bringing our ownership to 100%.
In June 1998 and May 1999, we purchased $10.4 million of common stock and
convertible preferred stock of National Sleep Technologies, Inc. ("NST"). NST
provides sleep diagnostic testing services in the United States through free
standing labs and, through contracts with hospitals, in hospital facilities, for
patients suspected of suffering from sleep disorders, such as obstructive sleep
apnea. In 2000, we converted our investment in the preferred stock of NST into
common stock and assumed control of NST. On January 1, 2002, NST merged with HSI
Medical Services, Inc., ("HSI"), a subsidiary of the Johns Hopkins Health
System. In this merger, we received a controlling interest in the merged entity,
known as Sleep Services of America, Inc. ("SSA"). We held a 70% and a 68% equity
interest in SSA, for both September 30, 2004 and 2003, respectively.
On March 28, 2002 we acquired Stelex Inc. ("Stelex"), a company engaged in
pharmaceutical technology services, through the merger of our wholly owned
subsidiary, The Validation Group ("TVG"), and Stelex Inc. The surviving entity
is known as Stelex-TVG ("Stelex"). TVG had been engaged in process validation
for pharmaceutical companies. The merger enabled us to move into the technology
services area through the sale of dedicated software and the customization of
this software.
2
For additional information regarding our products, see "Business--Products"
and for additional information regarding the accounting treatment of the Breas,
SSA and Stelex transactions, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Overview."
Forward-Looking Statements
This Annual Report on Form 10-K 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 this Annual Report on Form 10-K 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.
Acquisition Strategy
Historically, we have made both product and business acquisitions. Although
no assurances can be given with respect to future acquisitions, our acquisition
strategy is focused upon the following principal objectives: (i) identification
and acquisition of companies and/or products in the anesthesia,
respiratory/critical care, emergency, homecare, sleep/ventilation and
pharmaceutical technology services markets with the goal of expanding our
product line and improving our market share positions, (ii) expansion to
international markets, and (iii) acquiring unique technologies with research and
development capabilities. Such acquisitions may consume substantial amounts of
capital, both to fund the purchase price and to fund the working capital needs
of acquired companies and acquired product lines.
Principal Products and Services
Our primary products and services fall into four categories:
o anesthesia;
o respiratory/critical care;
o sleep/personal ventilation (referred to as "sleep"); and
o pharmaceutical technology services.
We believe that our broad range of product offerings represents a
competitive advantage over suppliers with more limited product offerings. We
continue to supplement our existing products and services with new offerings
designed to meet the needs of health care professionals. For example, in
response to reports of allergic reactions to medical devices containing latex,
we manufacture a number of latex-free products. As a leading provider of
single-patient use airway management products for the anesthesia and
respiratory/critical care markets, we have developed a reputation with
physicians for providing quality products. We believe that brand recognition
helps drive demand for our products.
We have leveraged our airway management expertise by providing products and
services for the high growth sleep/personal ventilation and sleep services
markets. We offer products for the treatment of obstructive sleep apnea and
operate approximately 60 sleep diagnosis centers which test the need for sleep
apnea products.
3
Our principal products and services are described below:
Anesthesia Products
Anesthesia Breathing Circuits. We offer a wide variety of single-patient
use anesthesia breathing circuits, which are used to ventilate and carry oxygen
and anesthesia to a patient while under general anesthesia during surgery.
Breathing circuits connect the patient to the anesthesia machine and to various
patient monitors. The traditional system is referred to as a "circuit" because
it is comprised of two tubes, one carrying inspiratory gases to a patient and
the other carrying expiratory gases away from the patient. Each breathing
circuit consists of flexible hoses, a breathing bag, and a "Y" and elbow
attachment. Since the breathing circuit needs of hospitals vary significantly,
we offer a large variety of circuits designed to be compatible with anesthesia
equipment manufactured by numerous other companies. Technological advances in
the areas of gas sampling, temperature monitoring, humidification and
bacterial/viral filtration have provided us with opportunities to expand our
breathing circuit offerings.
Face Masks. In 1981, Vital Signs introduced the first clear plastic
air-filled cushion facemask for single patient anesthesia and respiratory use.
We believe that the soft air-filled cushion facemask provides a better seal on
most patients than other facemasks, thus improving the delivery of anesthetic
gases and oxygen to the patient. A clear facemask also permits the clinician to
better observe certain patient problems, such as life-threatening aspiration,
while the patient is anesthetized. We offer various sizes and types of
facemasks. We anticipate that the usage of single-patient use face masks in
surgical procedures internationally will continue to expand as single-patient
use products become increasingly accepted in international hospitals.
General Anesthesia Systems (GAS'TM'). We assemble and market General
Anesthesia Systems (generically considered customized anesthesia kits), which
can include more than 20 products, such as air-filled cushion facemasks,
breathing circuits, blood pressure cuffs and temperature monitoring probes. In
marketing our GAS'TM' kits, our sales representatives use detailed
questionnaires to assist each customer in determining the particular products
the hospital desires in its anesthesia kits. We then assemble GAS'TM' kits to
meet the hospital's specific needs.
Limb-O'TM'. In the first quarter of Fiscal 2001, we introduced Limb-O'TM', a
single limb breathing circuit used for general anesthesia, transport and/or
critical care situations. The single limb incorporates a patented technology
with a septum to separate inspiratory and expiratory gases. It competes with the
traditional two limb system and is an alternative to the tube within a tube
circuit.
PAX'TM'. In the first quarter of Fiscal 2001, we introduced a pharyngeal
airway (PAX), a single use airway device promoted as an alternative to the LMA
(laryngeal mask airway) device. The PAX 'TM' is used for airway management
during general anesthesia procedures, and with just one size, can accommodate
all adults over 90 pounds
INFUSABLE'r' Disposable Pressure Infusor. Invasive pressure monitoring has
been used since the early 1970's as a means of monitoring blood and other fluid
pressures of patients in certain critical care situations. The monitoring
process involves inserting a catheter into the artery of the patient, connecting
the catheter to a transducer (a device which converts the pressure impulse from
the patient's blood into an electrical signal), and transmitting the electrical
signal to a monitoring screen. The monitoring process uses a fluid filled
conduit to connect the catheter to the transducer. The fluid generally is a
saline solution forced into the system by a pressure infusor. Our INFUSABLE'r'
disposable pressure infusor consists of an inflatable bladder, a bulb to pump
air into the bladder and a patented pressure gauge. The Infusable'r' also has a
mesh netting into which a package of sterile fluid or "solution bag" is placed.
The fluid is connected to the monitoring system and the pressure on the solution
bag is set at a pressure level designed to maintain the pressure required by the
monitoring system. The Infusable'r' is also designed to deliver blood or fluids
to a patient at a rapid rate usually under trauma conditions.
Vital View'TM' Single-Patient Use Fiberoptic Laryngoscope System. This
disposable system is designed to assist the anesthesiologist in correctly
placing an endotracheal tube within the trachea of the patient. Our Vital
View'TM' system has single-patient use blades which we believe offers several
advantages over traditional reusable metal blade laryngoscope systems, including
lowering the risk to both the patient and physician of infection associated with
reusable metal blades and handles. In addition, we believe that hospital capital
outlays for stocking emergency crash carts can be reduced by purchasing the
Vital View'TM'. system rather than a reusable fiberoptic system.
4
Thomas Medical Products
Thomas Medical Products, Inc. ("TMP"), a wholly-owned subsidiary of Vital
Signs, Inc., is an original equipment manufacturer ("OEM") and contract
development organization which relies upon its scientific, technical,
engineering, manufacturing and QA/Regulatory expertise in the disposable medical
device area. TMP manufactures devices which provide access primarily to the
vascular system by medical professionals and include products such as
introducers, sheaths, dilators, hemostasis valves and catheters. TMP's products
are sold primarily to other healthcare product providers to be used in their
products or as part of kits, or as a finished product. TMP is included in the
anesthesia business segment in Note 20 to the Notes to the Consolidated
Financial Statements.
Respiratory and Critical Care Products
Gas-Lyte'r' and Quick-ABG'r'. We offer a broad line of disposable arterial
blood gas ("ABG") syringes and collection systems. Blood gas syringes are used
to collect arterial blood for blood gas analyses routinely performed in
hospitals on patients suspected of having metabolic, respiratory or other
cardiopulmonary difficulties. The blood gas sample is processed through a blood
gas analyzer. Blood gas analyzers are manufactured by a wide range of
manufacturers. We offer our ABG products in both standard configurations and in
kits that are customized to meet a specific hospital's needs, and function with
their blood gas analyzers.
Code Blue II'TM'. Vital Signs was the first to offer single-patient use
manual resuscitators. Manual resuscitators are ventilation devices which are
squeezed by hand to force oxygen into a patient's lungs. They are used
throughout the hospital in a variety of settings. For example, patients on a
ventilator require the use of a resuscitator prior to tracheal suctioning
procedures. Another use is in providing oxygen while transporting the patient
between the operating room and other critical care units. In addition,
resuscitators are typically placed strategically throughout the hospital to
provide assistance to patients who have stopped breathing and require
resuscitation. Code Blue II'TM' resuscitators are sold in different sizes for
infants, children and adults. These resuscitators alleviate certain problems
involved in mouth-to-mouth emergency resuscitation, including the risk to both
the rescuer and the individual of transmitting infections. We believe that most
reusable manual resuscitators are costly to sterilize and require re-assembly,
which may result in errors that compromise proper function. In contrast, Code
Blue II'TM' resuscitators are relatively inexpensive and are delivered fully
assembled.
Babysafe'TM' and Hyper Inflation Systems. We offer both Babysafe'TM' and
traditional hyperinflation systems used for infant resuscitation, a specialized
line of infant hyperinflation products (BabySafe'TM' hyperinflation systems),
used in labor and delivery rooms and in neonatal intensive care units, where
controlling the spread of infection is particularly critical. BabySafe'TM'
offers the ability to adjust and limit the level of pressure that can be
delivered during resuscitation. Oxygen can be delivered without the risk of
barotrauma. These systems are available in a variety of configurations and sizes
to meet the needs of infants.
CleenCuff'TM' and CUFF-ABLE'r' Blood Pressure Cuffs. We manufacture and
sell single patient use blood pressure cuffs which are wrapped around the arm or
thigh of a patient to obtain a blood pressure reading. Our single-patient use
blood pressure cuffs provide hospitals with an alternative to traditional
reusable blood pressure cuffs that can become contaminated by touch, with blood
and other body fluids. While all patients admitted to hospitals are candidates
for their own dedicated blood pressure cuff, we believe that to date the primary
market for disposable cuffs has been for cases where infection control is a high
priority. Our cuffs are sold in a variety of sizes (including neonatal) and are
adaptable to all manual and electronic blood pressure monitors that utilize
blood pressure cuffs.
Continuous Positive Airway Pressure ("CPAP") Systems. Our facemask CPAP
systems provide a less invasive and more comfortable way of providing oxygen to
certain patients than conventional ventilator-based systems. Our facemask CPAP
systems eliminate the need to insert an endotracheal tube into the patient's
trachea and then attach the patient to a ventilator. Mask CPAP systems are now
being used successfully in the pre-hospital setting to treat patients with
cardiogenic pulmonary edema. The system consists of a compact flow generator
connected to an air filled cushion facemask. The facemask is attached to a
single patient use PEEP (positive end expiratory pressure) valve designed to
maintain positive airway pressure in the lungs, thus allowing for more oxygen to
diffuse into the patient's blood system.
Misty Ox'r' Respiratory Products. The MistyOx'r'line consists of two
respiratory product lines that deliver hydration to a patient, and is comprised
of a nebulizer which delivers medium to high flow and high concentrations of
oxygen to patients, and the addition of a regulated heater to the nebulizer.
These products may be used by infants, children and adults in many areas of the
hospital, including emergency, recovery and critical care.
5
ACTAR'r' and ACTAR D-Fib'TM' CPR Training Manikins. We manufacture a line
of patented cardiopulmonary resuscitation ("CPR") training manikins. The
ACTAR'r'manikin was re-designed in Fiscal 2000 to meet changing market demands.
The new Actar D-Fib incorporates additional functionality to meet the updated
requirements of the American Heart Association and the Red Cross. New features
include jaw thrust, abdominal thrust and anatomical landmarks for proper
defibrillation training. While maintaining the necessary features and anatomical
landmarks for CPR practices, our training manikins are far smaller and less
expensive than full size manikins typically used for CPR training. The smaller
size and affordable pricing enable each person in a CPR training class to
practice with his or her own manikin, rather than sharing a single demonstration
model.
Broselow/Hinkle'TM' Pediatric Emergency System and the Broselow-Luten System.
The Broselow/Hinkle'TM' Pediatric Emergency System and the Broselow-Luten System
are a part of our "Color Coding Kids" product line. These are the products of
extensive clinical efforts by James Broselow, M.D., Dr. Robert Luten, M.D., and
Alan Hinkle, M.D. to enable emergency care providers to determine the proper
dose of medication and appropriate equipment size for infants in emergency
situations. This system takes advantage of the direct correlation between a
pediatric patient's body length and the proper size of emergency supplies and
correct drug dosages. This patented system, licensed to Vital Signs, consists
of: a tape measure having eight color zones, a corresponding series of
color-coded single-patient use emergency kits or modules and a nylon organizer
bag custom-designed to hold all the supplies needed in either a trauma, cardiac
or respiratory pediatric emergency. During the 2004 fiscal year we, with the
direct assistance and input of Dr. Broselow and Dr. Hinkle, began to develop
additional products in the Broselow/Luten System. The newest product, which was
introduced in the fourth quarter of the 2004 fiscal year, is an easy reference,
spiral-bound, color-coded booklet entitled the Pediatric Resuscitation
Medication Pocket Guide. With these systems, emergency room and EMS personnel
can be confident that all the supplies necessary to manage a pediatric emergency
are readily identified, available and organized in a manner that minimizes
reaction time.
Sleep/Personal Ventilation Products
We have designed our sleep products to deliver airflow to patients
undergoing therapy for the treatment of obstructive sleep apnea with the
objective of increasing patient comfort and acceptance of the treatment.
Continuous positive airway pressure is a common method for treating obstructive
sleep apnea. We have manufactured and distributed continuous positive airway
pressure systems for more than a decade for other respiratory applications and
actively entered the sleep apnea market in 1997 through our interest in Breas
Medical AB, a European manufacturer of personal ventilators for obstructive
sleep apnea and long term ventilation. To date, most of our sales of these
devices have been overseas. We received FDA clearance for our first home care
continuous positive airway pressure product in August 2000. We have designed our
ventilation systems to produce and deliver gases to a patient requiring
ventilation or oxygen therapy in both hospitals and the home. In addition, we
provide diagnostic and therapeutic services through our Sleep Services of
America subsidiary, which was created in January 2002 when we merged our
National Sleep Technologies subsidiary with the sleep diagnostic business of The
Johns Hopkins Health Systems Corporation.
Our principal products and service offerings in this category are set forth
below. Other than the Breas PV10'TM', Breas PV10i, and the Breas HA50'TM', all
of the products below are currently sold only outside of the U.S. We provide our
sleep diagnostic services exclusively in the U.S.
Sleep Products
o CPAP Flow Generators are electromechanical devices which deliver
continuous positive airway pressure through a nasal mask to a patient
suffering from obstructive sleep apnea in order to keep the patient's
airway open during sleep. Given the importance of patient compliance
in treating obstructive sleep apnea, we have designed our products to
be easy to use, lightweight, small and quiet, making them relatively
unobtrusive at the bedside. The Breas PV10'TM' is a high-end standard
CPAP device meeting normal needs for obstructive Sleep apnea
treatment.
o In October 2003, we received FDA clearance for the Breas PV10i'TM'
CPAP system for sale in the United States for obstructive sleep apnea.
The PV10i is a self-adjusting Continuous Positive Airway Pressure
(CPAP) device that uses a highly advanced, patented technique to
respond to changes in an individual's breathing patterns. The device
can adjust treatment pressure appropriately, as patient needs change,
before apneic events occur. Traditional, constant CPAP devices must be
set to a maximum pressure that is usually higher than is required
throughout the night creating discomfort for the user. With the
PV10i'TM', the mean treatment pressure is lower. Clinical studies have
demonstrated that
6
patients prefer the lower pressure provided by the PV10i'TM' to other
devices available in the marketplace.
o Bi-Level CPAP such as our Breas PV101'TM' are electromechanical
devices which deliver two levels of continuous positive airway
pressure to a patient. It is used to treat more severe Obstructive
Sleep Apnea and is comfortable for the user.
o Humidification Systems are heated humidifiers for use with continuous
positive airway pressure or ventilation devices. Our Breas
Humidification system, HA 50'TM', is a heated humidifier constituting
an important factor in the function of the respiratory system.
o Sleep Disorder Home Screening Devices are home-use systems for
screening for sleep disorders, including obstructive sleep apnea. Our
Breas SC20'TM' is a lightweight screening system for measuring and
recording physiological data during sleep. The system can record
oxygen saturation, airflow, pulse, breathing effort, snoring, limb
movement and body position. The data is downloaded to a personal
computer where our analysis software provides an indication of the
presence of sleep apnea and other associated disorders.
o Sleep Diagnostic Services. We provide diagnostic and therapeutic
services through our Sleep Services of America ("SSA") subsidiary. As
of September 30, 2004, this business operated approximately 60 sleep
centers in 6 states and Washington, D.C., principally in the eastern
U.S. SSA is duly accredited by the Joint Commission on Accreditation
of Healthcare Organizations (JCAHO) in Ambulatory and Homecare. SSA
also has 11 laboratories accredited by the AASM with applications
submitted or pending for several others At these facilities, which
typically accommodate two patients per night, we conduct sleep studies
to determine whether the patients referred to us suffer from sleep
disorders. If a patient is determined to suffer from sleep apnea, we
can offer follow-up diagnostic and monitoring services to the patient
and may, under certain circumstances, be in a position to sell our
sleep products to the patient. A sleep study is the process of
recording various measurements used to identify different sleep stages
and classify various sleep problems. During sleep testing, the
activities that occur in a patient's body during sleep--brain waves,
muscle movements, eye movements, breathing through the mouth and nose,
snoring, heart rate, and leg movements--are monitored by small
electrodes and sensors applied to the patient. These functions can be
normal while the individual is awake, but abnormal during sleep. All
of this information is transmitted from the equipment being worn to a
special recorder, which saves these measurements for technicians to
analyze. The referring physician receives a sleep report which
includes a physician interpretation of the data and a diagnosis of the
sleep-related problem, if any.
Ventilation Products
Ventilators are electromechanical devices used to assist a patient with
respiratory problems. We have designed our systems for use in a clinical setting
or at home for life support ventilation.
PV102'TM' Bi-Level Ventilator. The PV102'TM' is an advanced bi-level
ventilator device which allows separate pressure levels for inspiratory and
expiratory phases of each individual breath. Ventilation can be matched to the
patient's own breathing pattern by setting levels which promote more comfortable
and more natural respiratory support. It can also be operated from an external
battery, so that it can be used during transportation and traveling.
PV403'TM' Mixed Lifesupport Ventilator. The PV403'TM' ventilator supports
the ventilation needs of patients suffering from respiratory insufficiency
diseases. Patients benefiting from the PV403'TM' may suffer from neuromuscular
(Duchene's), or other restrictive or obstructed diseases. The PV403'TM' is an
advanced mixed homecare ventilator which can provide volume and pressure
ventilation. It has various settings that make it very flexible to a broad band
of applications. It has both internal and external battery capability and is
well suited to be used in transport and traveling.
Pharmaceutical Technology Services
We deliver technology services to FDA regulated companies primarily in the
pharmaceutical sector. In addition, we also provide services from time to time
to medical device, diagnostic and biotechnology companies. We advise clients by
helping them establish and monitor processes designed to satisfy their
regulatory
7
requirements set forth by the FDA. Our focus has been in the areas of
development and validation of systems and processes used in the manufacturing,
information technology and infrastructure, research and development, laboratory
and quality assurance departments of our clients. In addition, we have developed
and currently market proprietary software products that we use in conjunction
with our services to help clients comply with FDA regulations.
In the 2004 fiscal year we have expanded our offering to include Sarbanes
Oxley section 404 compliance services in the area of information technology
compliance. These services, targeted at life sciences market, are designed to
help our clients bring their information systems into compliance with internal
controls requirements stipulated by well-known controls and governance
frameworks.
As of September 30, 2004 our staff consisted of 102 professionals and our
range of consulting services includes computer systems validation, IT
governance, process validation, equipment qualification, development and
implementation of quality control programs, regulatory auditing, development of
software for regulated environments, and customized training programs.
8
Market Data
The following table sets forth, for each of the past three fiscal years,
the dollar amount and approximate percentage of total net revenue represented by
our four business segments: anesthesia, respiratory/critical care, sleep and our
pharmaceutical technology services:
Year Ended September 30,
---------------------------------------------
2004 2003 2002
------------- ------------- -------------
Amount % Amount % Amount %
------ ---- ------ ---- ------ ----
(Dollars in millions)
Anesthesia ........................... $ 82.8 45.0 $ 76.0 41.7 $ 71.8 41.3
Respiratory/Critical Care ............ 42.1 22.9 45.8 25.2 46.8 26.9
Sleep ................................ 44.0 23.9 45.6 25.0 39.6 22.8
Pharmaceutical Technology Services ... 15.1 8.2 18.1 9.9 14.2 8.1
Rebate allowance adjustment (1) ...... -- -- (3.3) (1.8) -- --
Other (2) ............................ -- -- -- -- 1.6 .9
------ ---- ------ ---- ------ ----
Total ............................. $184.0 100% $182.2 100% $174.0 100%
====== ==== ====== ==== ====== ====
- ----------
(1) Reflects an adjustment made during the second quarter of fiscal 2003. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Critical Accounting Principles and Estimates".
(2) "Other" relates primarily to one-time licensing revenue recorded in the
first quarter of fiscal 2002 in the anesthesia business segment. Income
from continuing operations related to this one-time licensing revenue was
$1,439,000 before taxes ($953,000 after taxes).
For additional information regarding these segments, see Note 20 to the
Consolidated Financial Statements.
Sales, Marketing and Customers
U.S. Sales
We sell our anesthesia and respiratory/critical care products to hospitals
and surgery centers in the U.S. through our own sales force, which is led by our
Vice President of Sales. As of September 30, 2004, our U.S. sales force
consisted of 57 sales representatives and six regional sales managers.
We market our anesthesia and respiratory/critical care products primarily
to hospitals and other health care providers. While we utilize national
distributors to deliver a portion of our anesthesia and respiratory/critical
care products in the U.S., the end-user hospitals and other health care
providers determine the channel through which they receive our products, either
directly from us or through a distributor of their choice. See Note 19 to the
Consolidated Financial Statements.
Many of our customers are members of Group Purchasing Organizations
("GPO's"). GPO's provide their members access to discounted prices on products
by negotiating discounts with manufacturers like us. GPO's act as agents to
facilitate better pricing for their members. We have agreements with several
leading group purchasing organizations, including AmeriNet, Broadlane, Consorta,
Healthsouth, Healthtrust, MedAssets (HSCA), Novation, and Premier. Our strategy
is to more fully penetrate our existing Group Purchasing Agreements and secure
additional agreements. GPO's do not themselves make purchases, carry inventory
or physically handle products. GPO's provide access to discounted prices for
their members by negotiating a group price for their member hospitals and health
care providers. No sales are made to GPO's; therefore there is no revenue
recognition. Revenue is recognized upon the sale of goods, to either the end
user or via a sale to a distributor.
In July 2003, we were awarded a three-year competitively bid dual-source
supply agreement with the group purchasing division of Premier, Inc., Chicago,
IL. The agreement, effective August 1, 2003, includes our anesthesia
9
breathing systems and breathing bags, face masks, filters and HCH (Hygroscopic
Condensed Humidifier), airways and gas sampling lines. Premier is a leading
healthcare alliance, collectively owned by more than 200 independent hospitals
and healthcare systems in the United States, which are affiliated with nearly
1,500 hospitals and other healthcare sites, offering group purchasing supply
chain and performance improvement services to nearly 1,500 member not for profit
hospitals.
Also in July 2003, we were awarded two three-year dual-source supply
agreements with AmeriNet, St. Louis, MO. The new agreements include our
anesthesia breathing systems, facemasks, arterial blood gas kits, disposable
resuscitators, filters, HCH (Hygroscopic Condenser Humidifiers) and gas sampling
lines. AmeriNet represents more than 18,500 member facilities, including
hospitals, integrated delivery networks, long-term care facilities, surgery
centers, clinics, home care and emergency services.
Again in July 2003, we were awarded a supply agreement with Novation, the
supply chain management company based in Irving, TX. This is Vital Signs' first
supply agreement with Novation. The agreement, effective June 1, 2003 for three
years with the option of Novation to extend for up to an additional two years
includes Vital Signs' HEPA filters, bacterial/viral filters, pulmonary function
filters and related accessories. Novation serves the purchasing needs of more
than 2,300 VHA Inc. and UHC (University HealthSystem Consortium) members, made
up of community-based hospitals and academic medical centers. Novation
agreements are also available to HealthCare Purchasing Partners International
(HPPI) which serves more than 5,400 members and clients.
As new products that can be sold by our U.S. sales force are developed, we
educate and train our sales force in the need, use, application and advantages
of our products. We also hold quarterly training sessions for all of our sales
people and conduct additional training, as we deem appropriate.
As of September 30, 2004, the sales and marketing department of our
subsidiary, Sleep Services of America (SSA), consisted of four (4) field
personnel, a director of marketing communications and a Vice President of Sales.
The primary focus of this team is to increase the patient volumes of existing
accounts and negotiate contracts with new and existing sleep centers. SSA seeks
to differentiate itself from many of its competitors by providing clients a
range of marketing options from direct marketing to an al la carte selection of
services. In addition, SSA seeks to increase the number of laboratory beds,
improve the utilization of existing beds, increase sleep educational and disease
awareness programs directed toward physicians and by provide comprehensive high
quality service offerings to the communities that they serve.
As of September 30, 2004, our Stelex subsidiary had a team of seven sales
account managers, one sales manager, two marketing support personnel, and one
director of business development for our pharmaceutical technology services. Our
pharmaceutical technology services sales team is responsible for obtaining new
business in the continental U.S. and Puerto Rico. Our regulatory consulting team
calls on pharmaceutical and medical device companies regarding compliance with
FDA regulations. As of September 30, 2004, we also employed two sales people to
promote the video technology developed in the vioWorks'TM' division of our
Stelex subsidiary. Our vioWorks'TM' sales team sells online meetings,
presentation and multi-media conferencing via the Internet primarily to
pharmaceutical and medical device companies which are seeking to train their
sales forces and service organizations.
International Sales
For fiscal 2004, 2003 and 2002, international sales of $46.6 million, $45.3
million and $38.3 million, respectively, accounted for approximately 25%, 25%
and 22%, respectively, of our revenue. Our products are sold in over 55
countries worldwide. International net sales for our anesthesia and
respiratory/critical care products for fiscal 2004, 2003 and 2002 were $19.7
million, $18.8 million, and $15.9 million, respectively. We sell our anesthesia
and respiratory/critical care products in European and other international
markets primarily through a strategic alliance with Rusch GmbH, a manufacturer
of medical devices. In October 2002, we entered an exclusive multi-year
strategic alliance and distribution agreement with Rusch International, to
distribute Vital Signs anesthesia, respiratory and critical care products in
those countries where Rusch has a direct sales force in the healthcare market.
Rusch represents us in 10 countries. We view this alliance as an alternative to
our historic approach of relying upon local distributors to sell anesthesia and
respiratory/critical care products in foreign countries. However, during the
2004 fiscal year, Rusch's parent company announced its purchase of Hudson-RCI, a
competitor of ours in a number of respiratory and anesthesia products. We have
been meeting with Rusch to re-
10
assess the relationship in light of this acquisition. In the United Kingdom, we
have a sales manager and a direct sales force, which, as of September 30, 2004,
consisted of five people.
Our sleep/personal ventilation products are sold internationally through
Breas' direct sales force, which calls on home health care distributors in
France, Germany, Scandinavia, Spain and the United Kingdom, and through an
independent distribution network in other countries. As of September 30, 2004,
the Breas direct sales force consisted of 38 people. International net sales for
Breas for fiscal 2004, 2003, and 2002 were $26.9 million, $26.5 million, and
$22.7 million, respectively.
Marketing
Our marketing staffworks closely with our sales forces, collects and
analyzes customer responses to new and existing products, participates in our
product development program and assists in product training. In addition, our
marketing staff develops and helps implement various internal and external
promotional activities.
Research and Development
We believe that product development and innovation is an essential part of
our overall success. As of September 30, 2004 we employed 41 engineers,
scientists and technicians who are principally engaged in research and
development activities. We supplement their efforts with outside consultants
from time to time. The principal focus of our research and development
activities in fiscal 2004 was the development of a new generation of sleep and
ventilation products at our Breas subsidiary. Our other focus is to develop
product solutions for health care problems, specifically in the areas of
anesthesia, respiratory/critical care and sleep.
We incorporate technical, manufacturing, operations, sales and marketing,
and clinical expertise within our research and development processes. Our
research and development staff works with health care providers to develop an
in-depth understanding of, and to be responsive to, product applications and
clinical needs, and works with our sales and marketing teams to better
understand industry trends. We believe that we are often able to reduce the
costs associated with new product development by utilizing our in-house
manufacturing capabilities to rapidly produce quantities of prototype products
suitable for trial use and sale.
We expect to continue to rely principally on our internal staff to perform
research and development in our primary areas of expertise. Our research and
development expenses aggregated $7,036,000, $5,871,000 and $6,615,000 for fiscal
2004, 2003 and 2002, respectively.
Product Liability Exposure
We are exposed to potential product liability resulting from the use of our
products. We presently maintain primary and umbrella product liability insurance
coverage of $20,000,000 in the aggregate. Our product liability policy generally
protects us against claims of bodily injury or property damage arising out of
any products manufactured, sold or distributed by us. If a judgment in a product
liability suit were entered against us or we entered into a settlement agreement
in excess of a policy limit or outside the scope of coverage, including for
example, punitive damages, our profitability and financial condition may be
impacted significantly. We cannot assure you that our current level of insurance
will be sufficient to cover product liability claims or that such coverage will
remain available to us on satisfactory terms, if at all. See Note 15 to the
Consolidated Financial Statements for additional information on the limits of
our product liability coverage.
Manufacturing and Quality Control
We manufacture almost all of our products. Our manufacturing processes and
systems have allowed us to provide quality products, to react quickly to changes
in demand and to generate manufacturing efficiencies. We purchase resins, our
primary raw material used in a variety of our anesthesia and respiratory
products, in bulk. We believe that these capabilities allow us to contain costs,
control quality and maintain security of proprietary processes. For certain
products, our manufacturing function consists principally of assembling and
packaging components that we purchase from others. We continually evaluate our
manufacturing processes, with the objective of increasing automation,
streamlining production and enhancing efficiency in order to achieve cost
savings and improve quality.
11
We manufacture anesthesia breathing circuits, filters, blood pressure
cuffs, pressure infusors, arterial blood gas syringes, heated humidification
circuits, nebulizers, manual resuscitators, introducers, sleep therapy products
and ventilators. We perform tube extrusion, injection molding, radio frequency
welding, product assembly, product testing, packaging and distribution. In some
instances, plastic components incorporated in certain products are molded to our
specifications by outside custom injection molders who utilize molds that are
designed and, in most instances, owned by us. Our suppliers typically are
presented with written specifications to assure that components are manufactured
in conformity with our design.
As many of our products are utilized within the operating rooms and
critical care units of hospitals, we conduct quality control testing in all of
our facilities. Our quality systems are designed to meet the FDA's Quality
Systems Regulation. We are required to maintain records of all raw materials
received and used in the manufacturing process along with complete histories of
all devices manufactured. In order to distribute in Europe, our Quality Systems
have been certified to be in compliance with ISO 9001, EN46001 and ISO 13485
standards.
Significant Suppliers
In 1980, we acquired the rights to our air-filled cushion anesthesia
facemask through a collaboration arrangement with Respironics, Inc.
("Respironics"). Facemasks are used in a variety of our anesthesia circuits and
manual resuscitators and are sold individually to customers. We purchase our
facemasks from Respironics, a single source which manufactures the facemask in
the People's Republic of China. Our supply agreement with Respironics requires
Respironics to supply air-filled cushion facemasks of various specifications to
us on an exclusive basis for anesthesia purposes, and obligates us to purchase
all of our anesthesia facemasks from Respironics as long as Respironics is the
low cost supplier. We have had a series of supply agreements with Respironics
for many years. The current supply agreement with Respironics was renewed in
1999 to extend its term until 2006, with an additional option to further extend
the term of the agreement through 2011, providing us with a secure supplier
relationship on this key product.
If the supply of facemasks from Respironics should be interrupted for any
reason, we would seek to find alternative suppliers of facemasks. In such event,
we may experience disruption in our business. No assurance can be given that, in
the event of such an interruption or cessation, we could, in fact, maintain our
required supply of facemasks in a quantity and at a cost that would not have a
material adverse effect on our business and operating results. Our policy is to
maintain a stock of facemasks in the United States to lessen the impact of any
temporary production or supply disruption.
Sales Backlog
Our objective is to ship all orders within relatively short time frames;
therefore, backlog is not significant to our business.
Competition
The markets in which we do business are highly competitive. The principal
bases for competition in our markets include product features, price, quality,
customer service, performance, market reputation, breadth of product offerings
and effectiveness of sales and marketing. We believe that our products compete
favorably with respect to these factors.
12
We compete on a product-by-product basis with various companies, many of
which have greater financial and marketing resources, broader product lines or
both. Our primary competitors in each of our product and service categories are
the following entities and their affiliates.
Product/Service Category Primary Competitors
------------------------ -------------------
Anesthesia: ........................... Baxter International Inc.
King Systems Corporation
Medline
SIMS Portex, Inc.
Respiratory/Critical Care: ............ Cardinal Health Inc.
Ambu International A/S
Critikon, Inc./General Electric Medical Services
Fisher & Paykel Healthcare Corporation Limited
Teleflex
Kimberly-Clark Corporation
Tyco International, Inc.
Sleep/Personal Ventilation: ........... Fisher & Paykel Healthcare Corporation Limited
Resmed, Inc.
Respironics, Inc.
Tyco International, Inc.
Sleep centers maintained by hospitals and various local sleep centers.
Pharmaceutical Technology Services: ... Day & Zimmerman
Taratec
The Washington Group
Numerous national and regional companies.
Regulation
Medical Device Regulation
As a manufacturer of medical devices, we are subject to regulation by,
among other governmental entities, the FDA and the corresponding agencies of the
states and foreign countries in which we sell our products. We must comply with
a variety of regulations, including the Quality System Regulations of the FDA,
and are subject to periodic inspections by the FDA and applicable state and
foreign agencies. Enforcement of the Quality System Regulations has increased
significantly in recent years, and the FDA has publicly stated that compliance
will be more strictly scrutinized. If the FDA believes that its regulations have
not been fulfilled, it may invoke extensive enforcement powers. Noncompliance
with applicable requirements can result in, among other things, warning letters,
fines, injunctions, civil penalties, recall or seizure of products, total or
partial suspension of production, failure to receive pre-market clearances or
approvals, withdrawal of approvals and criminal prosecution. The FDA also has
the authority to require recall, repair, replacement or refund of the cost of
any device manufactured or distributed by us.
Medical devices are classified by the FDA into three classes that determine
the degree of regulatory control to which the manufacturer of the device is
subject, Class I being the least stringent and Class III being the most
stringent. Class I devices are subject to general controls, including reporting
certain types of device-related events to the FDA, labeling and adherence to the
Quality System Regulations. Class II devices are generally subject to general
and special controls including Section 510(k) clearance, performance standards,
postmarket surveillance, patient registries and FDA guidelines. Class III
devices are those which must receive pre-market approval by the FDA to ensure
their safety and efficacy; such devices include life-sustaining, life-supporting
and certain implantable devices, or new devices which have not been found to be
substantially equivalent to legally marketed Class I or
13
Class II devices. The pre-market approval process may take several years and
requires the submission of extensive performance and clinical information.
We believe that most of our products are either Class I or Class II
products. However, some of the devices manufactured by our Thomas Medical
Products subsidiary are Class III devices which are used for arterial closure
following angiography, angioplasty or stenting. Also some of our products in
development for use by patients with congestive heart failure may be classified
as Class III and, therefore, may be subject to the time-consuming and expensive
pre-market approval process. Many new medical devices, including most of our
products, and some modifications to existing medical devices, are subject to a
pre-market notification process pursuant to Section 510(k) of the Federal Food,
Drug, and Cosmetic Act. Furthermore, current FDA enforcement policy prohibits
the marketing of approved or cleared medical devices for unapproved or uncleared
uses. We cannot assure investors that we will be able to identify each
circumstance in which compliance with the pre-market notification process is
required.
After clearance or approval is given, the FDA or foreign regulatory
agencies may withdraw clearances or approvals or require us to change the device
or its manufacturing process or labeling, to supply additional proof of its
safety and effectiveness or to recall, repair, replace or refund the cost of the
medical device. The process of obtaining clearances or approvals to market
products can be costly and time consuming and can delay the marketing and sale
of our products.
Federal, state and foreign regulations regarding the manufacture and sale
of medical devices are subject to change. In the future, we cannot predict what
impact, if any, such changes might have on our business.
International sales of medical devices are subject to foreign government
regulations, which vary substantially from country to country. The time required
to obtain approval by a foreign country may be longer or shorter than that
required for FDA approval, and the requirements may differ significantly.
The European Union has adopted legislation, in the form of directives to be
implemented in each member state, concerning the regulation of medical devices
within the European Union. The directives include, among others, the Medical
Device Directive that establishes standards for regulating the design,
manufacture, clinical trials, labeling, and adverse event reporting for medical
devices. Under the Medical Device Directive, a Competent Authority is nominated
by the government of each member state to monitor and ensure compliance with the
Directive. The Competent Authority of each member state then nominates a
Notified Body to oversee the conformity assessment procedures set forth in the
Directive, under which manufacturers demonstrate that their devices comply with
the requirements of the Directive and are entitled to bear the "CE" marking.
"CE" is an abbreviation for Conformite Europeene, or European Conformity, and
the CE marking, when placed on a product, indicates compliance with the
requirements of the applicable directive. Medical devices properly bearing the
CE marking may be commercially distributed throughout the European Union. We
have approval to affix the CE marking on all our major product lines. As new
products are introduced, we intend to take steps to gain approval for CE
marking. While no additional premarket approvals in individual European Union
countries are required prior to marketing of a device bearing the CE mark,
practical complications with respect to marketing introduction may occur. For
example, differences among countries have arisen with regard to labeling
requirements. Failure to maintain the CE mark will preclude us from selling our
products in the European Union.
Canada requires device manufacturers to obtain licenses for their products.
To obtain these licenses, the manufacturer's quality systems must be audited by
a Canadian approved third party and the manufacturer must obtain a certification
to CAN/CSA ISO-13485-98. Failure to obtain and retain these licenses would
preclude us from selling our products into Canada.
A new Quality Systems Standard, ISO 13485-2003, has been adopted and all
medical device companies must transition to this standard and be third party
certified to it by 2006 in order to continue CE Marking of products and to
continue to obtain Canadian licenses. Failure to receive re-certification to
this standard by March 2006 would preclude us from selling our products in the
European Union and Canada.
Additionally, some of the services we provide in our Sleep business segment
are subject to additional regulation from various state and local regulatory
authorities. There has been a trend developing in the State to require the
licensing of technical personnel to perform diagnostic testing procedures.
Licensed personnel are more highly compensated than unlicensed personnel.
14
Health Care Regulation
As a provider of sleep diagnostic services, we are subject to regulation by
U.S. federal and state authorities aimed at combating fraud and abuse in the
health care industry. The federal government has enacted statutes and
corresponding regulations addressing, among other things, kickbacks,
self-referral, the submission of false claims for reimbursement and the failure
to follow physician prescriptions. Many states have enacted similar statutes.
The federal laws apply in any case where we may provide a product or service
that is reimbursable under the Medicare or Medicaid programs, or where we are
requesting reimbursement from Medicare or Medicaid.
The federal government is authorized to impose criminal, civil and
administrative penalties on a health care provider who files a false claim for
reimbursement from Medicare or Medicaid. Even where a claim has not been
submitted to Medicare or Medicaid, criminal penalties may be imposed against the
provider if the government can show that the claims constitute mail fraud or
wire fraud. The government has increasingly been applying penalties in a
broadening range of circumstances, for example, in instances where reimbursement
has been made or sought for medically unnecessary services or for services that
fall below clinical standards for quality care.
The federal anti-kickback law prohibits the offering, solicitation, payment
or receipt of anything of value which is intended to induce the referral of
Medicare or Medicaid patients, or to induce the ordering of items or services
that are reimbursable under those programs. The federal anti-kickback law has
been interpreted to apply where one purpose of an arrangement is to induce
referrals--it need not be the primary purpose of the arrangement. Arrangements
that meet certain so-called "safe harbors" are deemed not to violate the federal
anti-kickback law; but the failure of a particular arrangement to meet a safe
harbor also does not necessarily mean that such an arrangement is illegal per
se.
The federal self-referral law, commonly referred to as the Stark Law,
prohibits a physician from referring a patient to another health care provider
for certain designated health products and services reimbursable by Medicare or
Medicaid including durable medical equipment--if the referring physician has a
financial relationship with that provider. "Financial relationship" has been
broadly defined in the applicable regulations to include both direct and
indirect relationships, and includes both ownership interests and compensation
as forms of financial relationships. As with the federal anti-kickback law's
safe harbors, the Stark Law and its regulations exclude certain arrangements
from the general prohibition, provided that specific criteria applicable to each
arrangement are met.
Our ability to sell our Breas products in our sleep centers is restricted
by strict federal regulations which prohibit us from diverging from a
physician's prescription. If a physician prescribes a continuous positive airway
pressure product other than a Breas product for a patient at one of our sleep
centers, we are prohibited by federal regulations from substituting a Breas
product.
The penalties for violating these federal laws include criminal sanctions
and fines including treble damages and civil and administrative penalties, which
may include, but not be limited to, exclusion from the Medicare and Medicaid
programs, and the requirement to repay to the federal government any
reimbursement the provider has received in violation of the law.
Many states have enacted laws similar to the federal fraud and abuse laws.
There is a great degree of variability among these states in terms of the
applicability and requirements of each of their laws. For instance, some states'
laws are applicable only to services or products reimbursable under Medicaid,
while others' apply to all health care services regardless of the source of
payment. By way of further example, some states do not prohibit referrals to a
provider with which the referring physician has a financial relationship, but
only require that the patient be informed of the relationship before the
referral is made.
Privacy Regulation
Certain of our business activities require that we collect and/or use
information about individuals and their medical conditions. As a result, we are
subject to regulations by both U.S. and foreign authorities intended to protect
the privacy of those individuals by requiring that we maintain the
confidentiality of their information.
In 1996, the U.S. Congress enacted the Health Insurance Portability and
Accountability Act, which mandated, among other things, the promulgation of
regulations to address the privacy of health information and to reduce many of
the costs and administrative burdens of the health care industry. These
regulations have been developed by the U.S. Department of Health and Human
Services, and address three general areas: standardization of electronic
15
transactions, security of health information systems, and privacy of protected
health information. Collectively, these regulations are intended to establish
federal standards concerning the use, disclosure and protection of health
information which, by its nature, can be linked to specific individuals. In
addition to limited access to protected health information of our employees, our
SSA subsidiary collects protected health information of its clients.
In addition, the Health Insurance Portability and Accountability Act calls
for civil and criminal fines and penalties for the improper use and disclosure
of individually identifiable health information. The regulations continue to
evolve as the U.S. Department of Health and Human Services continues to receive
public comment and revise certain of the regulations, most notably those
addressing privacy. There is no meaningful history of enforcement efforts by the
federal government at this time. It is therefore not possible to ascertain the
likelihood of enforcement efforts in connection with the Health Insurance
Portability and Accountability Act regulations or the potential fines and
penalties that may result from the violation thereof.
Foreign governments are increasingly addressing concerns related to the
privacy of information collected about their citizens with laws and regulations
designed to protect the confidentiality of such information.
In addition, we are also subject to numerous federal, state and local laws
relating to such matters as safe working conditions, environmental protection
and fire hazard control. We cannot assure investors that we will not be required
to incur significant expenses to comply with such laws and regulations in the
future.
Third Party Reimbursement
The cost of medical care in the U.S. and many other countries is funded
substantially by government and private insurance programs. Although we do not
generally receive payment for our products or services directly from these
payors other than in connection with our sleep diagnostic services, our
continued success is dependent upon the ability of patients, hospitals and home
care distributors to obtain adequate reimbursement for our products and sleep
services. In most major markets, our products are purchased primarily by
hospitals, which are generally either government funded or which invoice
third-party payors directly, or otherwise invoice patients, who then seek
reimbursement from third-party payors. Other than our direct to hospital sales
and our sleep diagnostic services and any resulting sales of continuous positive
airway pressure equipment, our remaining sales are to distributors and
manufacturers of other medical products, who then sell to these customers. When
we provide sleep diagnostic services in our own sleep centers, patients are
generally covered by private insurance. In those instances, the patient is
responsible for his/her co-payment portion of the fee and we invoice the
patient's insurance company for the balance. In hospitals, we contract with the
hospital on a "fee for service" basis and the hospital assumes the risk of
billing.
In the U.S., third-party payors include Medicare, Medicaid and private
health insurance providers. These payors may deny reimbursement if they
determine that a device has not received appropriate FDA clearance, is not used
in accordance with approved applications, or is experimental, medically
unnecessary or inappropriate. Third-party payors are also increasingly
challenging prices charged for medical products and services, and certain
private insurers have initiated reimbursement systems designed to reduce health
care costs. The trend towards managed health care and the growth of health
maintenance organizations, which control and significantly influence the
purchase of health care services and products, as well as ongoing legislative
proposals to reform health care, may all result in lower prices for our products
and services. We cannot assure you that our products and services will be
considered cost-effective by third-party payors, that reimbursement will be
available or continue to be available, or that payors' reimbursement policies
will not adversely affect our ability to sell our products and services on a
profitable basis, if at all.
Intellectual Property
We primarily rely upon trade secrets and continuing technological
innovations to develop and maintain our competitive position. However, where
appropriate, we seek patent protection for inventions that we believe give our
products a competitive advantage. When deemed appropriate, we have enforced and
plan to continue to enforce and defend our patent rights. In an effort to
protect our trade secrets, we require certain employees, consultants and
advisors to execute proprietary information and invention assignment agreements
upon commencement of employment or consulting relationships with us.
Some of our patents relate to significant technologies that are utilized in
our anesthesia, respiratory/critical care and sleep therapy product lines. Our
ongoing success depends in part on our ability to maintain our patents,
16
obtain new patents, and develop new products and applications without infringing
the patent and other proprietary rights of third parties. There has been
substantial litigation involving the intellectual property rights of medical
device manufacturers. We have been involved in several such proceedings, often
at significant expense to us. We cannot assure you that any of our patents will
not be circumvented or challenged, that the rights granted by our patents will
provide competitive advantages or that any of our pending or future patent
applications will be issued with claims of the scope that we seek, if at all. If
challenged, we cannot assure you that our patents will be held valid or
enforceable. We cannot assure you that our products or proprietary rights do not
infringe the rights of third parties. If an infringement were established, we
could be required to pay damages, enter into royalty or licensing agreements on
onerous terms and/or be enjoined from making, using or selling the infringing
product. Any of these outcomes could have a material adverse effect on our
business. We may decide not to introduce a product in the United States or a
foreign country based upon the potential risk of patent infringement litigation.
Employees
As of September 30, 2004, we had 1,128 full-time employees and 28 part-time
employees. We believe that our relations with our employees are good. None of
our employees are members of unions, although certain employees outside of the
U.S. have statutory benefits comparable to collective bargaining agreements. Our
full-time employees by department as of September 30, 2004 were:
Manufacturing and quality control ...................................... 605
Sales and marketing .................................................... 112
Sleep center technical personnel ....................................... 147
Regulatory consultants ................................................. 102
Research and development ............................................... 41
Administration ......................................................... 121
-----
Total ............................................................... 1,128
=====
Item 2. Properties
We believe that our properties are adequate for our current needs. In
addition, we believe that adequate space can be obtained to meet our foreseeable
business needs. The following chart identifies the principal properties which we
own or lease.
The properties listed below relate to the anesthesia and
respiratory/critical care business segments, except for the Molnlyke, Sweden and
Glen Burnie, Maryland properties which relate to our sleep segment, and
Bensalem, Pennsylvania which relates to our pharmaceutical technology services
business segment.
Square
Location Feet
-------- -------
Totowa, New Jersey* (executive offices, principal manufacturing and warehouse facilities) ... 154,000
Englewood, Colorado* (manufacturing, warehouse and office space) ............................ 88,000
Burnsville, Minnesota (manufacturing, warehouse and office space) ........................... 35,000
Molnlyke, Sweden* (Breas--manufacturing, warehouse and office space) ........................ 27,000
Malvern, Pennsylvania (Thomas Medical--manufacturing, warehouse and office space) ........... 22,500
Bensalem, Pennsylvania (Stelex--office space) ............................................... 16,500
Glen Burnie, Maryland (Sleep Services of America--office space) ............................. 9,980
Littlehampton, United Kingdom (Vital Signs, Ltd--warehouse and office space) ................ 12,000
- ----------
* We own this facility.
Item 3. 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,
17
the court ordered the plaintiffs 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 presentation of testimony
of both the plaintiff's direct case and the defendant's case is essentially
completed. There may be additional testimony presented should the arbitrator
permit plaintiffs to present a rebuttal. The arbitrator has not set a schedule
for post-arbitration briefs or other submissions. It is likely that a decision
may be rendered by the arbitrator during the second quarter of fiscal 2005.
Plaintiff's have claimed damages in the pre-interest amount of approximately
$7.5 million. We have recorded a reserve in an amount not exceeding plaintiffs'
claim.
(b) 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") for a product designed to prevent adhesions in
certain surgical procedures sold under the brand name "Intergel" by Ethicon,
Inc. (a subsidiary of Johnson and Johnson). The complaint also names Lifecore
and Ethicon, Inc. as defendants. On January 28, 2004 this same plaintiff filed a
similar action in California state court. On October 21, 2004 plaintiff
voluntarily dismissed the state court action without prejudice.
Following the service of the complaints described in the preceding
paragraph, Vital Pharma became a defendant in 37 matters filed in state court in
Florida related to the Intergel product. Vital Pharma has been served with
complaints in most of these filed actions, but has not yet been served in all of
them. Additional claims may be filed. Each of the complaints assert multiple
theories of negligence and product liability claims against the defendants for
injuries allegedly sustained through the use of Intergel during surgery.
Lifecore was the manufacturer of the product, which had been approved by
the FDA for reducing post-surgical adhesions. Vital Pharma packaged the product
for Lifecore pursuant to a written agreement. The agreement contained mutual
indemnification provisions, pursuant to which Lifecore and Vital Pharma agreed
to indemnify each other in the event either had breached their contractual
obligations.
Vital Pharma has notified Lifecore of Lifecore's obligations to defend and
indemnify Vital Pharma for these claims. Our insurance carrier has been funding
the defense of each of the pending actions. We believe that we have meritorious
defenses to these actions. Additionally, except for our responsibility for
payment of the insured retention amounts under our product liability policy, we
believe that the coverage under the primary and umbrella insurance policies,
supplemented by Lifecore's indemnification obligation, provide for adequate
coverage for the claims. Also, in light of the early stages of the proceedings
we cannot quantify the exposure, if any, to us. In light of the foregoing
factors we have not established a reserve for these matters.
(c) 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.
18
Item 4. Submission of Matter to a Vote of Securities Holders
Not Applicable
Item 4A. Executive Officers of the Registrant
The Company's executive officers are as follows:
Name Age* Positions With the Company
---- ---- --------------------------
Terry D. Wall ......... 63 President, Chief Executive Officer and Director
Barry Wicker .......... 64 Executive Vice President--Sales and Director
Joseph J. Thomas ** ... 69 President, Thomas Medical Products, Inc. and Director
Alex Chanin ........... 36 Chief Information Officer
Richard Gordon ........ 49 Executive Vice President--Global Operations
- ----------
* As of September 30, 2004.
** Mr. Thomas resigned from his position on October 1, 2004
----------
Terry D. Wall founded the Company in 1972 and has been President, Chief
Executive Officer and a director of the Company since that time. He has also
invested in and serves on the board of directors of certain healthcare
businesses'. He received a Bachelor of Science degree in 1963 from the
University of Maryland and a Master of Business Administration degree from Pace
University in 1975. For the foreseeable future, the Company will remain
dependent upon the efforts of Mr. Wall. The Company does not maintain key man
life insurance on Mr. Wall's life.
Barry Wicker has served as a director and an Executive Vice President of
the Company since 1985 (with primary responsibility for sales and marketing).
Mr. Wicker joined the Company in 1978 as National Sales Manager and became Vice
President--Sales in 1981. Prior to joining the Company, he held various
marketing and sales positions with The Foregger Co. over a 20 year period.
Joseph J. Thomas has served as a director of the Company and President of
Thomas Medical Products, Inc. ("TMP") since the Company acquired TMP on October
1, 1992. Prior to the acquisition of TMP, Mr. Thomas was President of TMP from
1990--1992. Mr. Thomas was President and General Manager of Access Devices,
Inc., (a catheter manufacturer) from 1982 to 1989 and has held various research
and development positions with various companies including Johnson & Johnson. On
October 1, 2004 Mr. Thomas resigned his positions as Director and President of
Thomas Medical Products, Inc.
Richard Gordon has served as Executive Vice President of Global Operations
since January 2004. Mr. Gordon joined the Company in 1982 as Controller and
became Vice President for Operations in 1991. Mr. Gordon holds a Bachelor of
Business Administration from Baruch College of the City University of New York.
Alex Chanin has served as Chief Information Officer for the Company since
January 2004. He has served as President of the Company's Stelex, Inc.
Subsidiary from 2003 to 2004 and Vice President of Stelex, Inc. from April 2002
to 2003. Mr. Chanin was one of the founding partners (in 1991) of Stelex prior
to the Company's acquisition of Stelex. Mr. Chanin holds Bachelor of Science
degrees in Computer Science and Electrical Engineering from Drexel University
and a Masters of Science in Computer Engineering from Princeton University.
Each of the Company's executive officers serves as such at the pleasure of
the Board.
19
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Our Common Stock (the "Common Stock") is traded in the over-the-counter
market and quoted on the National Market System of the National Association of
Securities Dealers Automated Quotation System ("NASDAQ") under the symbol
"VITL". The following table sets forth the high and low closing sales prices of
the Common Stock on the NASDAQ National Market System, and the cash dividends
declared per share of Common Stock, for the periods indicated:
Dividend
High Low Per Share
------ ------ ---------
Fiscal Year Ended September 30, 2003:
Quarter ended December 31, 2002: .............. $31.90 $27.69 $.04
Quarter ended March 31, 2003: ................. 30.64 25.53 .05
Quarter ended June 30, 2003: .................. 29.91 21.95 .05
Quarter ended September 30, 2003: ............. 32.94 21.84 .05
Fiscal Year Ended September 30, 2004:
Quarter ended December 31, 2003: .............. $34.08 $29.01 $.06
Quarter ended March 31, 2004: ................. 35.75 30.00 .06
Quarter ended June 30, 2004: .................. 34.00 26.70 .06
Quarter ended September 30, 2004: ............. 33.72 27.65 .06
As of September 30, 2004, there were approximately 343 holders of record of
the Common Stock. This number of record holders does not represent the actual
number of beneficial owners of shares of our Common Stock because shares are
frequently held in "street name" by securities dealers and others for the
benefit of individual owners who have the right to vote their shares.
During fiscal 2004, the Company declared and paid cash dividends of $.24
per share. We expect to continue to pay dividends on our Common Stock. However,
the declaration of dividends is subject to the discretion of our Board of
Directors and will depend upon various factors, including our financial
condition, capital requirements, loan agreement restrictions and earnings, as
well as such other factors as our board may deem relevant.
The following table gives information about the Company's Common Stock that
may be issued upon the exercise of options, warrants and rights under all of the
Company's existing equity compensation plans as of September 30, 2004, including
the Company's Investment Plan, as amended and restated as of May 30, 2001, 1991
Director Stock Option Plan and 1990 Employee Stock Option Plan, as amended and
restated as of December 1, 1997, and the 2002 Stock Incentive Plan. No warrants
or rights are outstanding under the foregoing plans.
(a) (c)
Number of Number of Securities
Securities (b) Remaining Available for
to be Issued Upon Weighted Average Future Issuance Under
Exercise of Exercise Price of Equity Compensation Plans
Outstanding Options, Outstanding Options, (Excluding Securities
Plan Category Warrants and Rights Warrants and Rights Reflected in Column (a))
------------- -------------------- -------------------- -------------------------
Equity Compensation Plans Approved by
Shareholders ............................ 349,329 $26.85 1,581,759
======= =========
Equity Compensation Plans Not Approved by
Shareholders ............................ 165,900 $25.14 --
------- ---------
Total: ............................... 554,529 1,581.759
======= =========
In addition to options granted pursuant to Company benefit plans, the
Company, in fiscal 2004 has granted 55,400 stock options to employees
independent of any such plans. As such, these options represent contractual
commitments by the Company to the individual involved.
20
The following table provides information about purchases made by the
Company of its common stock during the quarter ended September 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
------ --------- ---------- ---------------- -----------------
7/1/2004-7/31/2004 ... -- $ -- -- $9,786,708
8/1/2004-8/31/2004 ... -- $ -- -- $9,786,708
9/1/2004-9/30/2004 ... 16,200 $32.34 16,200 $9,262,207
------ ------ ------ ----------
------ ------ ------ ----------
Total ............. 16,200 $32.34 16,200 $9,262,207
====== ====== ====== ==========
In May 2003, our Board of Directors authorized the expenditure of up to $20
million for the repurchase of Vital Signs' stock. During the year ended
September 30, 2004, we repurchased 274,6000 shares for $8.1 million at an
average price of $29.66. 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 6. Selected Financial Data
The selected financial data as of and for each of the five years ended
September 30, 2004 has been derived from consolidated financial statements that
have been audited by Goldstein Golub Kessler LLP, independent certified public
accountants. The information set forth below is not necessarily indicative of
the results of future operations and should be read in conjunction with our
consolidated financial statements and the related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this annual report.
Acquisitions occurring during the past five years, including National Sleep
Technologies, Now Sleep Services of America (acquired in June 2000), Breas
Medical AB (acquired from June 1997 through April 2002), HSI Medical Services,
Inc. (acquired in January 2002), and Stelex (acquired in April 2002) have been
accounted for as purchases and, accordingly, are only reflected herein for dates
and periods on and after the respective dates noted above.
In September 2002, our Board of Directors adopted a formal plan to sell our
Vital Pharma, Inc. subsidiary. Accordingly, we have classified the Vital Pharma
business as a discontinued operation. As such, the results of Vital Pharma have
not been included in any of the five years presented in the Selected Financial
Data schedule set forth below. See Note 2 to the Company's Consolidated
Financial Statements. On October 30, 2003, the Company sold its Vital Pharma
subsidiary to Pro-Clinical, Inc. No further gain or loss was recorded on the
sale. See Note 2 to the Consolidated Financial Statements.
For additional information regarding the NST, Breas, HSI and Stelex
acquisitions, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Overview."
21
SELECTED FINANCIAL DATA
Income Statement Data:
Year Ended September 30,
----------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(In thousands except per share data)
Net revenue .................................................... $183,991 $182,163 $174,018 $163,142 $146,478
Cost of goods sold and services performed ...................... 91,374 91,608 86,803 78,080 68,999
-------- -------- -------- -------- --------
Gross profit ................................................... 92,617 90,555 87,215 85,062 77,479
-------- -------- -------- -------- --------
Operating expenses:
Selling, general and administrative ......................... 50,115 51,338 44,216 41,063 38,317
Research and development .................................... 7,036 5,871 6,615 6,937 7,779
Restructuring charge ........................................ 539 -- -- -- --
Impairment and other charges (credit) (Notes 13) ............ -- 133 (3,428) 2,107 7,785
Goodwill amortization ....................................... -- -- -- 1,120 1,117
Other expense (income) net (Notes 1 and 12) ................. 612 717 305 (390) 1,196
-------- -------- -------- -------- --------
Total operating expenses ................................. 58,302 58,059 47,708 50,837 56,194
Operating income ............................................... 34,315 32,496 39,507 34,225 21,285
Other expense (income):
Interest income ............................................. (824) (654) (638) (976) (619)
Interest expense ............................................ 26 910 179 1,028 676
Loss on equity investments (Notes 1) ........................ -- -- -- -- 529
-------- -------- -------- -------- --------
Total other (income) expense ............................. (798) 256 (459) 52 586
Income from continuing operations before provision for income
taxes and minority interest ................................. 35,113 32,240 39,966 34,173 20,699
Provision for income taxes ..................................... 12,498 12,802 13,225 9,794 5,486
-------- -------- -------- -------- --------
Income from continuing operations before minority interest ..... 22,615 19,438 26,741 24,379 15,213
Minority interest .............................................. 447 248 241 9 387
-------- -------- -------- -------- --------
Income from continuing operations(a) ........................... $ 22,168 $ 19,190 $ 26,500 $ 24,370 $ 14,826
======== ======== ======== ======== ========
Earnings from continuing operations per common share:
Basic ....................................................... $ 1.73 $ 1.49 $ 2.05 $ 1.93 $ 1.22
======== ======== ======== ======== ========
Diluted ..................................................... $ 1.72 $ 1.48 $ 2.03 $ 1.90 $ 1.20
======== ======== ======== ======== ========
Basic weighted average number of shares outstanding ............ 12,793 12,905 12,896 12,633 12,177
======== ======== ======== ======== ========
Diluted weighted average number of shares outstanding .......... 12,907 12,985 13,036 12,850 12,318
======== ======== ======== ======== ========
- ----------
(a) See our consolidated financial statements for a disclosure of the operating
results and of the discontinued operations of Vital Pharma.
22
Balance Sheet and Other Data:
September 30,
----------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(In thousands except per share data)
Working capital: ............................................ $113,241 $ 98,469 $ 86,600 $ 70,493 $ 39,284
Total assets ................................................ 235,676 223,078 205,077 191,560 172,831
Long-term debt, excluding current installments .............. -- -- 1,560 1,842 2,711
Cash dividends ($0.24 per share in fiscal 2004, $0.19 per
share in fiscal 2003, $0.16 per share in fiscal
2000-2002) ............................................... 3,096 2,486 2,070 1,974 1,991
Total shareholders' equity .................................. 216,223 202,222 187,815 160,626 140,680
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and
results of operations should be read together with the "Selected Consolidated
Financial Data" and our financial statements and the related notes appearing
elsewhere in this Annual Report. This discussion and analysis contains
forward-looking statements that involve risks, uncertainties and assumptions.
The actual results may differ materially from those anticipated in these
forward-looking statements as a result of many factors, including but not
limited to those described in Exhibit 99.1 to this Annual Report.
Overview
We are a leading designer, manufacturer and marketer of medical products.
Many of our products are single-patient use airway products. Our products
address the anesthesia and respiratory/critical care markets as well as the
sleep/personal ventilation markets and the pharmaceutical technology services
market. See Note 20 to the Company's consolidated financial statements for
segment information.
In fiscal 2003, we classified our Vital Pharma business as a discontinued
operation. Accordingly, the results of Vital Pharma are not included in
continuing operations in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations." On October 30, 2003, we sold our Vital
Pharma subsidiary to Pro-Clinical, Inc. No further gain or loss was recorded on
the sale.
Our net revenue was derived from four business segments as follows during
the periods indicated:
Fiscal Years Ended September 30,
----------------------------------
Products and services 2004 2003 2002
- --------------------- -------- -------- --------
(In thousands)
Anesthesia ................................. $ 82,792 $ 75,949 $ 71,823
Respiratory/critical care .................. 42,078 45,829 46,753
Sleep ...................................... 44,053 45,580 39,628
Pharmaceutical technology services ......... 15,068 18,105 14,175
Rebate allowance adjustment (1) ............ -- (3,300) --
Other (2) .................................. -- -- 1,639
-------- -------- --------
Total ................................... $183,991 $182,163 $174,018
======== ======== ========
- ----------
(1) Reflects an adjustment made during the second quarter of fiscal 2003. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- "Critical Accounting Principles and Estimates." This rebate
adjustment relates to our anesthesia and respiratory/critical care segment.
(2) "Other" relates primarily to one-time licensing revenue relating to our
anesthesia segment recorded in the first quarter of fiscal 2002. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Critical Accounting Principles and Estimates".
23
The percentage of our net revenue derived from each of our product lines
was as follows during the periods indicated:
Fiscal Years Ended
September 30,
-------------------
Products and services 2004 2003 2002
- --------------------- ---- ---- -----
Anesthesia .............................................. 45.0% 41.7% 41.3%
Respiratory/critical care ............................... 22.9 25.2 26.9
Sleep ................................................... 23.9 25.0 22.8
Pharmaceutical technology services ...................... 8.2 9.9 8.1
Rebate allowance adjustment ............................. -- (1.8) --
Other ................................................... -- -- 0.9
---- ---- -----
Total ................................................ 100% 100% 100.0%
==== ==== =====
We sell our products in over 55 countries worldwide. In the U.S., we sell
most of our anesthesia and respiratory/critical care products primarily to
hospitals using our direct sales force and certain major health care
distributors. Outside of the U.S., most of our anesthesia and
respiratory/critical care sales have been made through a strategic alliance
agreement with a medical device manufacturer and distributor, Rusch GmbH. Our
sleep/ventilation products are sold primarily outside of the U.S. through our
direct sales force and country-specific distributors.
We compensate our direct sales force principally though salary and
commission payments, included in selling, general and administrative expenses.
Sales to distributors are made at our established price. When the distributor
provides us with documentation verifying that the product has been shipped to an
end-user that is entitled to a price lower than our established price, we owe
the distributor a rebate equal to the difference between our established price
and the lower price to which that end-user is entitled. The allowance for
rebates is recorded at the time the Company records the revenue for the product
sold to the distributor. We record this sales rebate allowance as a reduction of
gross revenue.
Recent Acquisitions
As part of our strategic plan to expand significantly into the obstructive
sleep apnea field, we acquired our interests in our Breas Medical AB and Sleep
Services of America subsidiaries through a series of transactions over a period
of several years:
Breas Medical AB:
o During the period from November 1997 through May 1, 2000, we acquired
a 53% ownership stake in Breas for $15.2 million.
o On May 2, 2001, we purchased an additional 41% of Breas from two
minority shareholders, for an initial payment of $3.7 million, with an
earnout based on a formula of sales and profits.
o The final earnout payment to the two minority shareholders for the
additional 41%, totaling $6.5 million, was made in April 2002.
o Our final purchase, amounting to $1.7 million, for the remaining 6% of
the minority interest in Breas, was completed in April 2002.
o The total purchase price for Breas was approximately $27 million.
Sleep Services of America:
o In June 1998 through May 1999, we purchased $10.4 million of common
stock and convertible preferred stock of National Sleep Technologies,
a company engaged in the operation of diagnostic sleep centers.
24
o In June 2000, we converted our preferred stock into common stock of
National Sleep Technologies; at that point, we owned 84% of the common
stock.
o On January 1, 2002, our National Sleep Technologies business was
merged with HSI Medical Services Corporation, a subsidiary of The
Johns Hopkins Health System Corporation, to form Sleep Services of
America. No cash was contributed at that time. Instead, we received a
62% equity interest in Sleep Services of America. An affiliate of
Johns Hopkins Health System Corporation received a 29% equity interest
in Sleep Services of America and the other minority shareholders of
National Sleep Technologies received a 9% interest in Sleep Services
of America.
o Subsequent to the merger, we paid $775,000 to certain of the minority
shareholders to increase our ownership to 70%, and reduce the minority
ownership to 1%.
o The portion of Sleep Services of America not owned by us is recorded
as a minority interest. See "Results of Operations" for fiscal 2004
and 2003 revenue and operating income information.
Stelex-TVG:
On March 28, 2002, we acquired Stelex Inc. for $13.3 million in cash.
Stelex was a private company which, like our subsidiary, The Validation
Group, Inc., was engaged in regulatory compliance counseling. We structured
the transaction as a merger of Stelex into The Validation Group, renamed
the surviving corporation Stelex--The Validation Group, Inc. and accounted
for the transaction as a purchase. The subsidiary now operates under the
name Stelex, Inc.
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, 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. Goodwill amounted to $69,506,000 at September 30,
2003 and 2004.
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 $563,000 at September 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
distributor price, the distributor is then due a rebate--the
difference between the established price and the lower
25
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
the expected rebate, to arrive at the net sale. 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
shipments to particular end-users and computes a rebate claim on such
shipments. Once the distributor has provided us with this claim, the
distributor will deduct the computed rebate from its net remittance.
The amount of the estimated rebate that has not yet been taken 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 claimed by the distributors through documentation but not
yet reimbursed and (2) an estimate by the Company of the amount of
future rebates due on any inventory that 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 Report on Form 10-Q for
the quarter ended March 31, 2003, the Company concluded that the
required allowance calculated as described in the previous paragraph
was greater than previously calculated by means of the historical
moving average calculation. As a result of this 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 now providing a better
estimate of the ultimate rebate our distributors are entitled to than
the estimate arrived at through utilization of the historical moving
average calculation.
The allowance for rebates was $8,162,000 and $6,156,000 at September
30, 2004 and September 30, 2003, respectively. Rebate expense was
$47,809,000 and $44,439,000 for the fiscal years ended September 30,
2004 and 2003, respectively
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 allowance, inventory is stated at the lower
of cost (first in, first out method) or its net realizable value. In
the fourth quarter of fiscal 2004, the Company wrote-off certain
inventory amounting to $939,000. Our inventory allowance for
obsolescence was $1,150,000 at September 30, 2004 and $981,000 at
September 30, 2003.
Accounting Principles. For information regarding new accounting principles,
see Note 1 of our notes to consolidated financial statements.
26
Results of Operations
The following table sets forth, for the periods indicated, certain
statement of income data as a percentage of our revenue.
Fiscal Years Ended
September 30,
---------------------
Consolidated Statement of Operations Data: 2004 2003 2002
- ------------------------------------------ ----- ----- -----
Net revenue ........................................... 100.0% 100.0% 100.0%
Gross profit .......................................... 50.3 49.7 50.1
Operating expenses .................................... 31.7 31.9 27.4
Income from continuing operations ..................... 12.0 10.5 15.2
Net income ............................................ 12.0 7.8 14.4
Comparison of Results for the Year Ended September 30, 2004 to the Year Ended
September 30, 2003
Net Revenue. Total net revenue increased 1.0%, from $182.2 million for the
year ended September 30, 2003 to $184.0 million for the year ended September 30,
2004. Of the 1.0% increase, (a 0.9% decrease excluding favorable foreign
exchange rates). Of our total revenues, $137.4 million (or 74.7%) were derived
from domestic sales and $46.6 million (or 25.3%) were derived from international
sales. Domestic revenues increased 0.4%, from $136.9 million for the year ended
September 30, 2003 to $137.4 million for the year ended September 30, 2004. The
0.4% increase resulted from a 9.0% increase in our Anesthesia segment which
offset declines in our Respiratory/Critical Care, Sleep and Pharmaceutical
Technology Services segments. International revenues increased 2.8% (a 4.6%
decrease excluding foreign exchange), from $45.3 million for the year ended
September 30, 2003 to $46.6 million for the year ended September 30, 2004,
principally from favorable foreign exchange rates. Following are the net
revenues by business segment for the year ended September 30, 2004 compared to
the year ended September 30, 2003.
REVENUE BY BUSINESS SEGMENT
For the Year
Ended September 30,
------------------- Percent
2004 2003 Change
-------- -------- -------
Anesthesia .................................... $ 82,791 $ 75,949 9.0%
Respiratory/Critical Care ..................... 42,079 45,829 (8.2%)
Sleep ......................................... 44,053 45,580 (3.4%)
Pharmaceutical Technology Services ............ 15,068 18,105 (16.8%)
Rebate allowance adjustment ................... -- (3,300) N/A
-------- -------- -----
$183,991 $182,163 1.0%
======== ======== =====
The rebate allowance of $3.3 million relates to our anesthesia and
respiratory/critical care segments. Refer to Footnotes 1 and 18 of the Notes to
Consolidated Financial Statements for a description of the rebate allowance.
Sales of anesthesia products increased 9.0% from $75.9 million for the year
ended September 30, 2003 to $82.8 million for the year ended September 30, 2004.
This increase was due to volume growth in anesthesia circuits, including our
Limb-O'TM', our patented anesthesia circuit, sales of which increased 70.5% to
$8.2 million, a 12.0% increase in sales of traditional anesthesia circuits to
$25.0 million and volume increases in our Thomas Medical Products subsidiary.
Domestic sales of anesthesia products increased 8.7%, from $69.8 million to
$75.9 million. International sales of anesthesia products increased 12.4%, from
$6.1 million to $6.9 million, principally from the European distribution
agreement with Rusch.
Sales of respiratory/critical care products decreased 8.2%, from $45.8
million for the year ended September 30, 2003 to $42.1 million for the year
ended September 30, 2004. Domestic sales declined 11.6%, from $33.2 million to
$29.3 million, resulting from increased competition within the segment.
International sales of respiratory/critical care products increased 0.8% from
$12.7 million for the year ended September 30, 2003 to $12.8
27
million for the year ended September 30, 2004, reflecting higher sales volumes
through our distributor arrangement in Europe with Rusch.
Our sleep segment revenues decreased 3.3% (a decrease of 10.2% excluding
favorable foreign exchange), from $45.6 million for the year ended September 30,
2003 to $44.0 million for the year ended September 30, 2004. Sleep Services of
America's revenues decreased 5.8% from $18.2 million for the year ended
September 30, 2003 to $17.1 million for the year ended September 30, 2004. SSA
has closed 14 sleep labs that had not returned the appropriate margins; however
it has opened 9 new sleep labs in fiscal 2004. In the continuing sleep labs,
revenue has increased 16.1%. Pre-tax margins in our SSA business improved to
14.3% for the year ended September 30, 2004, as compared to 7.4% in the
comparable period last year. Revenues at our Breas subsidiary decreased 1.7% (a
decrease of 12.8% excluding favorable foreign exchange) from $27.4 million for
the year ended September 30, 2003 to $26.9 million for the year ended September
30, 2004, resulting from increased competition in our ventilator product line
and from discontinuing certain OEM products as a result of the increased focus
on our own manufactured products
Service revenues in the Pharmaceutical Technology Services segment
decreased 16.8%, from $18.1 million for the year ended September 30, 2003 to
$15.1 million for the year ended September 30, 2004. Our larger pharmaceutical
customers have reduced their external resource usage with regards to 21 CFR Part
11 FDA regulatory compliance needs. Revenues trends in the Pharmaceutical
Technology Services segment have leveled off to approximately $3.7 million in
each of the last five quarters.
Cost of Goods Sold and Services Performed. Cost of goods sold and services
performed decreased 0.2% from $91.6 million for the year ended September 30,
2003 to $91.4 million for the year ended September 30, 2004.
Cost of goods sold increased $1.5 million, or 2.1%, from $71.9 million for
the year ended September 30, 2003 to $73.4 million for the year ended September
30, 2004. The increase resulted primarily from sales volume increases in our
anesthesia and respiratory/critical care segments. Increases due to inventory
adjustments (due in part to the closing of our California plant) were offset by
the planned reduction of costs at our New Jersey, Colorado, and Minnesota
facilities of approximately $900,000.
Cost of services performed decreased 9.1%, from $19.7 million for the year
ended September 30, 2003 to $17.9 million for the year ended September 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 2.3%; from $90.6 million for the
year ended September 30, 2003 to $92.6 million for the year ended September 30,
2004. Our overall gross profit margin was 50.3% for the year ended September 30,
2004 and 49.7% for the year ended September 30, 2003.Gross profit information
related to our four segments was:
Fiscal Year Ended
September 30,
-----------------
2004 2003
---- ----
Anesthesia ................................................. 54.4% 53.8%
Respiratory/CriticalCare ................................... 51.8% 54.3%
Sleep ...................................................... 45.3% 43.7%
Pharmaceutical Technology Services ......................... 38.6% 45.2%
---- ----
Total ...................................................... 50.3% 49.7%
==== ====
Gross profit improvements in our anesthesia segments resulted from sales volume
increases at Thomas Medical Products and cost improvement projects at our New
Jersey plant. The declines in gross profit in our Respiratory/Critical care
segment resulted primarily from sales volume declines and inventory writedowns
of $964,000. In both the Anesthesia and Respiratory/Critical Care segment the
Company continues to face pricing
28
pressures resulting from the increase membership of our customers in Group
Purchasing Organizations, who negotiate, on their member's behalf better
pricing. The Company intends to continue its efforts to mitigate the effect of
these pricing pressures through continued emphasis on increasing cost
efficiencies.
The gross profit decline in our Sleep segment resulted from volume and
price reductions at our Breas subsidiary, as described above. These declines
were offset by the cost saving effect of closing 14 SSA sleep laboratories that
were not returning appropriate margins. The gross profit percentage at SSA
increased from 45.0% for the year ended September 30, 2003 to 49.4% for the year
ended September 30, 2004.
Operating Expenses
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased 2.4%, from $51.3 million for the year ended
September 30, 2003 to $50.1 million for the year ended September 30, 2004. The
$1.2 million decrease consists primarily of cost reductions (primarily at our
Breas sales offices and our Stelex subsidiary) of approximately $1.7 million and
a $567,000 reduction in bad debt expense offset by an approximately $1.0 million
increase resulting from foreign exchange rate changes.
Research and Development Expenses. Research and development expenses
increased by approximately $1,165,000 or 19.8%, from $5.9 million for the year
ended September 30, 2003 to $7.0 million for the year ended September 30, 2004
as the Company invested in the development of new Sleep CPAP, ventilation
equipment and interfaces for our Breas subsidiary.
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. In May of 2003, the Company retained counsel in China to commence
certain legal actions against its distributor in China to collect its
receivable, and in the third quarter of fiscal 2003 wrote-off all amounts due
from this distributor, amounting to $553,000. In September 2003, the Company
received $420,000 in cash from this distributor and the Company is in the
process of receiving certain inventory. Accordingly, in the fourth quarter of
fiscal 2003, the Company recorded that payment as income. See Note 13 to the
Consolidated Financial Statements.
Other Expense--Net. Other net expense included in operating expense
decreased $105,000 from $717,000 for the year ended September 30, 2003 to
$612,000 for the year ended September 30, 2004. Included in the year ended
September 30, 2003 were costs of $322,000 for the costs of a public offering
that was discontinued due to market conditions, $226,000 for the costs of
charitable contributions, $169,000 of costs relating to the closing of several
redundant sales offices at our Breas and Stelex subsidiaries. Included in the
year ended September 30, 2004 were costs of $223,00 for charitable
contributions, $197,000 related to a failed acquisition and $190,000 for
severance costs.
Restructuring Expense. The company posted a $539,000 restructuring charge
in the fourth quarter of fiscal 2004 consisting of $172,000 for the closing of
our California plant, $111,000 for a reduction in force at our Totowa, NJ
location and $256,000 for the closing of the Breas sales office in Belgium.
Other Items
Interest Income and Expense. Interest income increased 26.0%; from $654,000
for the year ended September 30, 2003 to $824,000 during the year ended
September 30, 2004, resulting from the increase in the level of cash and cash
equivalents being invested. Interest expense decreased $884,000 from $910,000
for year ended September 30, 2003 to $26,000 during the year ended September 30,
2004. Interest expense for the year ended September 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 17 of the Notes to Consolidated Financial
Statements).
Provision for Income Taxes. The provision for income tax expense for the
year ended September 30, 2004 and 2003 was $12.5 million and $12.8 million,
respectively, reflecting effective tax rates of 35.6% and 39.7% for these
periods, respectively. Included in the provision for the year ended September
30, 2003 is an additional provision of
29
$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 refiling of certain state tax returns for prior periods. (See
Footnote 17 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 $115,000 for the year ended September 30, 2004 and
approximately $4,968,000 for the year ended September 30, 2003. (See Footnote 2
of the Notes to Consolidated Financial Statements).
Comparison of Results for the Year Ended September 30, 2003 to the Year Ended
September 30, 2002
Net Revenue. Total net revenue increased 4.7%, from $174.0 million for the
year ended September 30, 2002 to $182.2 million for the year ended September 30,
2003. Of the 4.7% increase, 2.4% 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 Note 1 to the
Consolidated Financial Statements). This rebate allowance adjustment is
attributable to our anesthesia and respiratory/critical care segments. Of our
total revenues, $136.9 million (or 75.1%) were derived from domestic sales and
$45.3 million (or 24.9%) were derived from international sales. Domestic
revenues increased 1.0%, from $135.4 million for the year ended September 30,
2002 to $136.9 million for the year ended September 30, 2003. The 1.0% increase
resulted from increases in our Anesthesia, Sleep and Pharmaceutical Technology
Services segments offsetting declines in our Respiratory/Critical Care segments,
and the above mentioned rebate adjustment (See Note 1 to the Consolidated
Financial Statements). International revenues increased 17.5% (6.1% increase
excluding foreign exchange), from $38.6 million for the year ended September 30,
2002 to $45.3 million for the year ended September 30, 2003, principally from
increased volumes related to our new distribution agreement entered into in
September 2002 with Rusch. Following are the net revenues by business segment
for the year ended September 30, 2003 compared to the year ended September 30,
2002.
REVENUE BY BUSINESS SEGMENT
For the Year Ended
September 30,
--------------------------- Percent
2003 % 2002 % Change
-------- ----- -------- ----- -------
Anesthesia ............................. $ 75,949 41.7 $ 71,823 41.3 5.7%
Respiratory/Critical Care .............. 45,829 25.2 46,753 26.9 (2.0%)
Sleep .................................. 45,580 25.0 39,628 22.8 15.0%
Pharmaceutical Technology Services ..... 18,105 9.9 14,175 8.1 27.7%
Rebate allowance adjustment ............ (3,300) (1.8) -- NA NA
Other (*) .............................. -- -- 1,639 NA NA
-------- ----- -------- ----- ----
$182,163 100.0 $174,018 100.0 4.7%
======== ===== ======== ===== ====
- ----------
* "Other" relates primarily to one-time licensing revenue recorded in the
first quarter of fiscal 2002 in the anesthesia business segment. Income
from continuing operations related to this one-time licensing revenue was
$1,439,000 before taxes ($953,000 after taxes).
Sales of anesthesia products increased 5.7% from $71.8 million for the year
ended September 30, 2002 to $75.9 million for the year ended September 30, 2003.
This increase was due to volume growth in anesthesia circuits including our
Limb-O'TM', a patented anesthesia circuit, which increased 74% to $4.8 million,
increased international revenues and increased revenue in our Thomas Medical
Products subsidiary, which increased 13% to $18.7 million. Domestic sales of
anesthesia products increased 3.7%, from $67.3 million for the year ended
September 30, 2002 to $69.8 million for the year ended September 30, 2003,
principally due to the aforementioned Limb-O'TM' and Thomas Medical Product
increases, offset by the above mentioned rebate adjustment. International sales
of
30
anesthesia products increased 36.0%, from $4.5 million to $6.1 million,
principally from increased volumes related to our new distribution agreement
entered into in September 2002 with Rusch.
Sales of respiratory/critical care products decreased 2.0%, from $46.8
million for the year ended September 30, 2002 to $45.8 million for the year
ended September 30, 2003. This was due primarily to lower domestic sales volumes
which declined 6.3%, from $35.4 million to $33.2 million, due principally to a
highly competitive market. International sales of respiratory/critical care
products increased 12.4% from $11.3 million for the year ended September 30,
2002 to $12.7 million for the year ended September 30, 2003, principally from
increased volumes related to our new distribution agreement entered into in
September 2002 with Rusch.
Our sleep segment revenues increased 15.0% (an increase of 4.1% excluding
favorable foreign exchange), from $39.6 million for the year ended September 30,
2002 to $45.6 million for the year ended September 30, 2003. Sleep Services of
America's revenues increased 10.7% from $16.4 million for the year ended
September 30, 2002 to $18.2 million for the year ended September 30, 2003. This
growth was 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 18.1% (an
increase of 0.2% excluding favorable foreign exchange) from $23.2 million for
the year ended September 30, 2002 to $27.4 million for the year ended September
30, 2003. Breas' relatively flat revenues resulted from increased competition in
the market place.
Service revenues in the Pharmaceutical Technology Services segment
increased 27.7%, from $14.2 million for the year ended September 30, 2002 to
$18.1 million for the year ended September 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 5.5% from $86.8 million for the year ended September 30,
2002 to $91.6 million for the year ended September 30, 2003.
Cost of goods sold increased 4.4%, from $68.8 million for the year ended
September 30, 2002 to $71.9 million for the year ended September 30, 2003. The
$3.1 million increase results primarily from an increase of approximately $2.3
million at our Breas subsidiary due to foreign exchange rate changes; the
write-off of certain inventory amounting to $1.1 million resulting from our
continuing evaluation of inventory; and $243,000 representing a twelve-month
volume related expense adjustment from a supplier. These increases were
partially offset by approximately $500,000 of savings realized from cost
improvement projects at our New Jersey and Colorado plants.
Cost of services performed increased 9.8%, from $18.0 million for the year
ended September 30, 2002 to $19.7 million for the year ended September 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 3.8%, from $87.2 million for the
year ended September 30, 2002 to $90.6 million for the year ended September 30,
2003. Our overall gross profit margin was 49.7% for the year ended September 30,
2003 and 50.1% for the year ended September 30, 2002. In addition to the items
noted above in cost of goods sold and cost of services, the decrease in gross
margin percentage primarily reflects the increase in rebate expense (see Note 1
to the Consolidated Financial Statements); charges for the write off of certain
inventory (see Note 3 to the Consolidated Financial Statements); 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. For gross profit information
related to our four segments, refer to Note 20 to the Consolidated Financial
Statements.
Operating Expenses
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 16.1%, from $44.2 million for the year ended
September 30, 2002 to $51.3 million for the year ended September 30, 2003. The
$7.1 million increase primarily reflects $3.0 million associated with additional
employee levels and other expense resulting from the acquisition of Stelex Inc;
an increase of approximately $1.3 million in selling, general and administrative
expenses at our Breas subsidiary due to foreign exchange rate changes; an
increase of $1.0 million in business and health insurance costs; an increase of
$651,000 in accounting and legal expenses (including $550,000 for accounting and
legal expenses applicable to a complaint filed against the Company by a former
Chief
31
Financial Officer of the Company and related matters); a $186,000 charge for
data processing charges for the year ended September 30, 2002 and increased
other expense of approximately $824,000, primarily relating to compensation
expense.
Research and Development Expenses. Research and development expenses
decreased by approximately $744,000, or 11.2%, from $6.6 million for the year
ended September 30, 2002 to $5.9 million for the year ended September 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. In May of 2003, the Company retained counsel in China to commence
certain legal actions against its distributor in China to collect its
receivable, and in the third quarter of fiscal 2003 wrote-off all amounts due
from this distributor, amounting to $553,000. In September 2003, the Company
received $420,000 in cash from this distributor. Accordingly, in the fourth
quarter of fiscal 2003, the Company recorded that payment as income.
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 judgment 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 year ended September 30, 2002.
Other Expense/(Income)--Net. Other expense/(income) increased $412,000 from
$305,000 for the year ended September 30, 2002 to $717,000 for the year ended
September 30, 2003. This was primarily due to a $322,000 charge relating to the
costs for a discontinued public offering and $151,000 of closure expenses for
Breas sales offices and other increases of $60,000, offset by a reduction of
$121,000 for product contributions to charitable organizations.
Other Items
Interest Income and Expense. Interest income increased 2.5%, from $638,000
for the year ended September 30, 2002 to $654,000 during the year ended
September 30, 2003, resulting from an increased amount of cash available for
investment, offset by the decrease in available interest rates.
Interest expense increased $731,000, from $179,000 for the year ended
September 30, 2002 to $910,000 during the year ended September 30, 2003. This
was primarily due to $690,000 of interest charges in connection with 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 Note 17 to the
Consolidated Financial Statements). 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
years ended September 30, 2003 and 2002 was $12.8 million and $13.2 million,
respectively reflecting effective tax rates of 39.7% and 33.1% for these
periods, respectively. Included in the provision for the year ended September
30, 2003 is an additional provision of $1.2 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 have
been or are in the process of being re-filed. The Internal Revenue Service
completed its examination in the fourth quarter of fiscal 2003. See Note 17 to
the Consolidated Financial Statements.
Discontinued Operations. In September 2002, we adopted a formal plan 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 as a discontinued operation
for all periods
32
presented. Based upon an appraisal of Vital Pharma's assets and several
non-binding bids received for its Vital Pharma business, the Company lowered its
investment in Vital Pharma to $2,500,000 and 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 year ended September 30, 2003 was $4,968,000, which represents an additional
loss of $3,513,000 over the loss from operations of Vital Pharma of $1,455,000
experienced in the year ended September 30, 2002. On October 30, 2003, the
Company sold its Vital Pharma subsidiary to Pro-Clinical, Inc. No gain or loss
was recorded on the sale.
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 September 30, 2004, 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 September 30, 2004.
Vital Signs continues to rely upon cash flows from its operations. During
the year ended September 30, 2004, cash and cash equivalents increased by $20.8
million. Operating activities provided $35.1 million of net cash, of which $35.3
million was provided by continuing operations, offset by $153,000 of cash used
in our discontinued operations at Vital Pharma. Investing activities used $3.7
million, of which $4.5 million was used for capital expenditures, $598,000 for
capitalized software, and $235,000 for capitalized patent costs. These costs
were offset in part by net proceeds of $417,000 from the sale of Vital Pharma's
assets and $1.2 million of net proceeds on the sale of Vital Pharma's real
estate. Financing activities used $11.2 million, consisting of: $3.1 million
paid for dividends; $8.1 million used to repurchase 274,600 shares of the
Company's stock and $1.7 million used to pay down debt. These amounts were
offset in part by $1.7 million of cash received upon the exercise of stock
options.
Cash and cash equivalents were $76.5 million at September 30, 2004 as
compared to $55.7 million at September 30, 2003 (see Note 1 to the Company's
Consolidated Financial Statements). At September 30, 2004 our working capital
was $113.7 million as compared to $98.5 million at September 30, 2003. At
September 30, 2004 our current ratio was 8.1 to 1, as compared to 6.5 to 1 at
September 30, 2003.
Our capital investments vary from year to year, based in part on capital
demands of newly acquired businesses. Capitalized costs include additions to
property, plant and equipment, as well as capitalized software development costs
and capitalization of patent costs. Capitalized costs were $5.3 million, $4.7
million and $3.9 million during fiscal 2004, 2003 and 2002, respectively. In
fiscal 2004 capitalized costs were approximately $5.3 million, and primarily
included expenditures for equipment used as part of cost improvement projects at
our Breas subsidiary ($200,000), New Jersey facility ($846,000), Colorado
facility ($595,000), MIS improvements ($454,000) new tooling and molds
($429,000) and Thomas Medical Products facility ($335,000), and the capitalized
costs of software development ($2.0 million) and patents ($235,000).
We expect that our capitalized costs in the future will depend in part upon
the capital requirements of any businesses that we acquire. We are in the
process of evaluating our information processing capabilities and potential
upgrades or replacements to these systems. Additional capital expenditures will
be required for these purposes. Non-capital expenditures related to these items
may also be incurred.
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 product development, product acquisitions and business acquisitions,
among other things. We regularly evaluate and negotiate with domestic and
foreign medical device companies regarding potential business or product line
acquisitions or licensing arrangements.
Our Board of Directors has authorized the expenditure of up to $20 million
for the repurchase of Vital Signs' stock. Through September 30, 2004, we had
repurchased 374,900 shares for $10,726,000, at an average price of $28.60. 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 $3.1 million in dividends (amounting to
$.24 per share) in the current fiscal year. On November 9, 2004 the Board
approved a quarterly dividend in the amount of $0.06 per share paid on November
30, 2004 to shareholders of record on November 23, 2004.
33
We believe that the funds generated from operations, along with our current
working capital position and available bank credit, will be sufficient to
satisfy our capital requirements for at least the next twelve months. This
statement constitutes a forward-looking statement. Our liquidity could be
adversely impacted and our need for capital could materially change if costs are
substantially greater than anticipated, we were to undertake acquisitions
demanding significant capital, operating results were to differ significantly
from recent experience or adverse events were to affect our operations.
At September 30, 2004, 2003 and 2002, we did not have any relationships
with unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. In addition, we do not engage
in trading activities involving non-exchange traded contracts. As such, we are
not materially exposed to any financing, liquidity, market or credit risk that
could arise if we had engaged in such relationships. We do not have
relationships or transactions with persons or entities that derive benefits from
their non-independent relationship with us or our related parties other than
what is disclosed in Note 21 of Notes to the Consolidated Financial Statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks, including the impact of material price
changes, changes in the market value of our investments, foreign currency
fluctuations and, to a lesser extent, interest rate changes. 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 25.3% of our total
net revenues. Our Breas subsidiary, located in Sweden, represents 57.8% 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 September 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 8. Financial Statements and Supplementary Data
The following audited consolidated financial statements and related report
are set forth in this Annual Report on the following pages:
Page
----
Independent Auditors' Report............................................. F-1
Consolidated Balance Sheet as of September 30, 2004 and 2003............. F-2
Consolidated Statement of Income for the years ended September 30, 2004,
2003 and 2002......................................................... F-3
Consolidated Statement of Stockholders' Equity for the years ended
September 30, 2004, 2003 and 2002..................................... F-4
Consolidated Statement of Cash flows for the years ended September 30,
2004, 2003 and 2002................................................... F-5
Notes to Consolidated Financial Statements............................... F-6
34
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Vital Signs, Inc.
We have audited the accompanying consolidated balance sheets of Vital Signs,
Inc. and Subsidiaries as of September 30, 2004 and 2003, and the related
consolidated statements of income, stockholders equity and cash flows for each
of the three years in the period ended September 30, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Vital Signs Inc. and
Subsidiaries as of September 30, 2004 and 2003 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2004 in conformity with United States generally accepted
accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of estimating rebates in 2003.
GOLDSTEIN GOLUB KESSLER LLP
New York, New York
November 12, 2004
F-1
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30,
-------------------
2004 2003
-------- --------
(In thousands
of dollars)
ASSETS
Current Assets:
Cash and cash equivalents (Note 1) ............................................................. $ 76,468 $ 55,660
Accounts receivable, less allowances for rebates and doubtful accounts of $8,725 and $7,075,
respectively (Notes 1, 18 and 19) ........................................................... 31,876 29,436
Inventory (Notes 1 and 3) ...................................................................... 16,766 21,857
Prepaid expenses (Note 4) ...................................................................... 2,816 3,239
Other current assets (Note 5) .................................................................. 1,596 4,129
Assets of discontinued business (Note 2) ....................................................... -- 2,104
-------- --------
Total current assets ........................................................................ 129,522 116,425
Property, plant and equipment--net (Notes 1 and 6) ................................................ 29,900 30,760
Goodwill--net (Notes 1 and 2) ..................................................................... 69,506 69,506
Deferred income taxes (Notes 1 and 17) ............................................................ 796 1,519
Other assets (Notes 1, 7 and 9) ................................................................... 5,952 4,868
-------- --------
Total Assets ................................................................................ $235,676 $223,078
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ............................................................................... $ 5,114 $ 6,072
Current portion of long-term debt (Note 8) ..................................................... -- 1,690
Accrued expenses (Note 10) ..................................................................... 7,780 6,299
Income taxes payable (Note 17) ................................................................. 3,387 3,392
Liabilities of discontinued business (Note 2) .................................................. -- 503
-------- --------
Total current liabilities ................................................................... 16,281 17,956
-------- --------
Minority interest ................................................................................. 3,172 2,900
-------- --------
Commitments and contingencies (Notes 2, 14 and 15)
Stockholders' Equity (Note 16)
Common stock--no par value; authorized 40,000,000 shares, issued and outstanding
12,715,243 and 12,915,566, respectively ..................................................... 24,279 30,467
Accumulated other comprehensive income (Notes 1) ............................................... 3,059 1,827
Retained earnings .............................................................................. 188,885 169,928
-------- --------
Stockholders' equity ........................................................................... 216,223 202,222
-------- --------
Total Liabilities and Stockholders' Equity .................................................. $235,676 $223,078
======== ========
See Notes to Consolidated Financial Statements
F-2
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Year Ended September 30,
--------------------------------
2004 2003 2002
-------- -------- --------
(In thousands except
per share amounts)
Revenue: (Note 1)
Net sales ............................................................. $151,794 $145,879 $143,428
Service revenue ....................................................... 32,197 36,284 30,590
-------- -------- --------
183,991 182,163 174,018
-------- -------- --------
Cost of goods sold and services performed:
Cost of goods sold .................................................... 73,449 71,887 68,842
Cost of services performed ............................................ 17,925 19,721 17,961
-------- -------- --------
91,374 91,608 86,803
-------- -------- --------
Gross profit ............................................................. 92,617 90,555 87,215
-------- -------- --------
Operating expenses:
Selling, general and administrative ................................... 50,115 51,338 44,216
Research and development .............................................. 7,036 5,871 6,615
Reversal of litigation accrual (Note 13) .............................. -- -- (5,006)
Impairment charge for China operations (Note 13) ...................... -- 133 1,578
Other expense net (Notes 1 and 12) .................................... 612 717 305
Restructuring charge (Note 11) ........................................ 539 -- --
-------- -------- --------
58,302 58,059 47,708
-------- -------- --------
Operating Income ......................................................... 34,315 32,496 39,507
Interest (income) expense:
Interest income ....................................................... (824) (654) (638)
Interest expense ...................................................... 26 910 179
-------- -------- --------
(798) 256 (459)
-------- -------- --------
Income from continuing operations before provision for income taxes and
minority interest ..................................................... 35,113 32,240 39,966
Provision for income taxes (Note 17) ..................................... 12,498 12,802 13,225
-------- -------- --------
Income from continuing operations before minority interest ............... 22,615 19,438 26,741
Minority interest in net income of subsidiary ............................ 447 248 241
-------- -------- --------
Income from continuing operations ........................................ 22,168 19,190 26,500
Discontinued Operations (Note 2): ........................................ (115) (4,968) (1,455)
-------- -------- --------
Net income ............................................................... $ 22,053 $ 14,222 $ 25,045
======== ======== ========
Earnings (loss) per Common Share:
Basic Income per share from continuing operations ..................... $ 1.73 $ 1.49 $ 2.05
Discontinued operations ............................................... $ (0.01) $ (0.39) $ (0.11)
-------- -------- --------
Basic net earnings per share .......................................... $ 1.72 $ 1.10 $ 1.94
======== ======== ========
Diluted Income per share from continuing operations ................... $ 1.72 $ 1.48 $ 2.03
Discontinued operations ............................................... $ (0.01) $ (0.38) $ (0.11)
-------- -------- --------
Diluted net earnings per share ........................................ $ 1.71 $ 1.10 $ 1.92
======== ======== ========
Basic weighted average number of shares outstanding ...................... 12,793 12,905 12,896
======== ======== ========
Diluted weighted average number of shares outstanding .................... 12,907 12,985 13,036
======== ======== ========
Dividends declared and paid per common share ............................. $ .24 $ .19 $ .16
======== ======== ========
See Notes to Consolidated Financial Statements
F-3
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Accumulated
Common Stock Other
-------------------- Comprehensive Retained Stockholders' Comprehensive
Shares Amount Income (Loss) Earnings Equity Income
---------- ------- ------------- -------- ------------- -------------
(Dollars in thousands except per share amounts)
Balance at September 30, 2001 ......... 12,935,656 $27,679 $(2,270) $135,217 $160,626
Net income ............................ 25,045 25,045 $25,045
Repurchase of common stock ............ (61,000) (2,268) (2,268)
Common stock issued under various
incentive plans .................... 63,346 1,341 1,341
Tax benefit from employees' and
directors' stock option plans
(Note 17) .......................... 2,172 2,172
Adjustment for aggregate unrealized
gain on marketable securities ...... 5 5 5
Acquisition of SSA .................... 1,888 1,888
Foreign currency translation gain ..... 1,076 1,076 1,076
Dividends paid ($.16 per share) ....... (2,070) (2,070)
---------- ------- ------- -------- --------
Balance at September 30, 2002 ......... 12,938,002 $30,812 $(1,189) $158,192 $187,815
-------
Comprehensive income ............... $26,126
=======
Net income ............................ 14,222 14,222 $14,222
Repurchase of common stock ............ (100,300) (2,579) (2,579)
Common stock issued under various
incentive plans .................... 77,864 1,936 1,936
Tax benefit from employees' and
directors' stock option plans
(Note 17) .......................... 298 298
Adjustment for aggregate unrealized
gain on marketable securities ...... 3 3 3
Foreign currency translation gain ..... 3,013 3,013 3,013
Dividends paid ($.19 per share) ....... (2,486) (2,486)
---------- ------- ------- -------- --------
Balance at September 30, 2003: ........ 12,915,566 $30,467 $ 1,827 $169,928 $202,222
-------
Comprehensive income ............... $17,238
=======
Net income ............................ 22,053 22,053 $22,053
Repurchase of common stock ............ (274,600) (8,143) (8,143)
Common stock issued under various
incentive plans .................... 74,277 1,695 1,695
Tax benefit from employees and
directors' stock option plans
(Note 17) .......................... 260 260
Foreign currency translation gain ..... 1,232 1,232 1,232
Dividends paid ($.24 per share) ....... (3,096) (3,096)
---------- ------- ------- -------- --------
Balance at September 30, 2004 ......... 12,715,243 $24,279 $ 3,059 $188,885 $216,223
========== ======= ======= ======== ========
-------
Comprehensive income ............... $23,285
=======
See Notes to Consolidated Financial Statements
F-4
VITAL SIGNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Year Ended September 30,
--------------------------------
2004 2003 2002
-------- ------- --------
(In thousands of dollars)
Cash flows from operating activities:
Net income ...................................................... $ 22,053 $14,222 $ 25,045
Add loss from discontinued operations ........................... 115 4,968 1,455
-------- ------- --------
Income from continuing operations ............................... 22,168 19,190 26,500
Adjustments to reconcile income from continuing operations to
net cash provided by continuing operations:
Depreciation and amortization ................................ 4,863 4,391 4,004
Deferred income taxes ........................................ 2,591 181 2,921
Impairment charge ............................................ -- 133 1,578
Minority interest in income of subsidiary .................... 447 248 241
Non cash gain on litigation accrual reversal ................. -- -- (5,006)
Tax benefit for stock options ................................ 260 297 2,172
Increase in rebate allowance ................................. -- 3,300 --
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable ...................... (2,233) 3,659 (274)
Decrease in inventory ........................................... 5,378 704 5,086
Decease (increase) in prepaid expenses and other current asset .. 1,121 (975) 2,418
Decrease in other assets ........................................ 449 755 34
(Decrease) in accounts payable .................................. (1,339) (231) (3,050)
Increase (decrease) in accrued expenses ......................... 1,505 (1,313) (300)
(Decrease) increase in income taxes payable ..................... (5) 5,883 --
Increase (decrease) in other liabilities ........................ 72 (869) (1,468)
-------- ------- --------
Net cash provided by continuing operations ................... 35,277 35,353 34,856
Net cash used in discontinued operations ..................... (153) (1,946) (1,204)
-------- ------- --------
Net cash provided by operating activities .................... 35,124 33,407 33,652
-------- ------- --------
Cash flows from investing activities:
Acquisition of property, plant and equipment .................... (3,069) (3,341) (2,323)
Net proceeds from sale of assets of Vital Pharma ................ 417 -- --
Net proceeds from sale of Vital Pharma real estate .............. 1,222 -- --
Capitalization of software development costs .................... (2,041) (924) (536)
Capitalization of patent costs .................................. (235) (397) (383)
Proceeds from sales of available for sale securities ............ -- 186 305
Acquisition of subsidiaries, net of cash acquired ............... -- -- (22,104)
-------- ------- --------
Net cash used in investing activities ........................ (3,706) (4,476) (25,041)
-------- ------- --------
Cash flows from financing activities:
Dividends paid .................................................. (3,096) (2,486) (2,070)
Proceeds from exercise of stock options ......................... 1,695 746 1,179
Repurchase of common stock ...................................... (8,143) (2,579) (2,268)
Issuance of common stock ........................................ -- -- 162
Principal payments on long-term debt and notes payable .......... (1,690) (265) (7,534)
-------- ------- --------
Net cash used in by financing activities ..................... (11,234) (4,584) (10,531)
-------- ------- --------
Effect of foreign currency translation ....................... 624 2,010 194
-------- ------- --------
Net increase in cash and cash equivalents .......................... 20,808 26,357 (1,726)
Cash and cash equivalents at beginning of year ..................... 55,660 29,303 31,029
-------- ------- --------
Cash and cash equivalents at end of year ........................... $ 76,468 $55,660 $ 29,303
======== ======= ========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest ..................................................... $ 22 $ 909 $ 185
Income taxes ................................................. $ 8,649 $ 6,373 $ 3,441
See Notes to Consolidated Financial Statements
F-5
Note 1--Summary of Significant Accounting Policies and Principal Business
Activities
Business Activities
Vital Signs, Inc. ("VSI") and its subsidiaries (collectively the "Company")
design, manufacture and market single-patient use products for the anesthesia,
respiratory/critical care, and sleep/personal ventilation markets. In addition,
the Company has two subsidiaries that provide services, one for the diagnosis of
sleep disorders through its sleep clinics, and the other for pharmaceutical
technology services.
Principles of Consolidation
The consolidated financial statements include the accounts of VSI and its
majority-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated. For comparability, certain 2003 and 2002 amounts
have been reclassified, where appropriate, to conform to the financial statement
presentation used in 2004.
Accounts Receivable
Accounts receivable are reported at their outstanding unpaid principal
balances reduced by an allowance for rebates and an allowance for doubtful
accounts. The Company records an allowance for rebates, on sales to
distributors, which is the difference between the established distributor 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 distributor price), less the amount of the
expected rebate, to arrive at the net sale. This net sale is the amount we
expect to receive in cash from the distributor on the sale. The Company also
records an allowance for doubtful accounts based on certain percentages of aged
receivables and historical payment experience. The Company writes off accounts
receivable against the allowance when a balance is determined to be
uncollectible.
Inventory
Inventory, net of reserves for obsolete and slow moving goods, are stated
at the lower of cost (first-in, first-out method) or market.
Depreciation
Depreciation and amortization of property, plant and equipment is provided
for by the straight-line method over the estimated useful lives of the related
assets.
Income Taxes
Income taxes are based upon amounts included in the Consolidated Statement
of Income. Deferred income taxes represent the tax effect of temporary
differences between the basis of assets and liabilities for income tax and
financial reporting purposes.
Revenue Recognition
For product sales to all customers except for certain domestic
distributors, revenue, net of allowances, is recognized upon shipment to the
customer, and when title passes. The Company establishes allowances for rebates
and sales returns. Substantially all of the Company's sales returns relate to
shipping errors or damaged goods. For service revenue, revenue is recorded when
the service is performed.
The Company's sales to U.S. distributors 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 the Company's
established distributor price, the distributor is then 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 the Company's sales to distributors, the Company records the
gross sale (at our established price), less the amount of the expected rebate,
to arrive at the net sale. This net sale is the amount the Company expects to
receive in cash from the distributor on the sale.
F-6
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 the Company with this
claim, the distributor will deduct the computed rebate from its net remittance.
The amount of the estimated rebate that has not yet been taken 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 claimed by the
distributors through documentation but not yet reimbursed and (2) an estimate by
the Company of the amount of future rebates due on any inventory that 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 the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003,
the Company concluded that the required allowance calculated as described in the
previous paragraph was greater than previously calculated by means of the
historical moving average calculation. As a result of this review of the rebate
allowance, the Company recorded an additional allowance for rebates of
$3,300,000 in the second quarter of fiscal 2003. The Company has continued to
monitor the recorded allowance for rebates, as well as the payments made against
this estimate, and believe that it is now providing a better estimate of the
ultimate rebate that distributors are entitled to than the estimate arrived at
through utilization of the historical moving average calculation.
Shipping and Handling
Costs incurred for shipping and handling fees are included in selling,
general and administrative expenses and amounted to $4,356,000, $4,375,000 and
$4,110,000 for the years ended September 30, 2004, 2003 and 2002, respectively.
Goodwill and Other Intangibles
The Company reviews the carrying value of long-lived assets, including
goodwill, on a periodic basis, or whenever events or changes in circumstances
indicate that the amounts may not be recoverable. If the events or circumstances
indicate that the carrying amount of an asset may not be recoverable, the
Company estimates the future undiscounted cash flows expected to result from the
use of the asset and its eventual disposition. An impairment loss will be
recognized if the carrying value of the assets exceeds the estimated future
undiscounted cash flows of those assets.
The Company performs 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. The Company completed this annual impairment test
during the three-month period ended March 31, 2004 and found no impairment.
Goodwill consists of the following:
For the Year Ended
September 30,
------------------
2004 2003
------- -------
(In thousands)
Beginning balance: ....................................... $69,506 $69,516
Other .................................................... -- (10)
------- -------
Ending balance ........................................... $69,506 $69,506
======= =======
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. The Company believes
it is not exposed to any significant credit risk with respect to its highly
liquid investments in money market securities and its commercial banking
facilities.
F-7
Net Income per Share of Common Stock
Basic net income per common share is computed using the weighted average
number of shares outstanding. Diluted net income per common share is computed
using the weighted average number of shares outstanding adjusted for the
incremental shares attributed to outstanding options to purchase common stock.
The following table sets forth the computation of basic and diluted net
income per share:
For the Year Ended September 30,
--------------------------------
2004 2003 2002
------- ------- -------
(In thousands, except
per share amounts)
Income applicable to common shares:
Income from continuing operations ....................... $22,168 $19,190 $26,500
Loss from discontinued operations ....................... (115) (4,968) (1,455)
------- ------- -------
Net income .............................................. $22,053 $14,222 $25,045
======= ======= =======
Shares outstanding
Basic weighted average common shares outstanding ........ 12,793 12,905 12,896
Dilutive effect of employee stock options ............... 114 80 140
------- ------- -------
Diluted outstanding shares .............................. 12,907 12,985 13,036
======= ======= =======
Earnings (loss) per common share:
Basic
Income per share from continuing operations ............. $ 1.73 $ 1.49 $ 2.05
Loss per share from discontinued operations ............. $ (0.01) $ (0.39) $ (0.11)
------- ------- -------
Net earnings ............................................ $ 1.72 $ 1.10 $ 1.94
======= ======= =======
Diluted
Income per share from continuing operations ............. $ 1.72 $ 1.48 $ 2.03
Loss per share from discontinued operations ............. $ (0.01) $ (0.38) $ (0.11)
------- ------- -------
Net earnings ............................................ $ 1.71 $ 1.10 $ 1.92
======= ======= =======
Capitalized Software
Software development costs are capitalized when technological feasibility
is established and are being amortized to cost of goods sold over the estimated
economic lives (generally three years) of the products that include such
software.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts in the financial statements. Actual
results could differ from those estimates.
Accounting for Stock-Based Compensation
The Company measures stock-based compensation cost for its employees and
directors using Accounting Principles Board ("APB") Opinion No. 25, as is
permitted by SFAS No. 123, Accounting for Stock-Based Compensation, and complies
with the other provisions and the disclosure-only requirements of SFAS No. 123.
Accordingly, the Company recognizes compensation expense for options granted to
employees and directors as the difference, if any, between the market price of
the underlying common stock on the date of grant and the exercise price of the
option.
F-8
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 years ended
September 30, 2004, 2003 and 2002 would approximate the pro forma amounts
indicated in the table below (dollars in thousands except per share amounts):
Year Ended September 30,
---------------------------
2004 2003 2002
------- ------- -------
Net income--as reported ............................... $22,053 $14,222 $25,045
Less: stock based compensation (net of related tax
benefit) ............................................ $ 1,215 $ 595 $ 365
Net income--pro forma ................................. $20,838 $13,627 $24,680
Basic net income per common share--as reported ........ $ 1.72 $ 1.10 $ 1.94
Diluted net income per common share--as reported ...... $ 1.71 $ 1.10 $ 1.92
Basic net income per common share--pro forma .......... $ 1.63 $ 1.06 $ 1.91
Diluted net income per common share--pro forma ........ $ 1.62 $ 1.05 $ 1.89
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 years ended September 30, 2004, 2003 and 2002,
respectively: expected volatility of 46%, 50% and 50%, respectively, risk-free
interest rate of 4.2%, 3.8%, and 5.2%, respectively, dividend yield rate of .6%,
..7%.and .5%, respectively, and expected lives of 5 years to 10 years.
Translation of Foreign Currency Financial Statements
The financial position and results of operations of the Company's foreign
subsidiaries are measured using local currency as the functional currency.
Assets and liabilities of these subsidiaries have been translated at current
exchange rates, and related revenue and expenses have been translated at average
monthly exchange rates. The aggregate effect of translation adjustments is
reflected as a separate component of stockholders' equity (accumulated other
comprehensive income (loss)) until there is a sale or liquidation of the
underlying foreign subsidiary.
Recent Accounting Pronouncements
The Company does not believe that any recently issued but not yet effective
accounting standards will have a material effect on the Company's consolidated
financial position or results of operations.
Note 2--Acquisitions/Dispositions
As part of the Company's strategic plan to expand significantly into the
obstructive sleep apnea field, the Company embarked on three strategic
acquisitions in which an interest in a European sleep therapeutic business was
acquired in 1999 followed by the acquisitions of two sleep diagnostic businesses
in the United States in 2000 and 2002. The Company purchased an additional
interest in the European sleep therapeutic business during 2001 and 2002. The
financial details of these acquisitions are described below.
Sleep Services of America, Inc./National Sleep Technologies, Inc.
On January 1, 2002 National Sleep Services completed its merger with HSI
Medical Services, Inc. ("HSI"), a subsidiary of the Johns Hopkins Health System
Corporation, with the merged entity known as Sleep Services of America, Inc.
("SSA"). This transaction resulted in a 62% ownership of SSA by the Company,
with an affiliate of Johns Hopkins Health System Corporation ("Hopkins")
receiving a 29% equity interest in SSA and the other minority shareholders of
NST receiving a 9% interest in SSA. In this transaction SSA issued 7,921,408
shares of its common stock with a fair value of approximately $4,753,000, along
with warrants to purchase 326,791 shares of SSA's common stock in exchange for
all of the outstanding common stock of HSI. The assets acquired, consisting
principally of cash and property and equipment, amounted to approximately $1.7
million and liabilities assumed, consisting principally of accounts payable and
accrued expenses, amounted to approximately $.4 million. The excess of the
purchase price over the fair value of the net assets acquired, goodwill, in this
transaction was approximately $3,561,000. Subsequently, the Company paid
approximately $775,000 for the purchase of shares of some of the minority
shareholders to increase its ownership to approximately 70% and reduce the
minority ownership (exclusive of Hopkins) to 1%. The above acquisitions have
been accounted for as purchases resulting in goodwill of
F-9
approximately $12.8 million, which is not deductible for income tax purposes and
which is included in the sleep segment. The goodwill was recognized in
accordance with SFAS No. 142 "Goodwill and Other Intangible Assets."
Breas Medical AB
Through September 30, 2000, the Company had acquired a 53% interest in
Breas Medical AB ("Breas"), a European manufacturer of personal ventilators for
obstructive sleep apnea ("OSA") and other applications, for an aggregate
investment of approximately $15.2 million. The assets acquired amounted to
approximately $7 million and liabilities assumed amounted to approximately $2
million. This acquisition has been accounted for as a purchase, resulting in an
excess of purchase price over the fair value of net assets acquired of
approximately $11.5 million. As of May 2, 2001, the Company purchased an
additional 41% of Breas from two minority shareholders, bringing the Company's
ownership percentage to 94%. The Company paid approximately $3.7 million upon
signing a definitive agreement, with the balance payable based upon an earnout
agreement calculated from a multiple of Breas' sales and earnings for the twelve
month period ended March 31, 2002. The final payment to the two minority
shareholders of $6.5 million, based on the earnout agreement, for the additional
41% ownership interest was made in April 2002. At the same time the Company
purchased the remaining 6% interest from the other minority shareholders for
$1.7 million.
As part of the settlement of the earnout agreement with one of the minority
shareholders, who was also the former chief executive officer of Breas, Breas
acquired the former chief executive officer's ownership interest in SPRL
Percussionaire. The purchase price for that interest is included in the $6.5
million payment. To complete the purchase of SPRL Percussionaire, additional
payments, in the form of an earnout agreement, were to be made to the founder of
SPRL Percussionaire, and the Company accrued an amount due of $1,015,000 in
September 2002. In fiscal 2003 Breas entered into a settlement agreement with
the founder of SPRL Percussionaire and terminated the obligation.
The total purchase price for Breas was approximately $27 million. Total
goodwill relating to the Breas transactions amounted to $19.9 million at
September 30, 2002 and was recognized in accordance with SFAS No. 142.
The Company has reflected the operations of Breas as a consolidated
subsidiary effective June 1, 1999.
Stelex--The Validation Group, Inc.
On March 28, 2002, the Company consummated the merger of Stelex Inc.
("Stelex") into the Company's wholly owned subsidiary, The Validation Group,
Inc. ("TVG"). The surviving entity is known as Stelex-TVG, Inc. The purchase
price for the acquisition of Stelex was approximately $13.7 million, including
costs of the acquisition of approximately $400,000. The assets acquired,
consisting principally of accounts receivable, amounted to $2.5 million and the
liabilities assumed, as adjusted, amounted to approximately $1.9 million,
consisting principally of amounts due to the former shareholders and deferred
revenue. The excess of the purchase price over the fair value of the net assets
acquired, goodwill, was approximately $13.1 million, which is deductible for
income tax purposes and which is included in the pharmaceutical technology
services segment. Goodwill was recognized in accordance with SFAS No. 142. The
results of operations of Stelex have been included in the Company's results of
operations since March 28, 2002.
The following summary, pro forma, unaudited data of the Company reflects
the acquisitions of Breas and National Sleep Technologies, SSA and Stelex as if
they had occurred on October 1, 2001.
Proforma/Unaudited
Fiscal 2002
--------------------
(In thousands except
per share amounts)
Net sales................................................ $181,461
Net income............................................... $ 26,477
Basic net income per share............................... $ 2.05
Diluted net income per share............................. $ 2.03
Such proforma data is not necessarily indicative of future results of
operations.
F-10
Vital Pharma, Inc.--Discontinued Operations
In September 2002, the Company adopted a formal plan to sell its Vital
Pharma, Inc. subsidiary, and as a result, classified the Vital Pharma business
as a discontinued operation. Vital Pharma, a fully integrated contract
manufacturer that utilizes blow-fill-seal technology, represented a product line
that was outside the Company's core business. The results of the discontinued
operations have been reported separately as discontinued operations in the
consolidated statement of income in accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. The Company lowered its
investment in Vital Pharma to the amount it expected to recover in the sale and
recorded a loss on disposal of $5,333,000 in fiscal 2003.
On October 30, 2003, the Company sold 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 accrues interest at 8%,
10%, and 12% in the first, second and third year of the note, respectively.
Interest is payable quarterly. If ProClinical had paid down the entire note in
the first twelve months, (which it did not do), the note would have been reduced
by $300,000. Should ProClinical pay down the entire note between the thirteenth
and eighteenth month, the note will be reduced by $200,000. The note is secured
by a first lien against all of the assets sold. No gain or further loss was
recorded on the sale.
The prior years' consolidated statements of income have been reclassified
to reflect the discontinued operations. During the quarter ended June 30, 2001,
the Company conducted a review by an outside appraiser to assess the carrying
value of the Company's investments. A major consulting firm was engaged to
assist the Company in an impairment analysis of Vital Pharma Inc., which had
sustained significant operating losses. The Company recorded a special charge
relating to Vital Pharma of approximately $18.2 million dollars. In the year
ended September 30, 2002, the Company reclassified the special charge of $18.2
million to discontinued operations. Vital Pharma has become a defendant in 37
separate lawsuits in connection with its packaging of a certain product for
Lifecore Biomedical, Inc. See Note 15, Contingent Liabilities, for additional
details.
Summarized selected financial information for the discontinued operations
is as follows:
For the Year Ended September 30,
--------------------------------
2004 2003 2002
----- ------- -------
(In thousands)
Revenue...................................... $ -- $ 3,383 $ 4,853
----- ------- -------
Loss before income tax benefit............... (178) (7,643) (2,176)
Income tax benefit........................... 63 2,675 721
----- ------- -------
Loss from discontinued operations............ $(115) $(4,968) $(1,455)
===== ======= =======
The assets and liabilities attributable to discontinued operations are
stated separately as of September 30, 2004 and 2003 on the consolidated balance
sheet. The major asset and liability categories attributable to discontinued
operations are as follows:
September 30,
--------------
2004 2003
---- ------
(In thousands)
Cash........................................................... $-- $ --
Accounts receivable............................................ -- 456
Inventories.................................................... -- 752
Net property, plant and equipment.............................. -- 892
Other assets................................................... -- 4
--- ------
Assets attributable to discontinued operations................. $-- $2,104
=== ======
Accounts payable and other accrued liabilities................. -- 184
Other liabilities.............................................. -- 319
--- ------
Liabilities attributable to discontinued operations............ $-- $ 503
=== ======
Cash flows of the discontinued operations consisted of the following for
the years ended September 30, 2004, 2003 and 2002:
F-11
2004 2003 2002
----- ------- -------
(In thousands)
Loss from discontinued operations........................ $(397) $(4,968) $(1,455)
Change in value of operating assets and liabilities...... (38) (383) 251
----- ------- -------
Net cash (used in) provided by discontinued operations... $(153) $(1,946) $(1,204)
===== ======= =======
Note 3--Inventory
Inventory consists of the following:
September 30,
-----------------
2004 2003
------- -------
(In thousands)
Raw materials............................................... $10,563 $12,570
Finished goods.............................................. 6,203 9,287
------- -------
Inventory, net.............................................. $16,766 $21,857
======= =======
Reserves for obsolete and slow moving goods at September 30, 2004 and 2003
were $1,151,00 and $981,000, respectively. Provisions charged to expense were
$732,000; $864,000 and $563,000 for fiscal 2004, 2003 and 2002, respectively.
Amounts written off against the reserve were $563,000, $321,000 and $303,000 for
fiscal 2004, 2003 and 2002, respectively.
Note 4--Prepaid Expenses
Prepaid expenses consist of the following:
September 30,
---------------
2004 2003
------ ------
(In thousands)
Prepaid taxes............................................... $ 147 $ 102
Prepaid insurance........................................... 1,067 1,514
Other....................................................... 1,602 1,623
------ ------
$2,816 $3,239
====== ======
Note 5--Other Current Assets
Other current assets consist of the following:
September 30,
---------------
2004 2003
------ ------
(In thousands)
Note and related party receivable........................... $ 181 $ 911
Deferred tax asset (Note 17)................................ 905 2,772
Other....................................................... 510 446
------ ------
$1,596 $4,129
====== ======
Related party receivables at September 30, 2004 and 2003 consist primarily
of unsecured promissory notes receivable dated November 30, 2001, from the CEO
at Thomas Medical Products who was also a Director of the Company, in the amount
of $154,000 and $637,000, respectively, bearing interest at 5.5% per annum and
due and was repaid on November 30, 2004, with the related accrued interest paid
annually. Mr. Thomas resigned from his position as CEO of Thomas Medical
Products and on the Board of Directors on October 1, 2004.
F-12
Note 6--Property, Plant and Equipment
Property, plant and equipment, at cost, consists of the following:
September 30,
----------------- Estimated
2004 2003 Useful Life
------- ------- --------------
(In thousands)
Land............................................. $ 2,232 $ 2,232
Building and building improvements............... 19,136 17,909 30 to 40 years
Equipment and molds.............................. 28,079 34,054 5 to 20 years
Fixtures and office equipment.................... 4,914 1,775 5 to 15 years
Transportation equipment......................... 36 49 5 years
------- -------
54,397 56,019
Less accumulated depreciation and amortization... 24,497 25,259
------- -------
$29,900 $30,760
======= =======
Note 7--Capitalized Software
Capitalized software is included in other assets and consists of the
following:
September 30,
---------------
2003 2002
------ ------
(In thousands)
Software development costs--Stelex Inc...................... $1,416 $ 818
Software development costs--Breas SA........................ 2,085 642
Accumulated amortization ................................... (920) (314)
------ ------
$2,581 $1,146
====== ======
SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased, or Otherwise Marketed," requires capitalization of software development
costs incurred subsequent to establishment of technological feasibility and
prior to the availability of the product for general release to customers. In
fiscal 2004 and fiscal 2003 the Company capitalized $2,041,000 and $924,000,
respectively, of software development costs, which primarily included personnel
and consulting costs. Amortization of capitalized software costs begins when
the product is available for general release to customers. Amortization is the
greater of the amount computed using (a) the ratio that current gross revenues
for the related product bear to the total of current and anticipated future
gross revenues for that product or (b) the straight-line method over the
remaining estimated economic life (generally three years) and charged to cost of
goods sold. For fiscal years 2004 and 2003, amortization was $606,000 and
$314,000, respectively.
Note 8--Long-term Debt
Long-term debt consisted of an Industrial Revenue Bond ("IRB") which was
payable in varying installments with an interest rate of 8.625% per annum
through December 2009. In accordance with the IRB agreement the Company prepaid
its full obligation in December 2003.
The Company has available a line of credit of $20,000,000 at September 30, 2004.
No amounts were outstanding under this line.
Note 9--Other Assets
Other assets consist of the following:
September 30,
---------------
2004 2003
------ ------
(In thousands)
Deposits on equipment......................................................... $ 752 $ 841
Capitalized Software (Note 7)................................................. 2,581 1,146
F-13
Receivable from participants in Vital Signs Stock Investment Plan (Note 15)... 846 1,098
Prepaid royalties............................................................. 653 800
Equity interest............................................................... 497 400
Other......................................................................... 623 583
------ ------
$5,952 $4,868
====== ======
Note 10--Accrued Expenses
Accrued expenses consist of the following:
September 30,
---------------
2004 2003
------ ------
(In thousands)
Interest.................................................... $ 68 $ 111
Payroll and vacations....................................... 3,538 2,436
Professional fees........................................... 1,026 979
Sales expenses.............................................. 233 182
Other taxes payable......................................... 543 252
Other....................................................... 2,372 2,339
------ ------
$7,780 $6,299
====== ======
Note 11--Restructuring Expense
The Company posted a $539,000 restructuring charge in the fourth quarter of
fiscal 2004 consisting of $172,000 for the closing of our California plant,
$111,000 for a reduction in force at our Totowa, NJ location and $256,000 for
the closing of the Breas sales office in Belgium.
Note 12--Other Expense (Income)--Net
Other operating expense (income)--net consists of the following:
For the Year Ended
September 30,
------------------
2004 2003 2002
---- ---- ----
(In thousands)
Charitable contributions of inventory..................... $223 $226 $347
Costs of discontinued public offering..................... -- 322 --
Acquisition costs......................................... 197 -- --
Other..................................................... 192 169 (42)
---- ---- ----
$612 $717 $305
==== ==== ====
Note 13--Impairment and Other Charges (Credits)
China
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. In
September 2003, the Company received $420,000 in cash from this distributor.
Accordingly in the fourth quarter of fiscal 2003, the Company recorded the
$420,000 payment as income, which reduced the net impairment charge to $133,000
during the year ended September 30, 2003.
During the quarter ended June 30, 2002, the Company recorded an impairment
charge of $1,578,000 related principally to its Chinese subsidiary based on an
evaluation of its business.
F-14
Japan
In September 1996, a patent infringement action was filed in Japan against
an original equipment manufacturer ("OEM") medical device distributor in
connection with the sale in Japan of Marquest Medical Products, Inc.'s
("Marquest") 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 in fiscal 2002.
Note 14--Commitments
Leases
The Company has entered into noncancelable operating leases providing for
the lease of office and warehouse facilities, equipment and certain other
assets. Rent expense, aggregating $1,659,000, $2,179,000 and $1,980,000 has been
charged to operations for the years ended September 30, 2004, 2003, and 2002,
respectively. The Company's commitment under such leases is as follows:
Year Ending September 30, (In thousands)
------------------------- --------------
2005........................................................... 1,214
2006........................................................... 1,102
2007........................................................... 841
2008........................................................... 301
2009........................................................... 198
2010 and thereafter............................................ 130
------
$3,787
======
Employment Agreements
The Company has entered into employment agreements, aggregating $1,926,000,
which expire at various dates through September 2005.
Note 15--Contingent Liabilities
Various lawsuits, claims and proceedings have been or may be instituted or
asserted against the Company in the normal course of business, including those
pertaining to patent and trademark issues and product liability matters. Where
the Company has deemed a loss probable, the amount of the expected loss, has
been accrued. While the amounts claimed or expected to be claimed in other
matters may be substantial, the ultimate liability cannot now be determined
because of the inherent uncertainties surrounding the litigation and the
considerable uncertainties that exist. However, based on facts currently
available, management believes that the disposition of matters that are pending
or asserted will not have a materially adverse effect on the financial position
of the Company.
On December 8, 1999, a complaint was filed against the Company 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 the Company's purchase of Vital
Pharma in December 1995. In August 2000, the court ordered the plaintiffs 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 presentation of testimony of both the plaintiff's direct
case and the defendant's case is essentially completed. There may be additional
testimony presented should the arbitrator permit plaintiffs to present a
rebuttal. The arbitrator has not set a schedule for post-arbitration briefs or
other submissions. It is likely that a decision may be rendered by the
arbitrator during the second quarter of fiscal 2005. Plaintiffs have claimed
damages in the pre-interest amount of approximately $8.0 million. The Company
has recorded a reserve in an amount not exceeding plaintiffs' claim.
F-15
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") for a product designed to prevent adhesions in
certain surgical procedures sold under the brand name "Intergel" by Ethicon,
Inc. (a subsidiary of Johnson and Johnson). The complaint also names Lifecore
and Ethicon, Inc. as defendants. On January 28, 2004 this same plaintiff filed a
similar action in California state court. On October 21, 2004 plaintiff
voluntarily dismissed the state court action without prejudice.
Following the service of the complaints described in the preceding
paragraph, Vital Pharma became a defendant in 37 matters filed in state court in
Florida related to the Intergel product. Vital Pharma has been served with
complaints in most of these filed actions, but has not yet been served in all of
them. Additional claims may be filed. Each of the complaints assert multiple
theories of negligence and product liability claims against the defendants for
injuries allegedly sustained through the use of Intergel during surgery.
Lifecore was the manufacturer of the product, which had been approved by
the FDA for reducing post-surgical adhesions. Vital Pharma packaged the product
for Lifecore pursuant to a written agreement. The agreement contained mutual
indemnification provisions, pursuant to which Lifecore and Vital Pharma agreed
to indemnify each other in the event either had breached their contractual
obligations.
Vital Pharma has notified Lifecore of Lifecore's obligations to defend and
indemnify Vital Pharma for these claims. The Company's insurance carrier has
been funding the defense of each of the pending actions. The Company believes
that it has meritorious defenses to these actions. Additionally, except for the
Company's responsibility for payment of the insured retention amounts under its
product liability policy, the Company believes that the coverage under the
primary and umbrella insurance policies, supplemented by Lifecore's
indemnification obligation, provide for adequate coverage for the claims. Also,
in light of the early stages of the proceedings the Company cannot quantify the
exposure, if any, to us. In light of the foregoing factors the Company has not
established a reserve for these matters.
The Company is also involved in other legal proceedings arising in the
ordinary course of business. The Company cannot predict the outcome of its legal
proceedings with certainty. However, based upon our review of pending legal
proceedings, the Company does 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.
Note 16--Stockholders' Equity
Preferred Stock
The Company has authorized 10,000,000 shares of no par value preferred
stock. No shares were issued or outstanding at September 30, 2004 or 2003.
Stock Options
Transactions relating to stock options are as follows:
Weighted Average
Number of Shares Price Per Share
---------------- ----------------
Balance September 30, 2001: .............. 456,257 $22.23
Granted ............................... 94,494 $34.49
Exercised ............................. (59,519) $19.80
Expired/canceled ...................... (31,898) $29.39
-------- ------
Balance September 30, 2002: .............. 459,334 $24.57
Granted ............................... 288,786 $28.56
Exercised ............................. (37,328) $19.95
Expired/canceled ...................... (72,933) $33.24
-------- ------
Balance September 30, 2003: .............. 637,859 $25.65
Granted ............................... 101,898 $30.02
F-16
Exercised ............................. (74,560) $22.85
Expired/canceled ...................... (110,668) $30.86
-------- ------
Balance September 30, 2004: .............. 554,529 $25.79
======== ======
The weighted average fair value per share calculated using the
Black-Scholes method for options granted during the years ended September 30,
2004, 2003, and 2002 amounted to $18.70, $17.52, and $21.42, respectively.
In 1994, the Company adopted a stock option and investment plan (covering a
maximum of 900,000 shares), whereby participants were granted two stock options
for each share of the Company's common stock that they acquired. The options are
granted at fair value at date of grant. Such stock options are subject to a
defined vesting schedule. Shares purchased by employees may be financed through
the Company.
The Company's Board of Directors and stockholders have approved the
adoption of the Vital Signs 2003 Investment Plan, which provides for the grant
of options to employees, officers and directors to purchase the Company's Common
Stock. In many respects, the 2003 Investment Plan is a renewal of the Company's
prior Investment Plan, which expires in January 2004. One million shares of the
Company's Common Stock have been authorized for share purchase and option
grants. Options may be granted at prices not less than fair value at the date of
grant. The options have a ten-year life. Options generally vest after a 2 year
period.
In fiscal 2002, the Company's Board of Directors and stockholders approved
the adoption of the 2002 Stock Incentive Plan, which provides for the grant of
options to employees, officers, directors and consultants to purchase a maximum
of one million shares. Although the Vital Signs option plans allow for the
grants of stock options to consultants, to date none have been granted to
consultants. Options may be granted at prices not less than fair value at the
date of grant. The options have a ten-year life. Options generally vest ratably
over a 5 year period commencing on the first anniversary of the grant with
respect to options granted under the 2002 Stock Incentive Plan and over 2 years
with respect to the Company's options granted as part of its investment plan and
to directors. The 2002 Stock Incentive Plan expires on May 31, 2012. As of
September 30, 2004, 335,578 shares had been granted under this plan.
In addition to options granted pursuant to Company benefit plans, the
Company, in fiscal 2004 and 2003 has granted (net of lapsed shares) 55,400 and
83,950, respectively, stock options to employees independent of any such plans.
As such, these options represent contractual commitments by the Company to the
individual involved.
In connection with the plans described above and other plans which are no
longer in force, options covering 1,694,715 shares (excluding lapsed shares)
have been granted through September 30, 2004.
The following table summarizes information about fixed stock options
outstanding at September 30, 2004:
Options Outstanding Options Exercisable
----------------------------------------- --------------------------
Weighted-
Number Average Weighted- Number Weighted-
Outstanding at Remaining Average Exercisable at Average
Range of September 30, Contractual Exercise September 30, Exercise
Exercise Prices 2004 Life (Years) Price 2004 Price
- ------------------ -------------- ------------ --------- -------------- ---------
1. $ 14.00 4,000 0.6 $14.00 4,000 $14.00
2. $ 17.25--$19.25 52,806 3.4 18.01 52,806 18.01
3. $ 20.00--$24.50 163,688 2.8 21.82 163,688 21.82
4. $ 25.52--$27.80 148,548 8.6 26.95 48,188 26.37
5. $ 28.90--$32.63 172,261 8.5 30.39 65,727 30.40
6. $ 34.94--$41.20 13,226 7.2 36.83 13,226 36.83
------- --- ------ ------- ------
Total: 554,529 6.3 $25.79 347,635 $23.97
======= === ====== ======= ======
F-17
Note 17--Income Taxes
The provision for income taxes consists of the following components:
For the Year Ended
September 30,
---------------------------
2004 2003 2002
------- ------- -------
(In thousands)
Current:
Federal.................................................. $ 8,510 $ 7,806 $ 9,872
State.................................................... 1,091 1,327 720
Foreign.................................................. 369 813 519
Deferred:
Federal.................................................. 2,508 112 1,313
State.................................................... 83 69 80
------- ------- -------
$12,561 $10,127 $12,504
------- ------- -------
Federal tax benefit from discontinued operations (Note 2)... $ (63) $(2,675) $ (721)
------- ------- -------
Income tax-expense from continuing operations............... $12,498 $12,802 $13,225
======= ======= =======
The breakdown of U.S. and Foreign income from continuing operations before
income taxes for the year ended September 30 was as follows:
2004 2003 2002
------- ------- -------
(In thousands)
United States..................................... $34,182 $29,904 $38,303
Foreign........................................... 931 2,336 1,663
------- ------- -------
Total income from continuing operations........ $35,113 $32,240 $39,966
======= ======= =======
The tax effect of temporary differences that give rise to the net
short-term deferred tax assets are presented below:
September 30,
--------------
2004 2003
---- ------
(In thousands)
Undistributed DISC earnings.................................... $(54) $ (88)
Net operating loss carryforward from acquisition............... 699 699
Deferred loss on disposal of discontinued operations........... -- 1,750
Other.......................................................... 260 252
---- ------
$905 $2,772
==== ======
The tax effects of temporary differences that give rise to the net
long-term deferred tax assets are presented below:
September 30,
---------------
2004 2003
------ ------
(In thousands)
Net operating loss carryforward from acquisition (Note 2).... $1,310 $2,009
Accelerated depreciation..................................... (744) (518)
Stelex goodwill.............................................. (634) (310)
Loss on sales of discontinued operation (Vital Pharma)....... 700 --
State net operating loss carryforward........................ 878 878
Undistributed DISC earnings.................................. -- (54)
F-18
Other........................................................ (152) 76
------ ------
$1,358 $2,081
====== ======
Less: Valuation allowance.................................... (562) (562)
------ ------
$ 796 $1,519
====== ======
At September 30, 2004, the Company has federal net operating loss
carryforwards of approximately $6,047,000 to offset future taxable income. These
net operating loss carryforwards expire from 2007 through 2010. The annual
amount available to offset consolidated taxable income is limited to
approximately $1,887,000 under Section 382 of the Internal Revenue Code. In
addition, at September 30, 2004, the Company has available approximately
$22,088,000 of New Jersey net operating loss carryforwards to offset future
state taxable income. The New Jersey operating loss carryforwards, as extended,
expire from 2007 through 2010. Utilization of these net operating losses has
been suspended for deduction carryover for privilege periods beginning during
calendar years 2002 and 2003, but this suspension extends the seven-year
carryforward period by two years. The Company has established a partial
valuation allowance against the New Jersey Net Operating loss carryforwards,
based upon management's estimate of future taxable earnings available to offset
the net operating loss.
The total provision for income taxes differs from that amount which would
be computed by applying the U.S. federal income tax rate to income before
provision for income taxes. The reasons for these differences are as follows:
For the Year Ended
September 30,
------------------
2004 2003 2002
---- ---- ----
Statutory federal income tax rate....................................... 35.0% 35.0% 35.0%
State income taxes net of federal tax benefit........................... 2.1 2.8 1.2
Product contributions................................................... -- -- (0.1)
Tax exempt interest..................................................... (0.6) -- --
Benefit from foreign sales corporation and extraterritorial exclusion... (0.9) (1.6) (1.1)
Income tax audit adjustment............................................. -- 3.4 --
Litigation reserve reversal............................................. -- -- (2.1)
Other................................................................... -- 0.1 0.2
---- ---- ----
Effective income tax rate............................................ 35.6% 39.7% 33.1%
==== ==== ====
Income taxes payable consist of the following:
September 30,
---------------
2004 2003
------ ------
(In thousands)
Federal income taxes payable.................................. $2,389 $2,538
State income taxes payable ................................... 422 236
Foreign income taxes payable ................................. 338 618
------ ------
$3,149 $3,392
====== ======
For the years ended September 30, 2004, 2003 and 2002, the Company
recognized for income tax purposes a tax benefit of $260,000, $298,000 and
$2,172,000, respectively, for compensation expense related to its stock option
plan for which no corresponding charge to operations has been recorded. Such
amount has been added to common stock in each year.
In connection with the routine Internal Revenue Service examination of the
Company's 1997, 1998 and 1999 Federal income tax returns, 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 in the
second quarter, and $40,000 in the third quarter of fiscal 2003. On October 6,
2003, the Company finalized the Internal Revenue Service tax audit for the years
1997, 1998 and 1999 and recorded an additional tax provision in the fourth
quarter of fiscal 2003 of $113,000. Also, certain state tax returns for prior
periods have been re-filed, resulting in additional tax expense of $297,000 and
interest expense of $70,000 in the third quarter of fiscal 2003.
F-19
Note 18--Allowance for Rebates and Doubtful Accounts
Information relating to the allowance for rebates and doubtful accounts is
as follows:
Balance
at end
Beginning of
Balance Charges(A) Deductions(B) Period
--------- ---------- ------------- -------
2002
Rebates................... $5,401 $36,912 $38,290 $4,023
Doubtful accounts......... 436 470 268 638
------ ------- ------- ------
$5,837 $37,382 $38,558 $4,661
====== ======= ======= ======
2003
Rebates................... $4,023 $44,439 $42,306 $6,156
Doubtful accounts......... 638 523 242 919
------ ------- ------- ------
$4,661 $44,962 $42,548 $7,075
====== ======= ======= ======
2004
Rebates................... $6,156 $47,809 $45,803 $8,162
Doubtful accounts......... 919 (232) 124 563
------ ------- ------- ------
$7,075 $47,577 $45,927 $8,725
====== ======= ======= ======
(A) Charges represent estimated rebates deducted from gross revenues and
estimated provision for doubtful accounts.
(B) Deductions represent actual rebates credited to the wholesaler and the
write-off of uncollectible accounts.
See Note 1 to the Consolidated Financial Statements for a further
description of rebates.
Note 19--Significant Customers
A portion of the Company's hospital customers are serviced by national and
regional medical supply distributors. During fiscal years 2004, 2003 and 2002,
respectively, 25%, 24%, and 26% of the Company's net revenue were made in this
distribution channel. In each fiscal year 2004, 2003 and 2002, one of the larger
national distributors represented approximately 11%, 10%, and 12%, respectively,
of net revenue. The same customer represented approximately 8% of outstanding
accounts receivable at September 30, 2004 and 2003, respectively.
Note 20--Segment Information
Vital Signs, Inc. sells single-patient use medical products to the
anesthesia, respiratory, critical care, sleep therapy and emergency markets. The
Company provides pharmaceutical technology services, principally to the
pharmaceutical companies and also, from time to time, to medical device,
diagnostic and biotechnology companies. 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
facilities, sales and administration support; therefore the operating expenses,
total assets, and capital expenditures are not specifically identifiable.
However the Company has allocated operating expenses, total assets, and capital
expenditures on a net sales basis. Management evaluates performance on 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
---------- ------------ ------- -------------- ------- ------------
2004
Net sales................. $ 82,791 $42,079 $44,053 $15,068 $ -- $183,991
Gross profit ............. 45,026 21,801 19,974 5,816 -- 92,617
Gross profit percentage... 54.4% 51.8% 45.3% 38.6% -- 50.3%
Operating profit.......... 21,783 9,618 1,689 1,225 -- 34,315
Total assets.............. 119,233 60,703 36,629 19,111 -- 235,676
F-20
Capital expenditures...... 1,022 950 1,879 647 -- 5,345
2003
Net sales................. $ 75,949 $45,829 $45,580 $18,105 $(3,300) $182,163
Gross profit.............. 40,880 24,866 19,921 8,188 (3,300) 90,555
Gross profit percentage... 53.8% 54.3% 43.7% 45.2% -- 49.7%
Operating profit.......... 19,416 11,023 2,874 2,483 (3,300) 32,496
Total assets.............. 105,221 63,493 35,387 18,977 -- 223,078
Capital expenditures...... 1,580 2,230 260 592 -- 4,662
2002
Net sales................. $ 71,823 $46,753 $39,628 $14,175 $ 1,639 $174,018
Gross profit.............. 37,129 26,107 17,660 4,880 1,439 87,215
Gross profit percentage... 51.7% 55.8% 44.6% 34.4% -- 50.1%
Operating profit.......... 20,940 14,243 887 1,998 1,439 39,507
Total assets.............. 103,545 65,899 28,117 7,516 -- 205,077
Capital expenditures...... 761 484 1,831 166 -- 3,242
The following table presents revenues by geographic area:
2004 2003 2002
-------- -------- --------
United States.................................. $137,404 $136,843 $135,740
Europe......................................... 35,258 35,101 29,232
Asia........................................... 3,619 4,864 5,113
Other.......................................... 7,710 5,355 3,933
-------- -------- --------
$183,991 $182,163 $174,018
======== ======== ========
Included in the Company's consolidated balance sheet are assets relating
to its foreign operations, which are primarily in Europe, and which total
approximately $28,260,000 and $27,665,000 at September 30, 2004 and 2003,
respectively.
Note 21--Related Party
One of the Company's subsidiaries, Thomas Medical Products, provides
product development and manufacturing services to X-Site Medical, LLC
("X-Site"), a company engaged in the development of arterial closure devices.
Through May 23, 2004 two of the shareholders of X-Site were also shareholders
and officers of the Company and two additional shareholders of X-Site were
independent members of the Company's Board of Directors. Thomas Medical Products
sales to X-Site were approximately $67,000 $363,000 and $375,000 during the
fiscal years ended September 30, 2004, 2003 and 2002, respectively, for these
services. Amounts due from X-Site are included in accounts receivable on the
Company's consolidated balance sheet and amounted to approximately $0 and
$199,000 at September 30, 2004 and 2003, respectively. X-Site was sold on May
24, 2004 to Datascope Corp., who is also a customer of Thomas Medical Products.
Note 22--Employee Benefit Plans:
The Company has established a savings incentive plan for substantially all
employees of the Company which is qualified under section 401(k) of the Internal
Revenue Code. The savings plan provides for contributions to an independent
trustee by both the Company and its participating employees. Under the plan,
employees may contribute up to 80% of their pretax base pay up to the dollar
limits set by law, $12,000 for each employee under 50 years of age, or $16,000
for each employee who is over 50 years of age in calendar year 2004 The Company
matches 25% of the first 6% of salary contributed by participants.
Participants vest immediately for their own contributions and for the Company's
contributions. Company contributions were approximately $350,000, $388,000, and
$295,000, for the years ended September 30, 2004, 2003 and 2002, respectively.
Note 23--Quarterly Financial Data (unaudited)
The following is a summary of the unaudited quarterly results of operations
for the years ended September 30, 2004 and 2003:
F-21
Fiscal Year Ended September 30, 2004
Income from Continuing Operations Net Income (Loss)
---------------------------------------------- -------------------------
Total Gross Basic Diluted Net Basic Diluted
Revenue Profit Income EPS EPS Income EPS EPS
-------- ------- ------- ----- ------- ------- ----- -------
1st Quarter... $ 43,848 $22,014 $ 5,224 $0.40 $0.40 $ 5,070 $0.39 $0.39
2nd Quarter... 46,637 23,238 5,414 0.42 0.42 5,397 0.42 0.42
3rd Quarter... 45,671 23,864 6,029 0.47 0.47 6,098 0.48 0.48
4th Quarter... 47,835 23,501 5,501 0.44 0.43 5,488 0.43 0.42
-------- ------- ------- ----- ----- ------- ----- -----
$183,991 $92,617 $22,168 $1.73 $1.72 $22,053 $1.72 $1.71
======== ======= ======= ===== ===== ======= ===== =====
Fiscal Year Ended September 30, 2003
Income from Continuing Operations Net Income (Loss)
---------------------------------------------- --------------------------
Total Gross Basic Diluted Net Basic Diluted
Revenue Profit Income EPS EPS Income EPS EPS
-------- ------- ------- ----- ------- ------- ------ -------
1st Quarter... $ 44,757 $23,215 $ 6,562 $0.51 $0.51 $ 6,205 $ 0.48 $ 0.48
2nd Quarter... 42,064 19,714 1,333 0.10 0.10 (1,222) (0.09) (0.09)
3rd Quarter... 48,171 23,783 5,378 0.42 0.41 3,788 0.30 0.29
4th Quarter... 47,171 23,843 5,917 0.46 0.46 5,451 0.42 0.42
-------- ------- ------- ----- ----- ------- ------ ------
$182,163 $90,555 $19,190 $1.49 $1.48 $14,222 $ 1.10 $ 1.10
======== ======= ======= ===== ===== ======= ====== ======
F-22
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Item 9A. 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.
Item 9B. Other Information
Not applicable
F-23
PART III
Item 10. Directors of the Registrant
The Company incorporates by reference herein information to be set forth in
its definitive proxy statement for its 2005 annual meeting of stockholders that
is responsive to the information required with respect to this Item. If such
proxy statement is not mailed to stockholders and filed with the Securities and
Exchange Commission within 120 days after the end of the Company's most recently
completed fiscal year, the Company will provide such information by means of an
amendment to this Annual Report on Form 10K.
Item 11. Executive Compensation
The Company incorporates by reference herein information to be set forth in its
definitive proxy statement for its 2005 annual meeting of stockholders that is
responsive to the information required with respect to this Item. If such proxy
statement is not mailed to stockholders and filed with the Securities and
Exchange Commission within 120 days after the end of the Company's most recently
completed fiscal year, the Company will provide such information by means of an
amendment to this Annual Report on Form 10K.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The Company incorporates by reference herein information to be set forth in its
definitive proxy statement for its 2005 annual meeting of stockholders that is
responsive to the information required with respect to this Item. If such proxy
statement is not mailed to stockholders and filed with the Securities and
Exchange Commission within 120 days after the end of the Company's most recently
completed fiscal year, the Company will provide such information by means of an
amendment to this Annual Report on Form 10K.
Item 13. Certain Relationships and Related Transactions
The Company incorporates by reference herein information to be set forth in its
definitive proxy statement for its 2005 annual meeting of stockholders that is
responsive to the information required with respect to this Item. If such proxy
statement is not mailed to stockholders and filed with the Securities and
Exchange Commission within 120 days after the end of the Company's most recently
completed fiscal year, the Company will provide such information by means of an
amendment to this Annual Report on Form 10K.
Item 14. Principal Accounting Fees and Services
The Company incorporates by reference herein information to be set forth in its
definitive proxy statement for its 2005 annual meeting of stockholders that is
responsive to the information required with respect to this Item. If such proxy
statement is not mailed to stockholders and filed with the Securities and
Exchange Commission within 120 days after the end of the Company's most recently
completed fiscal year, the Company will provide such information by means of an
amendment to this Annual Report on Form 10K.
35
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a-1) The financial statements listed in the index set forth in Item 8 of
this Annual Report on Form 10-K are filed as part of this Annual
Report.
(a-2) All schedules have been omitted because they are not applicable or
the required information is included in the financial statements or
notes thereto.
(a-3) The following exhibits are incorporated by reference herein or
annexed to this Annual Report:
Exhibit Description
- ------- -----------
3.1 -- Restated Certificate of Incorporation is incorporated by reference
to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the
year ended September 30, 1995.
3.2 -- Certificate of Amendment to the Restated Certificate of
Incorporation.
3.3 -- By-laws, as amended, are incorporated by reference to Exhibit 3.2
to the Company's Registration Statement on Form S-1 (No. 33-35864)
initially filed with the Commission on July 13, 1990.
4.1 -- 1984 Economic Development Authority Loan Agreement is incorporated
by reference to Exhibit 4.2 to the Company's Registration Statement
on Form S-1 (No. 33-35864) initially filed with the Commission on
July 13, 1990.
4.2 -- Amended and Restated Loan Agreement between the Company and the New
Jersey Economic Development Authority, dated as of November 1,
1990, is incorporated by reference to Exhibit 4.2 to the Company's
Registration Statement on Form S-1 (No. 33-34107) initially filed
with the Commission on February 21, 1991.
4.3 -- Letter of Credit and Reimbursement Agreement, dated August 27,
1993, between the Company and Chemical Bank New Jersey N.A. is
incorporated by reference to Exhibit 4.3 to the Company's Annual
Report on Form 10-K for the year ended September 30, 1993
10.1 -- 1990 Employee Stock Option Plan, as amended, is incorporated by
reference to Exhibit 10.1 to the Company's Annual Report on Form
10-K for the year ended September 30, 1997
10.2 -- 1991 Director Stock Option Plan, as amended, is incorporated by
reference to Exhibit 10.2 to the Company's Annual Report on Form
10-K for the year ended September 30, 1999.
10.3 -- Agreement between the Company and Respironics, Inc., dated
effective as of July 1, 1993, is incorporated by reference to
Exhibit 10.4 to the Company's Annual Report on Form 10-K for the
year ended September 30, 1993. Amendment to Agreement between the
Company and Respironics, Inc., dated September 14, 1999 is
incorporated by reference to Exhibit 10.3 to the Company's Annual
Report on Form 10-K for the year ended September 30, 1999.
10.4 -- Forms of Option Agreements with various employees of the Company
are incorporated by reference to Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (No. 33-39107) initially filed
with the Commission on February 21, 1991.
10.5 -- Vital Signs Investment Plan, as amended is incorporated by
reference to Exhibit 10.5 to the Company's Annual Report on Form
10-K for the year ended September 30, 1999.
10.6 -- Stock Option Grants to Terry D. Wall and Barry Wicker, replacing
stock options granted to Messrs. Wall and Wicker pursuant to the
1993 Executive Stock Option Plan, is incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-K for the
year ended September 30, 1996.
10.7 -- Form of Stock Option Agreement for certain employees of Thomas
Medical Products, Inc. is incorporated by reference to Exhibit 10.7
to the Company's Annual Report on Form 10-K for the year ended
September 30, 2001.
(table continued on next page)
36
(table continued from previous page)
Exhibit Description
- ------- -----------
10.8 -- Vital Signs 2002 Stock Incentive Plan, is incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended
September 30, 2003
10.9 -- Vital Signs 2003 Stock Investment Plan, is incorporated by
reference to the Company's proxy statement filed with the SEC on
September 2, 2003.
10.10 -- Employment agreement with Alex Chanin
14.1 -- Code of Ethics is incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended September 30, 2003.
21.1 -- Subsidiaries of the Registrant.
23.1 -- Consent of Goldstein Golub Kessler LLP.
24.1 -- Power of Attorney.
31.1 -- Certification of the Chief Executive Officer under Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 -- Certification of the Interim Chief Financial Officer under Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 -- Certification of the Chief Executive Officer Pursuant to 18 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 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.1 -- Risk Factors.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, this 14th day of
December, 2004.
VITAL SIGNS, INC.
By: /s/ RICHARD FEIGEL
-------------------------------
Richard Feigel
Interim Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ TERENCE D. WALL* President, Chief Executive Officer and Director December 14, 2004
- ------------------------------
(Terence D. Wall)
/s/ DAVID J. BERSHAD* Director December 14, 2004
- ------------------------------
(David J. Bershad)
/s/ HOWARD DONNELLY* Director December 14, 2004
- ------------------------------
(Howard Donnelly)
/s/ DAVID MACCALLUM* Director December 14, 2004
- ------------------------------
(David MacCallum)
/s/ RICHARD L. ROBBINS* Director December 14, 2004
- ------------------------------
(Richard L. Robbins)
/s/ GEORGE A. SCHAPIRO* Director December 14, 2004
- ------------------------------
(George A. Schapiro)
/s/ BARRY WICKER* Executive Vice President, December 14, 2004
- ------------------------------ International Sales and Director
(Barry Wicker)
/s/ RICHARD FEIGEL* Interim Chief Financial and Accounting Officer December 14, 2004
- ------------------------------
(Richard Feigel)
*By: /s/ RICHARD FEIGEL
-------------------------
Richard Feigel
Attorney-in-Fact
38
INDEX TO EXHIBITS
Exhibit Description
- ------- -----------
3.1 -- Restated Certificate of Incorporation is incorporated by reference
to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the
year ended September 30, 1995.
3.2 -- Certificate of Amendment to the Restated Certificate of
Incorporation.
3.3 -- By-laws, as amended, are incorporated by reference to Exhibit 3.2
to the Company's Registration Statement on Form S-1 (No. 33-35864)
initially filed with the Commission on July 13, 1990.
4.1 -- 1984 Economic Development Authority Loan Agreement is incorporated
by reference to Exhibit 4.2 to the Company's Registration
Statement on Form S-1 (No. 33-35864) initially filed with the
Commission on July 13, 1990.
4.2 -- Amended and Restated Loan Agreement between the Company and the
New Jersey Economic Development Authority, dated as of November 1,
1990, is incorporated by reference to Exhibit 4.2 to the Company's
Registration Statement on Form S-1 (No. 33-34107) initially filed
with the Commission on February 21, 1991.
4.3 -- Letter of Credit and Reimbursement Agreement, dated August 27,
1993, between the Company and Chemical Bank New Jersey N.A. is
incorporated by reference to Exhibit 4.3 to the Company's Annual
Report on Form 10-K for the year ended September 30, 1993
10.1 -- 1990 Employee Stock Option Plan, as amended, is incorporated by
reference to Exhibit 10.1 to the Company's Annual Report on Form
10-K for the year ended September 30, 1997
10.2 -- 1991 Director Stock Option Plan, as amended, is incorporated by
reference to Exhibit 10.2 to the Company's Annual Report on Form
10-K for the year ended September 30, 1999.
10.3 -- Agreement between the Company and Respironics, Inc., dated
effective as of July 1, 1993, is incorporated by reference to
Exhibit 10.4 to the Company's Annual Report on Form 10-K for the
year ended September 30, 1993. Amendment to Agreement between the
Company and Respironics, Inc., dated September 14, 1999 is
incorporated by reference to Exhibit 10.3 to the Company's Annual
Report on Form 10-K for the year ended September 30, 1999.
10.4 -- Forms of Option Agreements with various employees of the Company
are incorporated by reference to Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (No. 33-39107) initially filed
with the Commission on February 21, 1991.
10.5 -- Vital Signs Investment Plan, as amended is incorporated by
reference to Exhibit 10.5 to the Company's Annual Report on Form
10-K for the year ended September 30, 1999.
10.6 -- Stock Option Grants to Terry D. Wall and Barry Wicker, replacing
stock options granted to Messrs. Wall and Wicker pursuant to the
1993 Executive Stock Option Plan, is incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-K for the
year ended September 30, 1996.
10.7 -- Form of Stock Option Agreement for certain employees of Thomas
Medical Products, Inc. is incorporated by reference to Exhibit
10.7 to the Company's Annual Report on Form 10-K for the year
ended September 30, 2001.
(table continued on next page)
39
(table continued from previous page)
Exhibit Description
- ------- -----------
10.8 -- Vital Signs 2002 Stock Incentive Plan, is incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended
September 30, 2003
10.9 -- Vital Signs 2003 Stock Investment Plan, is incorporated by
reference to the Company's proxy statement filed with the SEC on
September 2, 2003.
10.10 -- Employment agreement with Alex Chanin
14.1 -- Code of Ethics is incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended September 30, 2003.
21.1 -- Subsidiaries of the Registrant.
23.1 -- Consent of Goldstein Golub Kessler LLP.
24.1 -- Power of Attorney.
31.1 -- Certification of the Chief Executive Officer under Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 -- Certification of the Interim Chief Financial Officer under Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 -- Certification of the Chief Executive Officer Pursuant to 18 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 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.1 -- Risk Factors.
40
STATEMENT OF DIFFERENCES
------------------------
The trademark symbol shall be expressed as............................. 'TM'
The registered trademark symbol shall be expressed as.................. 'r'