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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 December 31, 1997
[ ] 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 0-22229
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VITAL IMAGES, INC.
(Exact name of Registrant as specified in its charter)
MINNESOTA 42-1321776
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3100 WEST LAKE STREET, SUITE 100 55416
MINNEAPOLIS, MINNESOTA (Zip Code)
(Address of principal
executive offices)
(612) 915-8000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Preferred Stock Purchase Rights
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 27, 1998 was $6,821,527.
The number of shares outstanding of the issuer's classes of common stock as of
February 27, 1998: Common stock, $.01 Par Value - 4,804,562.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of registrant's definitive Proxy Statement in connection with the
Annual Meeting of Shareholders to be held May 13, 1998 ("1998 Proxy Statement")
are incorporated by reference into Part III.
VITAL IMAGES, INC.
FORM 10-K
TABLE OF CONTENTS
PART I
Page
Item 1. Business...........................................................3
Item 2. Properties........................................................22
Item 3. Legal Proceedings.................................................22
Item 4. Submission of Matters to a Vote of Security Holders...............22
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters...............................................22
Item 6. Selected Financial Data...........................................23
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................25
Item 8. Financial Statements and Supplementary Data.......................29
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...............................29
PART III
Item 10.Directors and Executive Officers of the Registrant................29
Item 11.Executive Compensation............................................30
Item 12.Security Ownership of Certain Beneficial Owners and Management....30
Item 13.Certain Relationships and Related Transactions....................30
PART IV
Item 14.Exhibits, Financial Statement Schedules and Reports on Form 8-K...31
Signatures........................................................32
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements. For
this purpose, any statements contained in this Form 10-K that are not statements
of historical fact may be deemed to be forward-looking statements. Without
limiting the foregoing, words such as "may," "will," "expect," "believe,"
"anticipate," "estimate" or "continue" or the negative or other variations
thereof or comparable terminology are intended to identify forward-looking
statements. These statements by their nature involve substantial risks and
uncertainties, and actual results may differ materially depending on a variety
of factors, including those set forth in the section below entitled "Important
Factors."
Item 1. BUSINESS
Vital Images, Inc. ("Vital Images" or the "Company") was incorporated in Iowa in
September 1988. In March 1997, the Company re-incorporated under the laws of the
state of Minnesota. The Company's principal executive offices are located at
3100 West Lake Street, Suite 100, Minneapolis, Minnesota 55416 (telephone (612)
915-8000, facsimile (612) 915-8010, e-mail - info@vitalimages.com ). From May
24, 1994 through May 11, 1997, the Company was a wholly-owned subsidiary of
Bio-Vascular, Inc. ("Bio-Vascular").
SPIN-OFF FROM BIO-VASCULAR
On October 28, 1996, the Board of Directors of Bio-Vascular, the former parent
company of Vital Images, Inc., approved a plan to spin off and establish Vital
Images as an independent, publicly-owned company. On May 12, 1997 (the
"Distribution Date"), Bio-Vascular distributed all of the shares of Vital Images
to the shareholders of Bio-Vascular (the "Distribution"), and on that date Vital
Images began operating as an independent public company. All Bio-Vascular
shareholders of record as of May 5, 1997 received one share of Vital Images
common stock for each two shares of Bio-Vascular stock held on that date, and
cash in lieu of fractional shares. As a result of Bio-Vascular's spin-off of
Vital Images, Vital Images' financial statements and notes thereto report the
business of Vital Images as an independent company. Vital Images is currently
traded on the OTC Bulletin Board under the symbol VTAL.
In anticipation of the Distribution, Bio-Vascular assigned to Vital Images,
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996. Subsequently, Bio-Vascular's Board of Directors agreed to make
such additional contributions as were necessary to bring cash, cash equivalents
and marketable securities to a combined total of $10,000,000 effective as of the
Distribution Date. On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balance to $10,000,000.
Additionally, Bio-Vascular made capital contributions to Vital Images of
approximately $3,200,000 representing net advances of cash over the period
beginning May 24, 1994, the date on which Vital Images was acquired by
Bio-Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular.
On July 17, 1997, the Board of Directors of the Company adopted a resolution
changing the Company's fiscal year end from October 31 to December 31, effective
with the calendar year beginning January 1, 1997. The 1997 fiscal year ended on
December 31, whereas the previous two fiscal years ended on October 31.
Accordingly, a two-month transition period from November 1, 1996 through
December 31, 1996 preceded the start of the new calendar year cycle. For
comparison purposes, results for the year ended December 31, 1997 are being
compared with results for the year ended October 31, 1996. The Company has not
recast the prior year financial information presented herein to conform to the
new fiscal year end, as management believes the October 31, 1996 results are
comparable to the December 31, 1997 results.
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BUSINESS DESCRIPTION
Vital Images is engaged in the business of developing, marketing and supporting
medical visualization software and systems for use in clinical diagnosis and
surgical planning. Medical visualization software involves the application of
computer graphics and image processing technologies to data supplied by standard
medical imaging equipment, such as computed tomography ("CT") scanners, magnetic
resonance imaging ("MRI") devices, and ultrasound scanning equipment. By
applying these technologies to medical imaging data, the Company's products
allow clinicians to create both two- and three-dimensional views inside the
human body and to "fly through" these images to support their clinical diagnosis
and surgical planning.
The Company has pioneered the use of computer-based visualization software and,
in particular, three-dimensional visualization software based on "volume
rendering" of imaging data. Initially, the Company focused on developing
powerful visualization software tools for use by engineers and researchers in a
variety of imaging applications, including oil and gas exploration, microscopy
and medical research.
In 1994, Vital Images was acquired by Bio-Vascular in a tax-free merger
accounted for as a "pooling of interests." The acquisition by Bio-Vascular
provided financial and management resources to Vital Images and enabled Vital
Images to leverage these resources and focus its efforts on medical applications
for its technologies. By the fall of 1994, Vital Images discontinued its efforts
in the microscopy market and, in July of 1995, granted an exclusive source code
license for its VoxelGeo product for gas and oil exploration to CogniSeis
Development, Inc. ("CogniSeis"). In exchange for this license, Vital Images
received a one-time license fee of $1,500,000 and future royalty payments that
began in 1997. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
The Company's current products include its VoxelView(R) and Vitrea(TM) medical
visualization software. VoxelView, the Company's first medical visualization
product, received 510(k) marketing clearance from the FDA in November 1995 and
currently has approximately 350 user sites around the world. The Vitrea system,
an advanced version of the Company's technology for medical visualization
applications, received 510(k) marketing clearance from the FDA in December 1996
and was released commercially in October 1997. The Company offers Vitrea both as
a software package and as part of an integrated software and hardware system to
radiologists, surgeons and other healthcare providers. Vitrea software and the
integrated Vitrea system are both designed for ready integration into hospital
radiology networks.
TECHNOLOGY
The core technologies underlying the Company's products are based on a
visualization technique known as "volume rendering." Volume rendering is an
advanced technique for displaying two- or three-dimensional views on a computer
monitor that has significant advantages over the alternative technique, known as
"surface rendering," in that it permits the direct display of imaging data
without mathematical modeling and allows interactive control of the level of
"transparency" of the data. By comparison, surface rendering requires the
creation of artificial surfaces based on imaging data, and the usefulness of the
resulting visual image is largely dependent on where these surfaces are "set" by
the clinical technician. Volume rendering is not dependent on the creation of
artificial surfaces and allows visualization of varying components that might
otherwise be eliminated from a surface rendered image due to surface
approximation.
Traditionally, volume rendering has largely been overlooked by visualization
companies because the computer power necessary to perform volume rendering is,
in general, significantly more intensive than the requirements for surface
rendering. The Company's experience with volume rendering has its basis in
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the efforts of Vincent J.Argiro, Ph.D., the founder of the Company, who
developed three-dimensional visualization software using volume rendering as an
aid in his research in developmental neuroscience. While other researchers
focused on optimizing their work within the constraints of surface rendering,
Dr. Argiro focused on accelerating the performance of volume rendering on
standard computer platforms. As a result of his work, he developed expertise in
accelerated volume rendering, which forms the core of the Company's volume
rendering technology.
As the performance of standard computer platforms continues to increase while
the relative cost of such performance continues to decrease, the Company
believes that volume rendering will be a more accessible imaging solution for
routine clinical applications.
STRATEGY
The Company's overall strategy is to develop and market leading edge medical
visualization software and systems to end users, and to seek opportunities to
integrate its technologies into medical imaging equipment developed and marketed
by other medical device manufacturers. The Company leverages its core
competencies in volume rendering, computer graphics, network technologies and
medical applications and, in addition, is pursuing collaborative partnerships
with leading medical institutions to further develop its product offerings.
The Company has concentrated its efforts, and will continue to do so during the
short-term, on the development and sale of advanced radiology visualization
systems, consisting of third party workstations and the Company's proprietary
visualization software. These workstations provide accelerated two- and
three-dimensional visualization capabilities for clinical diagnosis, screening
and surgical planning. As this strategy is advanced, the Company expects to
continue to add clinical value to these integrated systems, including additional
"pre-set" parameters for visualization of certain anatomical structures known as
"protocols", in order to establish a leading edge position in the clinical
application of its products. The Company also plans to migrate its technology to
increasingly cost-effective computers and operating environments, leveraging
personal computer and Internet technologies. As these technologies evolve, the
demand for integrated radiology workstations is expected to increase, extending
to primary care physicians, surgeons and other care providers. In addition, the
Company plans to offer elements of its software technologies or complete
customized software solutions to manufacturers of diagnostic and medical imaging
devices for integration into their systems. Although the Company expects to
focus its marketing efforts primarily on its Vitrea system, VoxelView software
and any successor product will continue to be offered to the medical
marketplace.
INDUSTRY BACKGROUND
Medical practices in the areas of diagnostic imaging, surgery and cancer
treatment have changed dramatically over the past 20 years, due in part to the
introduction of a variety of new imaging, visualization, computer, networking,
catheter and navigation technologies. The result has been the rapid adoption and
increased use of CT, MRI and ultrasound devices and the incorporation of new
physician-care practices based on the imaging information provided by these
devices.
Each of these modalities captures data that provides a two- or three-dimensional
image of the inside of the human body. These images have traditionally been
viewed as a series of two-dimensional, cross-sectional slices on x-ray-type
film. As computer and networking technologies improved, companies began offering
systems that provided for the electronic storage and transmission of these
images and allowed clinicians to view these images on a computer screen. The
first of these systems visualized the slice of data on a computer monitor and
then, more recently, began to permit viewing and manipulation of the data as a
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single, three-dimensional image. As a result, the medical visualization industry
today involves the visualization, manipulation, analysis and communication of
medical images in two and three dimensions.
While the market for medical imaging devices in the United States and other
industrialized countries is generally mature, the medical visualization industry
and the markets for medical visualization products have historically lagged the
imaging market due to the lack of industry standards for the generation,
transmission and storage of medical imaging data and due to computer costs and
performance considerations.
During the past five years, a number of technical and cost barriers to the
growth of the medical visualization industry and the picture archive and
communication systems ("PACS") industry have begun to erode. In particular, the
medical industry has embraced an image transmission and archiving standard
called DICOM3.0, promulgated by the American College of Radiology (ACR) and the
National Electronic Manufacturer's Association (NEMA). This standard permits
imaging, visualization, networking and archiving equipment and systems from
different vendors to work cooperatively within a single network. In addition,
the cost-to-performance ratio of computer products used in visualization and
PACS have improved dramatically, bringing the prices for medical visualization
capabilities and PACS within the grasp of many healthcare providers. The Company
believes that the increasing acceptance of industry standards such as DICOM3.0
and the improvements in the cost-to-performance ratio for clinical workstations
will support continued market growth in the medical visualization and PACS
industries.
The Company also expects that a number of other trends and innovations in
medical imaging and visualization will support growth in the medical
visualization industry, such as:
- higher levels of resolution, or image quality, being provided
by medical imaging devices, allowing higher quality
visualization results;
- increasing numbers of images or "slices" being provided by
medical imaging devices, making the viewing of printed images
on x-ray film, rather than in a visualization system,
logistically impractical and expensive; and
- increasing clinical acceptance of electronic visualization as
teaching institutions rely more heavily on computer technology
and as DICOM-compliant PACS networks and imaging systems
become standard in radiology departments.
The Company believes that the increased use of medical visualization
technologies and of PACS will improve medical practices and clinical and
economic outcomes in the fields of diagnostic radiology, surgery and oncology.
More specifically, the Company believes that:
- increased use of medical visualization technology has the
potential to improve radiologists' ability to determine
anatomical positions and pathologies and enhance their ability
to communicate their findings to fellow clinicians and
patients;
- advanced visualization may enhance surgeons' abilities to
plan and perform surgery by providing them with improved,
three-dimensional visual information regarding the position of
structures in the surgical field;
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- visualization may enhance oncologists' ability to isolate and
plan radiation therapy treatment and follow up on its
effectiveness by providing realistic, three-dimensional views
of the treatment area; and
- the integration of these clinical disciplines through
electronic visualization, networking and the Internet has the
potential to provide the opportunity for greater
cross-discipline coordination due to increased speed, access
to three-dimensional visual information, and the resulting
ability to perform consultative, interactive planning and
examination on computer workstations.
MARKETS
The Company participates in the developing medical visualization system market,
which has several segments, each at its respective stage of maturity and with
its own level of market penetration. The medical visualization system market
interrelates with a number of other markets such as the diagnostic imaging
equipment market, the PACS market and the hospital and clinical information
systems markets.
Medical visualization systems have applications in diagnostic screening and
radiology, remote diagnosis and consultation (e.g., telemedicine), surgical
assessment, planning, navigation and follow-up, cancer assessment and radiation
and chemotherapy treatment planning, and medical education. The customers for
these applications include radiology, surgery and oncology departments of
hospitals and research centers, diagnostic imaging and screening centers,
outpatient surgery centers and physician groups.
As discussed above, the overall market for medical visualization systems is in
its early stages, as the related technology and products that define this market
are relatively new and undergoing rapid change. Medical visualization system
solutions for diagnostic radiology have existed for the past five years.
However, most have been expensive (over $100,000), slow, difficult to use, and
of limited clinical application. The use of medical visualization systems to
assist in surgical planning and navigation has only begun to emerge into
clinical practice in the last three to five years, and primarily in applications
such as biopsy guidance in neuroradiology. While medical visualization systems
have also been used in these applications and to support cancer treatment
planning in the past, the Company believes that perspective, three-dimensional
volume rendering represents an untapped resource of practitioners for diagnostic
screening and radiology, surgical planning and navigation and cancer treatment.
PRODUCTS AND PRODUCT DEVELOPMENT
The Company's primary products include its initial medical visualization
software product, VoxelView, as well as Vitrea, its new advanced medical
visualization software product for clinical applications, which was commercially
released in October 1997.
The Company's VoxelView software received marketing clearance from the United
States Food and Drug Administration (the "FDA") in November 1995 for use as a
clinical diagnostic and surgical planning device when used with CT and MRI
medical imaging data. VoxelView software is marketed primarily to medical
researchers, although it is also used by radiologists and surgeons as a clinical
diagnostic and planning tool. VoxelView software's primary capability is the
ability to provide volume rendered, three-dimensional views of human anatomy
using three-dimensional image data sets from imaging devices such as CT and MRI
scanners. VoxelView software is a highly flexible tool, allowing the clinician
or researcher to interactively control many visualization parameters, including
brightness, contrast, color, transparency, shading, lighting, texture,
reflectivity and orientation. However, the ability to control these
visualization parameters limits the usefulness of VoxelView software in the
routine clinical setting, where an end user may be a skilled medical technician
lacking expertise in computer graphics techniques.
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In December 1995, the Company assessed its business strategy and determined that
to optimize its dedicated participation in the medical field it needed to create
a new product to be offered as an integrated software and hardware solution for
direct clinical application. The objective for this new product effort was to
produce an easy-to-use, clinical tool to allow radiologists and other clinicians
to use two- and three-dimensional visualization in their routine clinical
processes. Unlike its VoxelView software, the Company set out to design this new
product for users with clinical knowledge, rather than computer graphics
expertise. Specifications for this new product, called Vitrea, were developed in
early 1996, with software coding beginning in late spring of that year. The
Company submitted 510(k) documentation in September 1996 for the Vitrea system
and was granted marketing clearance by the FDA in December 1996 for use as a
clinical diagnostic and surgical planning device when used with CT and MRI
medical imaging data.
The Vitrea system capitalizes on the Company's experience in medical
visualization and provides clinicians with an easy-to-use tool with which to
diagnose and plan surgery, and represents the Company's most important step to
date as a provider of a range of clinical tools for broad distribution to the
medical visualization market. Vitrea's primary features are its high-speed
rendering capability and the ability to provide two- and three-dimensional
viewing for routine diagnosis and surgical planning, without requiring the user
to be trained in computer graphics techniques. The Company believes that both of
these features now make it possible to use three-dimensional medical
visualization in daily clinical routines. A Vitrea system user can view the
image data in two or three dimensions using visualization settings based on
specific clinical applications stored within the system, as dedicated
visualization protocols, and then interactively navigate around, or "fly
through," the image, allowing the user to view clinically relevant anatomies and
pathologies. The Company believes that no competitor has developed this
interactive "fly through" capability based on volume rendering operating on a
low-cost computer workstation. The Vitrea system also allows the user to capture
views by taking "snapshots," which can be downloaded into customized reports for
electronic transmission and archiving.
The Vitrea system conforms to the latest medical imaging and computer industry
standards, such as OpenGL(TM) computer graphics format and DICOM3.0.
The Company offers Vitrea both as a software package and as a part of an
integrated software and hardware system, consisting of Vitrea software installed
on a Silicon Graphics O2 workstation. Pursuant to an arrangement under a
reseller agreement between the Company and Silicon Graphics, the Company
purchases O2 workstation systems at a nominal discount, installs its Vitrea
software, and markets the package as an integrated medical visualization
solution, thereby implementing the Company's strategy to develop, market, sell
and support an integrated visualization workstation.
In addition to its immediate clinical applications, Vitrea software also
incorporates a number of additional technological advances, making it adaptable
to routine clinical use in surgical navigation and cancer treatment and for
integration into diagnostic imaging equipment manufactured by other companies.
In particular, Vitrea software was written using advanced programming
techniques, a modular, object-oriented design, C++ programming language, and a
shared messaging structure. These characteristics make it practical to modify
Vitrea software to suit the clinical needs of surgical navigation and oncology,
as well as allowing diagnostic equipment manufacturers to integrate the Vitrea
system or its components into imaging system consoles and off-line review
stations, thereby providing the Company with the opportunity to leverage the
Vitrea software development investment into new commercial areas.
In addition to its system and software products the Company also offers
maintenance and support contracts to its customers, as well as certain other
services such as installation and training. Maintenance contracts for VoxelView
software have typically been offered to licensees on an annual basis, and
provide
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for software updates, error correction, telephone support and other general
maintenance services in exchange for an annual maintenance fee. In connection
with the commercial release of the Vitrea system, the Company also markets
similar annual maintenance services for both the Vitrea software and the
integrated Vitrea system, pursuant to which the Company provides updates, error
correction, telephone support and general maintenance services. Outside of these
maintenance contracts, the Company is required by FDA regulation to provide
certain levels of support to end users as a result of use of its products as
medical devices. Maintenance contracts currently marketed by the Company do not
include installation, training, testing and other services, whether on- or
off-site, as such services are charged separately by the Company.
In August 1996, the Company entered into a product development agreement with
Advanced Technologies Laboratories, Inc. ("ATL"), one of the leading ultrasound
system vendors. Pursuant to this agreement, each party agreed to collaborate
exclusively with the other for a period of five years in connection with the
development of three-dimensional visualization products for medical diagnostic
ultrasound imaging applications, provided that the Company may collaborate with
other parties in connection with products to be used in multi-modality
environments (i.e., environments that offer multiple imaging technologies and
not just ultrasound imaging). ATL will reimburse the Company for certain product
development costs and will have responsibility for obtaining regulatory
approvals. Intellectual property developed jointly by the parties pursuant to
this agreement will be jointly owned by both parties, each with the right to use
or license such intellectual property.
The Company spent $2,255,000, $1,459,000 and $1,357,000 on research and
development efforts in each of the fiscal years ended December 31, 1997, October
31, 1996, and 1995, respectively.
COMPETITION
The medical visualization systems market is immature, and the competition in
this market is intense but fragmented, consisting of numerous types of competing
businesses, each with their own focus and basis for their competitive position.
The Company faces competition from five primary sources in the medical
visualization market: (i) diagnostic imaging system suppliers; (ii) other
visualization systems and software developers; (iii) PACS vendors; (iv)
hospital, radiology and clinical systems suppliers; and (v) internal development
projects sponsored by hospital radiology departments.
The most significant sources of competition faced by the Company are the various
diagnostic imaging systems suppliers, which are typically large, multinational
companies, having far greater financial and research and development resources
than the Company, and which also have well established sales and distribution
networks for their products. These companies, including GE Medical Systems,
Siemens Medical Systems, Inc., Picker International, Inc. and Philips Medical
Systems, are engaged in the business of developing and marketing medical imaging
systems, such as CT and MRI equipment, and either offer, or will likely seek to
offer, visualization capabilities integrated into their products in addition to
the visualization capabilities typically provided as a part of the operator's
console on the imaging equipment itself. This visualization capability may be
internally developed by these companies, or may be licensed from independent
vendors, such as Vital Images.
In addition, the Company faces competition from companies developing other
visualization technologies, such as electronic emulation of the traditional
film/light box viewing methods and surface rendering. PACS companies sometimes
provide visualization capability in addition to their image archiving and
networking products. Vendors of hospital, clinical and radiology information
systems have also diversified into the PACS and medical visualization product
lines, either through internal development or business development. These
companies, which may be large or small, attempt to offer an integrated system
covering a full range of administrative, clinical and radiology information
management
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capabilities to healthcare providers. Finally, many research and university
healthcare institutions attempt to develop their own visualization systems. Some
departments have in the past, and may in the future, attempt to secure FDA
clearance for such systems, and to license such systems or technology for
general commercial sale.
The Company's competitive position is based on its ability to (i) provide
differentiated medical visualization system products that operate in
multi-vendor network and image source environments; (ii) provide clinical
quality, three-dimensional images, volume rendered at high speed, and
interactive navigation on a low cost standard computer; (iii) integrate clinical
knowledge from its collaborative clinical partners into its products; (iv) offer
a "DICOM client" system which can operate on any DICOM network, independent of
the imaging system and network provider; (v) serve both original equipment
manufacturers ("OEM") and end-user customers through the development of a
modular end-user system that can easily be segmented for OEM customers; and (vi)
leverage its visualization technology across multiple clinical disciplines,
including radiology, surgery and oncology.
MARKETING, DISTRIBUTION AND CUSTOMER SUPPORT
The Company markets its products both as a software package and as part of an
integrated software and hardware system to primary care physicians,
radiologists, surgeons and medical researchers. The Company markets its products
directly to end-user customers, such as hospitals and clinics, as well as to
select diagnostic imaging companies, digital imaging equipment manufacturers and
PACS companies for resale on either a Vital Images' branded or private label
basis.
In addition, the Company markets its products directly to OEMs on either a
standard or customized basis. In connection with its OEM opportunities, the
Company will either provide complete systems for resale by such OEMs or will
provide elements of its technology for incorporation into the products and
systems of such OEMs. The Company has already established an OEM relationship
with ATL, pursuant to a sales and marketing agreement entered into in August
1996. Pursuant to this agreement, ATL has been granted exclusive world-wide
rights to market products jointly developed by the parties for use in the
medical diagnostic ultrasound market in return for royalty payments on such
sales. ATL's exclusivity will continue from year to year for each product upon
the attainment of agreed-upon market objectives.
The Company markets its products both domestically and internationally. In the
United States, the Company markets its products through its direct sales force
as well as through OEMs and resellers. Internationally, the Company markets its
products through OEMs and resellers. See Note 8 to the Financial Statements -
"Major Customers and Geographic Data" for information regarding the Company's
export sales. As of February 27, 1998, the Company had two direct salespeople,
one international reseller salesperson, one OEM customer and several
international resellers.
INTELLECTUAL PROPERTY
Although the Company has filed patent applications with respect to certain of
its technology, it generally does not rely on patent protection with respect to
its products and technologies. Instead, the Company relies primarily on a
combination of trade secret and copyright law, employee and third party
nondisclosure agreements and other protective measures to protect intellectual
property rights pertaining to its products and technologies. There can be no
assurance, however, that these measures will provide adequate protection of the
Company's trade secrets, know-how or other intellectual property from
unauthorized use, misappropriation or disclosure, or that others will not
independently develop similar technologies or duplicate technology developed by
the Company. In addition, to the extent that any
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patents are applied for, there can be no assurance that such applications will
result in issued patents or, if issued, that such patents will be held to be
valid or will otherwise be of value.
Competitors and potential competitors of the Company, many of which have
substantially greater resources, may have applied for or obtained, or may in the
future apply for or obtain, patents that could prevent, limit or interfere with
the ability of the Company to manufacture and sell its products and
technologies. Although the Company does not believe that its products and
technologies infringe any existing patents or intellectual property rights of
third parties, there can be no assurance that such infringement does not
currently exist or will not exist in the future. The costs of defending an
intellectual property claim could be substantial and could adversely affect the
Company, even if it were ultimately successful in defending any such claims. If
the Company's products or technologies were found to infringe the rights of a
third party, the Company could be required to pay significant damages or license
fees or cease production, which could have a material adverse effect on the
Company's business.
Because of the rapid pace of technological change in the medical visualization
industry, the Company believes that patent, trade secret and copyright
protection are less significant to its competitive position than factors such as
the knowledge, ability and experience of its personnel; new product developments
and enhancements; and ongoing, reliable product maintenance and support.
Pursuant to a licensing agreement dated June 30, 1992 between the Company and
Maharishi International University ("MIU"), MIU granted a perpetual, worldwide,
exclusive source code license to certain volume rendering software developed by
Dr. Argiro at MIU and used in the Company's VoxelView product. Royalty
obligations of the Company pursuant to this agreement expired in May of 1996.
Vitrea includes certain DICOM libraries that are owned by Duke University
("Duke"). These libraries, which allow the Company's products to interface with
DICOM networks, are the subject of a licensing agreement that was entered into
between the Company and Duke in August 1997. Under the terms of the agreement,
the Company has the right to use, market, distribute and sell the Duke DICOM
libraries with its products. In exchange for the license, which has a perpetual
term, the Company paid Duke $75,000.
MANUFACTURING AND SERVICE
The Company's manufacturing efforts are limited to the production, quality
assurance and distribution of its VoxelView and Vitrea software, which is
distributed on CD-ROM. The software is sent to the customer site and loaded into
the computer on site. VoxelView software is loaded into the computer by the
customer with telephone assistance from the Company, as needed. The software for
Vitrea is loaded into the computer by Company personnel, as part of the
Company's installation services. In addition to the loading of software into the
computer, the Company's installation services also include integrating Vitrea
workstations into customers' computer networks, configuring network requirements
and validating operations on site.
The Company relies primarily on its own software development as its core value
added. Given the nature of software, there is no raw material as such. The
Company sources its DICOM libraries from Duke and the operating system for
integrated computer workstations from other parties. In addition, the Company
sources systems components, computers and computer peripherals from suppliers
such as Silicon Graphics and Access Graphics, Inc.
11
GOVERNMENTAL REGULATION
As medical devices, the Company's medical visualization products are subject to
extensive and rigorous regulation by numerous governmental authorities,
principally the FDA and corresponding foreign agencies. In the United States,
the FDA administers the Federal Food, Drug and Cosmetics Act and amendments
thereto contained in the Safe Medical Devices Act of 1990. These regulations
classify medical devices as either Class I, II or III devices, which are subject
to general controls, special controls or premarket approval requirements,
respectively. All Class I and II devices, as well as some Class III devices
marketed prior to the effective date of the Medical Device Amendments of 1976,
can be cleared for marketing pursuant to a 510(k) pre-market notification
establishing that the device is "substantially equivalent" to a device that was
legally marketed prior to May 28, 1976, the date on which the Medical Device
Amendments of 1976 became effective. The 510(k) pre-market notification must be
supported by data establishing the claim of substantial equivalence to the
satisfaction of the FDA. The process of obtaining a 510(k) clearance typically
can take several months to a year or longer.
If substantial equivalence cannot be established, or if the FDA determines that
the device or the particular application for the device requires a more rigorous
review, the FDA will require that the manufacturer submit a pre-market approval
("PMA") application that must be carefully reviewed and approved by the FDA
prior to sale and marketing of the device in the United States. The PMA
application must include the results of clinical trials, the results of all
relevant prototype tests, laboratory and animal studies, a complete description
of the device and its components, and a detailed description of the methods,
facilities and controls used for manufacturing. In addition, the submission must
include the proposed labeling, advertising literature and training methods, if
applicable. The process of obtaining a PMA can be expensive, uncertain and
lengthy, frequently requiring anywhere from one to several years from the date
of FDA submission, if approval is obtained at all. Moreover, a PMA, if granted,
may include significant limitations on the indicated uses for which a product
may be marketed.
Both of the Company's current products, VoxelView and Vitrea, are classified as
Class II medical devices and have received marketing clearance from the FDA as
the result of 510(k) submissions. VoxelView software received marketing
clearance in November 1995 for use as a clinical diagnostic and surgical
planning device when used in concert with CT and MRI medical imaging data.
Vitrea was cleared for marketing in December 1996 for clinical diagnosis and
surgical planning in concert with CT and MRI medical imaging data, both as
stand-alone software and as a part of the integrated Vitrea system. Although the
Company has received marketing clearance for these products as Class II devices,
there can be no assurance that future products or enhancements to existing
products introduced by the Company will not be subject to the more rigorous PMA
process, or that marketing clearance will be granted at all. Vital Images has no
history of obtaining marketing clearance for its products as a company
independent from Bio-Vascular, although Vital Images has developed its own
internal regulatory affairs capability since the Distribution.
The Company is also increasingly becoming subject to regulation in those foreign
countries in which it sells its products with regard to product standards,
packaging requirements, labeling requirements, import restrictions, tariff
regulations, duties and tax requirements. Many of the regulations applicable to
the Company's products in such countries are similar to those of the FDA, and
the national health or social security organizations of certain of such
countries require the Company's products to be qualified before they can be
marketed in those countries. The Company's ability to successfully market and
sell its products internationally depends in large part on its ability to comply
with such foreign regulatory requirements. In October 1997, Vitrea software
obtained the CE mark, which cleared the product for marketing in the member
countries of the European Communities ("EC").
12
The Company is also subject to periodic inspections by the FDA, whose primary
purpose is to audit the Company's compliance with quality service regulations
("QSR") established by the FDA and other applicable government standards. Strict
regulatory action may be initiated in response to audit deficiencies or to
product performance problems. The Company believes that its manufacturing and
quality control procedures are in compliance with the material requirements of
the FDA regulations.
The financial arrangements through which the Company markets, sells and
distributes its products may be subject to certain federal and state laws and
regulations in the United States with respect to the provision of services or
products to patients who are Medicare or Medicaid beneficiaries. Violations of
these laws and regulations may result in civil and criminal penalties, including
substantial fines and imprisonment. In a number of states, the scope of these
laws and regulations have been extended to include the provision of services or
products to all patients, regardless of the source of payment, although there is
variation from state to state as to the exact provisions of such laws or
regulations. In other states, and, on a national level, several health care
reform initiatives have been proposed which would have a similar impact. The
Company believes that its operations and its marketing, sales and distribution
practices currently comply in all respects with all current fraud and abuse and
physician anti-referral laws and regulations, to the extent they are applicable.
Although the Company does not believe that it will need to undertake any
significant expense or modification to its operations or its marketing, sales
and distribution practices to comply with federal and state fraud and abuse and
physician anti-referral regulations currently in effect or proposed, financial
arrangements between manufacturers of medical devices and other health care
providers may be subject to increased regulation in the future. Compliance with
such regulations could adversely affect the Company's marketing, sales and
distribution practices, and may affect the Company in other respects not
presently foreseeable, but which could have an adverse impact on the Company's
business, financial condition and results of operations.
THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT
The Company's products are purchased primarily by hospitals, clinics and other
users that bill various third party payors for the services provided to the
patients. These payors, which include Medicare, Medicaid, private insurance
companies and managed care organizations, reimburse part or all of the costs and
fees associated with the procedures utilizing the Company's products. Medicare
and Medicaid reimbursement for hospitals is based on a fixed amount for
admitting a patient with a specific diagnosis. Because of this fixed
reimbursement method, hospitals have incentives to use less costly methods in
treating Medicare and Medicaid patients, and will frequently make capital
expenditures to take advantage of less costly treatment technologies.
Frequently, reimbursement is reduced to reflect the availability of a new
procedure or technique and, as a result, hospitals are generally willing to
implement new cost-saving technologies before these downward adjustments take
effect. Likewise, because the rate of reimbursement for certain physicians who
perform certain procedures has been and may in the future be reduced in the
event of changes in the resource-based relative value scale method of payment
calculation, physicians may seek greater cost efficiency in treatment to
minimize any negative impact of reduced reimbursement. Any amendments to
existing reimbursement rules and regulations which restrict or terminate the
reimbursement eligibility (or the extent or amount of coverage) of medical
procedures using the Company's products or the eligibility (or the extent or
amount of coverage) of the Company's products could have a material adverse
impact on business.
In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be proposals by legislators and regulators
and third party payors to reduce these costs. There has also been a significant
increase in the number of Americans enrolling in some form of managed care plan,
and over 80% of hospitals participate in or have agreements with HMOs. It has
become a typical practice for hospitals to affiliate themselves with as many
managed care plans as possible. Higher managed care
13
penetration typically drives down the prices of healthcare procedures, which in
turn places pressure on medical supply prices. This causes hospitals to
implement tighter vendor selection and certification processes, by reducing the
number of vendors used, purchasing more products from fewer vendors and trading
discounts on price for guaranteed higher volumes to vendors. Hospitals have also
sought to control and reduce costs over the last decade by joining group
purchasing organizations or purchasing alliances. The Company cannot predict
what continuing or future impact these practices, the existing or proposed
legislation, or such third party payor measures may have on its future business.
RELATIONSHIP BETWEEN BIO-VASCULAR AND VITAL IMAGES
For purposes of governing certain of the ongoing relationships between
Bio-Vascular and Vital Images after the Distribution, Bio-Vascular and Vital
Images entered into various agreements and relationships regarding the manner
and effect of the Distribution, certain transition services, employee benefits,
tax and indemnification matters, and other matters relating to the Distribution.
Each of the agreements is intended to set forth, on an arms-length basis, the
agreement of the parties with respect to each of these matters. The agreements
were included as exhibits to the Registration Statement on Form 10 and this
summary is qualified in its entirety by reference to the agreements as filed.
EMPLOYEES
As of February 27, 1998, the Company had 42 employees, with 18 involved in
research and development, 8 in sales and marketing, 7 in technical support
functions and 9 in administrative functions.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth, below, are the names of the executive officers of the Company as of
February 27, 1998, their ages, the year first elected as an executive officer of
the Company and employment for the past five years.
NAME AGE TITLE
- ------------------------ ---- ---------------------------------------
Douglas M. Pihl 59 Chairman of the Board, President,
Chief Executive Officer and Director
Vincent J. Argiro, Ph.D. 42 Executive Vice President, Chief
Technology Officer and Director
Gregory S. Furness 44 Vice President - Finance, Chief
Financial Officer, Treasurer
and Secretary
Jay D. Miller 38 Vice President, Marketing and Sales
Douglas M. Pihl. Mr. Pihl has been a director of the Company since May 1997, its
Chairman of the Board since December 1997, and its acting Chief Executive
Officer since January 1998. Since August 1996, Mr. Pihl has been a private
investor. From May 1992 to August 1996, Mr. Pihl was the President and Chief
Executive Officer of NetStar, Inc. Mr. Pihl has over 30 years of experience in
the computer industry with extensive responsibility in design, product planning
and management. From February 1989 to December 1990 he was Senior Vice
President, Development for Apertus Technologies, Inc. (formerly Lee Data
Corporation). From December 1987 until February 1989, Mr. Pihl was an
independent consultant. He was Senior Vice President-Development of Lee Data
Corporation ("Lee Data") from April
14
1979 until December 1987. Mr. Pihl was a founder in 1979 of Lee Data,
Minneapolis, Minnesota, which then developed, manufactured and marketed computer
peripheral products.
Vincent J. Argiro, Ph.D. Dr. Argiro was appointed Executive Vice President and
Chief Technology Officer of the Company in October 1995. From May 1994 until May
1997 Dr. Argiro also served as a Vice President of Bio-Vascular, the former
parent company of the Company. Dr. Argiro served as a director of Bio-Vascular
from May 1994 until March 1996. Following the acquisition of the Company by
Bio-Vascular in May 1994, Dr. Argiro served as President of the Company until
October 1995. Dr. Argiro, the founder of the Company, served as Chairman of the
Board of the Company from 1988 until May 1994. From 1988 to 1990 and from
September 1991 to June 1992, Dr. Argiro also served as President of the Company.
Prior to June 1992, Dr. Argiro served as an Associate Professor of Physiology at
Maharishi University of Management in Fairfield, Iowa, where he conducted
research in neuroscience and cell biology.
Gregory S. Furness. Mr. Furness was named Vice President - Finance, Chief
Financial Officer, Treasurer and Secretary of the Company in February 1997. From
December 1987 to December 1996 Mr. Furness served as Executive Vice President
and Chief Financial Officer of CAMAX Manufacturing Technologies, Inc., a
computer-aided manufacturing software developer, which was acquired by
Structural Dynamics Research Corporation in June 1996. Prior to December 1987,
Mr. Furness was employed as Vice President, Finance and Chief Financial Officer
of Mizar, Inc., and as an audit manager at Deloitte and Touche LLP. Mr. Furness
is a Certified Public Accountant.
Jay D. Miller. Mr. Miller was named Vice President, Marketing and Sales in
February 1998. Prior to January 1998 Mr. Miller served as the Company's Vice
President, Marketing and Business Development from February 1997. From 1989
until his employment by the Company, Mr. Miller was employed by GE Medical
Systems, Inc. in positions of increasing responsibility in the marketing area,
including serving as product manager and global product line strategy for MRI
imaging products and marketing manager for the cardiology market segment. Prior
to 1989 Mr. Miller was employed by Siemens Medical Systems in technical
marketing.
ITEM 1A - IMPORTANT FACTORS
The following factors are important and should be considered carefully in
connection with any evaluation of the Company's business, financial condition,
results of operations and prospects. Additionally, the following factors could
cause the Company's actual results to materially differ from those reflected in
any forward-looking statements of the Company.
HISTORICAL OPERATING LOSSES; UNCERTAIN PROFITABILITY PROSPECTS
The Company had operating losses of $5,211,000 for the year ended December 31,
1997, and $2,545,000 for the year ended October 31, 1996, and, with the
exception of the fiscal year ended October 31, 1995, has incurred operating
losses each year since 1990. While the Company had operating income of $252,000
for the year ended October 31, 1995, this income was entirely attributable to a
one-time license fee payment of $1,500,000 received by the Company during that
fiscal year as a result of granting a perpetual source code license for its gas
and oil exploration software product, VoxelGeo(R). As of December 31, 1997, the
Company's accumulated deficit was $10,802,000. The Company will likely continue
to incur operating losses in the near term given the early stage of the market
for its medical visualization products, and there can be no assurance that the
Company will be profitable at any time in the future. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
15
TRANSITION TO MEDICAL VISUALIZATION BUSINESS; EARLY STAGE OF INDUSTRY AND
BUSINESS
From its incorporation in 1988 until its acquisition by Bio-Vascular in 1994,
Vital Images was focused on developing and supporting visualization software
tools for use by engineers and researchers in a variety of imaging applications,
including gas and oil exploration, microscopy and medical research. Since its
acquisition by Bio-Vascular in 1994 and subsequent to the spin-off from
Bio-Vascular, Vital Images has consolidated its focus and is now focused solely
on developing, marketing and supporting visualization software packages and
systems for routine clinical use in medical applications. While Vital Images has
designed its Vitrea product in keeping with this refined focus, there can be no
assurance that Vital Images will be successful in marketing the Vitrea product
or any other product or that Vital Images will be successful in making the
transition from developing software tools for a variety of technical
applications to developing, marketing and supporting software packages or
integrated solutions for direct clinical application by medical personnel.
Additionally, the medical visualization industry in which the Company markets
its products is still in an early stage. The early stage of the industry is
attributable to the fairly recent availability of high performance computers at
reduced prices, the recent adoption of industry standards for the generation,
transmission and storage of medical imaging data, and changing medical
practices. Although the Company believes that the recent advances in the
affordability of high performance computers and in the development of industry
standards for imaging data will provide opportunities for growth in the medical
visualization industry, given the uncertainties associated with the early stage
of the industry, there can be no assurance that the industry will continue to
develop in the manner anticipated by the Company. Accordingly, there can be no
assurance that the medical visualization industry will provide growth
opportunities for the Company and its volume rendering software products or that
the Company's business strategies and focus on volume rendering technology will
be successful as the medical visualization industry continues to evolve.
Although the Company has received FDA clearance to market VoxelView software and
Vitrea systems for use as clinical diagnostic and surgical planning tools, there
can be no assurance of meaningful revenue from these early stage products in the
near term. The success of the Company's products will depend on its ability to
successfully commercialize and market its products, the ability and willingness
of physicians to use two- and three-dimensional imaging software in clinical
diagnosis, surgical planning, patient screening, and other diagnosis and
treatment protocols, and the ability of the Company to differentiate its volume
rendering software from competing products employing surface rendering or other
technologies. There can be no assurance that the Company will be able to succeed
in its efforts to further develop, commercialize, and achieve market acceptance
for VoxelView software or Vitrea systems, or for any other product. See
"Business--Description," "--Technology," "--Industry Background," "--Markets"
and "--Competition."
NEED FOR ADDITIONAL CAPITAL
In anticipation of the Distribution, Bio-Vascular agreed to assign to Vital
Images $10,000,000 in cash, cash equivalents and marketable securities effective
November 1, 1996. Subsequent to November 1, 1996, Bio-Vascular's Board of
Directors determined to make such additional capital contributions as necessary
to increase Vital Images' cash, cash equivalents, and marketable securities to
$10,000,000, effective as of the Distribution Date. Accordingly, on the
Distribution Date, Bio-Vascular transferred an additional $1,845,000 in cash
equivalents to Vital Images in order to increase Vital Images' cash, cash
equivalents and marketable securities to an aggregate of $10,000,000.
If Vital Images' operations progress as anticipated, of which there can be no
assurance, the Company believes that the capital contributions made by
Bio-Vascular, together with cash flows from operations,
16
should be sufficient to satisfy its cash requirements for at least two years
from the Distribution Date. The timing of Vital Images' future capital
requirements, however, will depend on a number of factors, including the ability
of Vital Images to successfully commercialize and market its products; the
ability and willingness of physicians to use two- and three-dimensional imaging
software in clinical diagnosis, surgical planning, patient screening and other
diagnosis and treatment protocols; the impact of competition in the medical
visualization business; the ability of Vital Images to differentiate its volume
rendering software from competing products employing surface rendering or other
technologies; and the ability to enhance existing products and develop new
products on a timely basis. To the extent that Vital Images' operations do not
progress as anticipated, additional capital will be required sooner. There can
be no assurance that any required additional capital will be available on
acceptable terms, or at all, and the failure to obtain any such required capital
would have a material adverse effect on Vital Images' business. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
HIGHLY COMPETITIVE INDUSTRY; RISK OF TECHNOLOGICAL OBSOLESCENCE
The Company faces intense competition in the medical visualization industry.
While the industry is in a relatively early stage, its development to date has
been characterized by rapid innovation and technological change. The Company
expects technology to continue to develop rapidly, and the Company's success
will depend to a large extent on its ability to maintain a competitive position
with its volume rendering technology. There can be no assurance that the Company
will be able to compete effectively in the marketplace or that products
developed by its competitors will not render its products obsolete or
non-competitive. Similarly, there can be no assurance that the Company's
competitors will not succeed in developing or marketing products that are viewed
as providing superior clinical performance or are less expensive relative to the
Company's products currently marketed or to be developed. Companies competing
with the Company in the medical visualization industry include large,
established manufacturers of medical imaging equipment. In addition to having
significantly greater capital and staffing resources for research and
development that are critical to success in the rapidly changing medical
visualization industry, such companies also have well-established marketing and
distribution networks and may have a competitive advantage in marketing
visualization tools as an integrated part of their imaging products.
Additionally, the Company faces competition from other entities, such as PACS
vendors, hospital, radiology and clinical systems suppliers and internal
development projects sponsored by hospital radiology departments. There can be
no assurance that the Company will be able to compete effectively with such
manufacturers or competing entities. See "Business--Technology," "--Industry
Background" and "--Competition."
DEPENDENCE ON SINGLE PLATFORM
The Company's primary product offerings, VoxelView and Vitrea, are designed to
run on workstations manufactured and sold by Silicon Graphics. While Vitrea
could be adapted to run on other types of hardware, Vitrea's performance on
other hardware might be reduced relative to its performance when operated on
Silicon Graphics workstations. In addition, other workstations capable of
running Vitrea software may be significantly more expensive than those
manufactured and sold by Silicon Graphics. Accordingly, the Company's ability to
market its products is dependent to a significant degree on the availability of
Silicon Graphics workstations and their use and acceptance by the Company's
customers. To the extent that Silicon Graphics workstations become unavailable
to the Company or that end-users of the Company's products utilize platforms
manufactured by other companies, the Company may encounter difficulty in
marketing its products. In any such event, the Company may be required to engage
in substantial research and development and sales and marketing efforts, at
potentially significant expense, to reconfigure and remarket its products to run
at optimal performance levels on workstations other than those manufactured by
Silicon Graphics. There can be no assurance that end-users of the Company's
products will not determine to use platforms other than those currently
compatible with the Company's
17
products, and any such use could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--Products
and Product Development."
DEPENDENCE ON MAJOR CUSTOMERS
For the year ended December 31, 1997, sales by the Company to CogniSeis
Development, Inc. accounted for approximately 26% of the Company's net revenue.
Approximately 54% of the Company's net revenue for the year ended December 31,
1997 was derived from sales to its eight largest customers. Further, management
believes a limited number of large customers may continue to account for a
significant portion of the Company's revenues during any given period for the
foreseeable future. The Company currently has no long-term purchase agreements
with any of its customers and sales are generally made pursuant to purchase
orders. A reduction, delay, or cancellation of orders from one or more of its
significant customers, could have a material adverse effect on the Company's
operating results. In addition, the timing of orders from major customers could
cause fluctuations in the Company's quarterly financial results.
UNCERTAIN PROTECTION FOR INTELLECTUAL PROPERTY; POSSIBLE CLAIMS OF OTHERS
Although the Company has filed patent applications with respect to certain
aspects of its technology, it generally does not rely on patent protection with
respect to its products and technologies. Instead, the Company relies primarily
on a combination of trade secret and copyright law, employee and third-party
nondisclosure agreements and other protective measures to protect intellectual
property rights pertaining to its products and technologies. There can be no
assurance, however, that these measures will provide meaningful protection of
the Company's trade secrets, know-how or other intellectual property in the
event of any unauthorized use, misappropriation or disclosure or that others
will not independently develop similar technologies or duplicate any technology
developed by the Company. In addition, to the extent that any patents are
applied for, there can be no assurance that such applications will result in
issued patents or, if issued, that such patents will be held to be valid or will
otherwise be of value. While the Company does not believe that its products and
technologies infringe any existing patents or intellectual property rights of
third parties, there can be no assurance that such infringement does not exist.
The costs of defending an intellectual property claim could be substantial and
could adversely affect the Company, even if it were ultimately successful in
defending any such claims. If the Company's products or technologies were found
to infringe the rights of a third party, the Company could be required to pay
significant damages or license fees or cease production, which could have a
material adverse effect on the Company's business. See "Business--Intellectual
Property."
PRODUCT LIABILITY RISK; LIMITED INSURANCE COVERAGE
The manufacture and sale of products used in the practice of medicine entail
significant risk of product liability claims. While the Company currently
maintains product liability insurance, there can be no assurance that its
coverage limits will be adequate to protect the Company from any liabilities it
might incur in connection with sales of its products, or that the Company will
be able to maintain this level of coverage in the future. In addition, in order
to compete in the medical visualization industry, the Company will have to
maintain a steady pace of new product rollouts and updates or enhancements of
existing products. Accordingly, the Company may require increased product
liability coverage as additional products and updates come to the marketplace.
Such insurance is expensive and in the future may not be available on acceptable
terms, if at all. A successful product liability claim or series of such claims
against the Company in excess of the Company's insurance coverage could have a
material adverse effect on its business.
18
DEPENDENCE ON KEY EMPLOYEE
The Company will depend upon the active participation of Dr. Argiro, its founder
and Executive Vice President and Chief Technology Officer. Loss of the services
of Dr. Argiro could have a material adverse effect on the Company's future
business. Furthermore, the Company's success as a company will depend on its
ability to enhance and develop markets for its current products as well as to
introduce new products to the marketplace. This success will depend largely on
its ability to attract and retain other qualified scientific and management
personnel. The Company competes for such personnel with other companies,
academic institutions, government entities and organizations, many of which have
substantially greater capital resources and research and development
capabilities than the Company. There can be no assurance that the Company will
be successful in recruiting or retaining such personnel, and the inability of
the Company to recruit and retain such personnel would have a material adverse
effect on the Company's business.
GOVERNMENT REGULATION
The Company's products are subject to regulation by the FDA and by comparable
agencies in foreign countries. In the United States, the FDA regulates the
development, introduction, manufacturing, labeling and recordkeeping procedures
for medical devices, including medical visualization software and systems. The
process of obtaining marketing clearance from the FDA for new products and new
applications for existing products can be time-consuming and expensive. All of
the products currently marketed by the Company have received marketing clearance
from the FDA pursuant to 510(k) pre-market notifications. There can be no
assurance, however, that clearance will be granted with respect to future
products or enhancements or that FDA review will not involve delays that would
adversely affect the Company's ability to market such future products or
enhancements. In addition, there can be no assurance that future products or
enhancements will not be subject to the more lengthy and expensive PMA process
with the FDA.
Even if regulatory approvals to market a product are obtained from the FDA,
these approvals may entail limitations on the indicated uses of the product.
Product approvals by the FDA can also be withdrawn due to failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
approval. The FDA could also limit or prevent the distribution of the Company's
products and has the power to require the recall of such products. FDA
regulations depend heavily on administrative interpretation, and there can be no
assurance that future interpretations made by the FDA or other regulatory bodies
will not adversely affect the Company. The FDA, various state agencies or
foreign regulatory agencies may inspect the Company and its facilities from time
to time to determine whether the Company is in compliance with various
regulations relating to specification, development, documentation, validation,
testing, quality control and product labeling. A determination that the Company
is in violation of such regulations could lead to imposition of civil penalties,
including fines, product recalls or product seizures and, in extreme cases,
criminal sanctions.
The Company intends to market its products both domestically and
internationally. International regulatory bodies have established varying
regulations governing product standards, packaging requirements, labeling
requirements, import restrictions, tariff regulations, duties and tax
requirements. The inability or failure of the Company to comply with the varying
regulations or the imposition of new regulations could restrict its ability to
sell its products internationally and could thereby adversely affect the
Company's business. See "Business--Governmental Regulation."
19
LIMITATIONS ON THIRD-PARTY REIMBURSEMENT
The Company's products are purchased by hospitals, clinics and other users,
which bill various third party payors, such as government health programs,
private health insurance plans, managed care organizations and other similar
programs, for the health care goods and services provided to their patients.
Payors may deny reimbursement if they determine that a product used in a
procedure was not used in accordance with established payor protocol regarding
cost-effective treatment methods or was used for an unapproved indication. Third
party payors are increasingly challenging the prices charged for medical
services and, in some instances, have put pressure on service providers to lower
their prices or reduce their services. The Company is unable to predict what
changes will be made in the reimbursement methods used by third party healthcare
payors. There can be no assurance that procedures in which the Company's
products are used will be considered cost effective by third party payors, that
reimbursement for such procedures will be available or, if available, that
payors' reimbursement levels will not adversely affect the Company's ability to
sell its products on a profitable basis. In addition, there have been and may
continue to be proposals by legislators, regulators and third party payors to
curb further these costs in the future. Failure by hospitals and other users of
the Company's products to obtain reimbursement from third party payors, changes
in third party payors' policies towards reimbursement for procedures using the
Company's products or legislative action could have a material adverse effect on
the Company's business. See "Business--Third Party Reimbursement and Cost
Containment."
INTERNATIONAL OPERATIONS
The Company sells its products to international customers as well as domestic
customers. Because foreign markets may be influenced by factors that are
different from those prevailing in the United States, there can be no assurance
that the Company's products will be accepted in international markets or that
the Company will be able to compete successfully in such markets. International
sales are also subject to certain political and economic risks, including
political instability, currency controls, trade restrictions, regulatory
requirements, exchange rate fluctuations and changes in import and export
regulations, any of which could have a material adverse effect on the Company's
business. See "Business --Marketing, Distribution and Customer Support" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Foreign Currency Transactions."
CERTAIN ANTI-TAKEOVER CONSIDERATIONS
The Company's Articles authorize the Board of Directors, without any action by
shareholders, to establish the rights and preferences of up to 5,000,000 shares
of undesignated preferred stock. The Company is also subject to certain
"anti-takeover" provisions of the Minnesota Business Corporation Act. In
addition, the Company has adopted a Shareholder Rights Plan (the "Rights
Agreement") designed to protect the Company and its shareholders from
unsolicited attempts or inequitable offers to acquire the Company. These
measures may, in certain circumstances, deter or discourage takeover attempts
and other changes in control of the Company not approved by its Board of
Directors. As a result, the Company's shareholders may lose opportunities to
dispose of their shares at the higher prices typically available in takeover
attempts or that may be available under a merger proposal. In addition, these
measures may have the effect of permitting the Company's current directors to
retain their positions and place them in a better position to resist changes
that shareholders may wish to make if they are dissatisfied with the conduct of
the Company's business.
20
EFFECTS OF TRADING IN THE OVER-THE-COUNTER MARKET
The Company's common stock is traded in the over-the-counter market on the OTC
Electronic Bulletin Board. Consequently, the liquidity of the Company's common
stock may be impaired, not only in the number of shares that may be bought and
sold, but also through delays in the timing of transactions, and coverage by
security analysts and the news media, may also be reduced. As a result, prices
for shares of the Company's Common Stock may be lower than might otherwise
prevail if the Company's Common Stock were traded on Nasdaq or a national
securities exchange.
APPLICABILITY OF "PENNY STOCK RULES"
Federal regulations under the Securities Exchange Act of 1934, as amended, (the
"Exchange Act"), regulate the trading of so-called "penny stocks" (the "Penny
Stock Rules"), which are generally defined as any security not listed on a
national securities exchange or Nasdaq, priced at less than $5.00 per share and
offered by an issuer with limited net tangible assets and revenues. In addition,
equity securities listed on Nasdaq which are priced at less than $5.00 are
deemed penny stocks for the limited purpose of Section 15(b)(6) of the Exchange
Act. Therefore, during the time in which the Company's common stock is traded in
the over-the-counter market, as well as during any time in which the Company's
common stock is quoted on Nasdaq and is priced below $5.00 per share, if such
quotation occurs at all, trading of the Company's common stock will be subject
to the provisions of Section 15(b)(6) of the Exchange Act which make it unlawful
for any broker-dealer to participate in a distribution of any penny stock
without the consent of the Securities and Exchange Commission if, in the
exercise of reasonable care, the broker-dealer is aware of or should have been
aware of the participation of a previously sanctioned person. Accordingly, it
may be more difficult for broker-dealers to sell the Company's common stock and
shareholders of the Company may therefore have difficulty in selling their
shares in the future in the secondary trading market.
Additionally, during the time that the Company's common stock trades below $5.00
per share and is not listed on Nasdaq or any national securities exchange,
trading of the Company's common stock is subject to the full range of the Penny
Stock Rules. Under these rules, broker-dealers must take certain steps prior to
selling a "penny stock," which steps include: (i) obtaining financial and
investment information from the investor; (ii) obtaining a written suitability
questionnaire and purchase agreement signed by the investor; and (iii) providing
the investor a written identification of the shares being offered and the
quantity of the shares. If the Penny Stock Rules are not followed by the
broker-dealer, the investor has no obligation to purchase the shares. The
application of the comprehensive Penny Stock Rules may make it more difficult
for broker-dealers to sell the Company's common stock and shareholders of the
Company may have difficulty in selling their shares in the future in the
secondary trading market.
21
Item 2. PROPERTIES
The Company's principal offices, sales, marketing and operations, as well as
some product development activities, are located in Minneapolis, Minnesota,
where the Company currently occupies approximately 14,000 square feet under a
lease that expires January 31, 2002. Under certain conditions, the lease may be
terminated early on January 31, 2000. The Company is required to post a security
deposit of up to $150,000 if, during the term of the lease, the aggregate
balance of cash and marketable securities owned by the Company falls below
$3,000,000 or its equity falls below $1,000,000.
In addition, some of the Company's product development, quality engineering and
customer support operations are conducted in facilities with approximately 9,000
square feet located in Fairfield, Iowa under a lease that expires on June 1,
2000.
The Company considers its current facilities adequate for its current needs and
believes that suitable additional space will be available as needed.
Item 3. LEGAL PROCEEDINGS
The Company is not engaged in any legal proceedings at this time.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There was no matter submitted to the vote of security holders during the fourth
quarter of 1997.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock has traded on the OTC Bulletin Board under the symbol
"VTAL" since May 14, 1997. The following table sets forth, for each of the
periods indicated, the high and low bid quotations for the Company's Common
Stock as reported by the OTC Bulletin Board. Such prices reflect inter-dealer
prices, do not include adjustments for retail mark-ups, mark-downs or
commissions and may not necessarily represent actual transactions.
1997 HIGH LOW
-------------- ------- --------
Fourth Quarter $1.6875 $1.1875
Third Quarter 2.1250 1.6250
Second Quarter 2.5000 1.5000
(commencing May 14, 1997)
The Company has never paid or declared any cash dividends on its Common Stock
and does not intend to pay dividends on its Common Stock in the near future. To
date, the Company has incurred losses and presently expects to retain its future
anticipated earnings to finance development of and expansion of its business. As
of February 27, 1998 there were approximately 6,100 beneficial owners of the
Company's common stock.
22
Item 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company is derived from the
Company's financial statements and notes thereto. The selected financial data
for each of the fiscal years in the five-year period ended December 31, 1997 is
derived from the audited financial statements of the Company. The information
set forth below should be read in conjunction with the Company's financial
statements, including the notes thereto, and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," which are included
elsewhere in this Annual Report on Form 10-K.
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
FOR THE YEAR FOR THE TWO MONTHS FOR THE YEAR ENDED OR AS OF
ENDED OR AS OF ENDED OR AS OF ---------------------------------------------------
DECEMBER 31, DECEMBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31, DECEMBER 31,
STATEMENTS OF OPERATIONS: 1997 1996 (1) 1996 (1) 1995(1) 1994(1)(2) 1993(2)(3)
-------- -------- -------- ------- ---------- ----------
Revenue...................... $1,218 $ 65 $ 882 $2,894(4) $ 1,680 $1,696
Gross margin................. 915 53 720 2,488(4) 1,170 1,022
Operating expenses:
Selling, general and
administrative............... 3,871 328 1,805 879 1,098 1,085
Research and development..... 2,255 333 1,460 1,357 1,255 745
Acquisition costs............ - - - - 71 -
-------- ----------- --------- --------- ------- -----
Operating income (loss)...... (5,211) (608) (2,545) 252(4) (1,254) (808)
Net income (loss)............ $(4,774) $(521) $ (2,546) $ 253 $(1,261) $ (821)
======== ======== ========= ====== ======== =======
Net income (loss)
per share - basic (5) $(1.00) $(.11) $(.54) $ .07
======= ======== ====== ======
Weighted average common shares
outstanding - basic (5) 4,772 4,745 4,716 3,786
======= ====== ====== ======
Net income (loss)
per share - diluted (5) $(1.00) $(.11) $(.54) $ .06
======= ====== ====== ======
Weighted average common shares
outstanding - diluted (5) 4,772 4,745 4,716 4,031
===== ====== ====== ======
BALANCE SHEETS:
Working capital (deficiency). $6,415 $6,214 $(258) $(144) $ 4 $(108)
Total assets................. 8,296 10,493 943 739 855 1,061
Short and long-term debt..... - - - - - 118
Preferred stock.............. - - - - - 537
Total equity................. 7,253 9,720 174 321 343 402
(1) Reflects Vital Images' results as a wholly-owned subsidiary of
Bio-Vascular. Vital Images was merged with Bio-Vascular in May 1994 in a
transaction accounted for as a pooling-of-interests. Results of operations
include allocations of general corporate overhead.
(2) Due to the merger in May 1994, Vital Images' fiscal year-end was changed to
October 31, effective as of October 31, 1994. Accordingly, the Statements
of Operations for fiscal 1994 and 1993 both include results of Vital Images
for November and December of 1993. Vital Images' revenues were $379 and the
net loss was $45 during this two-month period.
(3) Reflects Vital Images' results of operations as a separate company prior to
its merger with Bio-Vascular.
23
(4) Includes $1,500 of one-time license fee revenue, which contributed $1,322
to gross margin and operating income.
(5) For periods after the Distribution, basic and diluted net loss per share is
computed using the weighted average common shares outstanding during the
period.
For periods prior to the Distribution, the weighted average common shares
outstanding used in the net income (loss) per share calculation is one-half
of the weighted average of Bio-Vascular common shares outstanding based on
the distribution of one share of the Company's common stock for each two
shares of Bio-Vascular's common stock pursuant to the Distribution. To the
extent the common share equivalents are dilutive, the weighted average
common shares include one-half of Bio-Vascular's weighted average common
share equivalents.
24
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
On October 28, 1996, the Board of Directors of Bio-Vascular, Inc.
("Bio-Vascular"), the former parent company of Vital Images, Inc. (the "Company"
or "Vital Images"), approved a plan to spin off and establish Vital Images as an
independent, publicly-owned company. On May 12, 1997 (the "Distribution Date"),
Bio-Vascular distributed all of the shares of Vital Images to the shareholders
of Bio-Vascular (the "Distribution"), and on that date Vital Images began
operating as an independent public company. All Bio-Vascular shareholders of
record as of May 5, 1997 received one share of Vital Images common stock for
each two shares of Bio-Vascular stock held on that date, and cash in lieu of
fractional shares. As a result of Bio-Vascular's spin-off of Vital Images, Vital
Images' financial statements and notes thereto report the business of Vital
Images as an independent company. Vital Images is currently traded on the OTC
Bulletin Board under the symbol VTAL.
In anticipation of the Distribution, Bio-Vascular assigned to Vital Images,
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996. Subsequently, Bio-Vascular's Board of Directors agreed to make
such additional contributions as were necessary to bring cash, cash equivalents
and marketable securities to a combined total of $10,000,000 effective as of the
Distribution Date. On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balance to $10,000,000.
Additionally, Bio-Vascular made capital contributions to Vital Images of
approximately $3,200,000 representing net advances of cash over the period
beginning May 24, 1994, the date on which Vital Images was acquired by
Bio-Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular.
On July 17, 1997, the Board of Directors of the Company adopted a resolution
changing the Company's fiscal year end from October 31 to December 31, effective
with the calendar year beginning January 1, 1997. The 1997 fiscal year ended on
December 31, whereas the previous two fiscal years ended on October 31.
Accordingly, a two-month transition period from November 1, 1996 through
December 31, 1996 preceded the start of the new calendar year cycle. For
comparison purposes, results for the year ended December 31, 1997, are being
compared with results for the year ended October 31, 1996. The Company has not
recast the prior year financial information presented herein to conform to the
new fiscal year end, as management believes the fiscal year 1996 results are
comparable to the calendar year 1997 results.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1997 WITH THE YEAR ENDED OCTOBER 31,
1996
Total revenue increased 38% from $882,000 to $1,218,000. Revenue generated from
the sales of Vitrea software and systems, released by the Company in October
1997, and royalties under the agreement with CogniSeis Development, Inc.
("CogniSeis") were primarily responsible for the increase in revenue and more
than offset a decline in both license fee revenue and maintenance revenue from
VoxelView software. Management expects to achieve significant revenue growth in
1998 over 1997. However, actual results could vary materially from the foregoing
forward-looking statement as a result of lower than expected demand for the
Vitrea product or the timing of future releases of Vitrea software.
The gross margin percentage decreased from 82% to 75%, primarily as a result of
Vitrea system sales increasing as a proportion of the Company's product mix. The
Vitrea system, consisting of Vitrea software and third party hardware and
peripherals, is designed to offer end users an integrated visualization system.
The Company receives only a nominal discount in purchasing the third party
25
hardware and peripheral components of the Vitrea system and the Company's gross
margin on the resale of these system components approximates its discount. The
Company anticipates that as Vitrea systems increase as a proportion of the
Company's product mix, overall gross margin percentages will decrease. This
forward-looking statement will be influenced primarily by vendor discounts on
the third party hardware and peripheral components of the Vitrea system and on
the Company's product mix.
Research and development expenses were up 55% to $2,255,000 from $1,459,000. The
increase was primarily due to increased compensation costs resulting from
increased staffing for the development of the Vitrea product. In addition,
travel, depreciation and other expenses related to staffing also increased due
to increased development efforts for Vitrea software. The Company anticipates
that such costs will increase in future periods as future releases of Vitrea
software are developed, but at a rate less than the increase from 1996 to 1997.
Sales and marketing expenses increased to $2,167,000 from $846,000, a 156%
increase. The increase was primarily due to increased compensation costs,
including the addition of a Vice President of Marketing and Business
Development, as well as promotional, consulting and travel expenses related to
the marketing and promotion of the Vitrea product. The Company expects sales and
marketing costs to increase in future periods for the cost of additional sales
and customer support personnel, as well as customer support infrastructure
costs.
General and administrative expenses increased from $960,000 to $1,703,000, a 77%
increase. The increase was due to increases in the Company's administrative
infrastructure, and the incremental costs associated with becoming an
independent public company. During 1997, the Company leased new corporate
offices resulting in increased rent expense, increased its purchases of property
and equipment resulting in increased depreciation, and incurred costs for legal
and investor relations expenses as a result of becoming an independent public
company. In addition, compensation costs increased as a result of increased
staffing, including the addition of a Chief Financial Officer. The Company
believes that general and administrative costs will increase in future periods
primarily due to increased compensation expense for 1997 hires that will be
present for the entire year and administrative costs associated with being a
public company.
The increased expenses attributable to the continuing development of the
Company's management team and infrastructure and the development and promotion
of the Vitrea product, resulted in an operating loss of $5,211,000 for the year
ended December 31, 1997, compared to an operating loss of $2,545,000 for the
year ended October 31, 1996.
There was $443,000 of interest income for the year ended December 31, 1997,
compared to interest income of $1,000 for the year ended October 31, 1996. The
$10,000,000 in cash, cash equivalents and marketable securities assigned by
Bio-Vascular to the Company, effective November 1, 1996, as well as the
$1,845,000 contributed on the Distribution Date, less cash used for operations
subsequent to those dates, resulted in the increase in interest income during
the year ended December 31, 1997.
As a wholly-owned subsidiary of Bio-Vascular through May 11, 1997, the Company
did not file separate federal income tax returns, but rather was included in the
federal income tax returns filed by Bio-Vascular. The Company's allocated income
tax provisions for the years ended December 31, 1997 and October 31, 1996 are
based on the "separate return" method and consist solely of certain state
minimum fees. A valuation allowance has been established to completely reserve
for the deferred tax assets of the Company.
26
COMPARISON OF THE YEAR ENDED OCTOBER 31, 1996 WITH THE YEAR ENDED OCTOBER 31,
1995
In fiscal 1994, the Company began the process of focusing its resources on
medical visualization software and systems. This process involved the Company's
exit from its other markets, microscopy and geoscience. As a result, the
Company's year-to-year revenue, excluding even the $1.5 million one-time source
code license fee for the VoxelGeo software received in 1995, declined.
Revenue decreased $2,012,000, or 70%, to $882,000, from $2,894,000. However,
revenue from medical visualization increased 43% to $667,000, from $467,000. The
increase in revenue from medical visualization was a result of the Company's
changed focus. In addition to focusing some effort on additional sales of
VoxelView software, much of the Company's efforts and resources were directed
toward the development of more clinically powerful and practice-oriented medical
visualization software to answer the evolving needs of medical practice. For
1996, the only revenue the Company received from the geoscience and microscopy
revenue was maintenance revenue of $59,000 and $93,000, respectively. For 1995,
geoscience revenue was $2,127,000 and included a $1,500,000 one-time license fee
for the VoxelGeo software source code, while microscopy revenue was $243,000.
The gross margin percentage decreased to 82% from 86%, due to the mix of
products and services.
Sales and marketing expenses more than doubled from $380,000 to $846,000, an
increase of $466,000, or 123%. The increase was due primarily to the ongoing
costs of additions to personnel, including a Vice President of Sales in January
1996, the development of marketing materials and an expansion of marketing
activities.
General and administrative expense increased from $500,000 to $960,000, an
increase of $460,000, or 92%. Additions to personnel, including the employment
of a President in October 1995, and the associated increase in business activity
accounted for this increase.
Research and development expense increased 8% to $1,459,000, from $1,357,000,
due to expenses associated with additional personnel hired to increase the
Company's development capabilities.
Due to the expenses associated with its business and technological development
activities, and due to lower revenue as a result of its more defined market
focus, the Company reported an operating loss of $2,545,000 for the year ended
October 31, 1996. This compares to operating income of $252,000 in 1995, which
resulted from the licensing of the VoxelGeo software source code for a fee of
$1,500,000 and its $1,322,000 contribution to operating income.
27
LIQUIDITY AND CAPITAL RESOURCES
As of October 31, 1996, Vital Images had no cash and participated in
Bio-Vascular's centralized funding and cash management. When Bio-Vascular
acquired Vital Images on May 24, 1994, Vital Images had $286,000 in cash. Within
a month, Vital Images had effectively used its cash and Bio-Vascular began
financing the Company's activities. Bio-Vascular conducted the investing
activities and continued to finance the activities of Vital Images. The advances
of cash by Bio-Vascular to Vital Images had no payment requirements and were
interest-free, as Vital Images had, substantially, no ability to repay these
advances. Accordingly, the net cash received from Bio-Vascular through
intercompany advances was considered to be a contribution of capital.
In anticipation of the Distribution, Bio-Vascular agreed to assign to Vital
Images $10,000,000 in cash, cash equivalents and marketable securities effective
November 1, 1996. Subsequent to November 1, 1996, Bio-Vascular's Board of
Directors determined to make such additional capital contributions as necessary
to increase Vital Images' cash, cash equivalents and marketable securities to
$10,000,000, effective as of the Distribution Date. Accordingly, on the
Distribution Date, Bio-Vascular transferred an additional $1,845,000 in cash
equivalents to Vital Images in order to increase Vital Images' cash, cash
equivalents and marketable securities to an aggregate of $10,000,000.
If the Company's operations progress as anticipated, of which there can be no
assurance, management believes that its cash, cash equivalents and marketable
securities should be sufficient to satisfy its cash requirements for at least
two years from the Distribution Date. The timing of the Company's future capital
requirements, however, will depend on a number of factors, including the ability
and willingness of physicians to use three-dimensional visualization software in
clinical diagnosis, surgical planning patient screening and other diagnosis and
treatment protocols; the ability of the Company to build an effective sales and
distribution channel; the impact of competition in the medical visualization
business; and the ability to enhance existing products and develop new products
on a timely basis. To the extent that the Company's operations do not progress
as anticipated, additional capital will be required sooner. There can be no
assurance that any required additional capital will be available on acceptable
terms or at all, and the failure to obtain any such required capital would have
a material adverse effect on the Company's business.
For the years ended December 31, 1997 and October 31, 1996, cash used by
operating activities, primarily to fund the Company's operating loss, was
$4,075,000 and $1,905,000, respectively. The Company invested $796,000 and
$371,000 in equipment and improvements during the years ended December 31, 1997
and October 31, 1996, respectively, primarily for the acquisition of computer
equipment. The Company used $9,827,000 to purchase marketable securities and had
$6,863,000 of marketable securities mature during the year ended December 31,
1997.
The Company has no material commitments at this time other than facility leases
and expected employment contracts, but will be using cash in the near term as it
continues to develop the infrastructure to support its business and develop the
market for its products.
FOREIGN CURRENCY TRANSACTIONS
Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars.
INFLATION
Management believes inflation has not had a material effect on the Company's
operations or on its financial condition.
28
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. ("SFAS") 130, Reporting Comprehensive
Income, which establishes standards for reporting and display of comprehensive
income and its components (revenue, expenses, gains and losses) in a full set of
general-purpose financial statements. The Company will adopt SFAS 130 for its
year ending December 31, 1998.
In June 1997, the FASB issued SFAS 131, Disclosure about Segments of an
Enterprise and Related Information, which requires disclosure of segment data in
a manner consistent with that used by an enterprise for internal management
reporting and decision-making. SFAS 131 establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers and the material countries in which
the entity holds assets and reports revenue. Management believes that it will
report its operations as a single segment under SFAS 131. The Company will adopt
SFAS 131 for its year ending December 31, 1998.
In October 1997, the Accounting Standards Executive Committee issued Statement
of Position 97-2, Software Revenue Recognition (SOP 97-2), which provides
guidance on applying generally accepted accounting principles in recognizing
revenue on software transactions and supersedes SOP 91-1, Software Revenue
Recognition. SOP 97-2 will become effective for the Company on January 1, 1998.
Management does not anticipate that the adoption of SOP 97-2 will materially
impact the Company's revenue recognition practices, financial position or
results of operations.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements, supplemental schedule and
Report of Independent Accountants thereon, all of which are
included in this Annual Report on Form 10-K, are listed in Item 14
(a) (1) of this form 10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
(a) Directors of the Registrant.
The information under the caption "Election of Directors" in the
Company's 1998 Proxy Statement is incorporated herein by
reference.
(b) Executive officers of the Registrant.
Information concerning Executive Officers of the Company is
included in this Report on page 14 under Item 1, "Executive
Officers of the Registrant."
29
(c) Compliance with 16(a) of the Securities Exchange Act of 1934.
The information under the caption "Compliance with Section 16 (a)"
in the Company's 1998 Proxy Statement is incorporated herein by
reference.
Item 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation" and
"Compensation of Directors" in the Company's 1998 Proxy Statement
is incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Company's 1998 Proxy
Statement is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Certain Relationships and
Related Transactions" in the Company's 1998 Proxy Statement is
incorporated herein by reference.
30
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) The following financial statements and supplemental
schedule of Vital Images, Inc. and Report of Independent
Accountants thereon are included herein:
PAGE
Report of Independent Accountants.................................33
Balance Sheets as of December 31, 1997 and 1996...................34
Statements of Operations for the year ended
December 31, 1997, the two months ended
December 31, 1996 and the years ended
October 31, 1996 and 1995.................................35
Statements of Equity for the year ended
December 31, 1997, the two months
ended December 31, 1996 and the
years ended October 31, 1996 and 1995.....................36
Statements of Cash Flows for the year ended
December 31, 1997, the two months ended
December 31, 1996 and the years ended
October 31, 1996 and 1995.................................37
Notes to Financial Statements.....................................38
Schedule II. Valuation and Qualifying Accounts....................50
(a) (2) Included in Item 14 (a) (1) above
All other schedules to the financial statements required by Article 7
of Regulation S-X are not required under the related instructions or
are inapplicable and therefore have been omitted.
(a) (3) LISTING OF EXHIBITS
The Exhibits required to be a part of this Report are listed in the
Index to Exhibits which follows the Financial Statement Schedule on
page 51.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended December
31, 1997.
(c) EXHIBITS
Included in Item 14 (a) (3) above.
31
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, in Minneapolis, Minnesota,
on the 27th day of March 1998.
VITAL IMAGES, INC.
By: /S/ Gregory S. Furness
----------------------------------
Gregory S. Furness
Vice President-Finance and
Chief Financial Officer
(Principal Financial Officer)
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report
has been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
- ---------- ----- ----
/S/Douglas M. Pihl Chairman of the Board, President, March 27, 1998
- ----------------------- Chief Executive Officer and Director
Douglas M. Pihl (Principal Executive Officer)
/S/Gregory S. Furness Vice President-Finance, Chief March 27, 1998
- ----------------------- Financial Officer, Treasurer
Gregory S. Furness and Secretary
(Principal Financial Officer)
/s/Vincent J. Argiro Executive Vice President, Chief March 27, 1998
- ----------------------- Technology Officer and Director
Vincent J. Argiro
/s/Richard W. Perkins Director March 27, 1998
- -----------------------
Richard W. Perkins
/s/Edward E. Strickland Director March 27, 1998
- -----------------------
Edward E. Strickland
/s/ Michael W. Vannier Director March 27, 1998
- -----------------------
Michael W. Vannier
/s/Sven A. Wehrwein Director March 27, 1998
- -----------------------
Sven A. Wehrwein
32
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Vital Images, Inc.:
We have audited the financial statements and the financial statement schedule of
Vital Images, Inc. listed in Item 14 (a) (1) of this Form 10-K. These financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Vital Images, Inc. as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for the year ended December 31, 1997, the two months ended December 31, 1996,
and the years ended October 31, 1996 and 1995, in conformity with generally
accepted accounting principles. In addition, in our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information to be included therein.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota
February 13, 1998
33
VITAL IMAGES, INC.
BALANCE SHEETS
DECEMBER 31,
----------------------------
1997 1996
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 448,377 $ 6,481,067
Marketable securities 5,963,464 --
Accounts receivable, net of allowance for doubtful accounts of $40,000
and $49,500 as of December 31, 1997 and 1996, respectively 581,130 89,364
Prepaid expenses and other current assets 264,826 199,315
------------ ------------
Total current assets 7,257,797 6,769,746
Property and equipment, net 997,947 713,204
Patent costs 40,267 23,256
Marketable securities -- 2,986,875
------------ ------------
TOTAL ASSETS $ 8,296,011 $ 10,493,081
============ ============
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable $ 203,579 $ 87,530
Accrued payroll 322,572 122,652
Deferred revenue 212,556 279,763
Other current liabilities 104,003 66,107
------------ ------------
Total current liabilities 842,710 556,052
Deferred revenue 200,107 217,097
------------ ------------
Total liabilities 1,042,817 773,149
Commitments
Equity:
Preferred stock: $.01 par value; 5,000,000 shares
authorized and none issued as of December 31, 1997;
none authorized as of December 31, 1996 -- --
Common stock: $.01 par value; 20,000,000 shares
authorized and 4,806,561 shares issued and
outstanding as of December 31, 1997; 1,000 shares
authorized, issued and outstanding as of
December 31, 1996 48,066 10
Additional paid-in capital 18,006,824 13,003,047
Deferred compensation -- (440,834)
Net investment by Bio-Vascular -- 3,198,710
Accumulated deficit (10,801,696) (6,027,876)
Unrealized marketable securities holding loss -- (13,125)
------------ ------------
Total equity 7,253,194 9,719,932
------------ ------------
TOTAL LIABILITIES AND EQUITY $ 8,296,011 $ 10,493,081
============ ============
(The accompanying notes are an integral part of the financial statements.)
34
VITAL IMAGES, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS
FOR THE YEAR FOR THE TWO ENDED
ENDED MONTHS ENDED OCTOBER 31,
DECEMBER 31, DECEMBER 31, ----------------------
1997 1996 1996 1995
---- ---- ---- ----
Revenue:
License fees $ 751,810 $ 14,176 $ 506,267 $ 2,379,399
Maintenance and services 290,769 50,790 343,534 514,255
Hardware 175,592 -- 32,325 --
----------- ----------- ----------- -----------
Total Revenue 1,218,171 64,966 882,126 2,893,654
Cost of revenue:
License fees 143,135 11,894 122,714 267,746
Maintenance and services 3,309 -- 13,669 137,428
Hardware 157,032 -- 25,903 --
----------- ----------- ----------- -----------
Total Cost of Revenue 303,476 11,894 162,286 405,174
Gross margin 914,695 53,072 719,840 2,488,480
Operating expenses:
Research and development 2,255,030 333,011 1,459,490 1,356,578
Sales and marketing 2,167,400 179,066 845,561 379,808
General and administrative 1,703,024 148,743 959,961 499,665
----------- ----------- ----------- -----------
Total operating expenses 6,125,454 660,820 3,265,012 2,236,051
Operating income (loss) (5,210,759) (607,748) (2,545,172) 252,429
Interest income 443,439 87,045 923 1,291
----------- ----------- ----------- -----------
Income (loss) before income taxes (4,767,320) (520,703) (2,544,249) 253,720
Income taxes 6,500 -- 1,500 1,100
----------- ----------- ----------- -----------
Net income (loss) $(4,773,820) $ (520,703) $(2,545,749) $ 252,620
=========== =========== =========== ===========
Net income (loss) per share - basic $ (1.00) $ (0.11) $ (0.54) $ 0.07
=========== =========== =========== ===========
Weighted average common shares
outstanding - basic 4,771,739 4,744,547 4,716,401 3,785,685
=========== =========== =========== ===========
Net income (loss) per share - diluted $ (1.00) $ (0.11) $ (0.54) $ 0.06
=========== =========== =========== ===========
Weighted average common shares
outstanding - diluted 4,771,739 4,744,547 4,716,401 4,030,917
=========== =========== =========== ===========
(The accompanying notes are an integral part of the financial statements.)
35
VITAL IMAGES, INC.
STATEMENTS OF EQUITY
COMMON STOCK ADDITIONAL
--------------------------- PAID-IN DEFERRED
SHARES AMOUNT CAPITAL COMPENSATION
------ ------ ---------- ------------
Balances as of October 31, 1994 1,000 $ 10 $ 2,428,047 $ --
Net amount paid to Bio-Vascular -- -- -- --
Net income -- -- -- --
------------ ------------ ------------ ------------
Balances as of October 31, 1995 1,000 10 2,428,047 --
Issuance of option for common stock
at below market price -- -- 575,000 (575,000)
Amortization of deferred compensation -- -- -- 115,000
Net amount received from Bio-Vascular -- -- -- --
Net loss -- -- -- --
------------ ------------ ------------ ------------
Balances as of October 31, 1996 1,000 10 3,003,047 (460,000)
Contribution of capital from Bio-Vascular -- -- 10,000,000 --
Amortization of deferred compensation -- -- -- 19,166
Net amount received from Bio-Vascular -- -- -- --
Unrealized securities holding loss -- -- -- --
Net loss -- -- -- --
------------ ------------ ------------ ------------
Balances as of December 31, 1996 1,000 10 13,003,047 (440,834)
Cancellation of common stock
owned by Bio-Vascular (1,000) (10) -- --
Contribution of capital
from Bio-Vascular -- -- 1,797,814 --
Issuance of common stock in
connection with
spin-off from Bio-Vascular 4,772,422 47,724 3,150,996 --
Amortization of deferred compensation -- -- -- 440,834
Cancellation of restricted stock (2,565) (25) 25 --
Issuance of common stock under
Employee Stock Purchase Plan 15,776 158 20,490 --
Issuance of common stock awards 20,928 209 34,452 --
Unrealized marketable securities
holding gain -- -- -- --
Net loss -- -- -- --
------------ ------------ ------------ ------------
Balances as of December 31, 1997 4,806,561 $ 48,066 $ 18,006,824 $ --
============ ============ ============ ============
UNREALIZED
NET MARKETABLE
INVESTMENT SECURITIES
BY BIO- ACCUMULATED HOLDING TOTAL
VASCULAR DEFICIT LOSS EQUITY
-------------- ------- ---- ------
Balances as of October 31, 1994 $ 1,099,970 $ (3,214,044) $ -- $ 313,983
Net amount paid to Bio-Vascular (245,959) -- -- (245,959)
Net income -- 252,620 -- 252,620
------------ ------------ ------- ------------
Balances as of October 31, 1995 854,011 (2,961,424) -- 320,644
Issuance of option for common stock
at below market price -- -- -- --
Amortization of deferred compensation -- -- -- 115,000
Net amount received from Bio-Vascular 2,284,509 -- -- 2,284,509
Net loss -- (2,545,749) -- (2,545,749)
------------ ------------ ------- ------------
Balances as of October 31, 1996 3,138,520 (5,507,173) -- 174,404
Contribution of capital from Bio-Vascular -- -- -- 10,000,000
Amortization of deferred compensation -- -- -- 19,166
Net amount received from Bio-Vascular 60,190 -- -- 60,190
Unrealized securities holding loss -- -- (13,125) (13,125)
Net loss -- (520,703) -- (520,703)
------------ ------------ ------- ------------
Balances as of December 31, 1996 3,198,710 (6,027,876) (13,125) 9,719,932
Cancellation of common stock
owned by Bio-Vascular 10 -- -- --
Contribution of capital
from Bio-Vascular -- -- -- 1,797,814
Issuance of common stock in
connection with
spin-off from Bio-Vascular (3,198,720) -- -- --
Amortization of deferred compensation -- -- -- 440,834
Cancellation of restricted stock -- -- -- --
Issuance of common stock under
Employee Stock Purchase Plan -- -- -- 20,648
Issuance of common stock awards -- -- -- 34,661
Unrealized marketable securities
holding gain -- -- 13,125 13,125
Net loss -- (4,773,820) -- (4,773,820)
------------ ------------ ------- ------------
Balances as of December 31, 1997 $ -- $(10,801,696) $ -- $ 7,253,194
============ ============ ======= ============
(The accompanying notes are an integral part of the financial statements.)
36
VITAL IMAGES, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS
FOR THE YEAR FOR THE TWO ENDED
ENDED MONTHS ENDED OCTOBER 31,
DECEMBER 31, DECEMBER 31, ----------------
1997 1996 1996 1995
---- ---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(4,773,820) $(520,703) $(2,545,749) $252,620
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 511,085 33,613 183,396 204,636
Stock-based compensation 475,495 19,166 115,000 8,375
Provision for uncollectible accounts receivable 12,452 700 36,592 32,863
Other -- -- 1,073 (1,703)
Changes in operating assets and liabilities:
Accounts receivable (504,218) 100,743 6,633 153,293
Prepaid expenses and other current assets (65,511) 15,676 (51,255) (6,059)
Accounts payable 116,049 27,997 (7,327) (204,720)
Deferred revenue (84,197) (15,264) 378,613 (41,320)
Accrued payroll and other liabilities 237,816 (8,091) (21,629) 153,989
----------- ----------- ----------- -----------
Net cash (used in) provided by operating activities (4,074,849) (346,163) (1,904,653) 551,974
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (795,828) (95,466) (371,217) (306,015)
Additions to patent costs (17,011) (14,617) (8,639) --
Investments in marketable securities (9,826,875) -- -- --
Maturities of marketable securities 6,863,411 -- -- --
----------- ----------- ----------- -----------
Net cash used in investing activities (3,776,303) (110,083) (379,856) (306,015)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net investment by Bio-Vascular 1,797,814 6,937,313 2,284,509 (245,959)
Purchases of common stock under Employee Stock Purchase Plan 20,648 -- -- --
----------- ----------- ----------- -----------
Net cash provided by (used in) financing activities 1,818,462 6,937,313 2,284,509 (245,959)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (6,032,690) 6,481,067 -- --
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,481,067 -- -- --
----------- ----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 448,377 $ 6,481,067 $ -- $ --
=========== =========== =========== ===========
(The accompanying notes are an integral part of the financial statements.)
37
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(1) BUSINESS DESCRIPTION, BACKGROUND AND BASIS OF PRESENTATION
Business Description
Vital Images, Inc. (the "Company" or "Vital Images") develops and markets
visualization software and workstations for clinical diagnosis, surgical
planning and medical research. The Company's technology, which utilizes
high-speed visualization and analysis, as well as network communications based
on DICOM and Internet protocols, cost-effectively brings 3D visualization into
the routine, day-to-day practice of medicine. The Company markets its products
to healthcare providers and to manufacturers of diagnostic imaging systems
through a direct sales force in the United States and independent distributors
in international markets.
Background
On October 28, 1996, the Board of Directors of Bio-Vascular, Inc.
("Bio-Vascular"), the former parent company of Vital Images, approved a plan to
spin off and establish Vital Images as an independent, publicly-owned company.
On May 12, 1997 (the "Distribution Date"), Bio-Vascular distributed all of the
shares of Vital Images to the shareholders of Bio-Vascular (the "Distribution"),
and on that date Vital Images began operating as an independent public company.
All Bio-Vascular shareholders of record as of May 5, 1997 received one share of
Vital Images common stock for each two shares of Bio-Vascular stock held on that
date, and cash in lieu of fractional shares.
In anticipation of the Distribution, Bio-Vascular assigned to Vital Images,
$10,000,000 in cash, cash equivalents and marketable securities, effective
November 1, 1996. Subsequently, Bio-Vascular's Board of Directors agreed to make
such additional contributions as were necessary to bring cash, cash equivalents
and marketable securities to a combined total of $10,000,000 effective as of the
Distribution Date. On the Distribution Date, Bio-Vascular contributed to Vital
Images an additional $1,845,000 in cash equivalents in order to increase Vital
Images' cash, cash equivalents and marketable securities balance to $10,000,000.
Additionally, Bio-Vascular made capital contributions to Vital Images of
approximately $3,200,000 representing net advances of cash over the period
beginning May 24, 1994, the date on which Vital Images was acquired by
Bio-Vascular, and ending May 11, 1997, the last date on which Vital Images was a
part of Bio-Vascular.
Basis of Presentation
The financial statements for all periods presented other than those presented as
of December 31, 1997 reflect the assets, liabilities, equity, revenues and
expenses of the Company as it was operated as a wholly-owned subsidiary of
Bio-Vascular through May 11, 1997. Prior to May 12, 1997, the Statements of
Operations include an allocation of certain general corporate expenses of
Bio-Vascular for administration, accounting, finance, human resources and
regulatory functions. These allocations were based on estimates of personnel
time and effort spent on the Company. Management believes these allocations were
made on a reasonable basis. Corporate overhead allocations were $77,000 for the
year ended December 31, 1997, $38,000 for the two-month period ended December
31, 1996, and $226,000 and $66,000 for the years ended October 31, 1996 and
1995, respectively.
The Company's financing requirements through the Distribution Date were
represented primarily by cash transactions with Bio-Vascular and are reflected
in the "Net Investment by Bio-Vascular" equity account. Activity in the Net
Investment by Bio-Vascular equity account relates to net cash received from
Bio-
38
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Vascular through intercompany advances to fund the Company's operating deficits.
These amounts received from Bio-Vascular were considered to be capital
contributions, as the Company did not have the ability to substantially repay
these advances. The financial information included herein for periods prior to
the Distribution may not necessarily be indicative of the financial position,
results of operations or cash flows of the Company, if it had been a separate,
independent company during the periods prior to the Distribution.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
On July 17, 1997, the Board of Directors of the Company adopted a resolution
changing the Company's fiscal year end from October 31 to December 31, effective
with the calendar year beginning January 1, 1997. The 1997 fiscal year ended on
December 31, whereas the previous two fiscal years ended on October 31.
Accordingly, a two-month transition period from November 1, 1996 through
December 31, 1996 preceded the start of the new calendar year cycle.
Use of Estimates
The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates. Principal
areas requiring the use of estimates include the allocation of general corporate
expenses between the Company and Bio-Vascular for periods prior to the
Distribution, the determination of the treatment of software development costs
and the allowance for uncollectable accounts receivable.
Cash and Cash Equivalents
The Company considers all highly liquid investments acquired with an original
maturity of three months or less to be cash equivalents. Cash and cash
equivalents as of December 31, 1997 are primarily concentrated in one money
market fund. Cash and cash equivalents as of December 31, 1996 are invested
primarily in short-term investments.
Marketable Securities
Investments having original maturities in excess of three months are classified
as marketable securities. Investments are classified as short-term or long-term
on the balance sheet based on their maturity date. As of December 31, 1997 and
1996, all of the Company's marketable securities are classified as
available-for-sale and all mature in two years or less. Available-for-sale
investments are recorded at market value, which is based on quoted market
prices, with unrealized holding gains and losses included as a separate
component of equity. The Company's marketable securities include debt
instruments of financial institutions, government entities and corporations.
39
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Concentration of Credit Risk
Cash, cash equivalents and marketable securities are held by financial
institutions. The Company's customer base is generally concentrated with a small
base of customers. The Company reviews the creditworthiness of its customers
prior to product shipment and generally does not require collateral.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the related asset's estimated useful life, generally
three to seven years. Leasehold improvements are amortized over the shorter of
their estimated useful lives or the remaining terms of the related leases. The
asset and related accumulated depreciation or amortization accounts are adjusted
for asset retirement or disposal with the resulting gain or loss, if any,
credited or charged to other income.
Patent Costs
Patent costs are recorded at cost and are amortized using the straight-line
method over the estimated useful lives, generally three years, commencing when
patents are granted. The Company evaluates the net realizability of patents on
an ongoing basis, based on current and anticipated undiscounted cash flows.
As of December 31, 1997 and 1996, the Company has patents pending. Accordingly,
no amortization expense for patents was recorded in any of the periods
presented.
Revenue Recognition
Revenue is derived from the licensing of computer software, sales of system
hardware and from service revenue consisting of maintenance, installation,
training and consulting services. License and hardware revenue is recognized
upon shipment, provided there are no remaining significant post-delivery
obligations and collection is deemed probable. If significant post-delivery
obligations exist or if a product is subject to customer acceptance, revenues
are deferred until no significant obligations remain or, until acceptance has
occurred. Revenue from software maintenance contracts is recognized ratably over
the contract period and other service revenue is recognized as the services are
performed.
Research and Development Costs
Costs related to research, design and development of products are charged to
research and development expense as incurred. Software development costs are
capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release to
customers. Generally, the Company's products are released soon after
technological feasibility has been established. As a result, the Company has not
capitalized any software development costs, since such costs have not been
significant.
Income Taxes
The Company accounts for income taxes using the asset and liability method.
Deferred income tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences
40
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
are expected to reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amounts expected to be realized.
As a wholly-owned subsidiary of Bio-Vascular through May 11, 1997, the Company
did not file separate federal income tax returns, but rather was included in the
federal income tax returns filed by Bio-Vascular. The Company's allocated income
tax provisions for the year ended December 31, 1997, the two months ended
December 31, 1996 and the years ended October 31, 1996 and 1995 are based on the
"separate return" method and consist solely of certain state minimum fees.
Net Income (Loss) Per Share
For periods after the Distribution, net loss per share is computed using the
weighted average common shares outstanding during the period. Common share
equivalents are not included in the net loss per share calculations since they
are anti-dilutive. Warrants and options to purchase common stock could
potentially dilute basic earnings per share in future periods if the Company
generates net income.
For periods prior to the Distribution, the weighted average common shares
outstanding used in the net income (loss) per share calculation is one-half of
the weighted average of Bio-Vascular common shares outstanding based on the
distribution of one share of the Company's common stock for each two shares of
Bio-Vascular's common stock pursuant to the Distribution. To the extent the
common share equivalents are dilutive, the weighted average common shares
include one-half of Bio-Vascular's weighted average common share equivalents.
For the year ended October 31, 1995, the denominator used to calculate diluted
earnings per share includes the dilutive impact of 245,232 warrants and stock
options.
Stock-Based Compensation
Statement of Financial Accounting Standards No. ("SFAS") 123 Accounting for
Stock-Based Compensation, encourages but does not require companies to record
compensation cost for stock-based employee compensation awards at fair value.
The Company has chosen to continue to account for employee stock options using
the intrinsic value method prescribed by APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. Accordingly,
compensation cost for stock options granted to employees is measured as the
excess, if any, of the value of the Company's stock as of the date of the grant
over the amount an employee must pay to acquire the stock. Such compensation
cost is amortized on a straight-line basis over the underlying vesting term of
the option.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS 130,
Reporting Comprehensive Income, which establishes standards for reporting and
display of comprehensive income and its components (revenue, expenses, gains and
losses) in a full set of general-purpose financial statements. The Company will
adopt SFAS 130 for its year ending December 31, 1998.
In June 1997, the FASB issued SFAS 131, Disclosure about Segments of an
Enterprise and Related Information, which requires disclosure of segment data in
a manner consistent with that used by an enterprise for internal management
reporting and decision-making. SFAS 131 establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers and the material countries in which
the entity holds assets and reports revenue.
41
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Management believes that it will report its operations as a single segment under
SFAS 131. The Company will adopt SFAS 131 for its year ending December 31, 1998.
In October 1997, the Accounting Standards Executive Committee issued Statement
of Position 97-2, Software Revenue Recognition (SOP 97-2), which provides
guidance on applying generally accepted accounting principles in recognizing
revenue on software transactions and supersedes SOP 91-1, Software Revenue
Recognition. SOP 97-2 will become effective for the Company on January 1, 1998.
Management does not anticipate that the adoption of SOP 97-2 will materially
impact the Company's revenue recognition practices, financial position or
results of operations.
(3) SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION
DECEMBER 31,
---------------------------------
1997 1996
------------ -----------
PROPERTY AND EQUIPMENT CONSISTS OF:
Furniture and fixtures $ 177,647 $ 172,263
Equipment 1,922,852 1,221,678
Computer software 227,338 154,673
Leasehold improvements 23,048 23,048
----------- -----------
Total property and equipment 2,350,885 1,571,662
Less accumulated depreciation and amortization (1,352,938) (858,458)
----------- -----------
Property and equipment, net $ 997,947 $ 713,204
=========== ===========
Non-Cash Financing Transactions
Effective November 1, 1996, Bio-Vascular assigned approximately $3,000,000 of
marketable securities to Vital Images, along with the related accrued interest.
(4) DEFERRED REVENUE
Deferred revenue consists of deferred maintenance contract revenue and also
includes amounts received from Advanced Technology Laboratories, Inc. ("ATL") in
August 1996 to enter into an exclusive development agreement with the Company.
The agreement with ATL is a five-year agreement to co-develop the Company's 3D
volume rendering technology for use in ATL's ultrasound imaging systems. The
contract fee revenue of $300,000 received in 1996 from ATL is being amortized on
a straight-line basis over the five-year term of the agreement.
42
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(5) LEASE COMMITMENTS
The Company leases office facilities under a non-cancelable operating lease in
Minneapolis, Minnesota expiring January 31, 2002. Under the terms of the lease
the Company is also required to contribute to the cost of certain building
improvements and operating costs. In addition, the Company leases office
facilities in Fairfield, Iowa under a non-cancelable operating lease, which
expires on June 1, 2000. Total rent expense, including charges for monthly
operating costs, was $234,000 for the year ended December 31, 1997, $12,000 for
the two months ended December 31, 1996 and $74,000 for each of the years ended
October 31, 1996 and 1995.
Scheduled minimum lease payments are approximately as follows:
1998 $ 220,000
1999 225,000
2000 185,000
2001 157,000
2002 13,000
-------------
Total $ 800,000
=============
The lease on the Minneapolis facility also requires the Company to post a
security deposit of up to $150,000 if, during the term of the lease, the
Company's aggregate balance of cash and marketable securities falls below
$3,000,000 or the Company's equity falls below $1,000,000.
(6) EQUITY
Change in Authorized Shares
Prior to the Distribution, Bio-Vascular, the Company's sole shareholder,
approved an increase in the number of authorized shares of capital stock from
1,000 shares to 25,000,000 shares and the reservation of 5,000,000 of such
shares as undesignated preferred stock, having such rights, preferences and
designations as determined by the Board of Directors. As a result, the Company's
authorized capital stock as of December 31, 1997 consists of 20,000,000 shares
of common stock and 5,000,000 shares of preferred stock.
Warrants
In connection with a 1995 stock offering and issuance of Bio-Vascular common
stock, Bio-Vascular issued to the underwriter warrants to purchase 90,000 shares
of Bio-Vascular common stock, at an exercise price of $16.375 per share. Under
the agreement governing the Company's spin-off from Bio-Vascular (the
"Distribution Agreement"), the Company is required to assume its respective
obligations represented by such underwriter warrants and to issue 45,000 shares
of its common stock upon the exercise thereof, based upon the spin-off
distribution ratio of one share of the Company's common stock for each two
shares of Bio-Vascular common stock. In exchange, the Distribution Agreement
provides that the Company will receive a proportionate share of the exercise
price set by the agreement. Accordingly, upon exercise of the warrants, the
Company will receive proceeds of approximately $3.29
43
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
per share and Bio-Vascular will receive proceeds of approximately $13.08 per
share. The warrants are exercisable until September 1999. None of the warrants
have been exercised as of December 31, 1997.
Restricted Stock
Under certain compensation agreements, an arrangement which provides for awards
of restricted common stock to key management was adopted by Bio-Vascular in
1992. Pursuant to the Distribution Agreement, Vital Images assumed its
proportionate share of obligations represented by such restricted shares such
that 25,375 restricted shares were issued by the Company on the Distribution
Date in connection with the spin-off from Bio-Vascular. As of December 31, 1997,
12,683 shares of restricted stock, generally vesting over a period of one to
three years, remain unearned by certain key Bio-Vascular employees.
Rights Plan
In April 1997 the Company declared a dividend distribution of one Preferred
Stock Purchase Right for each outstanding share of the Company's common stock
(the "Rights"). With certain exceptions, the Rights become exercisable only in
the event that (i) an acquiring party accumulates 15% or more of the Company's
common stock, (ii) a party announces an offer to acquire 15% or more of the
Company's common stock, or (iii) the acquisition of a substantial amount of the
Company's common stock by a person whom the Board of Directors has determined is
an Adverse Person as defined in the underlying Rights Agreement. Each Right
entitles the holder to purchase one-thousandth of a share of the Company's
Series A Junior Preferred Stock at a price of $20.00 (the "Exercise Price"). If
a person or group becomes the beneficial owner of 15% or more of the Company's
common stock or the Board of Directors determines that a person is an Adverse
Person, each holder of a Right shall thereafter have the right to receive
preferred stock having a fair market value equal to two times the Exercise
Price. Upon the occurrence of certain mergers, combinations or acquisitions of
the Company's assets, each holder of a Right shall thereafter have the right to
receive that number of shares of common stock of the acquiring company which
equals the Exercise Price of the Right divided by one-half of the current market
price of such common stock as of the date of the occurrence of the event. The
Company is generally entitled to redeem the Right at $.001 per Right at any time
until ten days following the acquisition of 15% or more of the Company's common
stock or ten days after the point at which the Company's Board of Directors
determines that a person is an Adverse Person, as defined by the Rights
Agreement. The Rights expire on April 30, 2007, if not previously redeemed or
exercised.
Stock Option Plans
In connection with the Distribution, Bio-Vascular, as the sole shareholder of
the Company, approved and adopted several option plans and stand-alone option
grants, which covered employees of both Vital Images and Bio-Vascular. The
adopted plans include the Incentive Stock Option Adjustment Plan, the 1990
Management Incentive Stock Option Plan, the 1992 Directors' Option Adjustment
Plan, the 1992 Stock Option Plan, and the 1995 Stock Incentive Adjustment Plan
(collectively, the "Mirror Plans"). Each of these plans is intended to mirror
the provisions of a corresponding Bio-Vascular plan that was in effect at the
time of the Distribution. As each Bio-Vascular option plan generally provided
for the termination of options following termination of employment, each of the
Mirror Plans, as well as each of the stand-alone option grants (the "Mirror
Grants"), were approved and adopted to provide that the Distribution would not
cause a termination of any Vital Images employee for the purposes of such plans
or option grant, and that Bio-Vascular options held by Vital Images employees
following the Distribution would remain exercisable following the Distribution,
so long as such employees remain employed by
44
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
Vital Images or any subsidiary. Similar provisions were also adopted with
respect to Vital Images options held by Bio-Vascular employees. On the
Distribution Date, 608,534 options were issued in connection with the Mirror
Plans and the Mirror Grants (collectively, the "Mirror Options"). These options
have vesting periods ranging from less than one year up to four years and terms
ranging from less than one year up to ten years. No additional grants may be
made pursuant to any of the Mirror Plans.
In May 1997, Bio-Vascular, as the sole shareholder of the Company, approved
and adopted the Vital Images, Inc. 1997 Stock Option and Incentive Plan (the
"Stock Option Plan"), which became effective on the Distribution Date. Under the
terms of the plan, the Board of Directors may grant options and other
stock-based awards to key employees to purchase shares of the Company's common
stock at an option exercise price equal to or greater than 85% of the fair
market value on the date of grant. The options are exercisable at such times, in
installments or otherwise, as the Board of Directors may determine. Generally,
these options are incentive stock options with a term of eight years and are
exercisable to 28% of the total grant one year after the date of grant and 2%
per month thereafter. The total number of shares of common stock that may be
issued or awarded under the Stock Option Plan may not exceed 675,000. As of
December 31, 1997, there are 311,232 shares available for grant under the Stock
Option Plan.
Also in May 1997, Bio-Vascular, as the sole shareholder of the Company,
approved and adopted the Vital Images, Inc. 1997 Director Stock Option Plan (the
"Director Plan") (together with the Stock Option Plan, the "1997 Plans"), which
became effective on the Distribution Date. The Director Plan provides
non-employee directors with automatic grants of stock options, and allows the
Board of Directors to make additional discretionary option grants to any or all
directors. Options that are granted under the Director Plan are generally
granted with an option price equal to the fair market value on the date of
grant, are non-qualified options and become exercisable in three equal annual
installments beginning on the first occurring December 31 after the date of
grant. The total number of shares of common stock that may be issued or awarded
under the Director Plan may not exceed 75,000. As of December 31, 1997, there
are no shares available for grant under the Director Plan.
Subsequent to December 31, 1997, the Board of Directors approved an increase of
250,000 common shares for the Stock Option Plan and an increase of 30,000 common
shares for the Director Plan. These increases are subject to approval by the
shareholders of the Company.
The following table summarizes stock option activity for 1997:
Weighted-Average
Shares Under Price Per
Option Share
----------------- ---------------
Total outstanding as of December 31, 1996 - -
Mirror Options granted 608,534 $2.85
Options granted under 1997 Plans 482,268 2.34
Options exercised - -
Options canceled (143,784) 2.40
--------- -------
Total outstanding as of December 31, 1997 947,018 $2.66
========= =======
45
Various price ranges and weighted average information for options outstanding as
of December 31, 1997 are as follows:
SHARES UNDER OPTION OUTSTANDING SHARES UNDER OPTION EXERCISABLE
----------------------------------------------------- -------------------------------------
WEIGHTED
AVERAGE
NUMBER REMAINING WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING AS CONTRACTUAL AVERAGE EXERCISABLE AS AVERAGE
EXERCISE PRICES OF DEC 31, 1997 LIFE EXERCISE PRICE OF DEC 31, 1997 EXERCISE PRICE
- ------------------ ---------------- ---------------- --------------- ---------------- ----------------
$0.96 - $2.29 224,245 4.21 years $1.67 179,045 $1.65
$2.38 343,768 7.38 years $2.38 - -
$2.39 - $3.87 246,381 5.11 years $2.80 137,949 $2.79
$4.08 - $6.27 132,624 6.99 years $4.79 120,589 $4.72
------- -------
$0.96 - $6.27 947,018 5.98 years $2.66 437,583 $2.86
======= =======
Employee Stock Purchase Plan
The 1997 Employee Stock Purchase Plan (the "ESPP") was approved and adopted by
Bio-Vascular, as the sole shareholder of the Company, in May 1997. The ESPP,
which became effective on July 1, 1997, enables eligible employees to purchase
the Company's common stock at 85% of the fair market value of the stock on the
date an offering commences or on the date an offering terminates, whichever is
lower. The ESPP covers an aggregate of up to 250,000 shares of common stock that
can be issued and sold to participating employees of the Company through a
series of three-month offerings, beginning July 1, 1997. The ESPP covers
substantially all employees, subject to certain limitations. Each employee may
elect to have up to 10% of his or her base pay withheld and applied toward the
purchase of shares in each such offering. Purchases under the ESPP for 1997 were
15,776 shares generating proceeds to the Company of $20,648 at an average
purchase price of $1.31. As of December 31, 1997, there are 234,224 shares of
common stock reserved for purchases under the ESPP.
Stock-Based Compensation
The Company has adopted the disclosure-only provisions of SFAS No. 123 for
stock-based employee compensation. If compensation cost for the Mirror Options,
the ESPP, the Stock Option Plan and the Director Plan been determined based on
the fair value on the grant dates for awards in 1997 consistent with the
provisions of SFAS No. 123, the Company's net loss and net loss per share for
1997 would have been increased to the pro forma amounts indicated below:
Net loss As reported $ (4,773,820)
Pro forma $ (5,009,000)
Net loss per share - As reported $ (1.00)
basic and diluted Pro forma $ (1.05)
The 1997 pro forma loss includes the compensation costs related to the granting
of the Mirror Options, which were granted in connection with the Company's
spin-off from Bio-Vascular. The 1997 pro forma loss would have been lower had
the Company recorded, in years prior to 1997, the pro forma compensation cost
associated with the Mirror Options in the same year as the underlying
Bio-Vascular options were originally granted by Bio-Vascular.
46
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
The weighted average fair value of options granted during 1997 was:
Mirror Options $1.21
Options under ESPP $0.26
Options under the 1997 Plans $1.44
The weighted average fair value was based on the fair value of each Mirror
Option on the Distribution Date and the fair value of options under the 1997
Plans on the date of grant. The fair value of options under the ESPP was based
on the 15 percent purchase discount. The fair value of the Mirror Options and
options under the 1997 Plans was calculated using the Black-Sholes option
pricing model with the following weighted average assumptions:
Expected option life 4.4 years
Expected volatility factor 60.1%
Expected dividend yield 0%
Risk-free interest rate 6.42%
The pro forma effect on the net loss for 1997 is not necessarily representative
of the pro forma effect that may occur on the net earnings (loss) of future
periods.
(7) INCOME TAXES
The income tax provision, if any, for each of the periods presented represents
state minimum taxes. As of December 31, 1997 the Company has net operating loss
carryforwards of approximately $7,667,000 for income tax purposes and unused
research and development credits of approximately $346,000, which expire in
varying amounts from 2004 to 2012. For financial reporting purposes, a valuation
allowance has been established to completely reserve for the deferred tax assets
related to those carryforwards.
As a result of Bio-Vascular's acquisition of the Company in May 1994, the
Company experienced an ownership change as defined by the Internal Revenue Code
(the "Code"). Under the Code, the amount of pre-acquisition net operating loss
carryforwards and research and development credits that can be used to offset
future taxable income and income taxes will be limited. As of the date of the
Company's acquisition by Bio-Vascular, the Company had approximately $1,600,000
of net operating loss carryforwards and approximately $137,000 of research and
experimentation credits, both of which will be subject to limitation under the
Code.
The significant components of the Company's tax-effected net deferred tax assets
are:
DECEMBER 31, DECEMBER 31,
1997 1996
---- ----
Net operating loss carryforwards $ 3,067,000 $ 1,288,000
Research tax credit carryforwards 346,000 254,000
Amortization of deferred compensation 230,000 54,000
Deferred revenue 87,000 146,000
Other, net 52,000 32,000
----------- -----------
Net deferred tax assets before valuation allowance 3,782,000 1,774,000
Less valuation allowance (3,782,000) (1,774,000)
----------- -----------
Net deferred tax assets $ - 0 - $ - 0 -
=========== ===========
47
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(8) MAJOR CUSTOMERS AND GEOGRAPHIC DATA
PERCENTAGE
OF
SIGNIFICANT PERCENTAGE OF ACCOUNTS
CUSTOMER REVENUE TOTAL REVENUE RECEIVABLE
------------ --------- ------------- -----------
Year ended December 31, 1997 CogniSeis $ 313,000 26% -
Development, Inc.
Two months ended December 31, 1996 Advanced Technology 10,000 15% -
Labs
Stanford University 8,000 12% 6%
Year ended October 31, 1996 Mitsubishi 99,000 11% 9%
Chemical
Year ended October 31, 1995 CogniSeis 1,782,000 62% -
Development, Inc.
In August 1995, the Company entered into a source code license agreement with
CogniSeis Development, Inc. ("CogniSeis") granting CogniSeis a worldwide,
exclusive license for use in oil and gas exploration applications. Under the
agreement, CogniSeis became both the exclusive developer and marketer of
VoxelGeo(R). Upon validation of the source code, the Company received a
one-time license fee payment of $1,500,000 during fiscal 1995. In addition, the
Company also receives royalty payments based upon cash collections from sales of
VoxelGeo software by CogniSeis. These royalty payments will cease on January 1,
2001 or when the aggregate amount of royalties received equals $2,000,000,
whichever occurs earlier. During 1997, the Company received royalty payments of
$313,000. No royalty payments were received prior to 1997.
The Company's accounts receivable is generally concentrated with a small base of
customers. As of December 31, 1997, six customers accounted for 73% of accounts
receivable, while as of December 31, 1996, three customers accounted for 58% of
accounts receivable.
Export revenue amounted to 18% of total revenue for the year ended December 31,
1997, 27% for the two months ended December 31, 1996, and 13% and 39% for the
years ended October 31, 1996 and 1995, respectively. Substantially all of the
Company's export sales are negotiated, invoiced and paid in U.S. dollars.
Export sales by geographic area are summarized as follows:
FOR THE YEARS
FOR THE YEAR FOR THE TWO ENDED
ENDED MONTHS ENDED OCTOBER 31,
DECEMBER 31, DECEMBER 31, --------------------------------
1997 1996 1996 1995
------------------- ------------------ -------------- -----------------
Europe and Middle East $146,000 $ 4,000 $111,000 $115,000
Asia and Pacific Region 45,000 14,000 144,000 210,000
Canada, Mexico and others 26,000 - 6,000 56,000
48
VITAL IMAGES, INC.
NOTES TO FINANCIAL STATEMENTS
(9) EMPLOYEE BENEFIT PLAN
During 1997, the Board of Directors adopted the Vital Images, Inc. Salary
Savings Plan (the "Plan"), which is intended to qualify under Section 401(k) of
the Internal Revenue Code, as amended. The Plan covers substantially all
employees. Each employee may elect to contribute to the Plan through payroll
deductions up to 15% of his or her salary, subject to certain limitations. At
the discretion of the Board of Directors, the Company may make matching
contributions equal to a percentage of the salary reduction contributions or
other discretionary amounts. There were no contributions to the Plan by the
Company for 1997.
49
SCHEDULE II
VITAL IMAGES, INC.
VALUATION AND QUALIFYING ACCOUNTS
BALANCE AS OF CHARGES TO BALANCE
BEGINNING COST AND AS OF END
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
- ------------------------------------------------- ---------------- ------------- --------------- --------------
Allowance for doubtful accounts:
Year ended December 31, 1997 $49,500 $12,452 $21,952 $40,000
======= ======= ======= =======
Two months ended December 31, 1996 $48,800 $ 700 $ - $49,500
======= ======= ======= =======
Year ended October 31, 1996 $20,000 $36,592 $ 7,792 $48,800
======= ======= ======= =======
Year ended October 31, 1995 $10,000 $32,863 $22,863 $20,000
======= ======= ======= =======
50
VITAL IMAGES, INC.
FORM 10-K
INDEX TO EXHIBITS
ITEM NO. DESCRIPTION
- -------- -----------
3.1 Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.1 to the Company's registration statement
on Form 10 (File No. 0-22229)).
3.2 By-laws of the Company (incorporated by reference to Exhibit 3.2
to the Company's registration statement on Form 10 (File No.
0-22229)).
4.1 Articles of Incorporation of the Company (See Exhibit 3.1).
4.2 By-laws of the Company (See Exhibit 3.2).
4.3 Form of common stock Certificate of the Company (incorporated by
reference to Exhibit 4.3 to the Company's registration statement
on Form 10 (File No. 0-22229)).
4.4 Rights Agreement, dated effective as of May 1, 1997 between the
Company and American Stock Transfer and Trust Company, which
includes as Exhibit B the form of Rights Certificate
(incorporated by reference to Exhibit 4.4 to the Company's
registration statement on Form 10 (File No. 0-22229)).
4.5 Certificate of Designation, Preferences and Rights of Series A
Junior Preferred Stock of the Company (incorporated by reference
to Exhibit 4.5 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.1 Form of Distribution Agreement, effective as of May 2, 1997
between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.1 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.2 Form of Employee Benefits Agreement, effective as of May 2, 1997,
between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.2 to the Company's registration statement
on Form 10 (File No. 0-22229)).
51
10.3 Form of Tax Sharing Agreement, effective as of May 2, 1997,
between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.3 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.4 Form of Transition Services Agreement, effective as of May 2,
1997 between Bio-Vascular, Inc. and the Company (incorporated by
reference to Exhibit 10.4 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.5 Incentive Stock Option Adjustment Plan (incorporated by reference
to Exhibit 10.5 to the Company's registration statement on Form
10 (File No. 0-22229)).
10.6 1990 Stock Option Plan (incorporated by reference to Exhibit 10.6
to the Company's registration statement on Form 10 (File No.
0-22229)).
10.7 1992 Stock Option Plan (incorporated by reference to Exhibit 10.7
to the Company's registration statement on Form 10 (File No.
0-22229)).
10.8 1992 Director Stock Option Adjustment Plan (incorporated by
reference to Exhibit 10.8 to the Company's registration statement
on Form 10 (File No. 0-22229)).
10.9 1995 Stock Incentive Adjustment Plan (incorporated by reference
to Exhibit 10.9 to the Company's registration statement on Form
10 (File No. 0-22229)).
10.10 Employee Stock Purchase Plan (incorporated by reference to
Exhibit 10.10 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.11 1997 Stock Option and Incentive Plan (incorporated by reference
to Exhibit 10.11 to the Company's registration statement on Form
10 (File No. 0-22229)).
10.12 1997 Director Stock Option Plan (incorporated by reference to
Exhibit 10.12 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.13 Stock Option Adjustment Agreement between the Company and Andrew
M. Weiss (incorporated by reference to Exhibit 10.13 to the
Company's registration statement on Form 10 (File No. 0-22229)).
52
10.14 License Agreement dated August 25, 1995 between the Company and
CogniSeis Development, Inc. (incorporated by reference to Exhibit
10.14 to the Company's registration statement on Form 10 (File
No. 0-22229)).
10.15 Lease agreement dated May 14, 1993, as amended April 15, 1997,
between Vital Images, Inc. and Douglas Green IRA Trust
(incorporated by reference to Exhibit 10.15 to the Company's
registration statement on Form 10 (File No. 0-22229)).
10.16 Lease Agreement dated January 31, 1997 between ACKY - 3100 Lake
Limited Partnership and the Company (incorporated by reference to
Exhibit 10.16 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.17 Form of Change in Control Agreement between the Company and
Andrew M. Weiss, Vincent J. Argiro, Ph.D., David A. Davis,
Gregory S. Furness and Jay D. Miller (incorporated by reference
to Exhibit 10.17 to the Company's registration statement on Form
10 (File No. 0-22229)).
10.18 Joint Development Agreement dated August 14, 1996 between the
Company and ATL Ultrasound, Inc.* (incorporated by reference to
Exhibit 10.18 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.19 Sales and Marketing Agreement dated August 14, 1996 between the
Company and ATL Ultrasound, Inc.* (incorporated by reference to
Exhibit 10.19 to the Company's registration statement on Form 10
(File No. 0-22229)).
10.20 Software License Agreement dated August 1, 1997 between the
Company and Duke University (filed herewith electronically).
10.21 Severance Agreement dated February 13, 1998 between the Company
and Mr. Weiss (filed herewith electronically).
10.22 Employment Agreement dated February 1, 1998 between the Company
and Douglas M. Pihl (filed herewith electronically).
10.23 Non-qualified Stock Option Agreement dated February 24, 1998
between the Company and Douglas M. Pihl (filed herewith
electronically).
23.1 Consent of Coopers & Lybrand L.L.P., dated March 27, 1998 (filed
herewith electronically).
53
27.1 Financial Data Schedule (filed herewith electronically).
* Portions of such exhibit are subject to a request for confidential treatment
filed with the Commission by the Registrant.
54