Item 1. Business
Overview
ResMed Inc., a Delaware corporation, was formed in March 1994 as the ultimate holding company for its Australian, European and United States operating subsidiaries. On June 1, 1995 the Company completed an initial public offering of common stock and on June 2, 1995 the Company's common stock commenced trading on the NASDAQ Stock Market. Its Australian subsidiary ResMed Holdings Limited ("RHL") was originally organized in 1989 by Dr. Peter Farrell to acquire from Baxter Center for Medical Research Pty Limited ("Baxter"), the rights to certain technology relating to nasal Continuous Positive Airway Pressure ("CPAP") treatment of Obstructive Sleep Apnea ("OSA"), as well as Baxter's existing CPAP device business. Baxter had sold CPAP devices in Australia since 1988, having acquired the rights to the technology in 1987 from Dr. Colin Sullivan of the University of Sydney, who invented nasal CPAP for the treatment of OSA. The Company and its subsidiaries, since 1989, have specialized in the design, manufacture and marketing of patented nasal CPAP equipment for the diagnosis and treatment of OSA.
Recent Developments
The Company acquired the distribution business of both Dieter W Priess Medtechnik and Premium Medical SARL its German and French distributors on February 7, 1996 and June 12, 1996, respectively. The acquisition of the German Distributor, for US$6,500,000 was the subject of a separate report on Form 8K and amendment to a report on Form 8K which were filed with the Securities Exchange Commission on February 21, 1996 and April 26, 1996, respectively.
The Company in July and August 1996 respectively received FDA clearance to market its AutoSet(Trademark) Portable diagnostic products, AutoSet(Trademark) Clinical devices and its VPAP(Registered Trademark)II ST bilevel CPAP. The VPAP(Registered Trademark)II ST bilevel device features spontaneous and timed mode operation.
Obstructive Sleep Apnea
OSA is a breathing disorder in which an individual experiences a temporary collapse of the upper airway during sleep. This restricts breathing and severely disrupts the individual's sleep. Sleep is a complex neurological process that includes two distinct states: rapid eye movement ("REM") sleep and non-rapid eye movement ("non-REM") sleep. REM sleep, which occurs during about 20-25% of sleep in adults, is characterized by a high level of brain activity, bursts of rapid eye movement, increased heart and respiration rates, and paralysis of many muscles. Non-REM sleep is subdivided into four stages that generally parallel sleep depth: stage 1 is the lightest and stage 4 is the deepest. The inability of an individual to experience adequate amounts of REM and deeper levels (stages 3 and 4) of non-REM sleep results in daytime tiredness and reduced cognitive function, both of which are characteristic of OSA. - -2-
Normally, during REM sleep and deeper levels of non-REM sleep, upper airway muscles relax and the airway narrows. The upper airway has no rigid support and is held open by active contraction of upper airway muscles. Individuals with narrow upper airways or poor muscle tone are prone to upper airway closure during sleep (an "apnea"), resulting in an inability to breathe, or near closure (an "hypopnea") which causes snoring and breathing difficulties. These breathing irregularities result in a lowering of blood oxygen concentration, and after 10 seconds or more, the brain reacts to the lack of oxygen and signals the body to respond. Typically, the individual subconsciously arouses from REM sleep or from Stages 3 or 4 of non-REM sleep to Stages 1 or 2 of non-REM sleep, causing the throat muscles to contract, thus opening the airway. After a few gasping breaths, blood oxygen levels increase and the individual can resume a deeper sleep until the cycle repeats itself. The cycle of complete or partial upper airway closure with subconscious arousal to lighter levels of sleep can be repeated as many as several hundred times during six to eight hours of sleep. Sufferers of OSA typically experience ten or more such cycles per hour and as a result experience clinical symptoms of OSA, such as excessive daytime sleepiness or reduced cognitive function. These awakenings greatly impair the quality of sleep, although the individual is not normally aware of these disruptions.
Sleep fragmentation and the loss of the deeper levels of sleep caused by OSA can lead to excessive daytime sleepiness, reduced cognitive function (including memory loss and lack of concentration) and irritability. OSA has been associated with employment difficulties, marital discord, impotence and other adverse effects. Patients with OSA have been shown to have impaired daytime performance in a variety of cognitive functions including problem solving, response speed and visual motor coordination. Certain studies have linked OSA to increased occurrences of traffic and workplace accidents. OSA sufferers also may experience an increase in heart rate and an elevation of blood pressure during the cycle of apneas. Several reports indicate that the oxygen desaturation, increased heart rate and elevated blood pressure caused by OSA may be associated with increased risk of cardiovascular morbidity and mortality due to angina, stroke and heart attack.
The Market
In its "Wake Up America" report to Congress in 1993, the National Commission on Sleep Disorders Research estimated that approximately 40 million individuals in the United States suffer from chronic disorders of sleep and wakefulness, such as sleep apnea, insomnia and narcolepsy. According to this report, sleep apnea is the most common sleep disorder, affecting approximately 20 million individuals in the United States. Nearly 6.5 million of these persons over the age of 30 experience moderate to severe forms of sleep apnea. However, there is a general lack of awareness of OSA among both the medical community and the general public, which has led to a corresponding failure to diagnose the disorder. It is estimated that less than 3% of those persons afflicted by OSA know the cause of their fatigue or other symptoms. Health care professionals are often unable to diagnose OSA because they are unaware that such non-specific symptoms as fatigue, snoring and irritability are characteristic of OSA. - -3-
While OSA has been diagnosed in a broad cross-section of the population, it is predominant among middle-aged men and those who are obese, smoke, consume alcohol in excess or use muscle-relaxing drugs. In addition, patients who are being treated for certain other conditions, including those undergoing dialysis treatment or suffering from diabetes, are medically predisposed to OSA.
Generally, an individual seeking treatment for the symptoms of OSA is referred by a general practitioner to a specialist, such as a pulmonologist, neurologist or psychiatrist for further evaluation. The diagnosis of OSA typically requires monitoring the patient during sleep at either a sleep clinic or the patient's home. During overnight testing, respiratory parameters and sleep patterns are monitored along with other vital signs such as blood pressure, heart rate and blood oxygen levels. These tests allow sleep clinicians to detect any sleep disturbances such as apneas, hypopneas or subconscious awakenings.
The Company estimates that there are currently more than 1,200 sleep clinics in the United States, a substantial portion of which are affiliated with hospitals. Sleep clinics generally range in size from one to six beds. The number of sleep clinics has expanded significantly from approximately 100 such facilities in 1985. The Company believes that despite the increase in sleep clinics, testing facilities currently remain inadequate to address the large population of undiagnosed OSA sufferers.
Existing Therapies
Prior to 1981, the primary treatment for OSA was a tracheotomy, a surgical procedure to cut a hole in the patient's windpipe to create a channel for airflow. Most recently, surgery has involved either uvulopalatopharyngoplasty ("UPPP"), in which surgery is performed on the upper airway to remove excess tissue and to streamline the shape of the airway, or mandibular advancement, in which the lower jaw is moved forward to widen the patient's airway. UPPP alone has a poor success rate; however, when performed in conjunction with mandibular advancement, a greater success rate has been claimed. This combined procedure, performed by highly specialized surgeons, is expensive and involves prolonged and often painful recovery periods.
Nasal CPAP was first used as a treatment for OSA in 1980 by Dr. Colin Sullivan, the Chairman of the Company's Medical Advisory Board. CPAP systems were commercialized for treatment of OSA in the United States in the mid 1980's. Today, use of nasal CPAP, although not a medical cure for OSA, is generally acknowledged as the most effective and least invasive treatment for OSA, allowing the individual to enjoy a more normal sleep pattern. The Company estimates that during 1995, CPAP treatment was prescribed for over 100,000 new patients in the United States. - -4-
During nasal CPAP treatment, a patient sleeps with a nasal mask connected to a small portable air flow generator that delivers room air at a predetermined positive pressure. The patient breathes in air from the air flow generator and breathes out through an exhaust port in the mask. Continuous air pressure applied in this manner acts as a pneumatic splint to keep the upper airway open and unobstructed. Upon diagnosis of OSA and the decision to prescribe CPAP treatment for an OSA sufferer, the physician must determine an appropriate pressure setting for the CPAP device. This pressure titration (adjustment) procedure typically occurs in the sleep clinic while the patient sleeps using the CPAP device, and a technician manually increases the pressure until sleeping and breathing are normalized. After determination of the proper therapeutic pressure, the patient is prescribed a nasal CPAP device set to that pressure for home use.
CPAP is a treatment and not a cure for OSA, and therefore, must be used on a nightly basis for life. Patient compliance has been a major factor in the efficacy of CPAP treatment. Early generations of CPAP units provided limited patient comfort and convenience. Patients experienced soreness from the repeated use of nasal masks and had difficulty falling asleep with the CPAP device operating at the prescribed pressure. Recently, product innovations to improve patient comfort and compliance have been developed. These include more comfortable mask systems, delay timers which gradually raise air pressure allowing the patient to fall asleep more easily, and bi-level air flow generators which provide different air pressures for inhalation and exhalation.
Business Strategy
The Company believes that the number of OSA patients receiving treatment will increase in the future due to several factors, including increased awareness of OSA, an increase in the number and capacity of sleep clinics, and improved products for the diagnosis and treatment of OSA at home. The Company's strategy for the expansion of its business operations consists of the following key elements.
Continue Product Development and Innovation. The Company believes that it is a leading innovator in nasal CPAP technology for the treatment of OSA and that its continued product development and innovation will be a key factor in its success. Since its founding, the Company has introduced product advancements and improvements designed to increase patient comfort and encourage compliance, such as delay timers, heated humidifiers, and pliable Bubble Masks(Trademark). The Company is currently developing a range of automatic CPAP devices, including further developments of its existing range of AutoSet(Trademark) products, that are designed to continually adjust CPAP pressure to meet changing individual patient's needs and to eliminate the need for manual pressure titration.
Expand Market Presence. The Company currently markets its products in 40 countries through a network of independent distributors, the Company's direct sales force and manufacturers' representatives. The Company intends to increase its sales and marketing efforts in its current markets, particularly Europe and the United States, as well as to continue expansion into new countries. - -5-
Increase Public and Clinical Awareness. The Company intends to promote awareness of the prevalence of, and treatment alternatives for, OSA with three main groups: (1) the population with predisposition to OSA; (2) primary care physicians and other specialists, such as cardiologists and anesthesiologists; and (3) special interest groups, such as sleep disorder support groups. The Company is working with other physicians to explore new medical applications for nasal CPAP, including the treatment of post-operative surgery patients and pediatric patients, such as premature babies and infants at risk of Sudden Infant Death Syndrome.
Products
The Company designs, manufactures and markets nasal CPAP equipment for the diagnosis and treatment of OSA. These products consist of air flow generators, which are small, portable devices that provide a preset positive airway pressure, air delivery systems that include nasal masks, tubing and headsets that connect the airflow generator to the patient and AutoSet diagnostic equipment. In addition, the Company markets accessories to improve patient comfort, convenience and compliance, such as heated humidifiers. The Company also distributes Compumedics laboratory and portable sleep diagnostic products.
Air Flow Generators
The Company manufactures and markets a broad range of air flow generators which are sold to the end user at prices which vary from approximately $1,000 to $3,000, depending primarily upon the model, features and country of sale. Air flow generators accounted for approximately 61%, 66% and 68% of the Company's net revenues in 1994, 1995 and 1996, respectively.
CPAP. The Company's CPAP air flow generators consist of the SULLIVAN(Registered Trademark) III, SULLIVAN(Registered Trademark) IV and SULLIVAN(Registered Trademark) V series. The SULLIVAN(Registered Trademark) III, SULLIVAN(Registered Trademark) IV and SULLIVAN(Registered Trademark) V offer a range of enhancements to the Company's initial CPAP products, released in 1989 and 1991. The Company's primary air flow generator prior to July 1995 was the SULLIVAN(Registered Trademark) III, which weighs less than five pounds, is about four inches high and conveniently fits under most beds. The SULLIVAN(Registered Trademark) V range of flow generators which feature a 20% reduction in physical size when compared to the SULLIVAN(Registered Trademark) III was introduced in July 1995 and is now the Company's main air flow generator product. The SULLIVAN(Registered Trademark) V line of flow generators consists of three individual models with each model providing a range of features depending upon the needs of patients. Each model continuously delivers a fixed positive pressure air flow to the patients.
VPAP(Registered Trademark). Since the introduction of the SULLIVAN(Registered Trademark) VPAP(Registered Trademark) flow generator in 1994, the Company has released a number of Variable Positive Airway Pressure (VPAP) flow generators which it believes improve patient comfort by applying different air pressures for inhalation and exhalation. These features are particularly beneficial for those patients with impaired breathing ability who need high levels of air pressure for inhalation as well as less resistance for exhalation.
At June 1996 the Company had two main VPAP flow generators, the SULLIVAN(Registered Trademark) VPAP(Registered Trademark)II and SULLIVAN(Registered Trademark) Comfort. Both units were released in March 1996 and feature improved pressure switching and reduced noise. In August 1996 the Company received FDA approval for the marketing and sale of the VPAP(Registered Trademark)II ST flow generator, a bilevel pressure VPAP(Registered Trademark) device with timed and spontaneous/timed breathing modes of operation. - -6-
Air Flow Generators Under Development. The Company is developing the patented AutoSet(Trademark) CPAP devices for home use which are designed to automatically adjust air pressure as needed on a breath by breath basis. The Company markets similar devices for use in sleep clinics (AutoSet(Trademark) Clinical) in Europe and the rest of the world. The Company obtained FDA clearance for the AutoSet(Trademark) Clinical in July 1996 which conducts automated assessment of sleep apnea and the CPAP pressure required by patients. While conventional CPAP units operate at a fixed CPAP pressure, the actual pressure required for effective treatment of OSA can vary depending on factors such as weight change, alcohol consumption, sedative use, stage of sleep and body position. The AutoSet(Trademark) device is designed to detect the patient's level of airway resistance and to continually adjust the air pressure to the appropriate therapeutic level throughout the night. The Company is developing a version of AutoSet(Trademark) which will record airway resistance and actual levels of therapeutic air pressure during home use for later review by sleep physicians for diagnostic purposes. The Company is also developing a CPAP device for use with infants and children, the pediatric CPAP, which incorporates features such as tamper-resistant controls and certain alarms.
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The Company provides optional features including a patented delay timer, which allows the patient to select the time over which a gradual transition to full therapeutic pressure is achieved, allowing the patient to fall asleep more easily. Another feature, the SmartStart(Trademark) function, automatically starts airflow when the patient breathes into the mask and stops airflow upon removal of the mask. Some models record the number of hours a patient receives therapy, permitting physicians to monitor patient compliance. Most units come equipped with a carrying bag for enhanced portability. In addition, every unit has international electric voltage compatibility.
Mask Systems, Accessories and Other Products
Mask systems, accessories and other products accounted for approximately 37%, 30% and 30% of the Company's net revenues in 1994, 1995 and 1996, respectively.
Mask Systems
The Company's mask system includes the mask frame, a nasal cushion, and headgear to secure the nasal cushion to the face.
The Company's Bubble Mask(Trademark) includes a patented Bubble Cushion(Trademark) which represents a significant advance in patient comfort. Introduced in 1991, the Bubble Cushion(Trademark) contains a silicone membrane which readily adjusts to a patient's facial contours. Air pressure seals the thin membrane around the patient's nose, thereby minimizing air leakage and the possibility of skin irritation from repeated usage. The Company's headgear includes the ResCap(Registered Trademark) which has a five-point attachment method of stabilizing the Bubble Cushion(Trademark) on the patient's nose.
In addition, in July 1995 the Company introduced the modular mask frame which features T Bar forehead pads to prevent sideways movement of the frame and provide maximum stability.
Typically, patients replace masks or mask cushions every 12 to 18 months, at a cost of approximately $100-$200 depending upon the model. Bubble Masks(Trademark) are available in a variety of sizes and are sold independently of the Company's air flow generators either as replacement products or with other manufacturers' air flow generators. The Company also manufactures the Bubble Mask(Trademark) on an OEM basis for Nellcor Puritan Bennett, one of its competitors.
Accessories and Other Products
In order to enhance patient comfort, convenience and compliance, the Company markets a variety of other products and accessories. These products include humidifiers which connect directly with the CPAP and VPAP air flow generator to moisten (humidify) and, if desired, heat air delivered to the patient. This prevents the drying of nasal passages which can cause discomfort upon repeated use of the system. Other optional accessories include carry bags to carry portable flow generators, replacement filters.
Clinical Support
The Company also manufactures products that are used primarily in sleep clinics and hospitals to monitor key respiratory parameters. These products consist of CPAP devices together with additional diagnostic tools to assist clinicians in the diagnosis of OSA and establishment of therapeutic pressures necessary to treat OSA suffers. - -8-
CPAP Clinical Interface. Introduced in October 1995, the Universal Control Unit (UCU) is a diagnostic and monitoring device that is used by clinicians to measure and adjust the pressures being delivered by either the Company's CPAP or VPAP devices to a patient undergoing a sleep study. The clinical interface allows the clinician to conduct this review and adjustment from a remote location within the sleep lab. In the United States, clinical interface devices are typically provided to clinics by the Company without charge in order to increase clinical awareness and interest in the Company's products.
The SULLIVAN(Registered Trademark) Compliance Application (SCAN), introduced in October 1995 comprises the software necessary to download compliance data from flow generators with recording capabilities. In connection with a modem, this product allows compliance data to be downloaded from a flow generator in a patients name direct to the sleep laboratory.
AutoSet(Trademark) Clinical. The Company's AutoSet(Trademark) Clinical allows the clinical real-time observation and review by a clinician of respiratory parameters during a sleep study. AutoSet(Trademark) Clinical incorporates a PC-based monitoring device which permits real-time diagnosis of patient airway resistance. This device may also be used in the therapeutic mode for automatic breath-by-breath adjustment to maintain an open airway. AutoSet(Trademark) Clinical received FDA clearance in July 1996. The Company is currently developing an AutoSet(Trademark) CPAP device for home use
Product Development
The Company is committed to an ongoing program of product advancement and development. During the past year, the Company introduced several new products, including SULLIVAN(Registered Trademark) VPAPII, SULLIVAN(Registered Trademark) V, SULLIVAN(Registered Trademark) Comfort, AutoSet(Trademark) Clinical and improved nasal masks. Currently, the Company's product development efforts are focused on automated CPAP systems, improved mask systems and manufacturing cost-reduction programs.
The Company consults with physicians at major sleep centers throughout the world to identify technology trends in the treatment of OSA. Some of these physicians currently serve on the Company's Medical Advisory Board. New product ideas are also identified by the Company's marketing staff, direct sales force, network of distributors and manufacturers' representatives. Typically, new product development is then performed by the Company's internal development staff in collaboration with Dr. Sullivan and his colleagues at the Royal Prince Alfred Hospital, the University of Sydney, and other research groups around the world.
In each of the three fiscal years ended June 30, 1994, 1995 and 1996, the Company expanded $1,546,000, $1,996,000 and $2,841,000 respectively, on research and development.
Sales and Marketing
The Company currently markets its products in 40 countries using a network of distributors, independent manufacturers' representatives and its direct sales force. The Company attempts to tailor its marketing approach to each national market, based on regional awareness of OSA as a health problem, physician referral patterns, consumer preferences and local reimbursement policies.
North America. In the United States, the Company's marketing activities are conducted through a field sales organization comprised of 11 direct sales employees, including three regional sales managers, and 18 independent manufacturers' representatives' organizations. The Company's United States field sales organization markets and sells the Company's products primarily to more than 1,500 home health care dealer branch locations throughout the United States. The Company also promotes and markets its products directly to sleep clinics. Patients who are diagnosed with OSA and prescribed CPAP treatment are typically referred by - -9-
the diagnosing sleep clinic to a home health care dealer to fill the prescription. The home health care dealer, in consultation with the referring physician, will assist the patient in selecting the equipment, fits the patient with the appropriate mask and set the flow generator pressure to the prescribed level. In the United States, sales employees and manufacturers' representatives are managed by the three regional sales managers and the Company's national sales manager. A marketing manager, responsible for marketing in the United States and Canada, is based in the Company's office in San Diego. The Company's Canadian sales are conducted through a Canadian distributor. Sales in North America accounted for 47%, 53% and 49% of the Company's total net revenues for the fiscal year's ended June 30, 1994, 1995 and 1996, respectively.
Europe. The Company markets its products in most major European countries. In countries other than the United Kingdom, Germany and France, in each of which the Company has fully owned subsidiaries, the Company uses independent distributors to sell its products. These distributors have been selected in each country based on their knowledge of respiratory medicine as well as a commitment to nasal CPAP therapy. In each country in which the Company has a subsidiary a local senior manager is responsible for direct national sales. The Group's Senior Vice President, is responsible for coordination of all European distributors and, in conjunction with local management, the direct sales activity in Europe. In addition, the Company uses a consultant in Switzerland to assist in sales and marketing efforts for selected European countries. Sales in Europe accounted for 30%, 29% and 36% of the Company's total net revenues for the fiscal year's ended June 30, 1994, 1995 and 1996, respectively.
Australia/Rest of World. Prior to May 1994, the Company was the exclusive source of nasal CPAP air flow generator units in Australia as a result of ResMed Limited's ownership of Dr. Sullivan's original nasal CPAP patent. This patent, which covered the CPAP method of treating, and the device for treatment of, OSA, was challenged by the Australian distributor for Respironics and, in May 1994, was revoked by an Australian appeals court in reliance on issues specific to Australian patent law. Such revocation permits competitors to market CPAP products in Australia. Consequently, the Company's dominant market share in Australia has decreased in 1996. In May 1996 the Company concluded an exclusive distribution agreement with Medical Gases of Australia, the largest sleep medicine distributor in Australia, in an effort to secure the Company's existing market position. As part of this agreement the Company agreed to cease direct sales activities in Australia.
Marketing in the rest of the world is the responsibility of the Vice President of Sales and Marketing based in Sydney, Australia. Sales in Australia and the rest of the world accounted for 23%, 18% and 15% of the Company's total net revenues for the fiscal year's ended June 30, 1994, 1995 and 1996, respectively.
Medical Gases of Australia accounted for approximately 18%, 10% and 7% of net sales in 1994, 1995 and 1996, respectively, and another customer, Priess Med Technik, prior to the acquisition of its business by ResMed in February 1996, accounted for approximately 19%, 15% and 8% of net sales in 1994, 1995 and 1996, respectively. - -10-
Manufacturing
The Company performs its manufacturing operations at its facility in Sydney, Australia. The Company's manufacturing operations consist primarily of assembly and testing of the Company's air flow generators, masks and accessories. Of the numerous raw materials, parts and components purchased for assembly of the Company's diagnostic and therapeutic sleep disorder products, most are off-the-shelf items available from multiple vendors. Several components, such as printed circuit boards and plastic moldings, are produced by third parties to meet certain specifications established by the Company. Two key components of each of the Company's CPAP devices are purchased from two single source suppliers. The Company is currently qualifying additional sources of supply for these components. The Company's quality control group performs tests at various steps in the manufacturing cycle to ensure compliance with the Company's specifications. See Note 13 to Notes to Consolidated Financial Statement.
The Company generally manufactures to its internal sales forecasts and fills orders as received and as a result has no significant backlog of orders for its products. The Company uses management information systems to integrate its manufacturing planning, billing and accounting systems.
Service and Warranty
The Company offers one-to-two year limited warranties on its airflow generator products. Warranties on mask systems are for 90 days. In most markets, the Company relies on its distributors to repair the Company's products with parts supplied by the Company. In the United States, home health care dealers generally arrange shipment of products to the Company's San Diego facility for repair.
The Company has received returns of its products from the field for various reasons. The Company believes that the level of returns it has experienced to date is consistent with levels typically experienced by manufacturers of similar devices. The Company provides for warranties and returns based on historical data.
Patents and Proprietary Rights and Related Litigation
The Company, through its subsidiary ResMed Limited, owns or has licensed rights to five issued United States patents and eleven issued foreign patents. In addition, there are six pending United States patent applications and twelve pending foreign patent applications. Some of these patents and patent applications relate to significant aspects and features of the Company's products. These include United States patents relating to CPAP devices, a delay timer system, the Bubble Mask, and an automated means of varying air pressure based upon a patient's changing needs during nightly use, such as that employed in the Company's AutoSet Device. No patents are due to expire in the next five years.
The Company relies on a combination of patents, trade secrets, non-disclosure agreements and proprietary know-how to protect its proprietary technology and rights. ResMed Limited is pursuing an infringement action against one of its competitors (Respironics, Inc.) and is investigating possible infringement by others.
In October 1994, in Australia, a patent held by ResMed was revoked on appeal on the grounds that the patent was not entitled to claim priority to a "provisional" application, which was filed before the inventor's publication. As a result of this claim, ResMed based in part on advice from legal counsel, at June 30, 1994 accrued approximately $300,000 for costs associated with this patent litigation which remains outstanding at June 30, 1996. This amount is included in accrued expenses on the consolidated balance sheet. - -11-
Additional litigation may be necessary to enforce patents issued to the Company, to protect the Company's proprietary rights, or to defend third-party claims of infringement by the Company of the proprietary rights of others. Patent laws regarding the enforceability of patents vary from country to country. Therefore, there can be no assurance that patent issues will be uniformly resolved, or that local laws will provide the Company with consistent rights and benefits.
ResMed Limited is also defending alleged breaches of the Australian Trade Practices Act in a suit, claiming damages of $730,000 brought in Sydney Australia by Respironics and their Australian distributor. This action relates to ResMed Limited exercising its rights to the Australian original CPAP patent, which was revoked by the Federal Court of Australia in 1994.
Third-Party Reimbursement
The cost of medical care is funded in substantial part by government and private insurance programs. Although the Company does not generally receive payments for its products directly from these payors, the Company's success is dependent upon the ability of patients to obtain adequate reimbursement for the Company's products. In most markets, the Company's products are purchased primarily by home health care dealers, hospitals or sleep clinics, which then invoice third-party payors directly.
In the United States, third-party payors include Medicare, Medicaid and corporate health insurance plans. These payors may deny reimbursement if they determine that a device has not received appropriate FDA clearance, is not used in accordance with cost-effective treatment methods, or is experimental, unnecessary or inappropriate. Third-party payors are also increasingly challenging prices charged for medical products and services, and certain private insurers have initiated reimbursement systems designed to reduce health care costs. The trend towards managed health care and the concurrent growth of HMOs which could control or significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care, may result in lower prices for the Company's products.
In some foreign markets, such as Spain, France and Germany, government reimbursement is currently available for purchase or rental of the Company's products subject, however, to constraints such as price controls or unit sales limitations.
In Australia and in other foreign markets, such as the United Kingdom and Japan, there is currently limited or no reimbursement for devices that treat OSA.
Government Regulations
The Company's products are subject to extensive regulation particularly as to safety, efficacy and adherence to FDA Good Manufacturing Procedures (GMP) and related manufacturing standards. Medical device products are subject to rigorous FDA and other governmental agency regulations in the United States and regulations of relevant foreign agencies abroad. The FDA regulates the introduction, manufacture, advertising, labeling, packaging, marketing, distribution, and record keeping for such products, in order to ensure that medical products distributed in the United States are safe and effective for their intended use. In addition, the FDA is authorized to establish special controls to provide reasonable assurance of the safety and effectiveness of most devices. Noncompliance with applicable requirements can result in import detentions, fines, civil penalties, injunctions, suspensions or losses of regulatory approvals, recall or seizure of products, operating restrictions, refusal of the government to approve product export applications or allow the Company to enter into supply contracts, and criminal prosecution. - -12-
The FDA requires that a manufacturer introducing a new medical device or a new indication for use of an existing medical device obtain either a Section 510(k) premarket notification clearance or a premarket approval ("PMA") prior to it being introduced into the market. The Company's products currently marketed in the United States are marketed in reliance on a 510(k) pre-marketing clearance. The process of obtaining a Section 510(k) clearance generally requires the submission of performance data and often clinical data, which in some cases can be extensive, to demonstrate that the device is "substantially equivalent" to a device that was on the market prior to 1976 or to a device that has been found by the FDA to be "substantially equivalent" to such a pre-1976 device. As a result, FDA clearance requirements may extend the development process for a considerable length of time. In addition, in some cases, the FDA may require additional review by an advisory panel, which can further lengthen the process. The PMA process, which is reserved for new devices that are not substantially equivalent to any predicate device and for high risk devices or those that are used to support or sustain human life, may take several years and requires the submission of extensive performance and clinical information.
As a medical device manufacturer, the Company is subject to inspection on a routine basis by the FDA for compliance with the FDA's current GMP regulations which impose procedural and documentation requirements with respect to manufacturing and quality control activities. The Company believes that its manufacturing and quality control procedures meet the requirements for the regulations.
Sales of medical devices outside the United States are subject to regulatory requirements that vary widely from country to country. The time required to obtain approvals by foreign countries may vary from that required for FDA approval.
Competition
The markets for the Company's products are highly competitive. The Company believes that the principal competitive factors in all of its markets are product features, reliability and price. Reputation and efficient distribution are also important factors. Patent protection could also become an important issue in the future.
The Company competes on a market-by-market basis with various companies, some of which have greater financial and marketing resources than the Company. In the United States, its principal market, Respironics, Healthdyne Technologies, DeVilbiss and Nellcor Puritan Bennett are the primary competitors for the Company's CPAP products. The Company's principal European competitors are also Respironics, Healthdyne Technologies, DeVilbiss and Nellcor Puritan Bennett, as well as regional European manufacturers.
Any product developed by the Company that gains regulatory approval will have to compete for market acceptance and market share. An important factor in such competition may be the timing of market introduction of competitive products. Accordingly, the relative speed with which the Company can develop products, complete clinical testing and regulatory approval processes and supply commercial quantities of the product to the market are expected to be important competitive factors. - -13-
Employees
As of June 30, 1996, the Company had 229 employees including eight full time consultants, 111 persons in warehousing and manufacturing, 28 in research and development, 54 in sales and marketing and 36 in administration. Of the Company's employees and consultants, 163 are located in Australia, 33 in the United States and 33 in Europe. The Company believes that the success of its business will depend, in part, on its ability to attract and retain qualified personnel. None of the Company's employees is covered by a collective bargaining agreement. The Company believes that its relationship with its employees is good.
Medical Advisory Board
The Company has a Medical Advisory Board ("MAB") consisting of physicians and scientists specializing in the field of sleep disorders. MAB members meet as a group twice a year with members of the Company's senior management and members of its research and marketing departments to advise the Company on technology trends in the treatment of OSA and other developments in sleep disorders medicine. MAB members are also available to consult on an as-needed basis with the senior management of the Company. MAB members are as follows:
Colin Sullivan, M.D., Ph.D., F.R.A.C.P., age 52, is the inventor of nasal CPAP for treating obstructive sleep apnea and is a thoracic physician at the Royal Prince Alfred Hospital. He is Professor of Medicine and Director of the David Read Laboratory at the Sydney University Medical School. He is a Fellow of the Royal Australian College of Physicians and Director of the National SIDS Council Pediatric Sleep Laboratory at the Royal Alexandria Children's Hospital, Westmead. Dr. Sullivan is the Chairman of the Medical Advisory Board, and has continued to contribute to the Company's innovation, product development and clinical testing. He has authored over 100 papers in sleep disorders and related respiratory areas and is on the editorial board of several professional journals. Dr. Sullivan's M.D. and Ph.D. degrees are from the University of Sydney Medical School.
William C. Dement, M.D., Ph.D., age 69, is the Lowell W. and Josephine Q. Berry Professor of Psychiatry and Behavioral Sciences at the Stanford University School of Medicine and Director of the Stanford Sleep Disorders Clinic and Research Center. He was Chairman of the USA National Commission on Sleep Disorders Research. During the 1950's, Dr. Dement was part of the team at the University of Chicago that discovered REM sleep. In 1970 he established the first sleep disorders clinic in which he introduced polysomnography. Dr. Dement has co-authored more than 400 papers and has written definitive textbooks on sleep. He is on the editorial board of several professional journals. Dr. Dement is a graduate of the University of Washington, Seattle, and received his M.D. and Ph.D. degrees from the University of Chicago.
Neil J. Douglas, M.D., F.R.C.P., age 48, is Reader in Medicine and Respiratory Medicine, University of Edinburgh, an Honorary Consultant Physician, Lothian Health Board and Director, Scottish National Sleep Laboratory. He is a member of the Action on Smoking and Health Scotland Council and the National Panel of Specialists for Respiratory Medicine. He chairs the Ethics of Medical Research Volunteer Studies Sub-Committee of Lothian Health Board and is a member of the Working Party on Sleep Apnea of the Royal College of Physicians of London. He is the author of over 100 papers in the area of sleep and pulmonary medicine. Dr. Douglas has a M.D. from the University of Edinburgh. - -14-
Ralph Pascualy, M.D., A.C.P., age 46, is Medical Director, Pacific Northwest Sleep/Wake Disorders Center, Providence Medical Center, Seattle. He held research fellowships in psychiatry prior to a professional focus on sleep disorders medicine in the early 1980s. He was awarded the William C. Dement Award in Sleep Disorders Medicine in 1983 and became an Accredited Clinical Polysomnographer in 1986. Dr. Pascualy trained in sleep disorders medicine at Stanford. He is Editor-in-Chief of the Research Newsletter of the Clinical Sleep Society, Chairs the National Insurance Committee and is a member of the Technology Committee of the Association of Sleep Disorders Centers. He is also a member of the Gerontological Society, the American Psychiatric Association, and National Affairs Committee of the Association of Professional Sleep Societies. He is a graduate of Columbia University and received a M.D. from the State University of New York.
J. Woodrow Weiss MD age 47 is Associate Professor of Medicine at Harvard Medical School, as well as Physician Director, Pulmonary-Medical Intensive Care Unit and Co-Director of the Sleep Disorders Center at Beth Israel Hospital, Boston. His main research interests are in the cardiovascular consequences of sleep and sleep apnea, upper airway muscle control and dyspnea. Dr Weiss was in intern and resident at the University of California, San Francisco and completed research fellowships at both Dartmouth and Harvard Medical Schools; he is an internationally- recognized researcher in sleep disorders medicine. He holds a BA from Harvard and an MD from Case Western Reserve School of Medicine.
B. Tucker Woodson MD FACS age 39 is an Otolaryngologist and is an Associate Professor of Surgery at the Medical College of Wisconsin. He is a Fellow of the American Academy of Otolaryngology - Head and Neck Surgery and did surgical training with Dr. Fujite, the pioneer of uvulopalatopharyngoplasty to treat obstructive sleep apnea. He has a primary research interest in the surgical management of sleep apnea but is also a proponent of nasal CPAP. Dr. Woodson did his surgical training in otolaryngology at Detroit's Henry Ford Hospital and holds a BA from Washington University, St. Louis and an MD from the University of Missouri, Columbia.
Clifford W. Zwillich, M.D., age 56, is Chief, Division of Pulmonary and Critical Care Medicine, Pennsylvania State University, and Distinguished Professor of Medicine. His major scientific interest is the body's control of respiration. He serves on the Editorial Boards of more than 10 journals and is active in numerous associations specializing in pulmonary medicine and sleep disorders. Dr. Zwillich holds a B.A. degree from Hunter College and a M.D. from the University of Kansas. He completed his senior residency at the Harvard Medical School in the early 1970s and then undertook a research fellowship at the University of Colorado Health Services Center.
Members of the Medical Advisory Board, other than Dr. Sullivan, receive approximately $1,000 per month and all members receive reimbursement of traveling costs and other out-of-pocket expenses incurred in attending such industry conferences as may be requested by the Company.
Item 2
Item 2 Properties
The Company's principal offices are located in Sydney, Australia, at a leased facility of approximately 46,000 square feet. This facility is leased through 1999 and contains approximately 28,000 square feet of assembly space, and approximately 18,000 square feet devoted to research and administration offices. The Company believes that this facility is adequate to meet its requirements at least through early 1998. Sales and warehousing facilities are also leased in San Diego, California, Oxford, England, Moenchengladbach, Germany and Lyon, France. - -15-
Item 3.
Item 3. Legal Proceedings
The Company is currently engaged in significant patent litigation relating to the enforcement and defense of certain of its patents. In 1992 the Company's original Australian patent, which was due to expire in 1998 and covered the CPAP method of treating, and the device for treatment of OSA, was challenged by the Australian distributor for Respironics, Inc. and in May 1994, was revoked by an Australian appeals court in reliance on issues specific to Australian patent law. The Company's market share in Australia decreased in 1995 and 1996 and the Company expect that its market share in Australia will continue to decrease. At June 30, 1996, the Company had accrued approximately $300,000 for estimated additional costs associated with this litigation.
In January 1995, the Company filed a complaint for patent infringement in the United States against Respironics. The complaint seeks monetary damages from, and injunctive relief against Respironics resulting from its alleged infringement of three of the Company's patents. In February 1995, Respironics filed a complaint against the Company seeking a declaratory judgment that Respironics does not infringe claims of these patents and that the Company's patents are invalid and unenforceable. The two actions have been combined and will proceed in the United States District Court for the Western District of Pennsylvania. In June 1996 the Company initiated a further action in Pennsylvania against Respironics regarding alleged infringement of the Company's continuation patent, granted June 4, 1996, related to the delayed timer feature. The action is continuing and is expected to be defended by Respironics. Management believes based in part on advice from legal counsel, that this action will not have a material impact on the operations or financial position of the Company.
On May 17, 1995, Respironics and its Australian distributor filed a Statement of Claim against the Company and Dr. Peter Farrell in the Federal Court of Australia. The Statement of Claim alleges that the Company engaged in unfair trade practices, including the misuse of the power afforded by its Australian patents and dominant market position in violation of the Australian Trade Practices Act. The Statement of Claim asserts damage claims in the aggregate amount of approximately $730,000, constituting lost profit on sales. While the Company intends to defend this action, there can be no assurance that the Company will be successful in defending such action or that the Company will not be required to make significant payments to the claimants. Furthermore, the Company expects to incur ongoing legal costs in defending such action.
Item 4
Item 4 Submission of Matter to a Vote of Security Holders
None
PART II
As of September 23, 1996, there were approximately 122 holders of record of the Company's Common Stock The Company does not intend to declare any cash dividends in the foreseeable future. - -16-
- -17-
Item 7
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the selected financial data and consolidated financial statements and notes thereto included elsewhere herein.
The Company designs, manufactures and markets nasal CPAP equipment for the diagnosis and treatment of obstructive sleep apnea. The Company's net revenues are generated from the sale of its various nasal CPAP devices, nasal mask systems, accessories and other products, and, to a lesser extent from royalties. The Company receives other income through interest and certain Australian government grants.
Prior to 1992, the Company marketed its products in several countries primarily through independent distributors. In May 1992, the Company terminated its United States distributor, and acquired certain inventory maintained by the distributor, employed four of the distributor's sales employees, and issued stock options to the distributor, which were subsequently repurchased by the Company in October 1993. After such termination, the Company established a direct sales force in the United States and developed a network of independent sales representatives. In early 1992, the Company commenced in-house manufacturing operations, consisting primarily of assembly activities, at its Sydney, Australia facility. This facility was expanded in December 1994 and during fiscal 1996.
The Company has invested significant resources in research and development and product enhancement. Since 1989, the Company has developed several innovations to the original CPAP device to increase patient comfort and to improve ease of product use. The Company has recently been developing products for automated treatment and monitoring of OSA, such as AutoSet(Trademark). The Company's research and development expenses are subsidized in part by grants and tax incentives from the Australian federal government. The Company has also received grants from the Australian federal government to support marketing efforts to increase Australian export sales, and for incorporation of computer components into its products. Given Australian Government regulations the Company does not expect to receive future Australian export sales grants.
The Company's income tax rate is governed by the laws of the regions in which the Company's income is recognized. To date, a substantial portion of the Company's income has been subject to income tax in Australia where the statutory rate prior to June 30, 1995 was 33%, increased to 36% effective July 1, 1995. During fiscal 1994, 1995 and 1996, the Company's effective tax rate has fluctuated from approximately 25% to approximately 33%. These fluctuations have resulted from, and future effective tax rates will depend upon, numerous factors, including the amount of research and development expenditures for which a 150% Australian tax deduction is available, the level of non-deductible expenses, and the use of available net operating loss carryforward deductions and other tax credits or benefits available to the Company under applicable tax laws.
Following is a comparative discussion by fiscal year of the results of operations for the three years ended June 30, 1996. - -18-
Fiscal Year Ended June 30, 1996 Compared to Fiscal Year Ended June 30,
Net Revenues. Net revenues increased in fiscal 1996 to $34.6 million from $23.5 million in fiscal 1995, an increase of $11.1 million or 47.1%. This increase was primarily attributable to an increase in unit sales of the Company's flow generators and accessories in Europe where net revenues increased to $12.4 million from $6.8 million and, to a lesser extent, in North America, where net revenues increased to $16.8 million from $12.5 million. In addition, net revenues were affected favorably by a product mix shift to new, higher-priced products such as Sullivan VPAPII. This favorable effect was partially offset by a decrease in the selling prices of the Company's CPAP products in most geographic markets.
Gross Profit. Gross profit increased in fiscal 1996 to $17.6 million from $12.2 million in 1995, an increase of $5.4 million or 43.7%. The increase resulted primarily from increased unit sales during fiscal 1996. Gross profit as a percentage of net revenues declined in fiscal 1996 to 50.8% from 52.0% in 1995. The decrease was primarily due to an increase in the value of the Australian Dollar relative to the US Dollar over the period and continuing price competition in the United States, where prices for the Company's products are lower than elsewhere in the world. The increased value of the Australian Dollar increases the relative cost of manufacturing in Australia where the Company's manufacturing facilities are located.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased in 1996 to $11.1 million from $7.4 million for 1995, an increase of $3.7 million or 49.5%. As a percentage of net revenues, selling, general and administrative expenses increased in fiscal 1996 to 32.2% from 31.7% for fiscal 1995. The increase in expenses was due primarily to the acquisition of the Company's German distributor in February 1996, an increase to 87 from 58 in the number of sales and administrative personnel, and other expenses related to the increase in the Company's sales. In addition the Company incurred substantial legal fees with respect to its ongoing patent action of $773,000, and $278,000 in 1996 and 1995, respectively.
Research and Development Expenses. Research and development expenses increased in fiscal 1996 to $2.8 million from $2.0 million in fiscal 1995, an increase of approximately $800,000 or 42.3%. As a percentage of net revenues, research and development expenses in fiscal 1996 decreased to 8.2% from 8.5% in fiscal 1995. The dollar increase in research and development expenses was due primarily to an increase in research and development equipment and external consultancy fees.
Other Income. Other income increased in fiscal 1996 to $3.0 million from $994,000 for fiscal 1995, an increase of $2.0 million or 198.4%. This increase was due primarily to the recognition of unrealized gains on foreign currency options of $961,000, as a result of marking the options to market which arose from revaluation of the Australian Dollar over the year, and $1.1 million of interest income derived from funds generated from the Company's June 2, 1995 initial public offering of common stock.
Income Taxes. The Company's effective income tax rate for fiscal 1996 increased to approximately 31.4% from approximately 25.1% for fiscal 1995. This increase was primarily due to the an increase in the Australian income tax rate from 33% to 36% from July 1, 1995 and high relative taxes incurred in Germany. These higher tax rates were partially offset by additional research and development expenses in Australia for which the Company received a 150% deduction for tax purposes. - -19-
Fiscal Years Ended June 30, 1995 and June 30, 1994
Net Revenues. Net revenues increased in fiscal 1995 to $23.5 million from $13.9 million in fiscal 1994, an increase of $9.6 million or 69.6%. This increase was primarily attributable to an increase in unit sales of the Company's flow generators and accessories in North America, where net revenues increased to $12.5 million from $6.5 million, and, to a lesser extent, in Europe where net revenues increased to $6.8 million from $4.2 million. In addition, net revenues were affected favorably by a product mix shift to new, higher-priced products such as Sullivan VPAP. This favorable effect was partially offset by a decrease in the selling prices of the Company's products in most geographic markets.
Gross Profit. Gross profit increased in fiscal 1995 to $12.2 million from $7.6 million in 1994, an increase of $4.6 million or 60.0%. The increase resulted primarily from increased unit sales during fiscal 1995. Gross profit as a percentage of net revenues declined in fiscal 1995 to 52.0% from 55.2% in 1994. The decrease was primarily due to an increasing percentage of the Company's worldwide sales occurring in the United States, where prices for the Company's products are lower than elsewhere in the world. In addition, gross profit as a percentage of net revenues declined due to an increase in the value of the Australian Dollar relative to the United States Dollar during the period. This increased the relative cost of manufacturing which occurs in Australia. Also contributing to the decrease was the introduction of a new lower margin humidifier manufactured by a third party for the Company.
Selling, General and Administrative Expenses. Selling general and administrative expenses increased in 1995 to $7.4 million from $4.8 million for 1994, an increase of $2.6 million or 54.9%. As a percentage of net revenues, selling, general and administrative expenses declined in fiscal 1995 to 31.7% from 34.7% for fiscal 1994. The increase in expenses was due primarily to an increase to 58 from 34 in the number of sales and administrative personnel, and other expenses related to the increase in the Company's sales. Rent and leasehold expenses also increased primarily due to a substantial increase in the size of the Company's Australian facility. In addition, fiscal 1994 included $311,000 of expenses associated with the grant of compensatory stock options and the establishment of a $300,000 reserve for estimated cost associated with the Company's Australian patent litigation.
Research and Development Expenses. Research and development expenses increased in fiscal 1995 to $2.0 million from $1.5 million in fiscal 1994, an increase of approximately $500,000 or 29.1%. As a percentage of net revenues, research and development expenses in fiscal 1995 decreased to 8.5% from 11.2% in fiscal 1994. The dollar increase in research and development expenses was due primarily to an increase in the average number of research and development employees over the period to approximately 30 in fiscal 1995 from 20 in fiscal 1994. This increase was also attributable to higher payments for consulting fees related to product development efforts.
- -20-
Other Income. Other income increased in fiscal 1995 to $994,000 from $542,000 for fiscal 1994, an increase of $452,000 or 83.4%. This increase was due primarily to the recognition of income for the receipt in December 1994 of an up-front payment of $189,000 from a Japanese company for the exclusive rights to market certain respiratory and related products in the Japanese market that are under development by the Company. In addition, government grants for fiscal 1995 increased to $527,000 from $440,000 for fiscal 1994 as a result of government computer grant claims of $357,000 recognized by the Company on receipt of a favorable Australian government ruling in April 1995.
Income Taxes. The Company's effective income tax rate for fiscal 1995 decreased to approximately 25.1% from approximately 32.7% for fiscal 1994. This decrease was primarily due to the Company's use of net operating loss carryforward deductions available to offset United States income, and the additional research and development expenses in Australia for which the Company received a 150% deduction for tax purposes.
Recent Accounting Developments
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. ("SFAS") 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," effective for fiscal years beginning after December 15, 1995. SFAS 121 provides guidance for recognition and measurement of impairment of long-lived assets, certain identifiable intangible assets and goodwill related both to assets to be held and used and assets to be disposed of. The adoption of SFAS 121 is not expected to have a material effect on the Company's financial position or results of operations.
In October 1995, the Financial Accounting Standards Board issued SFAS 123, "Accounting for Stock-Based Compensation," effective for fiscal years beginning after December 15, 1995. Under the provisions of SFAS 123, the Company is encouraged, but not required, to measure compensation costs related to its employee stock compensation under the fair value method. The Company has elected not to recognize compensation expense under this methodology.
The company will adopt the proforma method of disclosure under SFAS 123 in fiscal year ended June 30, 1997
Liquidity and Capital Resources
As of June 30, 1996 and June 30, 1995, the Company had cash and cash equivalents and marketable securities available for sale of approximately $23.5 million and $23.8 million, respectively. The Company's working capital approximated $30.5 million and $27.4 million, respectively, at June 30, 1996 and 1995. The increase in working capital balances reflects the net of the receipt of approximately $4.5 million from the underwriter's exercise of their over allotment arising from the Company's initial public offering less the cash used to fund the acquisition of two European distributors. - -21-
With the exception of the proceeds of the initial public offering, the Company has predominantly financed its operations and capital expenditures through cash generated from operations and through sales of common stock. During the fiscal years ended June 30, 1996 and 1995, the Company's operations generated approximately $3.4 million and $694,000, respectively more cash than was used in operations, primarily as a result of continued increases in net revenues, offset in part by increases in accounts receivable levels and prepayments during 1996. However, cash and cash equivalents and marketable securities available for sale decreased to $23.5 million at June 30, 1996 from $23.8 million at June 30, 1995, a decrease of $300,000 after capital expenditures. During fiscal 1996 and 1995 approximately $468,000 and $1,718,000 of cash was received from sales of common stock on exercise of outstanding options.
The Company's June 30, 1996, balance sheet also reflects significant increases in the levels of inventory and accounts receivable over the levels reflected on the June 30, 1995, balance sheet as a result of the acquisition of Priess Medizintechnik and significant increases in the Company's sales during the period.
The Company's capital expenditures for the fiscal years ended June 30, 1996 and 1995 aggregated $8.7 million and $1.8 million, respectively. The majority of these expenditures were for the purchase of the businesses of Priess Medizintechnik and Premium Medical for $6.8 million, purchase of production tooling and equipment and, to a lesser extent, for the purchase of office furniture, computers and research and development equipment. As a result the Company's June 30, 1996 balance sheet reflects an increase in net property plant and equipment to approximately $3.3 million at June 30, 1996, from $2.0 million at June 30, 1995, an increase of approximately $1.3 million.
The results of the Company's international operations are affected by changes in exchange rates between currencies. Changes in exchange rates may negatively affect the Company's consolidated net sales and gross profit margins from international operations. The Company is exposed to the risk that the dollar-value equivalent of anticipated cash flows will be adversely affected by changes in foreign currency exchange rates. The Company manages this risk by entering into foreign currency option contracts.
In May 1993, the Australian Federal Government agreed to lend the Company up to $870,000 over a six year term. Such loan bears no interest for the first three years and will bear interest at a rate of 3.8% thereafter until maturity. The first repayment of loan funds will commence in November 1996. The outstanding principal balance of such loan was $867,000 and $787,000 at June 30, 1996 and 1995, respectively. - -22-
Item 9 Changes in and Disagreements with Accountant on Accounting and Financial Disclosure
None
PART III
Item 10 Directors and Executive Officers of the Registrant
Incorporated by reference to Registrant's definitive Proxy Statement for its November 12, 1996 meeting of stockholders, which will be filed with the Securities and Exchange Commission within 120 days from June 30, 1996.
Item 11 Executive Compensation
Incorporated by reference to Registrant's definitive Proxy Statement for its November 12, 1996 meeting of stockholders, which will be filed with the Securities and Exchange Commission within 120 days from June 30, 1996.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference to Registrant's definitive Proxy Statement for its November 12, 1996 meeting of stockholders, which will be filed with the Securities and Exchange Commission within 120 days from June 30, 1996.
Item 13. Certain Relationships and Related Transactions
Dr. Colin Sullivan, a member of the Company's Medical Advisory Board, provides consulting services to the Company pursuant to a Consulting agreement that terminates on December 31, 1997 ( subject to extension for an additional five-year term ) for which he receives annual payments based on the net sales ( as defined in the Consulting Agreement ) of certain of the Company's products subject to a $90,000 per annum minimum payment. The company also reimburses Dr. Sullivan for his out-of-pocket expenses in performing such consulting services. The Company has also agreed to pay such amounts to Dr. Sullivan for a period of 24 months following the termination of his consulting relationship with the Company. Total payments to Dr. Sullivan were $147,000, $228,000 and $314,000 for the Company's fiscal years ended June 30, 1994, 1995 and 1996, respectively.
- -23-
Dieter and Helmke Priess, the holders of approximately 4% of the outstanding shares of common stock of the Company, were the sole owners of Priess Medizintechnik, the distributor of the Company's products in Germany until the Company purchased the business of Priess in February 1996. Sales to Priess aggregated approximately $2.6 million, $3.5 million and $2.8 million, in fiscal 1994, 1995 and 1996 (up to February 7, 1996 the date of acquisition), respectively.
During the year ended June 30, 1995, there were outstanding options to purchase up to 421,900 shares of common stock of ResMed Holdings Limited (RHL), the Company's wholly owned subsidiary. The exercise prices of such options ranged from $0.38 to $9.10, with a weighted average exercise price of $5.35. The majority of such options were exercised for shares of common stock of RHL and each such share was surrendered in exchange for 2.5 shares of common stock of the Company. As a result, RHL received $1,768,000 and the Company issued 857,750 shares of common stock to such holders. The balance of such options were exchanged in June 1995, for options to purchase up to 197,000 shares of common stock of the Company at an aggregate exercise price of approximately $473,000. At June 30, 1996 approximately 9,500 RHL options remain outstanding with an aggregate exercise price of $3.64 each.
PART IV
Item 14 Exhibits, Consolidated Financial Statements Schedule, and Reports on Form 8-K
a) Report on Form 8-K
The Company lodged a report under item 2 of Form 8-K and an amended report under Item 2 of Form 8-K on February 21, 1996 and April 26, 1996, respectively, to reflect the acquisition of the business of Priess Medizintechnik on February 7, 1996. Incorporated within the initial report on Form 8-K and the amended report on Form 8-K, the Company lodged the following:
- - Audited Financial Statements of Dieter W Priess Medizintechnik for the years ended December 31, 1995 and December 31, 1994 and Independent Auditors Report thereon.
- - Unaudited Proforma Combined Condensed Consolidated Financial Statements of ResMed, Inc. and Priess Medizintechnik as of December 31, 1995 for the year ended June 30, 1995 and the six months ended December 31, 1995.
- -24-
Exhibits thereto
2.1 Purchase Agreement dated February 7, 1996 between Dieter W Priess Medizinische technische Ger te and ResMed-Priess GmbH (I, GR).
23.1 Consent of KPMG Deutsche Treuhand Gesellschaft.
99.3 Press Release, dated February 12, 1996, issued by ResMed, Inc.
b) The following documents are filed as part of this report:
1.1 Consolidated Financial Statements and Schedule.
The consolidated financial statements and schedule of the Company and its consolidated subsidiaries are set forth in the "Index to Consolidated Financial Statements" under Item 8