ITEM 1. BUSINESS
GENERAL
Zoll Medical Corporation designs, manufactures and markets an integrated line of proprietary, noninvasive cardiac resuscitation devices, external pacemaker/defibrillators, disposable electrodes, mobile ECG Systems, and EMS data management solutions. The Company's product line includes combination pacemaker/defibrillators, stand-alone pacemakers and defibrillators and disposable multi-function electrodes that permit cardiac monitoring, pacing and defibrillation through a single pair of electrodes, software and associated hardware. The company's software for EMS is used on portable rugged pen-based computers to automate all system and patient records. In addition, the Company markets hardware and associated software to acquire and send via fax or modem, a fully diagnostic patient ECG using a portable pen-based computer.
The principal markets for cardiac resuscitation equipment are hospitals and pre-hospital care providers such as paramedics, ambulance operators, emergency medical technicians ("EMTs"), firefighters, police and other "first response" emergency personnel.
MARKET BACKGROUND
Cardiac arrest accounts for approximately one-quarter of all deaths in the United States. Cardiac arrest can result from a heart attack or from many other causes. Victims of cardiac arrest may experience two basic types of "arrhythmia's," which are abnormal rhythms of the heart caused by insufficient circulation of oxygenated blood, drugs, electrical shock, mechanical injury, disease or other causes. In one class of arrhythmia, the heart beats too slowly (bradycardia) or stops (asystole). Pacing is a method of electrical therapy used to treat bradycardia and asystole. In the other class of arrhythmia, the heart beats chaotically (fibrillation) or too quickly (tachycardia). The definitive treatment for these conditions is defibrillation. The Company estimates that approximately 40% of cardiac arrest patients initially suffer from bradycardia/asystole and 60% suffer from fibrillation/tachycardia. It is possible for a patient to experience both types of arrhythmias during a cardiac arrest. In these situations, it is important to have resuscitation equipment with both pacing and defibrillation capabilities available.
The most important factor in treating cardiac arrest successfully is time. Unless treatment is begun within four to eight minutes of the onset of cardiac arrest, the victim is likely to die. The importance of immediate treatment creates a need for cardiac resuscitation equipment specifically designed for emergency use. Noninvasive temporary pacemakers and defibrillators, such as those sold by the Company, are used in emergency situations. Therefore, they do not compete with permanent, implantable pacemakers or defibrillators that are used to treat chronic arrhythmias. In fact, the products are complementary, because emergency cardiac resuscitation is often required during the implantation of a permanent device.
CARDIAC THERAPIES/DIAGNOSTICS PROVIDED
Bradycardia/Pacing
The principal therapies for the emergency treatment of bradycardia are drugs and temporary cardiac pacing, either or both of which may be used to stimulate effective cardiac contractions and restore circulation. Drugs utilized in treating bradycardia include isoproterenol and atropine, which are injected into the patient to stimulate the heartbeat. Cardiac pacing utilizes an electrical pulse to stimulate the patient's heartbeat. For the permanent treatment of chronic arrhythmia's, a pacemaker may be surgically implanted. For the emergency treatment of bradycardia, there are two primary techniques for temporary pacing - -- invasive endocardial pacing, in which a wire is inserted directly into the heart to provide the electrical stimulus; and noninvasive temporary pacing, which uses gelled electrodes applied to the patient's chest to conduct an electrical stimulus.
The American Heart Association ("AHA") has established standard protocols for the emergency treatment of cardiac arrest, including bradycardia. These Advanced Cardiac Life Support ("ACLS") protocols are widely followed by practicing physicians. In 1992, the AHA released new ACLS protocols recommending noninvasive pacing as the initial treatment method for certain serious cardiac conditions.
Fibrillation/Defibrillation
The other type of life-threatening cardiac arrhythmia is ventricular fibrillation, in which the heart's normal, regular electrical impulses become chaotic and the heart ceases to pump blood. The only accepted emergency treatment of fibrillation is defibrillation, in which a powerful electric shock is delivered to the heart to stop the fibrillation and permit the return of coordinated cardiac contractions. In emergency situations, defibrillation has conventionally been administered through hand-held paddles placed on the patient's chest. However, defibrillation can also be administered through disposable adhesive electrodes, which the Company believes is safer and easier to use than paddles.
In the hospital, most physicians and critical care nurses are trained and certified to operate defibrillators. Outside the hospital, these persons, as well as paramedics and other highly trained personnel were traditionally the only persons authorized to provide defibrillation. However, a number of jurisdictions now permit the use of automated defibrillators by less extensively-trained nurses, EMTs, firefighters, police and other emergency response personnel, following a brief course in the use of the device.
Cardioversion is a type of defibrillation used to treat tachycardias which have not degenerated into fibrillation. During cardioversion, the defibrillator delivers an electric shock which is synchronized to the patient's heartbeat in order to slow the heart to a normal rhythm. The Company's defibrillators include cardioversion capability.
Acute Myocardial Infarction
Rapid and accurate diagnosis of acute myocardial infarction (heart attack) and the early administration of thrombolytic (clot busting) drugs can reduce both mortality and morbidity from this disease. A growing number of communities are implementing programs to add highly accurate and sophisticated ECG acquisition capability to allow prehospital care providers to obtain this diagnostic information. With this information, paramedics and other pre-hospital providers can advise hospitals as to the nature of the patients conditions and expedite treatment on arrival at the hospital with drugs that reopen coronary arteries and ultimately minimize or reduce the extent or damage to the heart. The procedure can be lifesaving for some patients.
CARDIAC RESUSCITATION EQUIPMENT MARKETS
The principal markets for cardiac resuscitation equipment can be divided between the hospital and pre-hospital markets.
Hospital Market. The hospital market for cardiac resuscitation equipment in the United States consists of approximately 6,000 acute care community hospitals and 1,000 other hospitals. Hospitals have traditionally been the largest users of cardiac resuscitation equipment, both for patients admitted for cardiac arrest and for patients undergoing treatment for other reasons. Many hospital procedures such as surgery, cardiac catheterization, stress testing and general anesthesia may induce arrhythmias or cardiac arrest. Hospitals frequently use cardiac resuscitation devices on a standby basis in connection with these procedures. Since immediate treatment is the critical factor for successful cardiac resuscitation, hospitals typically place resuscitation devices throughout their facilities, including the cardiac and critical care units, emergency rooms, operating rooms, electrophysiology laboratories and, increasingly, in general wards. Hospitals also use portable devices during in-hospital transportation of cardiac patients. Some hospitals are now using AED's in remote settings and for use by nursing staff.
The hospital market outside of the United States is less developed and is expected to grow as more hospitals are built and existing hospitals modernize and update their approaches to cardiac and emergency care. In the international market, unlike the United States market, the administration of pacing and defibrillation is generally viewed as a skill reserved for physicians. Few other staff members are trained or certified to administer such treatment. It is expected that emerging standards of care and the acceptance of automated equipment will eventually result in increased use of cardiac resuscitation equipment by a broader range of health care personnel in the international market.
Pre-Hospital Market. Most sudden cardiac arrests and heart attacks occur outside of the hospital. Due to the importance of immediate treatment, there is a substantial market for portable cardiac resuscitation equipment designed for use by various emergency responders. The most highly trained segment of this pre-hospital market is comprised of paramedics, who are generally authorized to use defibrillators. Although paramedics are currently not as likely to be trained in pacing as in defibrillation, the Company believes that as noninvasive temporary pacing becomes more widely accepted in the hospital market, the use of combination pacemaker/defibrillators will become more widespread in the pre-hospital setting as well. Paramedics are also able to use more advanced diagnostics, such as the ZOLL System 12.
In addition to paramedics, there are numerous other first responders such as EMTs, ambulance operators, firefighters, police and other emergency personnel, many of who are currently authorized to use automated defibrillators. The Company believes that these first responders and their emergency vehicles will represent an increasingly important market for cardiac resuscitation equipment as the medical community places increased priority on providing such equipment and the necessary training to all first responders.
PRODUCTS
The Company designs, manufactures and markets an integrated line of noninvasive cardiac resuscitation devices, EMS information systems, and single-use disposable electrodes to meet the needs of health care providers treating cardiac arrest in a variety of settings. The following table summarizes the Company's principal products. In addition, the Company provides a full line of cables and other accessories.
PRODUCT DETAILS
1400. The PD 1400 is a portable combination pacemaker/defibrillator designed for both pre-hospital and hospital use. It is a full convential pacemaker/defibrillator that is used for emergency care at bedside and for the transport of patients either in the ambulance or within the hospital. In pre-hospital applications, where patients may be difficult to reach and treat, the weight, size and reliability of the resuscitation device (including the battery system) are important purchase considerations. In the hospital, its combination AC and battery operation make it ideal for versatile use in both fixed and portable applications. The PD 1400 weighs only 13 to 15 pounds depending on the electrode configuration, while retaining all of the pacing and defibrillation capabilities and the standardized design of previous Zoll models. The PD 1400 incorporates a reliable, rechargeable lead-acid battery system and accessory chargers. The D 1400 incorporates the basic design of the PD 1400, but without pacing capability. The D 1400 resuscitation system is an entry level device that can be upgraded to include the advisory feature and ZOLL non-invasive external pacing capability as hospital needs expand in the future.
2000. The PD 2000 product responds specifically to American Heart Association initiatives recommending early defibrillation. This resuscitation system includes an advisory algorithm that detects ventricular fibrillation, a life threatening arrhythmia for which rapid defibrillation is the only effective treatment. The PD 2000 device is designed for use by non-critical care staff to deliver defibrillation within one to two minutes of cardiac arrest in accordance with the latest American Heart Association guidelines. The PD 2000 is a complete resuscitation system designed to be used by either the first person to arrive at the patient's side or the ACLS team after a "code" is initiated in the hospital. Additionally, the unit provides monitoring, external pacing, and documentation of all treatment during both BLS and ACLS use. The D 2000 incorporates the basic design of the PD 2000, but without pacing capabilities. The D 2000 was introduced to meet the needs of hospitals which seek to purchase an advisory defibrillator only.
1600. The 1600 models comprise four semi-automatic defibrillators combined with optional features including strip chart recorder, voice recording, manual override, and external pacing. The four models are designed for use by many levels of pre-hospital care providers. Their optional features and configurable operation and design allow one 1600 model to be used by personnel trained at different skill levels, such as first responders and paramedics. The units can be switched between semi-auto and manual operation via a unique key switch. All units incorporate a sophisticated data collection system utilizing a removable
solid state memory. ZOLL's proprietary software programs can be loaded on a PC to provide data collection, review and archiving.
Westech Data Management Software. These products are proprietary software programs for the electronic collection of all EMS system and patient information on pen based computers, a master administration computer, and interfaces with other software applications used by the customer for billing, dispatching and training, and archiving. The Westech System improves productivity and efficiency by automating all data entry, eliminating paperwork and creating electronic files that are more accurate, complete and easily integrated with other electronic files for billing and system management. Data entry requirements from paper forms is reduced or eliminated all together and the electronic files are more easily used for system administration needs.
1700. This device is an AC and battery powered semi-automated defibrillator for hospitals with a resusitation data collection feature and is used by non-critical care nursing staff for early defibrillation. The device can switch to full-featured manual operation for physician and critical care staff use providing the capabilities of two different devices in one product.
System 12. This product is obtains a diagnostic ECG tracing consisting of 12 leads (views) of the heart's electrical activity. It is used to provide rapid and early identification of myocardial infarction in the pre-hospital setting. The tracing obtained can be transmitted to a receiving hospital to shorten the time to treatment after the patient arrives by ambulance. The system includes acquisition hardware and software that is used in conjunction with a portable computer in the field.
PowerCharger and Base PowerCharger(4x4). These products are used to power and recharge Zoll devices that store a common rechargeable battery. This system of compatible chargers and batteries provides customers with extensive flexibility in adopting Zoll products for use on both AC power and for portable battery operation. The Base PowerCharger(4x4) also provides automated battery testing eliminating testing all batteries manually and identifying batteries that need replacement before use without dependence on technicians or clinical staff.
Disposable Electrodes. The Company offers a variety of single-patient-use, proprietary disposable electrodes for use with its resuscitation devices. The Company's PD 2200 multi-function disposable electrode, introduced in late 1989, permits monitoring, pacing and defibrillation through a single pair of electrodes. In the conventional electrode configuration, three ECG electrodes are required for monitoring, two electrodes are required for pacing and two electrodes or paddles were required for defibrillation, all with accompanying cables. By reducing the number of electrodes and cables required for emergency treatment, the multi-function electrodes increase the ease and the speed of use. If simultaneous pacing and monitoring is required, a separate set of ECG-only electrodes can be used in addition to the multi-function electrodes.
The disposable multi-function electrodes allow the user to select monitoring, pacing or defibrillation by turning a single control knob on the Company's resuscitation devices. The electrodes are pre-gelled, which saves critical time in the treatment of cardiac arrest and permits "hands-off" therapy. Conventional paddle electrodes for defibrillation must be manually gelled for each use, which increases the risk of electrical shock to the operator.
In 1994, the Company began selling the Stat Padz multi-function electrodes. The Stat Padz electrode expands the Company's disposable product line to meet the need for speed in defibrillation and specialized requirements in disposables. Stat Padz are supplied in a proprietary Zoll Speed Pack that eliminates unnecessary packaging, reduces application steps and provides an organized means to apply lifesaving electrical therapy to the patient.
In 1996, the Company introduced both radiolucent and sterile Stat Padz multi-function electrodes. The radiolucent and sterile Stat Padz extend the Company's disposable product line. Radiolucent Stat Padz are made from a specially formulated conductive material which is virtually invisible to X-ray. The Sterile Stat Padz are specially packaged and sterilized allowing for use in surgical and other sterile environments. In addition to the disposable multi-function electrodes, the Company sells both a pacing-only electrode for use on adults and children (NTP 2000 and 2100) and standard ECG electrodes. The Company expects that the growing installed base of its pacing and defibrillation devices will generate increased demand for its disposable electrodes.
PRODUCT DESIGN AND NEW PRODUCT DEVELOPMENT
The Company's strategy has been to improve and expand its product line through the application of its proprietary technology to both devices and disposable electrodes. The Company pursues a multi-disciplinary approach to product design. The primary disciplines comprising the Company's current research and development program are mechanical, software and electronic design, which include both digital (microprocessor) and analog (high voltage) design.
The Company plans to focus its research and development efforts on the design of safer, more clinically efficacious, user friendly and cost effective manual and semi-automatic defibrillators. The company also intends to continue its research and development with respect to noninvasive pacing and defibrillation technologies. The Company also intends to continue its research and development with respect to disposable electrodes and electrode materials, which includes all phases of electrode design, testing and manufacture.
The company is developing an advanced biphasic waveform. Management believes that it can demonstrate improved defibrillation efficacy with less damage to the heart with this new waveform compared to conventional monophasic waveforms. The Company believes their new proprietary biphasic defibrillation waveform will offer compelling clinical benefits such that current defibrillator replacement cycles may be accelerated.
SALES AND MARKETING
The Company employs a direct North American sales force consisting of 62 full-time sales people as of September 27, 1997, including eight regional managers for North American Sales. In addition, the Company uses distributors to service certain less accessible geographic areas. The Company's North American marketing efforts are directed from its headquarters in Burlington, Massachusetts, with the sales force calling on hospitals and ambulance/paramedic services across the United States. Significant involvement by the sales person is generally required to establish new customers. A sales person must call on multiple parties within a hospital, including both the primary decision maker for the hospital area in which the device is to be used (e.g., cardiac care unit or emergency room) and the hospital administrators or equipment purchasing committees. By employing a direct sales force, the Company retains greater flexibility and control of its marketing efforts. The sales force reinforces its ties to its customers by training the users of the products in their operation. The Company has recruited an experienced EMS specialist sales team to provide coordination, special knowledge, and customer service to high potential EMS accounts.
Beginning in 1990, the Company began an aggressive effort to penetrate the international market. The Company has established a network of approximately 63 distributors in targeted international markets. International operations are based in the Netherlands, with regional managers in Europe, Latin America, the Middle East, and the Far East. The company has established a direct sales subsidiary in the United
Kingdom. In 1992 the Company entered into a distributorship agreement with a Japanese company for the sale of the Company's products in Japan. In 1994, the Company entered into an agreement with a German company to be the exclusive distributor of Zoll products to the hospital market in Germany. The Company believes that there is significant growth potential in the international market.
MANUFACTURING
Each of the Company's devices are assembled by the Company from components which are manufactured by outside vendors to Company specifications. Detailed vendor qualification requirements are set and verified by the Company. Many critical components are manufactured and tested by such vendors utilizing the Company's own tooling and test stations. The completed devices are tested by the Company to determine compliance with its engineering and quality assurance specifications.
All of the Company's disposable electrodes are manufactured by the Company from raw material, which is purchased in bulk. Each step of the manufacturing process is qualified and validated so that the units produced consistently meet performance requirements.
Certain materials and components used in the Company's devices and electrodes are purchased from various single sources. Although the Company believes that alternative sources of supply for such materials and components could be developed over a relatively short period of time, the failure to secure such alternative sources when needed could have a material adverse effect on the Company's business.
COMPETITION
The domestic and international markets for the Company's products are highly competitive. Some of the Company's competitors have significantly greater financial, technical, research and development or marketing resources than the Company.
The Company's principal competitor is Physio-Control Corporation ("Physio"), formerly a subsidiary of Eli Lilly and Company. Management believes that Physio has a dominant position in the cardiac resuscitation equipment industry. Physio is the only competitor that competes across the Company's entire defibrillation product line. Other competitors include Hewlett-Packard Co., and Laerdal Medical Corporation. International competitors also include Nihon-Kohden, S&W, Bruker-Odam, and Hellige.
The Company believes that the principal competitive factors in the hospital market for cardiac resuscitation equipment are clinical efficacy, reliability, safety, ease of use and standardization. In the pre-hospital market, in addition to the foregoing considerations, portability (small size and light weight), durability and a reliable battery system are significant competitive factors. The Company believes that its products compete favorably with respect to each of these factors.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company's United States pacing system patent, which expires in 1999, covers the combination of the duration and shape of the pacing pulse and the characteristics of the electrodes. Corresponding patents have been issued in Canada, France, United Kingdom and Japan. A number of additional U.S. and foreign patents are now pending or have been issued relating to other non-invasive cardiac pacing techniques and novel Biphasic defibrillation waveform technologies.
Several United States patents related to features of the 1400, 1600 and 2000 pacer/defibrillators, Powercharger and Stat Padz electrodes have been issued. Foreign patents relating to the 1400/1600/2000 pacer/defilrillators are pending.
Although the validity of the Company's United States pacing system patent has been upheld by the United States Court of Appeals for the Federal Circuit, there can be no assurance that any other patents will prove to be enforceable, that any patents will be issued as a result of pending or future application, or that competitors will not develop functionally similar devices outside the protection of any patents the Company has or may obtain. The Company intends to protect its proprietary technology aggressively and may incur in the future, substantial expenses relating to the protection of its patents or other intellectual property.
The Company also relies on trade secrets and proprietary know-how, particularly with respect to its disposable electrodes. Although the Company seeks to protect such information, in part through the use of confidentiality agreements, there can be no assurance that the Company's trade secrets and proprietary know-how will not become known to or independently developed by competitors.
GOVERNMENT REGULATION
The manufacture and sale of the Company's products are subject to extensive regulation by numerous governmental authorities, principally by the United States Food and Drug Administration (the "FDA") and corresponding foreign agencies. The FDA administers the Federal Food, Drug and Cosmetic Act, as amended (the "FDA Act"). The Company is subject to the standards and procedures respecting the manufacture of medical devices contained in the FDA Act and the regulations promulgated thereunder and are subject to inspection by the FDA for compliance with such standards and procedures.
The Company's products have been classified by the FDA as Class II devices (defibrillation only), and as Class III devices (pacing /defibrillation). These devices must secure either a 510(k) pre-market notification clearance or an approved Pre-Market Approval Application ("PMA") before they can be introduced into the United States market. The process of obtaining 510(k) clearance typically takes several months and involves the submission of limited clinical data supporting assertions that the product is substantially equivalent to another medical device on the market prior to 1976. The PMA process typically requires substantially more time than does 510(k) clearance and requires the submission of significant quantities of clinical data and supporting information. Delays in obtaining either 510(k) or if necessary, PMA clearance could have an adverse effect on the introduction of future products.
Every company that manufactures or assembles medical devices is required to register with the FDA and to adhere to certain "good manufacturing practices," which regulate the manufacture of medical devices and prescribe record keeping procedures and provide for the routine inspection of facilities for compliance with such regulations. The FDA also has broad regulatory powers in the areas of clinical testing, marketing and advertising of medical devices.
Medical device manufacturers are routinely subject to periodic inspections by the FDA. If the FDA believes that a company may not be operating in compliance with applicable laws and regulations, it can place the company under observation and reinspect the facilities; issue a warning letter apprising of violative conduct; detain or seize products; mandate a recall; enjoin future violations, and assess civil and criminal penalties against the company, its officers or its employees. Failure to comply with regulatory requirements or any adverse regulatory action could have a material adverse effect on the Company.
On November 21, 1997, the Company received a warning letter from the FDA. The warning letter was issued as a procedural follow-up to a Form 483 resulting from a routine inspection. The warning letter
included observations that Zoll's definitions for complaints and Medical Device Reports (MDR) were not appropriate. The Company believes it has implemented corrective actions to address all issues identified in the warning letter. This action plan has been reviewed with the FDA District Office. The Company is in the process of clearing the warning letter through a standard third party certification process. The Company believes that the warning letter will not have a material adverse impact on its financial position or its results of operations.
The Company is also subject to regulation in each of the foreign countries in which it sells its products. Many of the regulations applicable to the Company's products in such countries are similar to those of the FDA. However, the national health or social security organizations of certain countries require the Company's products to be qualified before they can be marketed in those countries. No assurance can be given that such clearances will be obtained.
Regulations regarding the manufacture and sale of products such as the Company's are subject to change. The Company cannot predict what impact, if any, such changes might have on its business. Compliance with domestic and foreign government regulations, which are stringent and subject to change, and delays in regulatory approvals, may have a material adverse impact on the Company.
PRODUCT LIABILITY AND INSURANCE COVERAGE
The manufacture and sale of medical products entail significant risk of product liability claims or product recalls. While the Company believes that the amount of product liability insurance maintained by the Company is adequate, there can be no assurance that the amount of such insurance will be sufficient to satisfy claims made against the Company in the future or that the Company will be able to maintain insurance in the future at satisfactory rates or in adequate amounts. Product liability claims could result in costs or litigation and could have a material adverse effect on the business, the financial condition and results of operations of the Company.
UNCERTAIN CUSTOMER DECISION PROCESSES
Many of the customers in the pre-hospital market consist of municipal fire and EMS departments. As a result, there are numerous decision-makers and governmental procedures in the decision process. Also, many hospitals, as a result of consolidation within the healthcare industry as well as increased pressure to reduce costs, have been using buying groups to make their purchases. Accordingly, the Company believes the purchasing decision of many of its customers may be characterized by long decision processes, which may result in long sales cycles for the Company's products.
HEALTHCARE REFORM
Uncertainty remains with regard to future changes within the healthcare industry. The trend towards managed care and economically motivated buyers may result in continued pressure on selling prices and deterioration of gross margins. The United States marketplace is increasingly characterized by consolidation among healthcare facilities and purchasers of medical devices who prefer to limit the number of suppliers from whom they purchase medical products. There can be no assurance that these entities will continue to purchase products from the Company. In addition, international markets are also being affected by economic pressure to contain healthcare costs. Although these factors will continue to impact the growth rate of the Company, as well as its profit margins, management believes that it is well positioned to take advantage of opportunities for growth that exist in the markets it serves.
FLUCTUATIONS IN OPERATING RESULTS
The Company's results of operations may fluctuate from quarter to quarter and will depend upon numerous factors, including actions relating to regulatory matters, the extent to which the Company's
products gain market acceptance, and competition. Results of operations will also be affected by the timing of orders received and the ability of its sales force to effectively commercialize the Company's products.
EMPLOYEES
As of September 27, 1997, the Company had 338 full-time and 10 part-time employees. The Company expects to employ additional personnel as it expands its operations. Management believes that its relations with its employees are excellent.
ITEM 2.
ITEM 2. PROPERTIES
The Company's facilities are located in Burlington, Massachusetts and Pawtucket, Rhode Island. The Company's executive headquarters are located at the Burlington facility, along with its research and development and its device manufacturing operations. The Company owns a 33,000 square foot building in Rhode Island, which it uses to manufacture its disposable products. The Company leases approximately 70,000 square feet of office and assembly space in Burlington under a lease expiring August 2003, and 2685 square feet of office space in Vancouver, British Columbia expiring in 2002. The Company also has administrative offices in Manchester, England. The Company believes that its current facilities will be adequate for its current needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the course of normal operations, the Company is involved in litigation arising from commercial disputes and claims of former employees which management believes will not have a material impact on the Company's financial position or its results of operations.
During the quarter ended December 28, 1996, the Company incurred a charge of approximately $1,300,000 to cover the litigation costs to defend itself in a shareholder lawsuit initiated in 1994. The Company has been unable to reach a reasonable settlement with plaintiffs' attorneys. The Company believes it has meritorious defenses to the lawsuit and therefore will prevail in trial. The Company believes that such litigation accrual and insurance reimbursement is adequate provision for probable losses arising from the litigation, and as such, the Company believes that the litigation will not have a material adverse affect on its financial position or its results of operation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
EXECUTIVE OFFICERS OF REGISTRANT
Frits J. Borst 55 Vice President - International Operations
Donald Boucher 45 Vice President - Research and Development
Ward M. Hamilton 50 Vice President - Marketing
Mr. Stutz joined the Company as President, Chief Executive Officer and director in 1983. From 1978 to 1983, Mr. Stutz held a variety of domestic and international management positions with Millipore Corporation, a manufacturer of high technology membrane filtration and purification products for the analytical pharmaceutical and microelectronics markets. Mr. Stutz received an A.B. from the University of North Carolina and an M.B.A. from the Harvard Graduate School of Business Administration. He is a director of HemaSure Corporation, Cambridge Heart, Inc., and Lifecor, Inc.
Mr. Packer joined the Company in 1992 and has served as President, Chief Operating Officer and director since May 1996. Since 1992 he has served as Chief Financial Officer and Vice President of Operations of the Company. Prior to this time, Mr. Packer served from 1987 to 1992 as Vice President of various functions for Whistler Corporation, a consumer electronics company. Prior to this, Mr. Packer was a manager with the consulting firm of PRTM/KPMG, specializing in operations of high technology companies. Mr. Packer has received B.S. and M. Eng. degrees from the Rensselaer Polytechnic Institute and an M.B.A. from the Harvard Graduate School of Business Administration.
Mr. Knight joined the Company in August 1996 as the Vice President of Administration and Chief Financial Officer. From 1989 to 1996, Mr. Knight served as Vice President and Corporate Controller of Analytical Technology, Inc., a manufacturer of scientific instrumentation. Prior to that Mr. Knight was Vice President, Chief Financial Officer and one of the founders of Mattson Instruments, Inc., a manufacturer of scientific instrumentation. Mr. Knight is a Certified Public Accountant. Mr. Knight received a B.S. in Accounting from the University of Wisconsin.
Mr. Maley joined the Company as Vice President of Sales & Marketing in January 1996. From 1992 to 1995 Mr. Maley served as Vice President of Marketing for one of Boston Scientific's cardiology divisions. Prior to that he held various vice president and management positions with Advance Surgical Intervention and Alcon Surgical, manufacturers of medical devices in urology and ophthalmic specialties, respectively. Mr. Maley has received an M.B.A. and a B.S. in economics from the University of California.
Mr. Borst joined the Company as Vice President of International Operations in October 1993. Prior to joining the Company, Mr. Borst served from 1978 to 1993 with Datascope Corporation, most recently as Director of Sales & Marketing for their international division. Mr. Borst received a B.S. in Business Administration and Hotel Management from the Management Centre Europe, in Brussels.
Mr. Boucher joined the Company as Vice President of Research and Development in December 1993. Prior to joining the Company, Mr. Boucher served from 1977 to 1993, with Corometrics Medical Systems, Inc., a manufacturer of fetal and neonatal monitors most recently as Vice President of Engineering. Mr. Boucher received an M.B.A. from the University of Connecticut, an M.S.E. in bioengineering from the University of Pennsylvania, and a B.S. in engineering from Northeastern University.
Mr. Hamilton joined the Company as Vice President of Marketing in February 1992. Prior to this time, Mr. Hamilton served from 1985 to 1991 as Director of New Business Development and Director of Marketing for ACLS products for Laerdal Medical Corporation, a manufacturer of portable automated defibrillators, and from 1977 to 1985 as Marketing Manager for defibrillators and noninvasive blood pressure monitors for Datascope Corporation. Mr. Hamilton received a B.A. in political science from Hartwick College and an M.P.A. in public administration from the University of Southern California.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market System under the symbol "ZOLL." The following table sets forth the high and low sales prices during the calendar quarters specified:
SALES PRICES 1997 1996 HIGH LOW HIGH LOW - --------------------------------------------------------------------------
FIRST QUARTER $ 16 $8-5/8 $ 9-3/4 $ 7-1/2 SECOND QUARTER 12 8-1/2 13-1/4 8-1/2 THIRD QUARTER 9-5/8 6-7/8 18-1/4 11-1/2 FOURTH QUARTER 8-3/4 6-5/8 17-1/4 10-1/2
The Company has never declared or paid cash dividends on its capital stock. The Company currently intends to retain any future earnings to finance the growth and development of its business and therefore does not anticipate paying any cash dividends in the foreseeable future.
As of September 27, 1997, there were 198 stockholders of record of the Company's Common Stock. The Company believes there were substantially in excess of 1,000 beneficial holders of the Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data for fiscal years 1993 through 1997 are qualified in their entirety by reference to the more fully detailed consolidated financial statements and the report of independent auditors thereon which are included elsewhere herein.
*During the year ended September 27, 1997, excluding a one-time charge taken in Q1 aggregating $2.3 million, net income would have been $2,033 and earnings per share would have been $0.32.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
1997 COMPARED TO 1996
The Company's net sales increased 3% to $56,336,000 for the year ended September 27, 1997 from $54,762,000 for the year ended September 28, 1996. The increase was primarily attributable to a 12% increase in sales of disposable electrodes and a 5% increase in sales to international markets.
Gross profit as a percentage of sales remained at 55%.
Selling and marketing expenses increased as a percentage of sales to 33% from 30%. Selling and marketing expenses increased 10% to $18,422,000 from $16,709,000. Of this increase, $734,000 was due to higher payroll related costs and travel expenditures due to higher staffing levels in North America, $350,000 was due to higher international selling expenditures, $295,000 was due to increased product services and support, and $349,000 was due to increased expenditures for promotion and advertising activities.
General and administrative expenses increased as a percentage of sales to 11% from 8%. General and administrative expenses increased 40% to $6,176,000 from $4,423,000. Of this increase, $1,300,000 was related to the estimated cost of proceeding to trial in a class action shareholder lawsuit that was initiated in 1994 and $591,000 was due to increased payroll related costs and travel expenditures because of higher staffing levels and the acquisition of the mobile computing business of Westech Information Systems, Inc. (Westech).
Research and development expenses increased as a percentage of sales to 11% from 8%. Research and development expenses increased 43% to $6,235,000 from $4,355,000. Of this increase, $1,000,000 is applicable to the value of in-process research and development acquired in the purchase of the assets from Westech, and $885,000 is due to increased staffing related to new product development.
Net investment income increased to $367,000 from $286,000. The increase was due primarily to higher average cash balances.
At September 27, 1997, the Company has available tax loss carryforwards of approximately $1,267,000 of which $720,000 expires at various dates through 2002 and $547,000 have an indefinite life. Approximately $1,157,000 of the tax loss carryforward is attributable to the Company's foreign operations and is not available to offset domestic taxable income.
1996 COMPARED TO 1995
The Company's net sales increased 20% to $54,762,000 for the year ended September 28, 1996 from $45,664,000 for the year ended September 30, 1995. The increase was primarily attributable to a 127% increase in domestic defibrillator sales to the pre-hospital market, a 51% increase in sales to international markets and a 9% increase in disposable electrode sales.
Gross profit as a percentage of sales remained at 55%.
Selling and marketing expenses decreased as a percentage of sales to 30% from 34%. Selling and marketing expenses increased 7% to $16,709,000 from $15,553,000. Of this increase, $903,000 was due to higher payroll related costs and travel expenditures due to higher staffing levels in North America; $525,000 was due to higher international selling expenditures and $170,000 was due to increased product services and support. These amounts were partially offset by a $400,000 decline in marketing related expenses for promotion and advertising activities, including the costs associated with new product introductions during 1995.
General and administrative expenses decreased as a percentage of sales to 8% from 9%. General and administrative expenses increased 7% to $4,423,000 from $4,151,000. This increase was due to increases in general operating expenses.
Research and development expenses decreased as a percentage of sales to 8% from 10%. Research and development expenses were essentially unchanged at $4,355,000 vs. $4,360,000 for 1995.
Net investment income increased to $286,000 from $243,000. The increase was due primarily to higher returns generated on the investment portfolios.
At September 28, 1996, the Company has available tax loss carryforwards of approximately $1,271,000 of which $753,000 expires at various dates through 2002 and $518,000 of which has an indefinite life. Approximately $1,118,000 of the tax loss carryforward is attributable to the Company's foreign operations and is not available to offset domestic taxable income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and investments at September 27, 1997 was $10,038,000 compared to $7,927,000 at September 28, 1996, an increase of $2,111,000. Cash provided by operating activities for the year ended September 27, 1997 increased $484,000 over the same period in 1996. This increase was primarily due to a net reduction in accounts receivable of $1,779,000.
The amount of cash required to fund investing activities was $5,273,000 lower for the year ended September 27, 1997 compared to the same period in 1996. The decrease was primarily due to an increase in the redemption of investments, and the investment in common stock of Lifecor, Inc., in 1996.
Cash provided by financing activities decreased $326,000 for the year ended September 27, 1997 primarily due to the decrease in the exercise of stock options in 1997 as compared to 1996.
The Company maintains a working capital line of credit with its bank. Under this working capital line, the Company may borrow up to $3,000,000 on a demand basis. Borrowings under this line bear interest at
the bank's base rate (8.50% at September 27, 1997). The full amount of the line was available to the Company at September 27, 1997.
The Company expects that the combination of existing funds, cash generated from operations and its existing line of credit will be adequate to meet its liquidity and capital requirements, for the foreseeable future.
SAFE HARBOR STATEMENTS
Except for the historical information contained herein, the matters set forth herein are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in the forward looking statements. Such risks and uncertainties include, but are not limited to: product demand and market acceptance risks, the effect of economic conditions, results of pending or future litigation, the impact of competitive products and pricing, product development and commercialization, technological difficulties, the government regulatory environment and actions, trade environment, capacity and supply constraints or difficulties, the results of financing efforts, actual purchases under agreements, and the effect of the Company's accounting policies.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, Notes thereto, Independent Auditors Report, Quarterly Financial Data (Unaudited) and Supplementary Schedule are listed under Part IV, Item 14, in this report.
ITEM 9.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information appearing in the Company's Proxy Statement for its 1998 Annual Meeting of Stockholders (the "Proxy Statement") under the caption "Proposal I - Election of a Class of Directors" is incorporated herein by this reference. Information regarding Executive Officers of the Company called for by Item 10 is set forth at the end of Part I of this Report under the caption "Executive Officers of Registrant."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information appearing in the Proxy Statement under the captions "Proposal I - - Election of a Class of Directors" and "Executive Compensation" is incorporated herein by this reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information appearing in the Proxy Statement under the captions "Proposal I - - Election of a Class of Directors" and "Other Matters -- Principal Stockholders" is incorporated herein by this reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing in the Proxy Statement under the captions "Proposal I - - Election of a Class of Directors" and "Certain Relationships" is incorporated herein by this reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following Consolidated Financial Statements, Notes thereto and Independent Auditors' Report of the company are filed on the pages listed below, as part of Part II, Item 8 of this report:
Page ----
Report of Independent Auditors Consolidated Balance Sheets Consolidated Income Statements Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements -
(a)(2) The following Consolidated Financial Statement Schedules are included herein:
Schedule II - Valuation Accounts S-1
All other schedules have been omitted since the required information is not presented, the amounts are not sufficient to require submission of the schedules or because the information is included in the consolidated financial statements.
(a)(3) The following is a complete list of Exhibits filed or incorporated by reference as part of this Report:
3.1 Restated Articles of Organization.* 3.2 Amended and Restated By-laws.* 10.1 1992 Stock Option Plan.* 10.2 1983 Incentive Stock Option Plan, as amended and restated February 6, 1990.* 10.3 Revolving Loan and Security Agreement dated March 9, 1992 between the Company and Brown Brothers Harriman & Co.* 10.4.1 License Agreement dated as of November 21, 1984 between the Company and S&W Medico Teknik A/S.*
10.4.2 License Agreement dated as of April 8, 1987 between the Company and S&W Medico Teknik A/S.* 10.4.3 Amendment to License Agreement dated January 1, 1990 between the Company and S&W Medico Teknik A/S.* 10.5 Stock Purchase Agreement dated July 1, 1985, as amended as of May 24, 1991, among the Company and certain purchasers of the Company's Common Stock and Preferred Stock.* 10.8 Distributorship Agreement dated as of June 15, 1992 between the Company and Fukuda Denshi Co., Ltd.* 10.9 Employment Agreement dated July 19, 1996 between the Company and Rolf S. Stutz regarding Mr. Stutz's employment. ** 10.10 Employment Agreement dated July 19, 1996 between the Company and Richard A. Packer regarding Mr. Packer's employment. ** 10.11 Non Employee Directors' Stock Option Plan dated April 23, 1996*** 21.1 Subsidiaries of the Company.*** 23.1 Consent of Ernst & Young LLP.*** 27 Financial Data Schedule ***
* Incorporated by reference from the Company's Registration Statement on Form S-1, as amended, under the Securities Act of 1933 (Registration Statement No. 33-47937).
** Incorporated by reference from the Company's Annual Report for 1996 Form 10-K, as amended, filed with the Securities and Exchange Commission on December 27, 1996.
*** Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on December 23, 1997.
ZOLL MEDICAL CORPORATION
By: /s/ Rolf S. Stutz --------------------------- Rolf S. Stutz Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
FINANCIAL STATEMENTS PAGES TO FINANCIAL STATEMENT SCHEDULE PAGE S-1
EXHIBIT INDEX
3.1 Restated Articles of Organization* 3.2 Amended and Restated By-laws* 10.1 1992 Stock Option Plan* 10.2 1983 Incentive Stock Option Plan, as amended and restated February 6, 1990* 10.3 Revolving Loan and Security Agreement dated March 9, 1992 between the Company and Brown Brothers Harriman & Co.* 10.4.1 License Agreement dated as of November 21, 1984 between the Company and S&W Medico Teknik A/S* 10.4.2 License Agreement dated as of April 8, 1987 between the Company and S&W Medico Teknik A/S* 10.4.3 Amendment to License Agreement dated January 1, 1990 between the Company and S&W Medico Teknik A/S* 10.5 Stock Purchase Agreement dated July 1, 1985, as amended as of May 24, 1991, among the Company and certain purchasers of the Company's Common Stock and Preferred Stock* 10.8 Distributorship Agreement dated as of June 15, 1992 between the Company and Fukuda Denshi Co., Ltd.* 10.9 Employment Agreement dated July 19, 1996 between the Company and Rolf S. Stutz regarding Mr. Stutz's employment** 10.10 Employment Agreement dated July 19, 1996 between the Company and Richard A. Packer regarding Mr. Packer's employment** 10.11 Non Employee Directors' Stock Option Plan dated April 23, 1996*** 21.1 Subsidiaries of the Company*** 23.1 Consent of Ernst & Young LLP*** 27 Financial Data Schedule ***
* Incorporated by reference from the Company's Registration Statement on Form S-1, as amended, under the Securities Act of 1933 (Registration Statement No. 33-47937).
** Incorporated by reference from the Company's Annual Report for 1996 Form 10-K, as amended, filed with the Securities and Exchange Commission on December 27, 1996.
*** Filed herewith.
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders ZOLL Medical Corporation
We have audited the accompanying consolidated balance sheets of ZOLL Medical Corporation as of September 27, 1997 and September 28, 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended September 27, 1997. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ZOLL Medical Corporation at September 27, 1997 and September 28, 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 27, 1997, in conformity with generally accepted accounting principles.
Boston, Massachusetts November 20, 1997
ZOLL MEDICAL CORPORATION CONSOLIDATED BALANCE SHEETS (000's omitted)
See notes to consolidated financial statements.
ZOLL MEDICAL CORPORATION CONSOLIDATED INCOME STATEMENTS
See notes to consolidated financial statements.
ZOLL MEDICAL CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
ZOLL MEDICAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOW
See notes to consolidated financial statements.
ZOLL MEDICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
Description of Business: ZOLL Medical Corporation (the Company) designs, manufactures and markets an integrated line of proprietary, noninvasive cardiac resuscitation devices and disposable electrodes. The Company's products are used for the emergency resuscitation of cardiac arrest victims. ZOLL also designs and markets software, which automates collection and management of both clinical and non-clinical data for emergency medical service providers.
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Fiscal Year: The company's fiscal year ends on the Saturday closest to September 30. The years ended September 27, 1997, September 28, 1996 and September 30, 1995 all included 52 weeks.
Cash and Cash Equivalents: The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents. Substantially all cash and cash equivalents are invested in a money market investment account. These amounts are stated at cost which approximates market.
Inventories: Inventories, principally purchased parts, are valued at the lower of first-in, first-out (FIFO) cost or market. Market is replacement value for raw materials and net realizable value, after allowance for estimated costs of completion and disposal, for work-in-process and finished goods.
Intangible Assets: The excess of cost over fair value of the net assets acquired is amortized on a straight-line basis over 15 years. Accumulated amortization amounted to $22,000 at September 27, 1997.
Property and Equipment: Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated economic useful lives of the assets (forty years for buildings, three to ten years for machinery and equipment, and five years for tooling, software, and furniture and fixtures). Leasehold improvements and equipment under capital leases are being amortized over the life of the lease.
Revenue Recognition: Revenue from product sales is recognized upon shipment of the product and recorded net of estimated returns. Revenue from software license fees and the sale of hardware products is recognized upon shipment of the product, provided that no significant customizations remain and collection of the receivable is considered probable. Service revenue earned on extended warranty contracts is recognized on a straight-line basis over the life of the contract period.
Product Warranty: Expected future product warranty liability, included in accrued expenses and other liabilities, are recognized at the time of sale for all products covered under warranty. Warranty periods range from one to five years.
Earnings Per Share: Earnings per share data are computed using the weighted average number of shares of Common Stock outstanding and common equivalent shares (using the treasury stock method).
In February 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" (FAS 128) which is effective for financial statements for both interim and annual periods ending after December 15, 1997. FAS 128 will require the presentation of "basic" and "diluted" EPS. The Basic EPS calculation does not consider the possible effects of potentially dilutive securities. Basic and diluted EPS calculated in accordance with FAS 128 is not expected to differ significantly from EPS as currently reported.
Reclassifications: Certain reclassifications have been made to the prior year's consolidated financial statements to conform to the 1997 presentation.
Pervasiveness of Estimates: The preparation of the 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Stock Option Plans: The Company accounts for its stock compensation awards under the provisions of APB No. 25 "Accounting for Stock Issued to Employees" and will continue to do so in the future.
Newly Issued Pronouncements: In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130 (FAS 130), "Reporting Comprehensive Income" and Statement No. 131 (FAS 131) "Disclosures About Segments of an Enterprise and Related Information." FAS 130 establishes standards for the reporting and display of comprehensive income and its components. FAS 131 establishes standards for the way that public companies report information about operating segments in financial statements. This Statement supersedes Statement No. 14, "Financial Reporting for Segments of a Business Enterprise," but retains the requirements to report information about major customers. The Statements are effective for fiscal years beginning after December 15, 1997. The Company does not believe that the adoption of these Statements will have a material effect on the Company's financial statements.
NOTE B - INVESTMENTS
Investments in equity securities and debt securities are classified as available for sale at September 27, 1997. Available for sale securities consisted of $278,000 of corporate obligations at September 27, 1997. The securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity. At September 27, 1997, there was no difference between the cost basis and the estimated market value on the security portfolio. The maturity periods on the securities held were all due within one year.
The cost of securities sold is based on the specific identification method. Realized gains and losses and declines in value judged to be other than temporary are included in investment income.
During 1996, the Company invested $2 million in the common stock of Lifecor, Inc., which represents approximately 6% of Lifecor's outstanding common stock. The Company accounts for this investment at cost, which approximates market. This investment is included in other assets on the balance sheet.
NOTE C - STOCKHOLDERS' EQUITY
Preferred Stock: The Board of Directors is authorized to fix the designations, relative rights, preferences, and limitations on the Preferred Stock at the time of issuance.
Stock Option Plans: The Company's 1983 and 1992 stock option plans provide for the granting of options to officers and other key employees to purchase the Company's Common Stock at a purchase price, in the case of incentive stock options, at least equal to the fair market value per share of the outstanding common stock of the Company at the time the option is granted, as determined by the Compensation committee of the Board of Directors. The number of shares originally authorized for these plans was 1,610,000. Options are no longer granted under the 1983 plan. Options become exercisable ratable over four years and have a maximum duration of 10 years. Approximately 954,000 shares of Common Stock are reserved for issuance under the Company's stock option plan as of September 28, 1997.
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (FAS 123), "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized with respect to the Company's stock option grants. Had compensation cost for this plan been determined based on the fair value methodology prescribed by FAS 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below.
(000's omitted, except per share data) 1997 1996 ----------------------------------------------------------------------
Net earnings - as reported $ 515 $3,413 Net earnings - pro forma $ 269 $3,333 Earnings per share - as reported $0.08 $ 0.55 Earnings per share - pro forma $0.04 $ 0.53
The above pro forma amounts may not be representative of the effects on reported net earnings for future years. The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1997 and 1996:
1997 1996
Dividend yield 0% 0% Expected volatility 4.84% 4.84% Risk-free interest rate 5.98% 5.96% Expected lives 5 years 5 years
Activity as to stock options under the two plans is as follows:
The following table summarizes information about stock options outstanding at September 27, 1997.
Under the Company's 1992 stock option plan 166,900 options ranging in option price from $14.00 to $14.50 per share were repriced to $8.75 per share and 227,750 options ranging in price from $21.75 to $38.25 were repriced to $14.50 per share, during 1996. The purpose of these transactions was to restore the incentive effect of such options. On November 21, 1996 the Board of Directors adopted an amendment to the Plan, to increase the number of shares of Common Stock available for issuance under the Plan by 200,000 shares. In all other respects, the Plan remained unchanged.
NOTE D - ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued liabilities consist of: SEPT. 27, SEPT. 28, (000's omitted) 1997 1996 - ------------------------------------------------------------ ---------
Accrued salaries and wages $2,383 $2,086 Accrued professional services 1,003 264 Accrued warranty expense 996 721 Accrued income taxes 963 394 Other accrued expenses 2,032 1,206 ------ ------
Total accrued expenses and other liabilities $7,377 $4,671 ====== ======
NOTE E - INDEBTEDNESS
The Company maintains an unsecured working capital line of credit with its bank. Under this working capital line, the Company may borrow up to $3,000,000 on a demand basis. This line of credit bears interest at the bank's base rate (8.5% at September 27, 1997), and requires a compensating balance of $275,000. The full amount of the line was available to the Company at September 27, 1997.
In 1994, the Company purchased land and building, which replaced leased operating facilities, for $900,000. The land and building are mortgaged under a $900,000 bank note bearing interest at 8.2%. The mortgage requires equal monthly principal payments of $7,500 plus interest over seven years, with a final payment of $270,000 due in July 2001. The mortgage contains various covenants including minimum levels of net worth, working capital and pre-tax earnings. The Company is in compliance with all covenants of the agreement.
Long-term debt consisted of : (000's omitted) 1997 1996 - ------------------------------------------------------ ----
Mortgage note payable $623 $712 Capital lease obligations - Note G 39 63 Total long-term debt 662 775 Less current portion 110 114 ---- ---- $552 $661 ==== ====
The schedule of principal payments on long-term debt is as follows:
1998 $110 1999 103 2000 90 2001 359 ---- $662 ====
- --------------------------------------------------------------------
NOTE F- INCOME TAXES
The provision for income taxes consists of the following:
(000's omitted) 1997 1996 1995 ---- ---- ---- - --------------------------------------------------------------
Federal: Current $ 942 $1,288 $462 Deferred (722) 144 3 ----- ------ ---- 220 1,432 465
State: Current 222 337 31 Deferred (176) (11) - ----- ------ ---- 46 326 31 ----- ------ ----
$ 266 $1,758 $496 ===== ====== ====
The effective income tax rate differed from the statutory federal income tax rate due to:
1997 1996 1995 ---- ---- ---- Statutory income tax rate 34.0% 34.0% 34.0% Tax credits, federal and state - (2.6) (6.2) State income taxes, net of federal benefit 3.9 4.2 4.8 Unbenefited foreign losses 1.6 1.1 3.8 Other (5.5) (2.7) (2.4) ---- ---- ----
Effective income tax rate 34.0% 34.0% 34.0% ==== ==== ====
At September 27, 1997, the Company has available tax loss carryforwards of approximately $1,267,000 of which $720,000 expires at various dates through 2002 and $547,000 have an indefinite life. Approximately $1,157,000 of tax loss carryforward is attributable to the Company's foreign operations and is not available to offset domestic taxable income.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The valuation allowance increased $13,000 as a result of foreign losses incurred in 1997.
Significant components of the Company's deferred tax assets and liabilities are as follows:
(000's omitted) 1997 1996 ---- ---- - ----------------------------------------------------------------------
Deferred tax assets: Accounts receivable and inventory $ 718 $ 523 Net operating loss carryforwards 420 423 Product warranty accruals 389 282 Purchased research & development 365 - Shareholder litigation accrual 288 - Other liabilities 206 103 Valuation allowance for deferred tax assets (384) (371) ----- -----
Total deferred tax assets 2002 960
Deferred tax liabilities: Accelerated tax depreciation 700 635 Prepaid expenses 277 198 ----- ----- Total deferred tax liabilities 977 833 ----- -----
Net deferred tax asset $1025 $ 127 ===== =====
NOTE G - LEASES
The Company leases certain office and manufacturing space and equipment under capital and operating leases. Listed below are the future minimum rental payments required under capital leases and operating leases with noncancellable terms in excess of one year at September 27, 1997, together with the present value of net minimum lease payments.
CAPITAL OPERATING LEASES LEASES TOTAL - ---------------------------------------------------------------------------- (000's omitted) 1998 27 303 330 1999 14 306 320 2000 - 338 338 2001 - 338 338 2002 - 338 338 Thereafter - 281 281 --- ------ ------
Net minimum lease payments 41 $1,904 $1,945
Less interest payments 2 ---
Present value of net minimum lease payments $39 ===
Included in machinery and equipment at September 27, 1997 and September 28, 1996 are certain items recorded as capital leases with a book value of $134,000 and related accumulated depreciation of $93,000 and $68,000 in 1997 and 1996, respectively.
The Company's office lease is subject to adjustments based on actual floor space occupied. The lease also requires payment of real estate taxes and operating costs. Total rental expense for 1997, 1996, and 1995 was approximately $566,000, $508,000, and $418,000, respectively.
NOTE H - EMPLOYEE BENEFIT PLAN
The Company has a defined contribution retirement plan which contains a "401(k)" program for all employees with six months of service who have attained 21 years of age. The Company may contribute a discretionary percentage of the employee's contribution. The Company may make an additional discretionary profit sharing contribution. The Company made a $100,000 contribution to the plan in fiscal 1997 and no contribution in fiscal 1996 or 1995.
NOTE I - CONCENTRATION OF CREDIT RISK
The Company sells its products primarily to hospitals and universities. The Company performs periodic credit evaluations of its customers' financial condition and does not require collateral. Credit losses associated with these customers historically have been small, which is consistent with management's expectations. The Company entered the pre-hospital market segment recently, and as a result the Company believes it will face a greater degree of credit risks as sales to this market segment expand.
The Company had export sales of approximately $12,322,000, $11,649,000, and $7,730,000 in 1997, 1996 and 1995 respectively.
NOTE J - CONTINGENCIES
In the course of normal operations, the Company is involved in litigation arising from commercial disputes and claims of former employees which management believes will not have a material impact on the Company's financial position or its results of operations.
During the quarter ended December 28, 1996, the Company incurred a charge of approximately $1,300,000 to cover the litigation costs to defend itself in a shareholder lawsuit initiated in 1994. The Company has been unable to reach a reasonable settlement with plaintiffs' attorneys. The Company believes it has meritorious defenses to the lawsuit and therefore will prevail in trial. The Company believes that such litigation accrual and insurance reimbursement is adequate provision for probable losses arising from the litigation, and as such the Company believes that the litigation will not have a material adverse affect on its financial position or its results of operations.
NOTE K - ACQUISITION
On November 6, 1996 the Company acquired the assets of the mobile computing business of Westech Information Systems, Inc. for approximately $1,500,000 in cash. The acquisition was accounted for as a purchase and the purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values at the date of acquisition. The excess of the cost over the fair value of net assets acquired is being amortized over fifteen years. In connection with the acquisition, the Company incurred a non-recurring charge of $1,000,000 for acquired in process research and development which was charged to operations because in management's' opinion, technological feasibility for the acquired research and development had not been established. The Company's consolidated results of operations include the operations of the mobile computing business of Westech Information Systems, Inc. from November 1996.
The following unaudited pro forma information shows the results of operations as if the transaction occurred at the beginning of each year (in thousands, except per share amounts):
1997 1996 --------------------------------------------------------------------------- Net Sales $56,438 $55,751 Net income $ 504 $ 2,987 Earnings per common share $ 0.08 $ 0.48
The pro forma results of operations are not necessarily indicative of the actual results of operations that would have occurred had the purchase actually been made at the beginning of the respective periods and is not necessarily indicative of results that may be obtained in the future.
NOTE L - QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for 1997 and 1996 is as follows:
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
S-1