-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Gt481T0/jmuzSW9rOpqyLF+3HImRVIyF8CIpm7BKt3hR/EVSUs+W8tV6LK0VfrrU v/QBLBzdW8ske6LeyVn/uQ== 0001047469-98-012646.txt : 19980401 0001047469-98-012646.hdr.sgml : 19980401 ACCESSION NUMBER: 0001047469-98-012646 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PHYSIO CONTROL INTERNATIONAL CORP \DE\ CENTRAL INDEX KEY: 0001003088 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 911673799 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27242 FILM NUMBER: 98580116 BUSINESS ADDRESS: STREET 1: 11811 WILLOWS RD NE CITY: REDMOND STATE: WA ZIP: 98052 BUSINESS PHONE: 2068674331 MAIL ADDRESS: STREET 1: 11811 WILLOWS ROAD NE CITY: REDMOND STATE: WA ZIP: 98052 FORMER COMPANY: FORMER CONFORMED NAME: PHYSIO CONTROL HOLDING CORP \DE\ DATE OF NAME CHANGE: 19951106 10-K 1 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 Commission file number 0-27242 PHYSIO-CONTROL INTERNATIONAL CORPORATION (Exact name of registrant as specified in its charter) Washington 91-1673799 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 11811 Willows Road N.E., Redmond, WA 98052 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (425) 867-4000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01 per share (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ---- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) The aggregate market value of voting stock held by non-affiliates of the registrant as of March 2, 1998, at a closing sale price of $18.62 as reported by the Nasdaq National Market was approximately $324,396,690. As of March 2, 1998, the registrant had 17,558,625 shares of Common Stock, par value $0.01 per share, outstanding. Documents Incorporated by Reference Portions of the Registrant's Proxy Statement to be used in connection with the solicitation of proxies for the 1998 Annual Meeting to be held in May 1998 are incorporated by reference in Part III, Items 11-13. 1 PHYSIO-CONTROL INTERNATIONAL CORPORATION INDEX TO ANNUAL REPORT ON FORM 10-K
Page No. PART I Item 1. Business................................................................................ 3 Item 2. Properties.............................................................................. 11 Item 3. Legal Proceedings....................................................................... 11 Item 4. Submission of Matters to a Vote of Security Holders..................................... 11 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............... 12 Item 6 Selected Financial Data................................................................. 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................................... 15 Item 8. Financial Statements and Supplementary Data............................................. 20 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................................................ 40 PART III Item 10. Directors and Executive Officers of the Registrant...................................... 41 Item 11. Executive Compensation................................................................... * Item 12. Security Ownership of Certain Beneficial Owners and Management........................... * Item 13. Certain Relationships and Related Transactions........................................... * PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 43
* Incorporated by reference to the Company's Proxy Statement which the Company will file with the Commission on or before April 3, 1998, pursuant to General Instruction 6(3) to Form 10-K. 2 Business Physio-Control International Corporation (the "Company") designs, manufactures, markets and services an integrated line of noninvasive emergency cardiac defibrillator and vital sign assessment devices, disposable electrodes and data management software. The Company's products are used in both out-of-hospital and hospital settings for the early detection and treatment of life threatening events including trauma, heart attack and the acute heart rhythm disturbances of ventricular fibrillation, tachycardia and bradycardia. The Company established the market for noninvasive emergency cardiac defibrillators with the introduction of the first commercially available, direct current external defibrillation device for hospital use in 1961. Since that time, the Company has developed a full product line to meet the needs of a broad spectrum of users including first responders, emergency medical technicians ("EMTs"), paramedics, hospital code teams, critical care nurses and physicians. The Company was founded in 1955 by a renowned cardiac surgeon, Dr. William Edmark, who sought to reduce deaths related to cardiac arrest. The Company was a publicly traded corporation from 1971 through 1980 and, from 1980 to mid-1994, operated as a wholly owned subsidiary of Eli Lilly and Company ("Lilly"). On July 29, 1994, the stock of the Company and certain other related assets were purchased from Lilly in an acquisition led by affiliates of Bain Capital, Inc. and certain other investors. In December 1995, the Company again became a publicly traded corporation upon the completion of an initial public offering of 13,421,650 shares of its Common Stock. As used herein, the term "Company" refers to Physio-Control International Corporation and its subsidiaries, and the term "Predecessor" refers to the Company during the period in which it was a wholly owned subsidiary of Lilly. Physio Control-Registered Trademark-, PHYSIO-CONTROL-Registered Trademark-, LIFEPAK-Registered Trademark-, and FIRST MEDIC-Registered Trademark- are registered trademarks of the Company. QUIK-COMBO-TM-, QUIK-VIEW-TM-, QUIK-STAT-TM-, Shock Advisory System-TM-, LIFENET-TM-, and CODE-STAT-TM- are trademarks. Background Cardiac defibrillator and vital sign assessment devices are used in a variety of emergency situations for the early detection, assessment and treatment of life threatening events arising from heart disease and trauma. The most important factor in successfully treating a life threatening emergency is time. In an emergency situation, the first action of a caregiver is usually an assessment of the patient's vital signs. Therefore, it is critical to have these assessment and treatment devices readily available. Trauma is one of the leading causes of death in the U.S. Although various conditions are associated with trauma, the most serious are shock and cardiac arrest. Assessment of heart rhythms and blood pressure is crucial to determine whether a patient is in shock or cardiac arrest. The Marketplace The Company estimates that the 1997 worldwide market for emergency cardiac defibrillator and vital sign assessment devices, including service and supplies, was approximately $425 million. The market can be described in terms of the U.S. out-of-hospital market (1997 sales of approximately $115 million), the U.S. hospital market (1997 sales of approximately $105 million), and the international market (1997 sales of approximately $205 million). U.S. Out-of-Hospital Market. This market can be characterized in several distinct segments, typically defined by the skill level of the device user: Advanced Life Support ("ALS"). The ALS market consists of a highly skilled paramedic group. Paramedics generally receive over 1,500 hours of training in emergency medicine including assessment and treatment of trauma. The ALS market demands durable and reliable products that are suitable for a high-use, harsh 3 environment. Cardiac defibrillator and vital sign assessment devices sold to this market include manual defibrillation, cardioversion, pacing, 12-lead and other vital sign assessment capabilities. Basic Life Support ("BLS"). The BLS market consists of both EMTs and other medically trained caregivers who are likely to have the first contact with a patient in an emergency. These individuals include firefighters and others with limited training in defibrillation therapy. Cardiac defibrillator and vital sign assessment devices sold to this user group generally do not include pacing, cardioversion capability or 12-lead assessment. In this segment, users rely on arrhythmia detection software for automated detection and semi-automated delivery of defibrillation therapy. First Responder. The first responder market consists of minimally trained personnel such as security personnel, flight attendants and extended care facility staff. While the potential size of this market is substantial, the market is currently in the early development stages. Cardiac defibrillator and vital sign assessment devices sold to this user group must be easy to use, rely on voice-prompted protocols that assume little user training, must be low maintenance and incorporate long battery life as well as automated self-testing that alerts users to electromechanical problems or a low battery condition. The Company introduced the LIFEPAK 500 automatic external defibrillator in early 1997 to service this market group. To date, the Company has received orders for over 7,500 units of the LIFEPAK 500 automated external defibrillator (AED). U.S. Hospital Market. Hospitals have traditionally been the largest users of cardiac defibrillator and vital sign assessment devices both for patients admitted for chest pain and for patients undergoing treatment for other reasons. Many hospital procedures such as surgery, cardiac catheterization, stress testing and general anesthesia place the patient at increased risk for arrhythmias or cardiac arrest. Hospitals frequently use cardiac defibrillator and vital sign assessment devices on a standby basis in connection with these procedures. Since immediate treatment is a critical factor for successful cardiac resuscitation, cardiac defibrillator and vital sign assessment devices are placed throughout the hospital, including 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 patients. International Market. The international market is segmented into developed markets such as Europe, Australia and Japan, and emerging markets, such as Eastern Europe, China, India and Latin America. The Company's non-U.S. sales have principally occurred in developed markets where growth is driven by the development of out-of-hospital emergency services similar to those which have developed in the U.S. out-of-hospital market during the past 15 years. In emerging markets, growth is driven by the development of basic medical facilities that typically require emergency cardiac defibrillator and vital sign assessment devices. Products The Company's current devices include the LIFEPAK 9, the LIFEPAK 10, the LIFEPAK 11, the LIFEPAK 12, the LIFEPAK 300, the LIFEPAK 500, and the FIRST MEDIC products. All are noninvasive external defibrillator and vital sign assessment devices, some having optional noninvasive pacing and shock advisory. The Company also offers tools for data management through its CODE-STAT products. The Company has consistently supported all product introductions and enhancements with extensive support documentation and training. The Company's products are designed to maintain functional compatibility with its installed base of over 200,000 units through the use of common device controls, electrodes, protocols, batteries and data management software. The cost and time involved in training caregivers to use devices such as those sold by the Company are significant. The Company's current focus on functional compatibility between old and new products is important in reducing the need to provide additional training and in reducing the risk of associated user error. In addition, the Company's defibrillation and vital sign assessment devices record the patient data monitored and action taken by the caregiver for post-event review by an EMS medical director or other responsible parties, thereby permitting post-event monitoring of caregiver performance and product effectiveness. 4 Defibrillator Products The LIFEPAK 9 family of products combines cardiac vital sign assessment and manual defibrillation. The products are also available with external noninvasive pacing and an automated Shock Advisory System (to allow use by minimally trained personnel). These products can be configured to provide monitoring, defibrillation and pacing through a single pair of disposable QUIK-COMBO electrodes. The LIFEPAK 9 products are targeted to the hospital where they are used in the emergency room, special procedure rooms, critical care units and general floors. These products are also used in surgical centers, clinics and physician offices. The LIFEPAK 10 family of portable products combines a cardiac vital sign assessment device with manual defibrillation. The products are available with external noninvasive pacing and QUIK-COMBO electrode capability. The LIFEPAK 10 unit is used primarily in the out-of-hospital ALS market and for transport of patients within the hospital. The LIFEPAK 11 unit is an advanced, portable product for the ALS market that, in addition to manual defibrillation and noninvasive pacing capabilities, also includes diagnostic 12-lead ECG capability. This product has made the Company the leader in field collected diagnostic ECGs, which allow for earlier diagnosis and faster treatment of myocardial infarctions. The LIFEPAK 12 defibrillator/monitor provides therapeutic and diagnostic functions in a single small device designed for both out-of-hospital and hospital users. This new and innovative platform design provides ease of use and the flexibility to add new features and enhancements at a future date. Configurable options include automated and manual defibrillation, pacing, pulse oximetry and interpretive 12-lead ECG analysis. Additional parameters under development include non-invasive blood pressure, end-tidal CO2 and invasive pressures. The Company obtained U.S. Food and Drug Administration ("FDA") approval under Section 510(k) in January 1998 for the LIFEPAK 12 defibrillator/monitor. The LIFEPAK 300 defibrillator is a portable product that combines a cardiac vital sign assessment device with a manual and automated defibrillator. This product incorporates the Shock Advisory System, which supports its use as an automated defibrillator by minimally trained personnel. While the LIFEPAK 300 unit is targeted for the BLS market, it can also be operated in manual mode by ALS personnel. The product also includes event documentation capability and a data management software package for use by a medical director for efficient quality assurance. The LIFEPAK 500 AED is a lightweight automated device that is designed to be used by first responders to cardiac emergencies. This rugged device is extremely portable at only seven pounds. Low maintenance requirements and simple operation make it the ideal product for the first responder market. The FIRST MEDIC 510 product is a portable automated defibrillator designed primarily for EMT and fire department first responders. The product also includes event documentation capability and a data management software package for use by a medical director for efficient quality assurance. The FIRST MEDIC 710 defibrillator is a portable product that combines a cardiac vital sign assessment device with manual and automated defibrillation for mixed BLS and ALS systems. The product is designed as a platform product to incorporate additional assessment capabilities utilized by the ALS market such as oximetry (for determining the amount of oxygen being carried in the blood). This device can be used in either the manual or semi-automatic mode at the option of the caregiver and is therefore attractive to mixed ALS/BLS applications. The product also includes event documentation capability and data management software for use by a medical director for efficient quality assurance. Other Products The Company's QUIK-COMBO electrodes allow customers to upgrade from traditional single function electrodes to multiple function electrodes permitting the Company's pacing products to pace, defibrillate, and monitor electrocardiograms through a single pair of electrodes. QUIK-COMBO electrodes are compatible 5 across the LIFEPAK product lines, enabling continuity of care from first responders to BLS providers to ALS providers to hospital providers. With this product, caregivers can provide one set of electrodes which remain with the patient through different levels of care. The Company's CODE-STAT data management system, a Windows(TM) based software program, allows users to conduct post-event review and analyze system data. This software stores data from the LIFEPAK 11 diagnostic cardiac monitor and LIFEPAK 300 devices. The CODE-STAT system extends the Company's data management product line, which began with the introduction of the QUIK-VIEW data review system and the QUIK-STAT statistical report generator in 1988. A significant upgrade to the CODE-STAT product line will be available approximately mid-1998. CODE-STAT Suite data management platform provides quality assessment and system performance analysis and offers post event viewing, storage and report generation for both continuous and static waveforms. Optional modules will include Utstein, chest pain and response time reporting. The Suite is compatible with LIFEPAK 500, 11 and 12 products. Future iterations will continue to enhance the utility of the LIFENET system discussed below. The Battery Support System 2 is an intelligent, highly automated system which recognizes and optimizes maintenance of both NiCd (FASTPAK and FASTPAK 2) and Sealed Lead-Acid (LIFEPAK SLA) chemistry batteries. All battery wells allow charging, conditioning and shelf life testing. The FASTPAK 2 battery provides an immediate battery capacity reading at the push of a button. It is designed to be used with the LIFEPAK 12, 11, 10 and 5 products. The LIFENET system is a data management solution which includes LIFEPAK medical devices and the CODE-STAT Suite. By working with the Company, other manufacturers' data management systems can become LIFENET compatible. The system will be compatible with the MUSE CV(R) cardiovascular information system from Marquette Medical Systems. Service The Company provides extensive, high quality, direct, on-site and depot service in the U.S. and in Western Europe through a dedicated service team of more than 150 individuals. The Company believes its service force is the industry's only direct field service organization for the out-of-hospital market segment. The Company also provides comprehensive service in other markets through a network of third-party service partners. Service is provided under the Company's standard product warranties which generally range from 90 days to five years, through annual service contracts which the Company sells to its customers for a fixed fee and upon request for repair services. The services provided include repair service, scheduled preventive maintenance, product technical support and technical training. In the hospital market, in addition to on-site service, the Company provides support to hospital maintenance staff in the form of parts sales, product training programs and technical support. Product Development The Company's product development efforts include products for the hospital, ALS, BLS and first responder market segments, as well as data management software. The majority of the product development effort is focused on product enhancements and new products which span the entire spectrum of anticipated customer and clinical needs in all resuscitation and emergency vital sign assessment market groups. The Company's product development strategy is based on developing product platforms which have the flexibility to be configured to respond to a variety of customer requirements. The Company believes this strategy provides an opportunity to reduce the cost of developing new products for use in multiple market segments. 6 Sales and Marketing The Company sells its broad product line across a diverse global customer group, including individual hospitals, hospital buying groups, fire departments, EMS departments, governments, militaries, as well as alternative healthcare delivery sites including surgery centers and sub-acute care centers. With the 1997 introduction of the LIFEPAK 500 AED, the Company's customer base has now been expanded to include minimally trained first responders such as police officers and security personnel. The Company's marketing strategy is to target specific customer groups, as well as align itself with strategic partners that will broaden the market spectrum through joint sales and distribution agreements. During February 1997 the Company also announced a sales, marketing and technology transfer alliance with Marquette Medical Systems, Inc. located in Milwaukee, Wisconsin. Marquette is a market leader in the diagnostic cardiology, patient monitoring and clinical information system markets. In late 1996 the Company announced a sales and marketing alliance with Ambu International A/S, a Danish company engaged in the development, manufacture and sale of airway management products and CPR training devices for the emergency medical market. Ambu's products are sold throughout the world. The Company has been very successful during 1997 in marketing Ambu products in the U.K., and has begun distribution of Ambu products in several other European markets. Through these strategic alliances, the Company has positioned itself to provide integrated products and clinical data management capabilities, from the point of first intervention at the scene of a medical emergency, through the point of final treatment. The Company principally sells its products through a direct sales force in the U.S. The Company's U.S. sales organization consists of approximately 105 individuals, principally comprised of a direct field sales force located around the country, a dedicated national accounts team and a telemarketing and customer support group. In early 1998, the Company realigned its direct sales force into a hospital and an out-of-hospital focus. The Company believes that this segregation will allow the sales organization to specialize in each of the market segments, penetrate the market in a more efficient manner, and provide the best customer service. In addition, the Company has executed a limited number of distribution agreements with third parties to service the alternate U.S. site market which includes doctors' offices, surgery centers, sub-acute care centers and industrial accounts. This alternative distribution channel is intended to penetrate the numerous sites where the Company's sales force does not currently focus. The Company's purchasing agreements with ten major hospital buying groups cover approximately 75% of U.S. hospital beds. In addition, the Company has agreements with the U.S. government and several major ambulance companies. The Company believes these purchasing agreements contribute to growth opportunities within the evolving managed care environment. For the year ended December 31, 1997, domestic sales accounted for approximately 71% of the total net revenues. In the international market, the Company sells through both a direct sales force and through distributors. The Company's international direct sales force consists of a team of approximately 50 individuals located in Canada, United Kingdom, Eastern Europe, France, Spain, Italy, Sweden, Finland, Netherlands, Germany and Austria. The Company sells its products in other geographical areas such as Japan, Asia Pacific, Australia, the Middle East and Latin America using distribution partners, many of whom have been selling the Company's products for more than ten years. The Company also invested in the Chinese marketplace during 1996 by establishing a representative office in Beijing and developed alliances with three distribution partners in major regions of China. For the year ended December 31, 1997, international sales accounted for approximately 29% of total net revenues. Research and Development As of December 31, 1997, the Company had an in-house research and development staff of approximately 200 engineers and technicians. Product development work is driven by small, dedicated teams which have overall responsibility for the development of new products. These teams are supported by a strong functional network of technical specialists who maintain expertise in specific technologies such as software engineering, 7 mechanical design engineering and electrical design engineering. The work of this organization is complemented by a number of external, proprietary development relationships, focused primarily on the development of non-critical support or ancillary products. During the three years ended December 31, 1997, 1996 and 1995, the Company's expenditures for research and development totaled $21.0 million, $18.8 million and $19.5 million, respectively. To enhance its research and development capabilities, the Company has developed close alliances with several leading research institutions and universities. Currently, the Company supports basic research in the areas of cardiac predictive and assessment algorithms, cardiac assessment models and new waveform and energy transfer techniques. Competition The cardiac defibrillator and vital sign assessment device market is highly competitive. The Company competes with many companies, some of which may have access to greater financial and other resources than the Company. The Company's primary domestic competitors include Hewlett-Packard Co., Zoll Medical Corporation, Laerdal Medical Corporation, Heartstream, Inc., and SurVivaLink. International competitors also include Nihon-Kohden, Corpuls, Bruker-Odam, and Hellige. The Company believes that the principal competitive factors for cardiac defibrillator and vital sign assessment devices are ease of use, compatibility with existing equipment, durability and technical support. In the out-of-hospital market, additional factors include reliability of the product and battery system, portability, automation, multi-parameter capability, data management, as well as field service and training. The Company believes that its products compete favorably in these areas. Government Regulation As a manufacturer of medical devices, the Company is subject to regulation by, among other governmental entities, the FDA and the corresponding agencies of foreign countries in which the Company sells its products. These regulations govern the introduction of new medical devices, the maintenance of certain records, the tracking of device location and other matters. Noncompliance with applicable requirements can result in warning letters, fines, injunction, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance or premarket approval for a device, and criminal prosecution. The Company believes that it is in substantial compliance with all such governmental regulations. FDA Regulation. The FDA requires that prior to introducing any medical device in the U.S. market, the manufacturer of such device must secure either a premarket notification clearance pursuant to Section 510(k) of the Federal Food, Drug, and Cosmetic Act (a "510(k) clearance") or an approved premarket approval application. A 510(k) clearance indicates that the FDA agrees with an applicant's determination that the product for which clearance has been sought is substantially equivalent to a legally marketed medical device. In addition to requiring clearance or approval for new products, the FDA may require clearance or approval prior to marketing products that are modifications of existing products or that change the intended use of existing products. To date, the Company has obtained FDA marketing clearances only through the 510(k) clearance process. There can be no assurance that all necessary approvals will be granted on a timely basis or at all. It is possible that delays in receipt of or failure to receive any necessary clearance or approval could have a material adverse effect on the Company. For any device that is cleared through the 510(k) process, changes or modifications that could significantly affect safety or effectiveness, or make a major change in the intended use of the device, require a new 510(k) notification submission. The Company is required to register with the FDA as a device manufacturer and is required to comply with the FDA's good manufacturing practices ("GMP") regulations. These regulations require that the Company 8 manufacture its products and maintain its records in a prescribed manner with respect to manufacturing, testing and control activities. Further, the Company is required to comply with FDA requirements for labeling and promotion of its products. The FDA's medical device reporting ("MDR") regulations require that the Company provide information to the FDA whenever there is an assertion which reasonably suggests that one of its devices may have caused or contributed to a death or serious injury, or that a malfunction has occurred that would be likely to cause or contribute to a death or serious injury if the malfunction were to reoccur. Due to the large number of the Company's products already in use and the fact that these products are frequently used in an attempt to resuscitate patients who are already clinically dead, the Company regularly submits MDRs to the FDA and expects to continue to do so. 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 re-inspect 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. Product Recalls. The Company manufactures critical medical devices and has a strong commitment to providing highly reliable products. On occasion, the Company has, on its own initiative or in response to customer or FDA concerns, taken voluntary action to modify and upgrade customer products at the Company's expense or provide instructional information to customers to optimize the reliability of its products. Under the medical device regulations, several of these actions have been classified as "recalls" or "safety alerts" by the FDA. While the FDA has regulatory authority to mandate medical device recalls of any manufacturer, all of the Company's product upgrades have been voluntary. To date, no such recall or safety alert has had a material adverse impact on the Company, although there can be no assurance that future recalls or safety alerts would not have such an effect. International Regulation. Medical device laws and regulations are also in effect in many of the countries in which the Company does business outside the U.S. These laws and regulations range from comprehensive device approval requirements for some or all of the Company's medical device products to simple requests for product data or certifications. The number and scope of these requirements are increasing. International sales of certain medical devices manufactured in the U.S. but not approved by the FDA for distribution in the U.S. are subject to FDA export requirements. Thus, failure to comply with applicable international or FDA regulations could have a material adverse effect on the Company. FDA Consent Decree. In July 1992, the FDA filed a civil complaint against the Company for alleged violations of the GMP and MDR regulations. The complaint alleged, among other things, violations of the FDA's GMP regulations relating to the methods used in, and the facilities and controls used for, the manufacture, packing and storage of Company devices and the FDA's MDR regulations relating to the failure to submit reports to the FDA. The Company did not agree with the allegations and voluntarily entered into a consent decree for mutual resolution of the complaint. The terms of the consent decree had a material adverse effect on the Company. The Company, however, has met all obligations of the consent decree. It has no substantive ongoing impact on the Company's operations so long as the Company maintains compliance with applicable GMP and MDR regulations. The laws and regulations applicable to the manufacture and sale of medical devices and other aspects of the Company's business and the level of enforcement thereof are subject to change. Any changes in the FDA's laws and regulations or noncompliance with the Consent Decree could have a material adverse effect on the Company. 9 Intellectual Property The Company believes that patents and other proprietary rights are important to its business and relies upon them to develop and maintain its competitive position. The Company currently holds numerous U.S. and foreign patents and patent applications which relate to aspects of the technology used in the Company's products. There can be no assurance that patent applications filed by the Company will result in the issuance of patents or that any of the Company's intellectual property will provide competitive advantages for the Company's products or will not be challenged or circumvented by others. The Company also relies upon trade secrets and proprietary technology for protection of its confidential and proprietary information. There can be no assurance that others will not independently develop substantially equivalent proprietary information or techniques or that third parties will not otherwise gain access to the Company's trade secrets or disclose such technology. It is the Company's policy to require its employees, consultants, outside collaborators, advisors and vendors to execute confidentiality agreements. These agreements generally require that all information provided by the Company be kept confidential and not be disclosed to third parties, except in specific circumstances. In the case of employees and consultants, the agreements generally provide that all technology and confidential information relating to the Company's business that is developed while rendering services for the Company will be the exclusive property of the Company. There can be no assurance, however, that these agreements will provide meaningful protection or adequate remedies for the Company's trade secrets in the event of disclosure of such information. Employees As of December 31, 1997, the Company had approximately 840 full-time employees. The Company considers its employee relations to be good. Environmental Compliance The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. In the course of its business, the Company is involved in the handling, storing and disposal of materials which are classified as hazardous; however, it does not anticipate that any related expenditures or expenses will have a material adverse effect on its business, financial condition or results of operations. Product Liability Exposure The design, manufacture and marketing of medical devices produced by the Company entail an inherent risk of product liability. The Company's principal products are designed for use in the detection of abnormal heart rhythm disturbances and for use in applying electrical therapy to restore or maintain appropriate heart rhythms. As such, the Company's products are most often used in emergency response settings, both in out-of-hospital and hospital settings. While the Company believes that, based on claims made against the Company in the past, 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 and the financial condition of the Company. In addition, the Company is required, under certain of its contractual agreements, to indemnify third parties against certain product liability claims. Seasonality The Company has not experienced significant seasonality over the past three fiscal years. 10 Backlog The Company's product backlog at December 31, 1997 and 1996 was $5.6 million and $9.9 million, respectively. Foreign and Domestic Operations The information relating to the foreign and domestic operations of the Company required by Item 1 is set forth in "Item 8, Financial Statements and Supplementary Data." Item 2. Properties. The Company's manufacturing operations are carried out in an approximate 100,000 square foot owned facility located at the Company's headquarters in Redmond, Washington. The Company believes that its current facility will be sufficient to meet all of its manufacturing capacity requirements in the foreseeable future. The Company's European headquarters is an 8,000 square foot leased facility located in the United Kingdom. The Company also leases certain facilities for use as sales and service offices in the United States and throughout the world. Item 3. Legal Proceedings. The Company is party to certain legal actions arising in the ordinary course of its business. Based on information presently available to the Company, the Company believes that it has adequate legal defenses or insurance coverage for these actions, and the ultimate outcome of these actions will not have a material adverse effect on the Company. In November 1995, the Company initiated litigation in Washington State Court against Heartstream, Inc. ("Heartstream"), a company formed to develop, manufacture and market defibrillators, as well as certain individuals who were formerly employed by the Company and who are founders of and employees of Heartstream. The Company claimed that Heartstream and such individuals had, among other things, misappropriated certain of the Company's intellectual property and that such individuals breached contractual obligations to the Company. In addition, Heartstream initiated litigation against the Company in January 1997 alleging that the Company had infringed a Heartstream patent related to product self-test features. The Company filed an answer denying Heartstream's claims and alleged certain counterclaims against Heartstream for infringement of a Company self-test patent. Effective as of October 10, 1997, the Company and Heartstream have entered into a settlement agreement under which the referenced lawsuits have been dismissed with prejudice and all outstanding claims between the parties have been settled on mutually acceptable terms. The terms of the settlement are confidential. Item 4. Submission of Matters to a Vote of Security Holders. There were no matters submitted to the stockholders of the Company for action in the fourth quarter of 1997. 11 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters. The following table sets forth on a per share basis, the high and low closing sale prices per share for the Common Stock as reported by the Nasdaq National Market during 1997 and 1996.
High Low -------- -------- 1997 - -------------- First Quarter 23 1/2 13 1/4 Second Quarter 15 1/4 11 3/8 Third Quarter 19 1/8 12 1/2 Fourth Quarter 17 1/2 14 1/2 1996 - -------------- First Quarter 22 1/2 17 1/2 Second Quarter 23 3/4 17 1/8 Third Quarter 25 1/4 15 3/8 Fourth Quarter 24 1/8 18 1/4
As of March 2, 1998, the Company's Common Stock was held by approximately 104 holders of record. The Company believes, however, it has a significantly greater number of beneficial owners. The Company does not presently intend to pay any cash dividends on the Common Stock in the foreseeable future. Payment of future dividends, if any, will be at the discretion of the Company's Board of Directors after taking into account various factors, including the Company's financial condition, operating results, current and anticipated cash needs and plans for expansion. Furthermore, as a holding company, the ability of the Company to pay dividends in the future is dependent upon the receipt of dividends or other payments from its operating subsidiaries. Such operating subsidiaries are currently prohibited under the Company's bank credit agreement from declaring or paying any cash dividends or otherwise transferring any cash to the Company for the purpose of paying dividends to the holders of Common Stock. 12 Item 6. Selected Financial Data. Income Statement Data (1) (dollars in thousands, except share and per share data)
Company Combined Company Predecessor ------------------------------------ ------------ ------------ ------------------------ Year Ended Year Ended Year Ended January 1 to July 30 to January 1 Year Ended December 31, December 31, December 31, December 31, December 31, to July 31, December 31, 1997 1996 1995 1994 (2)(3) 1994 (2) 1994 (2) 1993 (4) ----------- ----------- ----------- ----------- ------------ ----------- ------------ (unaudited) Net sales $ 175,311 $ 173,165 $ 148,702 $ 150,028 $ 60,208 $89,820 $ 107,129 Cost of sales 88,320 84,360 69,537 82,205 37,390 44,815 67,229 --------- --------- --------- --------- ----------- --------- --------- Gross margin 86,991 88,805 79,165 67,823 22,818 45,005 39,900 Research and development 21,065 18,849 19,518 19,053 7,822 11,231 11,575 Selling, general and administrative 50,003 44,167 41,547 44,343 18,115 26,228 40,694 Corporate expense allocations and management consulting fees 2,950 2,708 258 2,450 4,571 Restructuring and special charges (credits) (5,767) (5,767) 16,701 --------- --------- --------- --------- ----------- --------- --------- Operating income (loss) 15,923 25,789 15,150 7,486 (3,377) 10,863 (33,641) Interest expense (1,640) (1,844) (2,836) (1,313) (1,313) Other income (expense), net 88 (347) (482) 51 236 (185) (456) --------- --------- --------- --------- ----------- --------- --------- Income (loss) before income tax, extraordinary item and cumulative effect of a change in accounting principles 14,371 23,598 11,832 6,224 (4,454) 10,678 (34,097) Income tax (expense) benefit (5,039) (8,259) (4,118) (2,991) 959 (3,950) (763) --------- --------- --------- --------- ----------- --------- --------- Income (loss) before extraordinary item and cumulative effect of a change in accounting principles 9,332 15,339 7,714 3,233 (3,495) 6,728 (34,860) Extraordinary loss from early extinguishment of debt, net of income tax benefit of $780 (1,460) Cumulative effect of a change in accounting principles (1,087) --------- --------- --------- --------- ----------- --------- --------- Net income (loss) $ 9,332 $ 15,339 $ 6,254 $ 3,233 $ (3,495) $ 6,728 $ (35,947) --------- --------- --------- --------- ----------- --------- --------- Basic earnings per common share $0.54 $0.91 Weighted average common shares outstanding 17,198,323 16,830,794 Diluted earnings per common and common equivalent share $0.53 $0.87 Weighted average number of common and common equivalent shares outstanding 17,733,471 17,609,826 Pro forma basic earnings per common share $0.42 Pro forma weighted average common shares outstanding 14,765,470 Pro forma diluted earnings per common and common equivalent share $0.40 Pro forma weighted average number of common and common equivalent shares outstanding 15,427,527
13 Balance Sheet Data (dollars in thousands)
Company Predecessor -------------------------------------------------------------- ------------------------------------- December 31, 1997 December 31, 1996 December 31, 1995 December 31, 1994 December 31, 1993 ----------------- ----------------- ----------------- ----------------- ----------------- Working capital $52,039 $50,484 $35,172 $33,415 $14,863 Total assets 106,659 95,862 78,500 93,544 83,045 Total debt 16,531 21,031 16,211 36,496 Stockholders' equity 56,204 44,220 26,681 6,512 30,694
Notes to Selected Financial Data (1) The periods beginning July 30, 1994 reflect data of the Company and its subsidiaries after the acquisition of stock by Bain Capital, Inc. The periods prior to and including July 29, 1994 reflect data of the Predecessor, which was acquired by the Company on July 29, 1994 from Lilly. See "Item 1, Business." (2) The Company's domestic sales during 1994 were positively impacted by shipments of the Company's significant backlog from 1993 and 1992. Such large backlog in the earlier periods was due to governmental restrictions. See "Item 1, Business." (3) For comparative purposes, the results of operations of the Predecessor from January 1, 1994 to July 29, 1994 and of the Company from July 30, 1994 to December 31, 1994 have been combined. (4) Operating results for 1993 were adversely affected by the temporary suspension of the Predecessor's manufacturing operations in May 1992, after the Predecessor received notification by the FDA of alleged deficiencies in compliance with FDA regulations. See "Item 1, Business." 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview This Management's Discussion and Analysis of Financial Condition and Results of Operation (and other portions of this report) may contain forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements due to many factors, including but not limited to those discussed in "Item 1, Business," the effect of general economic conditions, including without limitation those in Asia/Pacific, the impact of competitive products and pricing, customer demand, product development, commercialization and technological difficulties, U.S. and foreign regulatory requirements, the effects of accounting policies and financing requirements, and other such risks and factors. Management's discussion and analysis provides information with respect to the results of operations of the Company for the years ended December 31, 1997, 1996 and 1995. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 For the year ended December 31, 1997 the Company reported worldwide sales of $175.3 million. Revenues increased $2.1 million or 1% from the comparable 1996 year. Domestic sales of $123.9 million decreased $3.8 million or 3% while international sales of $51.4 million increased $6.0 million or 13% from the comparable prior year. The 13% increase in the international market was driven by strong performance in Europe and Canada, partially offset by a 4% decline from unfavorable currency movements in most foreign markets. The sales increase in Europe reflected higher revenue in the United Kingdom and former eastern block countries partly offset by weak sales in Germany. The decrease in the domestic market is attributable to purchasing deferrals and anticipation of the 1998 LIFEPAK 12 product release, offset by growth in service and supply revenues. Total equipment sales of $110.0 million decreased $6.0 million (5%) during the current year primarily resulting from a 14% decline in the U.S. hospital market, mainly due to purchasing deferrals and a 4% decline in the U.S. out-of-hospital market as customer purchasing deferrals in anticipation of the LIFEPAK 12 product release were only partly offset by strong sales of LIFEPAK 500 AED's. International equipment revenue increased 2% from the comparable 1996 period. Supplies (disposable and accessories) revenue totaled $36.0 million, an increase of $6 million or 20% from the comparable 1996 year. The increase was driven by higher sales of accessories including distributed products (training materials and portable monitors in Europe) and electrodes. Worldwide service revenue of $29.4 million increased $2.1 million (8%) driven by the Company's ever increasing installed base. During the year ended December 31, 1997 worldwide product orders totaled $154.1 million, an increase of $10.1 million or 7% over the prior year. The increase in product orders resulted primarily from strong demand for the LIFEPAK 500, and solid performance in the international markets. Domestic and international orders increased 6% and 9%, respectively, from 1996. Gross margin for the year ended December 31, 1997 was 50%, a decrease from 51% in the prior year, largely due to a less favorable product mix, mainly higher service and supplies revenues, and the impact of a strong U.S. dollar in international markets. Research and development ("R&D") expenditures during the current year totaled $21.1 million, an increase of $2.2 million over the comparable prior year. The increase is attributable to the final developmental stages of the Company's newest release, the LIFEPAK 12 product. The Company received FDA approval for this product during January 1998. The Company has and will continue to invest in the R&D activity as it is committed to new product development and to conduct ongoing research for future products and technology. 15 Selling, general and administrative ("SG&A") expenses totaled $50.0 million during the year ended December 31, 1997. As a percentage of sales, these expenses increased to 29% during 1997, from 26% in the prior year. Sales and marketing expenses increased $5.2 million and is attributable to enhanced sales and marketing efforts worldwide as well as additional selling expenses associated with the Company's strategic alliances introduced and developed during 1997. General and administrative expenditures of $10.7 million increased $0.6 million from the prior year due primarily to an increase in legal expenses. Interest expense totaled $1.6 million during 1997, a decrease of $0.2 million from 1996. The decrease is attributable to a reduction in the Company's outstanding borrowings and lower interest rates obtained in the June 1997 refinancing of existing indebtedness as discussed below. As a result of the above factors, net income totaled $9.3 million during 1997 with basic earnings per share reported at $0.54 and diluted earnings per share reported at $0.53. Net income during 1997 represents a $6.0 million or 39% reduction in net income from the comparable 1996 year. Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 The Company reported worldwide sales of $173.2 million for the year ended December 31, 1996, an increase of $24.5 million or 16% from 1995. Domestic sales of $127.8 million increased $20.3 million or 19% while international sales of $45.4 million increased $4.2 million (10%) from 1995. On a consolidated basis, equipment sales of $116.0 million increased 11% during 1996 due primarily to increased demand for the Company's family of LIFEPAK products, primarily the LIFEPAK 11 product. Worldwide service revenue of $27.2 million increased 10% and supplies revenue of $30.0 million increased 54% from 1995, driven by disposable and accessory product sales. The 19% increase in domestic revenue during 1996, when compared to 1995, resulted from a 23% increase in out-of-hospital equipment sales, due mainly to strong demand for LIFEPAK 11 products, and from a 30% increase in service and supplies revenue (supplies revenue increased 56%). Domestic hospital equipment sales increased 2% over 1995 in line with total hospital market growth estimates. The 10% increase in international revenue for 1996 reflected a strong demand for LIFEPAK 9 products. During the year ended December 31, 1996 worldwide product orders totaled $144.0 million, an increase of $13.7 million or 11% over the comparable prior year. The increase in product orders resulted primarily from strong demand for the LIFEPAK 11 products and expanded growth in the international markets. International and domestic orders increased 15% and 9%, respectively, from 1995. Gross margin of $88.8 million increased $9.6 million or 12% during 1996 when compared to 1995. As a percentage of sales, gross margin decreased from 53% in 1995 to 51% in 1996, largely as a result of changes in product mix, mainly higher service and supplies revenue, as well as certain trade-in programs established earlier in the year which resulted in higher product discounts. R&D expenditures during 1996 were $18.8 million, a decrease of $0.7 million or 3% from the comparable prior year. As a percentage of sales, R&D expenses decreased from 13% in the prior year to 11% during 1996. SG&A expenses of $44.2 million during 1996 increased $2.6 million or 6% from 1995. The increase resulted from costs incurred to further develop the Company's direct sales and service operations in Europe, as well as increased selling expense related to a higher sales volume in 1996. As a percentage of sales, SG&A expenses decreased during 1996 to 26% from 28% during 1995. Management consulting fees due to Bain Capital, Inc. totaled $2.9 million during 1995. During the fourth quarter of 1995, the management consulting agreement was terminated. No management consulting fees were incurred during 1996. 16 Interest expense totaled $1.8 million during 1996, a decrease of $1.0 million from the comparable prior year. The decrease resulted from lower interest expense attributable to a reduction of the Company's outstanding debt and lower interest rates obtained in the refinancing of the Company's then existing credit facility during December 1995. As a result of the above factors, net income totaled $15.3 million during 1996, with basic earnings per share reported at $0.91 and diluted earnings per share reported at $0.87. Net income during 1996 represents a $9.1 million or 145% increase in net income from the comparable 1995 year. Quarterly Results The Company's results of operations may fluctuate from quarter to quarter. Various factors may affect results of operations, including variations in timing of product orders, changes in product mix, timing of new product introductions, changes in distribution channels, actions of competitors and budgetary practices of the Company's customers. Liquidity and Capital Resources The Company has historically financed its operations with funds provided from operations and bank borrowings, as well as the 1995 receipt of approximately $23.7 million from Lilly in connection with certain 1994 purchase price adjustments (see Part I, Item 1.). For the years ended December 31, 1997 and 1995, the Company generated approximately $9.8 million and $12.2 million, respectively, in cash from operating activities. The cash provided from operations during 1997 was driven by operating income and an increase in trade accounts payable, offset by an increase in inventories. Cash provided from operations during 1995 was due primarily to the receipt of the $23.7 million from Lilly described above. For the year ended December 31, 1996, the Company used $0.1 million in cash from operations. For the three years ended December 31, 1995, 1996 and 1997, the Company made capital expenditures of approximately $5.9 million, $9.9 million and $7.0 million, respectively. During 1995 the majority of these capital expenditures were for manufacturing molds, computer equipment and maintenance equipment. During 1996 and 1997 the majority of the capital expenditures related to software development and implementation of the Company's new computer business system. The Company currently has no capital commitments outside the ordinary course of business. The Company's principal working capital requirements are for financing accounts receivable and inventories. As of December 31, 1997, the Company had working capital of $52.0 million, including approximately $39.1 million of trade accounts receivable and $38.7 million of inventories. In connection with the Company's initial public offering in December 1995, the Company refinanced its then existing indebtedness and entered into the Amended and Restated Credit Agreement (the "Revolver"). The Revolver provided a credit facility in an amount not to exceed $30.0 million. The Revolver bore interest, at the Company's option, at either (i) LIBOR plus 1.0%, or (ii) the lender's base rate (the higher of such lender's prime rate or the federal funds rate plus 0.5%). During June 1997, the Company again refinanced its indebtedness under the Revolver and entered into a new $30.0 million revolving bank credit facility (the "Agreement") of which up to $5.0 million may be used for issuance of standby letters of credit. The Agreement, which matures during May 2000, replaced the $30.0 million Revolver scheduled to expire during December 1998. Interest on advances under the Agreement bear interest at the borrower's option, at either (i) LIBOR plus 0.5% or (ii) the reference rate (the higher of the lender's prime rate or federal funds rate plus 1%) or (iii) quoted rate (rate quoted by lender and accepted by borrower plus 0.5%). Such rates are subject to increase in the event that the Company does not meet the fixed charge coverage ratio as defined in the Agreement. 17 The Company's current indebtedness is secured by all of the accounts receivable and inventories of the Company located in the United States. At December 31, 1997, the interest rate on the amount outstanding under the Agreement was 6.67%. At December 31, 1997, the Company had borrowing availability under the Agreement of $15.9 million, after consideration of outstanding letters of credit of $0.1 million, and was in compliance with all related loan covenants. The Company has subordinated promissory notes payable to Lilly related to the 1994 sale. Notes with a principal balance of $1.5 million bear interest at LIBOR plus 3.25% (9.25% at December 31, 1997) and mature on January 31, 2001. An additional note payable for $1.0 million bears interest at LIBOR plus 3.0% (9.0% at December 31, 1997) and matures November 15, 1998. At December 31, 1997, the Company had an aggregate indebtedness of approximately $2.5 million to Lilly under such notes. The Company believes that, based upon current levels of operations and anticipated growth, funds generated from operations together with other available sources of liquidity, including borrowings under the current bank Agreement, will be sufficient over the next twelve months for the Company to make anticipated capital expenditures and fund working capital requirements. One of the Company's strategies is to evaluate and make strategic acquisitions of and/or alliances with companies with complementary product lines. Future acquisitions may be financed by issuance of additional common stock, borrowings, or excess cash flow. Approximately 29% of the Company's net revenues during 1997 were from international customers and the Company expects that sales to international customers will continue to represent a material portion of its net sales. Certain of the Company's international receivables are denominated in foreign currency, and exchange rate fluctuations impact the carrying value of these receivables. The Company has elected to hedge certain assets denominated in foreign currency with the purchase of forward contracts. Historically, fluctuations in foreign currency exchange rates have not had a material effect on the Company's results of operations and together, with certain hedging activities, the Company does not expect such fluctuations to be material in the foreseeable future. Year 2000 The Company has begun to review the impact of the Year 2000 upon its business environment and business products. The Company has recently completed a successful transition to a new, fully integrated, computer system with a heavy emphasis in the manufacturing process. The transition also included migration to a PC based, network environment. The new manufacturing and financial modules within the system are designed to deal with the Year 2000. Based on its initial assessment, the Company does not believe the software in the Company's products currently in the marketplace will be materially affected by the Year 2000. The Company has not yet determined the full effect this event may have on its customers, suppliers, and other business partners. Recent Accounting Pronouncements The Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income," in June 1997. This statement establishes new standards for reporting and displaying comprehensive income in the financial statements. In addition to net income, comprehensive income includes charges or credits to equity that are not the result of transactions with shareholders. This statement is effective for fiscal years beginning after December 15, 1997. Adoption of this standard will only require additional financial statement disclosure detailing the Company's comprehensive income. In June 1997, FASB also issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes new standards for reporting information about operating segments in interim and annual financial statements. This statement is also effective for fiscal years beginning after 18 December 15, 1997. The Company is currently evaluating the impact, if any, this statement will have on disclosures in the consolidated financial statements. Effect of Inflation Inflation generally affects the Company by increasing the interest expense of floating rate indebtedness and by increasing the cost of labor, equipment and raw materials. The Company does not believe that inflation has had any material effect on the Company's business over the past three years. Item 7A. Qualitative and Quantitative Disclosures Regarding Market Risk. None. 19 Item 8. Financial Statements and Supplementary Data. Index to Consolidated Financial Statements and Supplementary Data
Page No. ------- Report of Independent Accountants ................................................ 21 Consolidated Balance Sheets at December 31, 1997 and 1996 ........................ 22 Consolidated Statements of Earnings for the years ended December 31, 1997, 1996 and 1995 ............................................... 23 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995 ............................................... 24 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 ............................................... 25 Notes to Consolidated Financial Statements ....................................... 26 Financial Statement Schedules: Report of Independent Accountants .............................................. 47 Schedule II Valuation and Qualifying Accounts and Reserves ..................... 48
All other financial statement schedules have been omitted because they are not applicable or the required information is included elsewhere herein or incorporated by reference. 20 Report of Independent Accountants - ----------------------------------------------------------------------------- To the Board of Directors and Stockholders of Physio-Control International Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Physio-Control International Corporation and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. Price Waterhouse LLP Seattle, Washington January 27, 1998 21 Physio-Control International Corporation Consolidated Balance Sheets - ------------------------------------------------------------------------------- (dollars in thousands, except share data) - -------------------------------------------------------------------------------
December 31, 1997 December 31, 1996 ----------------- ----------------- Assets Current Assets Cash and cash equivalents $4,340 $3,336 Accounts receivable, net 39,161 38,869 Inventories, net 38,711 31,811 Prepaid expense 1,237 1,401 Deferred income tax 2,463 Prepaid income tax 3,967 ---------------- ---------------- Total current assets 85,912 79,384 Noncurrent Assets Other assets 1,281 1,180 Deferred income tax 2,114 2,175 Property, plant and equipment, net 17,352 13,123 ---------------- ---------------- Total assets $106,659 $95,862 ---------------- ---------------- Liabilities and Stockholders' Equity Current Liabilities Accounts payable $14,630 $9,260 Accrued liabilities 17,103 19,146 Current portion of long-term debt 1,000 Income tax payable 1,140 Deferred income tax 494 ---------------- ---------------- Total current liabilities 33,873 28,900 ---------------- ---------------- Noncurrent Liabilities Long-term debt 15,531 21,031 Unfunded pension obligation 1,051 1,711 ---------------- ---------------- Total noncurrent liabilities 16,582 22,742 ---------------- ---------------- Commitments and contingencies (Note 15) Stockholders' Equity Preferred stock, par value $0.01 per share, 5,000,000 shares authorized, no shares issued or outstanding Common stock, voting, par value $0.01 per share, 40,000,000 shares authorized; 17,300,840 and 17,020,245 shares issued and outstanding, respectively 173 170 Additional paid-in capital 28,627 25,707 Retained earnings 27,430 18,098 Equity adjustment from foreign currency translation (26) 245 ----------------- ---------------- Total stockholders' equity 56,204 44,220 ---------------- ---------------- Total liabilities and stockholders' equity $106,659 $95,862 ---------------- ----------------
The accompanying notes are an integral part of these financial statements -22- Physio-Control International Corporation Consolidated Statements of Earnings - ------------------------------------------------------------------------------- (dollars in thousands, except share and per share data) - -------------------------------------------------------------------------------
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ------------------ ----------------- Net sales $175,311 $173,165 $148,702 Cost of sales 88,320 84,360 69,537 ----------------- ----------------- ---------------- Gross margin 86,991 88,805 79,165 ----------------- ----------------- ---------------- Research and development 21,065 18,849 19,518 Sales and marketing 39,289 34,042 30,073 General and administrative 10,714 10,125 11,474 Management consulting fees 2,950 ----------------- ----------------- ---------------- Operating expenses 71,068 63,016 64,015 ----------------- ----------------- ---------------- Interest expense (1,640) (1,844) (2,836) Other income (expense), net 88 (347) (482) ----------------- ----------------- ---------------- Other expense (1,552) (2,191) (3,318) ----------------- ----------------- ---------------- Income before income tax and extraordinary item 14,371 23,598 11,832 Income tax expense (5,039) (8,259) (4,118) ----------------- ----------------- ---------------- Income before extraordinary item 9,332 15,339 7,714 Extraordinary loss from early extinguishment of debt, net of income tax benefit of $780 (1,460) ----------------- ----------------- ---------------- Net income $9,332 $15,339 $6,254 ----------------- ----------------- ---------------- Basic earnings per common share $0.54 $0.91 Weighted average common shares outstanding 17,198,323 16,830,794 Diluted earnings per common and common equivalent share $0.53 $0.87 Weighted average number of common and common equivalent shares outstanding 17,733,471 17,609,826 Pro forma basic earnings per common share $0.42 Pro forma weighted average common shares outstanding 14,765,470 Pro forma diluted earnings per common and common equivalent share $0.40 Pro forma weighted average number of common and common equivalent shares outstanding 15,427,527
The accompanying notes are an integral part of these financial statements -23- Physio-Control International Corporation Consolidated Statements of Changes in Stockholders' Equity - ------------------------------------------------------------------------------- (dollars in thousands, except share data) - -------------------------------------------------------------------------------
Equity Common Stock Common Stock Adjustment Class L (Voting) (Voting) Additional Retained from Foreign ---------------- -------- Paid-in Earnings Currency Shares Dollars Shares Dollars Capital (Deficit) Translation Total ------- ------- ------ ------- ------- ---------- ----------- ------ Balance at December 31, 1994 1,410,636 $15 12,695,702 $127 $9,873 $(3,495) $(8) $6,512 Issuance of common shares in acquisition 705,953 8 15 23 Conversion of Class L shares immediately preceding initial public offering (1,410,636) (15) 2,219,754 22 (7) Net proceeds from initial public offering 1,133,500 11 13,734 13,745 Equity adjustment from foreign currency translation 147 147 Net income 6,254 6,254 ----------- ----- ---------- ------ -------- --------- ---- ------- Balance at December 31, 1995 16,754,909 168 23,615 2,759 139 26,681 Issuance of common shares 11,318 212 212 Stock issued upon exercise of options 254,018 2 363 365 Income tax benefit from exercise of stock options 1,517 1,517 Equity adjustment from foreign currency translation 106 106 Net income 15,339 15,339 ----------- ----- ---------- ------ -------- --------- ---- ------- Balance at December 31, 1996 17,020,245 170 25,707 18,098 245 44,220 Issuance of common shares 60,993 1 1,060 1,061 Stock issued upon exercise of options 219,602 2 991 993 Income tax benefit from exercise of stock options 869 869 Equity adjustment from foreign currency translation (271) (271) Net income 9,332 9,332 ----------- ----- ---------- ------ -------- --------- ---- ------- Balance at December 31, 1997 - $ - 17,300,840 $173 $28,627 $27,430 $(26) $56,204 ----------- ----- ---------- ------ -------- --------- ---- -------
The accompanying notes are an integral part of these financial statements -24- Physio-Control International Corporation Consolidated Statements of Cash Flows - -------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------- (dollars in thousands) - ----------------------------------------------------------------------------------------------------------------- Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- Cash Flows From Operating Activities Net income $9,332 $15,339 $6,254 Adjustments to Reconcile Net Income to Net Cash Provided by (Used in) Operating Activities: Depreciation and amortization 2,755 1,006 1,677 Extraordinary loss from early extinguishment of debt, net 1,460 Increase in accounts receivable (1,108) (9,414) (5,151) Decrease (increase) in other receivables 816 (1,921) 24,259 Increase in inventories (6,900) (1,603) (4,577) Decrease (increase) in prepaid income tax 3,967 (1,330) (2,637) Decrease (increase) in prepaid expense and other assets 63 (947) 1,906 Decrease (increase) in deferred income tax (2,896) 4,233 3,619 Increase (decrease) in accounts payable 5,370 (849) 1,687 Decrease in accrued liabilities (2,703) (4,642) (9,919) (Decrease) increase in income tax payable 1,140 (6,354) -------- -------- -------- Net cash provided by (used in) operating activities 9,836 (128) 12,224 -------- -------- -------- Cash Flows From Investing Activities Purchases of property, plant and equipment (6,984) (9,919) (5,853) Acquisition of net assets, net of cash acquired (2,044) Proceeds from sale/leaseback activity 1,788 1,540 -------- -------- -------- Net cash used in investing activities (6,984) (8,131) (6,357) -------- -------- -------- Cash Flows From Financing Activities Net proceeds from issuance of common stock 2,054 577 13,768 Debt issue costs (151) Repayment of term debt (10,000) Borrowings under revolving debt 45,984 59,395 17,031 Repayments on revolving debt (50,484) (54,575) (27,316) Income tax benefit from exercise of stock options 869 1,517 -------- -------- -------- Net cash provided by (used in) financing activities (1,577) 6,914 (6,668) -------- -------- -------- Effect of exchange rate changes (271) 106 147 -------- -------- -------- Net increase (decrease) in cash and cash equivalents 1,004 (1,239) (654) Cash and cash equivalents at beginning of year 3,336 4,575 5,229 -------- -------- -------- Cash and cash equivalents at end of year $4,340 $3,336 $4,575 -------- -------- -------- Supplemental Information Cash paid during the year for interest $1,804 $1,561 $3,145 Cash paid during the year for income tax $2,000 $4,498 $3,405
The accompanying notes are an integral part of these financial statements -25- Notes to Consolidated Financial Statements - ------------------------------------------------------------------------------- (dollars in thousands, except share and per share data) - ------------------------------------------------------------------------------- NOTE 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS Physio-Control International Corporation as successor by merger to Physio-Control Acquisition, Inc. (the "Company") was incorporated in Delaware during 1994 to effect the acquisition on July 29, 1994 of Physio-Control Corporation and certain assets of its affiliates ("Predecessor") from Eli Lilly and Company ("Lilly"). During May 1997, the Company was re-incorporated in the State of Washington. The consolidated financial statements of the Company include its wholly owned subsidiary, Physio-Control Corporation ("PCC") and its subsidiaries, (i) Physio-Control Manufacturing Corporation ("PCMC"), (ii) European and (iii) Canadian subsidiaries of PCC. The Company's primary business activity is the design, manufacture, distribution and servicing of an integrated line of noninvasive emergency cardiac defibrillators and vital sign assessment devices, disposable electrodes and data management software. The Company is headquartered in Redmond, Washington and operations consist of manufacturing facilities in Redmond, Washington and strategically located sales and service offices worldwide. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This summary of significant accounting policies is presented to assist the reader in understanding and evaluating the accompanying consolidated financial statements. These policies are in conformity with generally accepted accounting principles and have been consistently applied unless otherwise noted. Principles of Consolidation The consolidated financial statements include all majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Revenue Recognition Revenue from product sales are recorded by the Company when products are shipped to customers. Provision for sales returns is recorded for estimated products returned by customers. Service revenue is recognized upon the completion of service repair work. Additional service revenue earned on extended warranty contracts is recognized on a straight-line basis over the life of the contract period which is generally one year or less. Earnings Per Share Statement of Financial Accounting Standards No. 128 (SFAS 128) was issued in February 1997. This pronouncement modifies the calculation and disclosure of earnings per share and was adopted by the Company during 1997. Under the provisions of SFAS 128, basic earnings per share is calculated as income available to common stockholders divided by the weighted average number of common shares outstanding during the periods. Diluted earnings per share is based on the weighted average number of shares of common stock and common stock equivalents outstanding during the periods, including options computed using the treasury stock method. All earnings per common share amounts from prior periods have been restated to reflect the adoption of SFAS 128. -26- Pro forma Earnings Per Share (Unaudited) As a result of the changes in the Company's capital structure effective with the initial public offering during December 1995 as described in Note 9, historical earnings per common and common equivalent share amounts would not be meaningful and therefore have not been presented for 1995. For purposes of calculating pro forma net earnings per share, the weighted average number of shares outstanding has been calculated giving retroactive effect to the Recapitalization described in Note 9. Cash Equivalents The Company considers all highly liquid investments, with an original maturity of three months or less, to be cash equivalents. These amounts are stated at cost, which approximate fair value. Inventories Inventories are stated at the lower of cost, determined by the first-in, first-out (FIFO) method, or market. Property, Plant and Equipment Property, plant and equipment is recorded at cost. Depreciation is determined using the straight-line method over the estimated useful lives of the assets, which are as follows: land and buildings improvements 18 to 40 years; machinery and equipment 3 to 10 years; and furniture and fixtures 5 to 10 years. All direct costs associated with the development and implementation of software for internal use are capitalized and depreciated over 7 years. Expenditures for renewals and betterments are capitalized, and maintenance and repairs are charged to operations. Income Taxes Deferred income taxes are provided for all significant temporary differences in reporting items of income and expense for financial statement purposes versus income tax reporting. The Company files a consolidated income tax return with its wholly owned subsidiaries. Research and Development Expenditures Expenditures related to the development of new products and processes, including significant improvements and refinements are expensed as incurred. Warranty and Service Update Allowances Allowances are provided for the estimated cost of product coverage programs, which include warranty and service updates. The reserves for warranty costs and service updates are reviewed periodically and appropriately adjusted to ensure adequate provisions. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Employee Stock Options The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock-based compensation plans. -27- Foreign Currency The functional currency of each of the Company's foreign subsidiaries is the local currency in its respective country. Asset and liability accounts of each entity are translated at the current exchange rate and income accounts are translated at average exchange rates prevailing during the period. Gains and losses resulting from the translation of these foreign currency financial statements are classified as a separate component of stockholders' equity. For other foreign operations of the Company, all monetary assets and liabilities denominated in foreign currencies are remeasured into U.S. dollars at current exchange rates. Income and expense items are remeasured at average exchange rates during the period. The Company hedges its net position in all material foreign currency exposures by entering into forward contracts. The contracts are entered into in the regular course of business to manage its exposure against foreign currency fluctuations. Discounts and premiums related to forward contracts are amortized to income over the lives of the agreements and changes in market value of the foreign currency are recognized into income currently. As of December 31, 1997 the Company had foreign exchange contracts of $5.9 million maturing in one to three months. Concentration of Credit Risk/Financial Instruments Financial instruments that potentially subject the Company to credit risk consist principally of trade receivables. Trade receivables from international customers account for a substantial portion of receivables, for which collateral is generally not required. The risk associated with this concentration is limited due to the large number of distributors and their geographic dispersion. The carrying values of cash equivalents and other current assets and liabilities (such as accounts receivable and payable) approximate fair value at December 31, 1997. The carrying value of the revolving credit facility approximates fair value as the interest rate adjusts based upon market interest rate changes. Reclassification Certain amounts have been reclassified in the prior years in order to conform with the current year presentation. NOTE 3. ACCOUNTS RECEIVABLE Accounts receivable consist of the following:
December 31, 1997 December 31, 1996 ----------------- ----------------- Trade receivables $38,215 $37,118 Accounts receivable, other 1,701 2,517 Less allowances (755) (766) -------------- -------------- Total accounts receivable $39,161 $38,869 ------------- -------------
NOTE 4. INVENTORIES Inventories consist of the following:
December 31, 1997 December 31, 1996 ----------------- ----------------- Finished products $22,665 $18,734 Purchased parts and assemblies in process 7,544 6,534 Service parts 10,654 9,037 ------------- ------------- 40,863 34,305 Less inventory allowances (2,152) (2,494) -------------- -------------- Total inventories $38,711 $31,811 ------------- -------------
-28- NOTE 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following:
December 31, 1997 December 31, 1996 ----------------- ----------------- Land $880 $880 Buildings and land improvements 442 388 Software development 7,223 4,955 Equipment, furniture and fixtures 13,087 8,616 ------------- ------------- 21,632 14,839 Less accumulated depreciation (4,280) (1,716) -------------- -------------- Total property, plant and equipment $17,352 $13,123 ------------- -------------
The Company has entered into several agreements for the sale and leaseback of a portion of its production and operating equipment. The leases are classified as operating leases in accordance with FAS 13, "Accounting for Leases." The net book value of the equipment sold during 1996 and 1995 totaled $1,539 and $1,393, respectively, and the gain realized on these transactions was $0 and $147 in 1996 and 1995, respectively. No sale leaseback transactions occurred during 1997. Rental expense related to these operating leases during 1997, 1996 and 1995 was $811, $344 and $7, respectively. Future minimum lease payments are disclosed in Note 15. NOTE 6. ACCRUED LIABILITIES Accrued liabilities consist of the following:
December 31, 1997 December 31, 1996 ----------------- ----------------- Employee compensation $6,034 $7,421 Deferred service contract revenue 3,014 3,045 Accrued product or technical service upgrade and update 1,773 2,287 Warranty allowance 1,075 997 Restructuring allowance 210 487 Other accruals 4,997 4,909 ------------- ------------- Total accrued liabilities $17,103 $19,146 ------------- -------------
Product and Technical Service Upgrades and Updates As of December 31, 1997, the Company has recorded its best estimate of the cost to provide future update and upgrade services for its existing product lines. The liabilities at December 31, 1997 and 1996 represent management's best estimate of (i) the number of product upgrades and updates that will be made, (ii) the related cost of each upgrade, and (iii) the cost of certain product service updates. Management believes that any liability that may ultimately result from the resolution of product upgrades and updates in excess of amounts provided will not have a material adverse effect on the financial position or results of operations of the Company. -29- NOTE 7. LONG-TERM DEBT As a result of the Company's initial public offering in December 1995, the Company received net proceeds of $13.7 million, after discounts and other charges of approximately $2.7 million. Of this amount, the Company used $12.0 million to reduce its term loan and its revolving credit facility in December 1995. This prepayment of debt resulted in an extraordinary loss of $1,460 ($0.09 per share), net of an income tax benefit of $780. Immediately thereafter, the Company entered into an Amended and Restated Credit Agreement with a bank for a $30.0 million revolving credit facility (the "Revolver") which matured December 15, 1998. Of this amount, up to $5.0 million could be used for issuance of commercial and standby letters of credit on behalf of the Company. Interest on drawings under the Revolver bore interest at the Company's option, at either (i) LIBOR plus 1.0% or (ii) the lender's base rate (the higher of such lender's prime rate or the federal funds rate plus 0.5%). Such rates were subject to increase in the event that the Company did not meet certain leverage and interest coverage ratios. During June 1997, the Company refinanced its existing indebtedness and entered into a new $30.0 million revolving bank credit facility (the "Agreement") of which up to $5.0 million may be used for issuance of standby letters of credit. The Agreement, which matures during May 2000, replaced the existing $30.0 million Revolver scheduled to expire during December 1998. Interest on advances under the Agreement bear interest at the borrower's option, at either (i) LIBOR plus 0.5% or (ii) the reference rate (the higher of the lender's prime rate or federal funds rate plus 1%) or (iii) quoted rate (rate quoted by lender and accepted by borrower plus 0.5%). Such rates are subject to increase in the event that the Company does not meet the fixed charge coverage ratio as defined in the Agreement. The Company is required to pay a commitment fee equal to 0.125% of the amount by which the available credit exceeds the outstanding advances on a quarterly basis. This rate is also subject to increase in the event that the Company does not meet the fixed charge coverage ratio as defined. At December 31, 1997, the interest rate on drawings under the Agreement was 6.67% and the outstanding balance on the Agreement was $14,000. At December 31, 1997 $15,900 was available for future borrowings, after consideration of outstanding letters of credit of $0.1 million. The Agreement is secured by a first priority security interest in and lien on all of the accounts receivable and inventories of the Company (located in the United States) and is guaranteed by all material subsidiaries. The Agreement includes various affirmative and negative financial covenants which require, among other things, that the Company maintain a certain fixed charge coverage ratio, debt to net worth ratios, as well as a minimum tangible net worth, as defined in the Agreement. The Company has subordinated notes payable to Lilly in connection with the acquisition of certain foreign assets. Notes with a principal balance of $1,531 mature on January 31, 2001 and bear interest at LIBOR plus 3.25% (9.25% at December 31, 1997). An additional note payable with a principal balance of $1,000 matures November 15, 1998 and bears interest at LIBOR plus 3.0% (9.0% at December 31, 1997). NOTE 8. ACQUISITION OF FIRST MEDIC On April 5, 1995, the Company completed the acquisition of substantially all of the assets and the liabilities of the FIRST MEDIC Division of SpaceLabs Medical Inc. ("FIRST MEDIC"), consisting primarily of inventory, fixed assets, certain intangibles, and warranty liabilities. FIRST MEDIC is an out-of-hospital, portable defibrillator product line. The acquisition was accounted for by the purchase method of accounting in accordance with Accounting Principles Board No. 16, "Business Combinations" and, accordingly, the operating results from FIRST MEDIC product sales have been included in the consolidated operating results since the date of acquisition. The purchase price of the acquisition was $2.1 million in cash and 705,953 shares of voting common stock, which was assigned a value of $23 ($0.033 per share) as agreed between the parties. The fair value of the net assets acquired approximated the purchase price and accordingly no goodwill was recorded. 30 NOTE 9. STOCKHOLDERS' EQUITY Immediately prior to the completion of the 1995 initial public offering, the Company's outstanding shares of capital stock were reclassified into one class of common stock and effected a 2.6246-for-one split of all of the then outstanding shares of common stock (the "Recapitalization"). In connection with the Recapitalization, each outstanding share of Class L common stock was reclassified into one share of common stock plus an additional number of shares of common stock determined by dividing a preferential payment amount for such share of Class L common stock by the value of a share of common stock based on the initial public offering price in the offering. The preferential payment amount was equal to the original cost of such share plus an amount which accumulated on a daily basis at 12.5% per annum on such cost and on the amount so accumulated in prior quarters. Upon conversion, each share of Class L common stock was entitled to the aforementioned preferential payment upon any distribution by the Company to holders of its capital stock (whether by dividend, liquidating distribution or otherwise). An aggregate of 2,219,754 shares of common stock was issued in exchange for the outstanding shares of Class L common stock in connection with the Recapitalization. All references in the accompanying consolidated financial statements to the number of common shares, per share amounts, and options exercisable into common stock have been restated to reflect the stock split. NOTE 10. EARNINGS PER SHARE The difference between the weighted average number of common shares outstanding used to calculate basic earnings per share and the weighted average number of common and common equivalent shares outstanding used to calculate diluted earnings per share is the incremental shares attributed to outstanding options to purchase common stock computed using the treasury stock method.
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- (Pro-Forma) Weighted average number of common shares 17,198,323 16,830,794 14,765,470 outstanding Effect of dilutive options 535,148 779,032 662,057 Weighted average number of common and common equivalent shares outstanding --------------- -------------- -------------- 17,733,471 17,609,826 15,427,527 --------------- -------------- --------------
Options to purchase 442,000 shares of common stock were outstanding at December 31, 1997, but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares. -31- NOTE 11. STOCK OPTIONS 1994 Stock Purchase and Option Plan During 1994, the Company adopted the 1994 Stock Purchase and Option Plan (the "1994 Plan"), which authorizes grants of stock options to current or future employees, directors, consultants, or advisors of the Company. The 1994 Plan authorizes the granting of stock options for up to an aggregate of 262,460 shares of Class L common stock and 2,624,600 shares of common stock. The stock option grants are of three types: time option grants, target option grants, and fair market value option grants. Time option grants are granted at the fair market value of the common stock on the date of grant. Prior to the effectiveness of the Company's registration statement under the Securities Act of 1933, the options vested in five equal installments on each anniversary of the grant date. Effective with the offering, all options vested immediately. At December 31, 1997 there were options outstanding to purchase 241,009 shares of common stock at an exercise price of $0.03 per share. Target option grants are granted at the fair market value of the common stock on the date of grant. Prior to the effectiveness of the Company's registration statement, the options vested on the earlier of ten years or upon the occurrence of one of several events, including a change in ownership. Effective with the offering, all options vested immediately. Fair market value options granted during 1994 (229,786) became fully vested with the effectiveness of the Company's offering. Fair market value options granted during 1995 (533,364) vest annually in five equal installments commencing on December 31, 1995 of which 271,590 options vested upon the completion of the offering. The exercise price of the stock option is determined on the date the option vests and is equivalent to the fair market value of the common stock on the vesting date. On October 16, 1995 the 1994 Plan was amended to fix the exercise price of the fair market value options at $12.57 per share. 1996 Stock Incentive Plan In December 1995, the Company adopted the Physio-Control International Corporation 1996 Stock Incentive Plan (the "1996 Plan"). The 1996 Plan provided for the granting to employees and other key individuals who perform services for the Company and its subsidiaries the following types of incentive awards: stock options, stock appreciation rights, restricted stock, performance grants and other types of awards. An aggregate of 1,250,000 shares of Common Stock were reserved for issuance under the 1996 Plan. Options granted under the 1996 Plan were issued at the fair market value on the date of grant, and vest in equal installments over a five year period. 1997 Stock Incentive Plan In May 1997, the Company adopted the Amended and Restated Physio-Control International Corporation 1997 Stock Incentive Plan (the "1997 Plan") which amends and replaces the 1996 Plan described above. The 1997 Plan increases the shares of common stock reserved for issuance under the Plan to an aggregate of 2,250,000 shares. There were no other significant changes from the 1996 Plan. Options granted under the 1997 Plan are issued at the fair market value on the date of grant, and vest under varied schedules. -32- The table below summarizes the Company's stock option activity:
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ------------------------ ----------------------- -------------------- Weighted Weighted Weighted average average average Number of exercise Number of exercise Number of exercise shares price shares price shares price --------- --------- --------- --------- --------- --------- Outstanding at beginning of year 2,292,180 $10.96 1,682,292 $ 5.72 1,148,901 $ 2.54 Granted 873,300 13.37 898,500 18.20 533,391 12.57 Exercised (219,602) 4.25 (254,018) 1.45 Forfeited (93,631) 16.96 (34,594) 14.34 --------- --------- --------- Outstanding at end of year 2,852,247 $12.01 2,292,180 $10.96 1,682,292 $ 5.72 --------- --------- --------- Options exercisable at year end 1,723,768 $ 9.80 1,442,821 $ 7.23 1,472,861 $ 4.75 Weighted average fair value of options granted during the year $ 8.08$ 18.03 $12.32
The following table summarizes information about stock options outstanding at December 31, 1997:
Options outstanding Options exercisable Weighted average Weighted Weighted remaining average average Range of Number contractual exercise Number exercise exercise prices outstanding life price exercisable price - --------------- ----------- ----------- -------- ----------- -------- $0.03 547,901 6.58 $0.03 547,901 $0.03 $12.57 - $15.38 1,862,346 8.60 $13.53 999,067 $13.27 $19.75 - $20.50 442,000 8.10 $20.46 176,800 $20.46
Employee Share Purchase Plan In December 1995, the Company adopted the Physio-Control International Corporation Employee Share Purchase Plan (the "Share Purchase Plan"), which permits employees of the Company to purchase Common Stock at 85% of the lower of its beginning-of-the-year or end-of-year market price through payroll deductions. All employees of the Company are eligible to participate in the Share Purchase Plan. An aggregate of 600,000 shares of Common Stock have been authorized for issuance under the Share Purchase Plan. During January 1998, a total of 48,422 shares were purchased by employees from contributions made during 1997. Certain Pro Forma Disclosures As discussed above, the Company has three-stock-based compensation plans: the 1994 Stock Purchase and Option Plan, the 1997 Stock Incentive Plan, and the Employee Share Purchase Plan. The Company accounts for these plans in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." In October 1995 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 ("FAS 123"), "Accounting for Stock-Based Compensation," which established a -33- fair value based method of accounting for employee stock option plans and share purchase plans. FAS 123 provides for the disclosure of the value of compensation associated with options held by participants, based on a fair value methodology. If compensation cost for the Company's stock-based compensation plans had been determined based on the fair value at the grant and/or purchase dates, as prescribed by FAS 123, the Company's pro forma net income and pro forma net earnings per common and common equivalent share would have been as follows:
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- Net income $9,332 $15,339 $6,254 Pro forma net income $3,958 $10,109 $3,496 Basic earnings per common share $0.54 $0.91 $0.42 Pro forma basic earnings per common share $0.23 $0.60 $0.24 Diluted earnings per common and common equivalent share $0.53 $0.87 $0.40 Pro forma diluted earnings per common and common equivalent share $0.22 $0.57 $0.23
Stock option plans. For the purpose of the FAS 123 pro forma disclosures, the fair value of each option grant has been estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during 1997, 1996, and 1995: dividend yield of 0.0% for all years; volatility of 54% for 1997 and 190% for 1996 and 1995 and risk-free interest rates of 5.7% to 6.5%, 5.2% to 6.7%, and 5.5% to 5.8% for options granted during 1997, 1996 and 1995, respectively. The Company has estimated an expected option term of five years for options granted during each of the three years. Employee Share Purchase Plan. For the purpose of the FAS 123 pro forma disclosures, the fair value of the employees' purchase rights was estimated using the Black-Scholes model using the same assumptions as stated above in determining the fair value of options granted under the Company's stock option plans. Based on the valuation model which considers such factors, the weighted average valuation of these purchase rights granted during 1997 and 1996 was $8.55 and $17.20 respectively. Because additional option grants and share purchases are expected to be made in future years, the above pro forma disclosures are not representative of pro forma effects on reported net income for future years. -34- NOTE 12. FEDERAL INCOME TAXES Income taxes have been provided as follows:
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- Current Income Tax (Expense) Benefit U.S. federal tax (expense) benefit $(7,475) $(2,030) $1,363 Foreign tax expense (460) (1,996) (1,862) ------------ -------------- --------------- Total current tax expense (7,935) (4,026) (499) Deferred Income Tax (Expense) Benefit 2,896 (4,233) (3,619) ------------- -------------- -------------- Total income tax (expense) $(5,039) $(8,259) $(4,118) ------------- -------------- --------------
Significant components of the Company's deferred tax assets and liabilities included in the provisions referred to above are as follows:
December 31, 1997 December 31, 1996 ----------------- ----------------- Deferred Tax Assets: Property, plant and equipment $1,055 $2,175 Accrued product upgrades and service updates 686 864 Restructuring and special charges 295 541 Accrued pension liability 538 791 Vacation liability 621 439 Warranty accrual 445 397 Accounts receivable allowance 277 196 Subpart F income 450 463 Other 750 210 -------------- ------------- Total deferred tax assets 5,117 6,076 -------------- ------------- Deferred Tax Liabilities: Inventories (540) (4,395) --------------- ------------- Net deferred taxes $4,577 $1,681 -------------- -------------
At December 31, 1997 and 1996 the Company has not provided a valuation allowance against its deferred tax assets because the Company believes it is more likely than not that the assets will be realized. A reconciliation of income taxes computed at federal statutory rates to the reported income tax expense is as follows:
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- Income tax expense computed at federal statutory tax rates $(5,030) $(8,259) $(4,023) Permanent differences (99) (181) (286) State taxes, net of federal tax expense (307) (433) (190) Research tax credit 330 181 210 Effect of international operations 87 167 171 Other (20) 266 ------------- ------------- ------------- Income tax expense $(5,039) $(8,259) $(4,118) ------------- ------------- --------------
-35- Pretax income for the periods presented was taxed under the following jurisdictions:
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- Domestic $13,056 $20,813 $9,151 Foreign 1,315 2,785 2,681 ------------- ------------- -------------- Total pretax income $14,371 $23,598 $11,832 ------------- ------------- --------------
NOTE 13. EMPLOYEE BENEFIT PLANS Retirement Plan The Company has a noncontributory defined benefit retirement plan that covers substantially all United States employees. Benefits under this plan prior to its amendment in September 1994 were calculated by using one of several formulas. These formulas were based on a combination of years of service, final average earnings, primary social security benefits and age. Effective September 1, 1994, the defined benefit plan was amended to become a cash balance plan. Under the amended plan, the Company makes contributions to the plan based on certain percentages of the participants' salaries. The Company's funding policy for all plans is consistent with governmental and tax funding requirements. Plan assets consist of equity and fixed income instruments. Net pension expense for the U.S. retirement plan includes the following components:
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- Service costs-benefits earned during the period $214 $23 $32 Interest cost on projected benefit obligation 787 750 359 Actual return on plan assets (1,364) (1,564) (876) Net amortization and deferral (297) 106 (409) Settlement gain (1,233) Cost of special termination benefits 1,806 ------------- ------------- -------------- Net pension benefit $(660) $(685) $(321) -------------- -------------- ---------------
On December 1, 1994, the Company offered for a short period of time (through January 15, 1995) special benefits to its employees in connection with their voluntary early retirement. The terms of the offer included the option of a lump-sum payment (settlement) and the automatic addition of two years of service and three years to the participants' age in the calculation of the termination benefits due (special termination benefits). The lump-sum payments and the resulting relief of the plan's obligation to the participants and special termination benefits offered constitute a settlement and special termination benefits respectively, under FAS No. 88, "Employers' Accounting for Settlement and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," which resulted in a settlement gain of $1,233 and a special termination benefits cost of $1,806 during the year ended December 31, 1995. The decrease in the projected benefit obligation and the plan assets was primarily a result of the early retirement program and the associated lump sum payments made. -36- The following table sets forth the funded status and amounts recognized in the accompanying financial statements:
December 31, 1997 December 31, 1996 ----------------- ----------------- Actuarial present value of benefit obligations: Vested benefit obligation $11,666 $9,976 Nonvested benefit obligation 345 313 -------------- ------------- Accumulated benefit obligation $12,011 $10,289 -------------- ------------- Plan assets at fair value $18,751 $15,910 Projected benefit obligation (12,011) (10,289) --------------- -------------- Plan assets in excess of projected benefit obligation 6,740 5,621 Unrecognized prior service cost (6,394) (6,796) Unrecognized net asset arising at transition 1,057 1,162 Unrecognized net gain (loss) (2,454) (1,698) --------------- ------------- Unfunded pension obligation $(1,051) $(1,711) --------------- --------------
The assumptions used in the actuarial computations are as follows:
December 31, 1997 December 31, 1996 ----------------- ----------------- Discount rate 7.25% 7.5% Expected long-term rate of return on plan assets 8.5% 8.0%
Team Savings Plan The Company also has defined contribution savings plans that cover eligible employees worldwide. Participation in a given plan is dependent upon the country in which the participant is employed. Certain employees are eligible to participate in the plans. The purpose of the plans is generally to provide additional financial security during retirement by providing employees with an incentive to make regular savings. Contributions to the plans are determined by the Company based on employee contributions and the level of the Company match. Company contributions to the plans were as follows:
Year ended December 31, 1995 $703 Year ended December 31, 1996 $405 Year Ended December 31, 1997 $423
-37- NOTE 14. GEOGRAPHICAL INFORMATION
Year Ended Year Ended Year Ended December 31, 1997 December 31, 1996 December 31, 1995 ----------------- ----------------- ----------------- Net Sales United States sales to domestic customers $123,914 $127,808 $107,460 United States sales to foreign customers 10,742 10,120 9,734 Transfers to foreign subsidiaries 11,273 9,323 8,491 ------------- ------------- ------------ Total United States sales 145,929 147,251 125,685 International sales 40,655 35,237 31,508 Eliminations (11,273) (9,323) (8,491) ------------- ------------- ------------ Net sales $175,311 $173,165 $148,702 ------------- ------------- ------------ Income Before Taxes Domestic $13,056 $20,813 $9,151 International 4,082 5,703 5,319 Eliminations (2,767) (2,918) (2,638) ------------- ------------- ------------ Income before taxes $14,371 $23,598 $11,832 ------------- ------------- ------------ Total Assets United States $81,457 $70,591 $61,335 International 25,969 26,158 18,055 Eliminations (767) (887) (890) ------------- -------------- ------------ Total assets $106,659 $95,862 $78,500 ------------- ------------- ------------
Export sales were $10,742, $10,120 and $9,734 for the years ended December 31, 1997, 1996 and 1995, respectively. NOTE 15. COMMITMENTS AND CONTINGENCIES Leases The Company leases office space, automobiles and equipment under various operating lease agreements. Total rent expense is as follows:
Year ended December 31, 1995 $1,539 Year ended December 31, 1996 $1,735 Year ended December 31, 1997 $3,011
Future minimum annual rental commitments on all operating leases at December 31, 1997 are as follows:
Year Ended December 31, - ----------------------- 1998 $3,180 1999 1,629 2000 360 2001 11 2002 -- Thereafter -- -------- Total future minimum annual rental commitments $5,180 --------
-38- FDA Compliance The Company is subject to routine inspections by the Food and Drug Administration ("FDA"). The FDA issued a report of its observations, Form FDA 483, to the Predecessor on May 14, 1992, which contained observations that the Predecessor's manufacturing processes and methods of documentation were not in compliance with FDA current Good Manufacturing Practices ("GMP") and Medical Device Reporting ("MDR") regulations. On May 18, 1992, the Predecessor voluntarily suspended its manufacturing operations for the U.S. in order to evaluate its operations and to assure compliance with GMP. In July 1992, the Predecessor entered into a consent decree with the government which, among other things, required that the Predecessor be subject to FDA inspection and approval in order to resume production and distribution of its current products in the United States. The consent decree is in effect for a minimum of five years from July 1992, after which time the Company may apply for its termination. The Company has met all obligations of the consent decree and resumed shipping its products in stages. Litigation The Company is a party to certain legal actions arising in the ordinary course of its business. The Company's estimates of these exposures are based primarily on historical claims experience. The Company expects settlements related to these claims to be paid out over the next several years. The majority of the costs associated with defending and disposing of these suits are covered by insurance. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial position of the Company. In November 1995, the Company initiated litigation in Washington State Court against Heartstream, Inc. ("Heartstream"), a company formed to develop, manufacture and market defibrillators, as well as certain individuals who were formerly employed by the Company and who are founders of and employees of Heartstream. The Company claimed that Heartstream and such individuals had, among other things, misappropriated certain of the Company's intellectual property and that such individuals breached contractual obligations to the Company. In addition, Heartstream initiated litigation against the Company in January 1997 alleging that the Company had infringed a Heartstream patent related to product self-test features. The Company filed an answer denying Heartstream's claims and alleged certain counterclaims against Heartstream for infringement of a Company self-test patent. Effective as of October 10, 1997, the Company and Heartstream have entered into a settlement agreement under which the referenced lawsuits have been dismissed with prejudice and all outstanding claims between the parties have been settled on mutually acceptable terms. The terms of the settlement are confidential. -39- NOTE 16. SUMMARY OF QUARTERLY FINANCIAL DATA (Unaudited)
1997 ----------------------------------------------------------- First Second Third Fourth ------- ------- ------- ------- Net sales $40,727 $45,011 $44,109 $45,464 Gross margin 20,881 23,052 20,967 22,091 Operating expenses 16,105 17,825 18,397 18,741 Net income 2,653 2,983 1,379 2,317 Basic earnings per weighted average common share outstanding $0.16 $0.17 $0.08 $0.13 Diluted earnings per weighted average common share and common equivalent shares outstanding $0.15 $0.17 $0.08 $0.13
1996 ----------------------------------------------------------- First Second Third Fourth ------- ------- ------- ------- Net sales $42,755 $42,923 $41,694 $45,793 Gross margin 21,323 22,208 21,553 23,721 Operating expenses 15,475 15,688 16,384 15,469 Net income 3,396 3,887 2,891 5,165 Basic earnings per weighted average common share outstanding $0.20 $0.23 $0.17 $0.30 Diluted earnings per weighted average common share and common equivalent shares outstanding $0.19 $0.22 $0.16 $0.29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. 40 PART III Item 10. Directors and Executive Officers of the Registrant. The information under this Item is furnished pursuant to Instruction 3 to Item 401(b) of Regulation S-K. Executive officers of the Company are elected by and serve at the discretion of the Board of Directors. Richard O. Martin, has been Chairman of the Board and Chief Executive Officer of the Company since February 1997 and a Director of the Company since July 1994. Prior to that appointment, Dr. Martin was the President and Chief Executive Officer of the Company from July 1994 and prior thereto served as President of the Company's predecessor since April 1991. Prior to being named President of the Company's predecessor and since November 1989, Dr. Martin was a Vice President of SULZERmedica Inc., a medical device company specializing in implantable products. From January 1988 to November 1989, Dr. Martin was the President and Chief Operations Officer of Positron Corporation, a medical device company specializing in medical diagnostic imaging equipment. Dr. Martin also serves as a director of Encore Orthopedics, Inc., a designer and manufacturer of implantable orthopedic devices; of Maxxim Medical Inc., a designer, manufacturer and marketer of a diversified range of specialty medical products; of SeaMED Corporation, a designer and manufacturer of electromechanical products; and of CardioDynamics, Inc., a developer, manufacturer and marketer of non-invasive cardiac output systems. Dr. Martin is 58 years old. Robert M. Guezuraga has been President and Chief Operating Officer of the Company since February 1997 and a Director of the Company since September 1994. Prior to this appointment, Mr. Guezuraga served as Executive Vice President, Chief Operating Officer and a Director of the Company from September 1994. From 1989 to September 1994, Mr. Guezuraga was the President, Chief Executive Officer and a director of Positron Corporation, a medical device company specializing in medical diagnostic imaging equipment. Mr. Guezuraga was previously employed by General Electric Company in various managerial positions in numerous operating divisions, including its medical systems business division. Mr. Guezuraga serves as a director of CPR Prompt, Inc. Mr. Guezuraga is 48 years old. Joseph J. Caffarelli has been Executive Vice President and Chief Financial Officer of the Company since November 1994. From 1989 to November 1994, Mr. Caffarelli was the Executive Vice President and Chief Financial Officer of OECO Corporation, a diversified electronics manufacturer. Mr. Caffarelli was previously employed by General Electric Company in various financial management positions including positions in its manufacturing operations. Mr. Caffarelli is 52 years old. V. Marc Droppert has been Executive Vice President-Law, Human Resources and Corporate Affairs and Secretary of the Company since February 1997. Prior to this appointment, Mr. Droppert served as Senior Vice President-Law, Human Resources and Corporate Affairs and Secretary of the Company from December 1994. From April 1993 to December 1994, Mr. Droppert was President of Virginia Mason Health Plan, a 40,000 member HMO, and Associate Administrator of Virginia Mason Medical Center. Mr. Droppert was previously employed as a consultant and by PACCAR Inc, a manufacturer of motor vehicles, in various legal and human resources positions. Mr. Droppert serves as a director of MEDMARC Mutual Insurance Company. Mr. Droppert is 46 years old. Information with respect to Directors of the Company is set forth in the Proxy Statement under the heading "Election of Directors," which information is incorporated herein by reference. Information required by Item 405 of Regulation S-K is set forth in the Proxy Statement under the heading "Compliance with Section 16(a) of the Securities Exchange Act of 1934," which information is incorporated herein by reference. 41 Item 11. Executive Compensation. Information with respect to executive compensation is set forth in the Proxy Statement under the heading "Compensation of Executive Officers," which information is incorporated herein by reference (except for the Compensation Committee Report on Executive Compensation and the Performance Graph). Item 12. Security Ownership of Certain Beneficial Owners and Management. Information with respect to security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the heading "Beneficial Ownership of Common Stock," which information is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions. Information with respect to certain relationships and related transactions is set forth in the Proxy Statement under the headings "Election of Directors - -Compensation Committee Interlocks and Insider Participation" and "Election of Directors - Certain Relationships and Related Transactions," which information is incorporated herein by reference. 42 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) Documents filed as a part of this report: 1. Financial Statements. Reference is made to the Index to Consolidated Financial Statements and Supplementary Data included in Item 8 herein. 2. Financial Statement Schedules. Reference is made to the Index to Consolidated Financial Statements and Supplementary Data included in Item 8 herein. 3. Exhibits. The Company will furnish to any eligible stockholder, upon written request of such stockholder, a copy of any exhibit listed below upon the payment of a reasonable fee equal to the Company's expenses in furnishing such exhibit.
Exhibit No. Exhibit ------- ------- 2.1 Stock Purchase Agreement, dated July 29, 1994, between Eli Lilly and Physio Control Acquisition Corp. (1) 3.1(i) Restated Certificate of Incorporation of the Company. (2) 3.1(ii) Amended and Restated By-laws of the Company. (2) 3.2 Agreement and Plan of Merger. (3) 3.2 (i) Articles of Incorporation. (3) 3.2 (ii) Certificate of Merger. (3) 3.2 (iii) Articles of Merger. (3) 4.1 Form of certificate representing shares of Common Stock, par value $0.01 per share.(1) 4.2 Registration Rights Agreement, dated July 29, 1994, among the Company and the stockholders named therein. (1) 4.3 Stockholders Agreement, dated July 29, 1994, among the Company and the stockholders named therein. (1) 10.1 Credit Agreement dated July 29, 1994, between the Company, the banks named therein and Creditanstalt- Bankverein, as administrative agent. (1) 10.2 Pledge Agreement, dated July 29, 1994, between the Company and Creditanstalt-Bankverein, as collateral agent. (1) 10.3 Security Agreement, dated July 29, 1994, between the Company and Creditanstalt-Bankverein, as collateral agent. (1) 10.4 Subordinated Promissory Notes issued by the Company in favor of Eli Lilly and Company on July 29, 1994. (1) 10.5 1994 Stock Purchase and Option Plan. (1)* 10.6 Amended and Restated Management Agreements for Messrs. Martin and Guezuraga. (1)* 10.7 Management Advisory Agreement, dated July 29, 1994, between the Company and Bain Capital, Inc. (1) 10.8 Physio-Control International Corporation 1996 Stock Incentive Plan. (2)*
43 10.9 Indemnification Agreement between the Company and its directors and executive officers. (2)* 10.10 Physio-Control International Corporation Employee Share Purchase Plan. (2)* 10.11 Letter, dated October 18, 1994, to Joseph J. Caffarelli regarding severance arrangement.(1)* 10.12 Amended and Restated Management Agreements for Messrs. Caffarelli and Droppert. (2)* 10.13 Amended and Restated Credit Agreement, dated December 15, 1995, by and among Physio-Control Corporation, certain banks and Creditanstalt-Bankverein, as administrative agent and collateral agent. (2) 10.14 Reaffirmation, dated December 15, 1995, between Physio-Control International Corporation and Creditanstalt-Bankverein, as collateral agent. (2) 10.15 Amended and Restated Pledge Agreement, dated December 15, 1995, between Physio-Control Corporation and Creditanstalt-Bankverein, as collateral agent. (2) 10.16 Release Agreement, dated June 3, 1997, between Physio-Control International Corporation, Physio-Control Corporation and Creditanstalt-Bankverein. (3) 10.17 Credit Agreement, dated June 3, 1997, by and among Physio-Control Corporation, certain banks and Bank of America, National Trust and Savings Association, as administrative agent. (3) 10.18 Commercial security agreement, dated June 3, 1997, between Physio-Control Corporation and Bank of America, National Trust and Savings Association, as administrative agent. (3) 10.19 Commercial Security Agreement, dated June 3, 1997, between Physio-Control Manufacturing Corporation and Bank of America National Trust and Savings Association, as administrative agent. (3) 10.20 Amended and Restated 1997 Stock and Incentive Plan. (Incorporated by Reference to the Company's Annual Proxy Statement filed with the Securities and Exchange Commission in April, 1997.) 10.21 Termination Agreement for Messrs. Martin, Guezuraga, Caffarelli and Droppert (all substantially in the form attached as Exhibit 10.21 except that the "blank" in paragraph 6(a) is completed by "two and one-half," "two and one-half," "one and one-half", and "one," respectively. 21.1 Subsidiaries of the Company. 23.1 Consent of Price Waterhouse LLP. 24.1 Power of Attorney for 1995 Annual Report on Form 10-K. (2) 27.1 Financial Data Schedule for Fiscal Year ended December 31, 1997. 27.2 Financial Data Schedule for Quarters 1, 2, 3 and Year ended December 31, 1996. 27.3 Financial Data Schedule for Quarters 1, 2, 3 of Fiscal Year 1997.
--------------- (1) Incorporated herein by reference to the same numbered exhibit filed with the Securities and Exchange Commission as part of the Company's Registration Statement on Form S-1, as amended (Registration No. 33-98856), as declared effective by the Commission on December 12, 1995. (2) Incorporated herein by reference to the same numbered exhibit filed with the Securities and Exchange Commission as part of the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 44 (3) Incorporated herein by reference to the same numbered exhibit filed with the Securities and Exchange Commission as part of the Company's Report on Form 10Q for the quarter ended June 30, 1997. * Denotes a management contract or compensatory plan or arrangement required to be filed with this Form 10-K pursuant to Item 14(c) of Form 10-K. (b) Reports on Form 8-K. None. 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 30th day of March, 1998. PHYSIO-CONTROL INTERNATIONAL CORPORATION By /s/ Joseph J. Caffarelli -------------------------------- Joseph J. Caffarelli Executive Vice President and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on this 30th day of March, 1998.
Signature Capacity /s/ Richard O. Martin ----------------------------- Chairman of the Board, Chief Executive Officer Richard O. Martin and Director (Principal Executive Officer) /s/ Robert M. Guezuraga ----------------------------- President, Chief Operating Officer and Director Robert M. Guezuraga /s/ Joseph J. Caffarelli ----------------------------- Executive Vice President and Chief Financial Officer Joseph J. Caffarelli (Principal Financial Officer and Principal Accounting Officer) /s/ V. Marc Droppert ----------------------------- Executive Vice President-Law, Human Resources V. Marc Droppert and Corporate Affairs and Secretary /s/ Stephen G. Pagliuca ----------------------------- Director Stephen G. Pagliuca /s/ Ronald W. Dollens ----------------------------- Director Ronald W. Dollens /s/ Robert A. Sandler ----------------------------- Director Robert A. Sandler /s/ Robert C. Gay ----------------------------- Director Robert C. Gay /s/ John J. O'Malley ----------------------------- Director John J. O'Malley
46 Report of Independent Accountants on Financial Statement Schedule To the Board of Directors and Stockholders of Physio-Control International Corporation Our audit of the Physio-Control International Corporation consolidated financial statements referred to in our report dated January 27, 1998, appearing on page 21 of this Annual Report on Form 10-K, also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. Price Waterhouse LLP Seattle, Washington January 27, 1998 47 PHYSIO-CONTROL INTERNATIONAL CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNT AND RESERVES (dollars in thousands) - -----------------------------------------------------------------------------
Balance at Charge to Costs Balance at Beginning of Period and Expenses Deductions End of Period ------------------- --------------- --------- ------------- Year ended December 31, 1997 Allowance for doubtful accounts $ 766 $ 282 $ (293) $ 755 Inventory Allowances 2,494 838 (1,180) 2,152 Year ended December 31, 1996 Allowance for doubtful accounts 649 280 (163) 766 Inventory Allowances 3,687 4,513 (5,706) 2,494 Year ended December 31, 1995 Allowance for doubtful accounts 918 673 (942) 649 Inventory Allowances 1,778 6,981 (5,072) 3,687
48 Consent of Independent Accounts We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-00248 and 333-00640) of Physio-Control International Corporation of our reports dated January 27, 1998, appearing on page 21 of this Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page 47 of this Form 10-K. Price Waterhouse LLP Seattle, Washington March 27, 1998 EX-10.21 2 EXHIBIT 10.21 Exhibit 10.21 TERMINATION AGREEMENT THIS TERMINATION AGREEMENT ("Agreement") is made between PHYSIO-CONTROL INTERNATIONAL, INC. a Washington corporation (the "Company") and ____________________, an individual (the "Executive"), as of November 12, 1997 with respect to the following facts: RECITALS: A. The Executive is a principal officer of the Company and an integral part of its management. B. The Company wishes to assure both itself and the Executive of continuity of management in the event of any actual or threatened change of control of the Company. C. This Agreement is not intended to alter materially the compensation and benefits that the Executive could reasonably expect in the absence of a change in control of the Company and, accordingly, this Agreement, though taking effect upon execution thereof, will be operative only upon a change of control of the Company, as that term is defined herein. AGREEMENT --------- NOW, THEREFORE, in consideration of the foregoing recitals and the agreements of the parties contained herein, the parties do hereby agree as follows: 1. Operation of Agreement ---------------------- This Agreement shall be effective immediately upon its execution by the parties hereto. Anything in this Agreement to the contrary notwithstanding, neither this Agreement nor any provision thereof shall be operative unless and until there has been a "Change in Control" of the Company as defined in Section 5 below. Upon such a Change in Control of the Company, this Agreement and all provisions hereof shall become operative immediately. 2. Purpose and Intent ------------------ The Board of Directors of the Company (the "Board") recognizes the possibility of a Change in Control of the Company exists and that such possibility, and the uncertainty and questions which it necessarily raises among management, may result in the departure or distraction of key management personnel to the detriment of the 1 Company and its shareholders in this period when their undivided attention and commitment to the best interests of the Company and its shareholders are particularly important. Accordingly, the Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's management, including the Executive, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a Change in Control of the Company. 3. Term of Agreement ----------------- This Agreement shall be effective upon the execution thereof by the parties, and shall remain in effect until December 31, 2002, at which time it shall terminate; provided, however, that the term of this Agreement shall be extended by one day for each day after December 31, 2000 that notice of termination by either party has not been given to the other, so that at all times after December 31, 2000, if neither party has given notice of termination then this Agreement shall extend for two years. If any notice of termination is given after December 31, 2000, then this Agreement shall terminate on that date two years after such notice is given. 4. Termination Following Change in Control --------------------------------------- For purposes hereof only, a termination of the Executive's employment following a Change in Control ("Termination Following Change in Control") shall be deemed to occur if at any time during the two-year period immediately following a Change in Control: (a) there has been an actual termination by the Company of the Executive's employment, other than "for cause" as defined herein; (b) the Company reduces the Executive's base salary, bonus computation or title; (c) the Company substantially reduces the Executive's responsibilities as in effect immediately prior to the Change in Control or as the same may be increased from time to time, or there is a change in employment conditions deemed by the Executive to be materially adverse as compared to those in effect immediately prior to the Change in Control, any of which is not remedied within 30 days after receipt by the Company of notice by the Executive, of such reduction in responsibilities or change in employment conditions; (d) without the Executive's express written consent, the Company requires the Executive to be based anywhere other than King County, Washington, 2 except for required travel on the Company's business to an extent substantially consistent with that prior to the Change in Control; (e) the Company fails to obtain the assumption of the performance of this Agreement by any successor of the Company; or (f) the Company takes any action which would deprive the Executive of any material fringe benefit enjoyed by the executive at the time of the Change in Control, or the Company fails to provide the Executive with the number of paid vacation days to which the Executive is then entitled in accordance with the Company's normal vacation policy in effect on the date of the Change in Control. The voluntary termination by the Executive of his employment by the Company shall in no event constitute a "Termination Following Change in Control". 5. Definition of Change in Control ------------------------------- A Change in Control will be deemed to have occurred if: (a) any "person," as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1943 (the "Exchange Act"), is or becomes a beneficial owner, directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding equity securities; (b) during any period of twenty-four (24) consecutive months, commencing before or after the date of this Agreement, individuals who at the beginning of such twenty-four (24) month period were directors of the Company for whom the Executive shall have voted cease for any reason to constitute at least a majority of the Board of Directors of the Company; (c) an event occurs which constitutes a change in control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Exchange Act, whether or not the Company is then subject to such reporting requirements; (d) there is a merger or consolidation of the Company in which the Company does not survive as an independent public company; or (e) the business or businesses of the Company for which the Executive's services are principally performed are disposed of by the Company pursuant to a partial or complete liquidation of the Company, a sale of assets (including stock of a subsidiary) of the Company, or otherwise. 3 6. COMPENSATION FOLLOWING TERMINATION ---------------------------------- (a) Subject to the terms and conditions of this Agreement, upon a Termination Following Change in Control, as defined in Section 4, which occurs during the term of this Agreement, the Executive shall be entitled to (i) a lump sum payment, within fifteen (15) days following such termination, in an amount equal to ________________ times the highest annual level of total cash compensation (including any and all bonus amounts) paid to the Executive by the Company (as reported on Form W-2) during the three calendar years ended immediately prior to such termination, (ii) the immediate vesting of all previously granted but unvested stock options to acquire securities from the Company which were outstanding on the date of the termination, and (iii) payment by the Company of continuing health coverage for a period of twenty-four (24) months, at a level commensurate with that which the Executive enjoyed with the Company immediately prior to such Change in Control. (b) The Executive shall not be required to mitigate the amount of any payment provided for in this Section 6 by seeking other employment or otherwise, nor shall the amount of any payment or benefit provided for in this Section 6 be reduced by any amounts to which the Executive shall be entitled by law (nor shall payment hereunder be deemed in lieu of such amounts), by any compensation earned by the Executive as the result of employment by another employer or by retirement benefits after the date of termination or voluntary termination, or otherwise, provided however, if Executive receives health coverage through subsequent employment during such twenty-four (24) month period at a level commensurate with that which Executive enjoyed with the Company, the Company's obligations under Section 6 (a) (iii) shall cease. (c) Anything to the contrary notwithstanding, all payments required to be made by the Company hereunder to the Executive or his estate or beneficiaries shall be subject to the withholding of such amounts, if any, relating to tax and other payroll deductions as the Company may reasonably determine it should withhold pursuant to any applicable law or registration. In lieu of withholding such amounts, the Company may accept other provisions to the end that it has sufficient funds to pay all taxes required by law to be withheld in respect of any or all of such payments. 4 7. Definition of "For Cause" ------------------------- The Termination of the Executive's employment by the Company shall be deemed "For Cause" if it results from: (a) the willful and continued failure by the Executive to substantially perform his duties hereunder or regular failure to follow the specific directives of the Board, after demand for substantial performance that specifically identifies the manner in which the Company believes the Executive has not substantially performed his duties is delivered by the Company; (b) the willful engaging by the Executive in misconduct which is materially injurious to the Company, monetarily or otherwise; (c) the Executive's death; or (d) an accident or illness which renders the Executive unable, for a period of at least six (6) consecutive months, to perform the essential functions of his job, notwithstanding the provision of reasonable accommodation by Employer. For purposes of this section, no act, or failure to act, on the Executive's part shall be considered "willful" unless done, or omitted to be done, by him not in good faith and without reasonable belief that this action or omission was in the best interest of the Company. Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated For Cause under subsection (a) or (b) without (i) reasonable notice to the Executive setting forth the reasons for the Company's intention to terminate For Cause, (ii) an opportunity for the Executive, together with his counsel, to be heard before the Board, and (iii) delivery to the Executive of a notice of termination from the Board finding that, in the good faith opinion of the Board, the Executive was guilty of conduct set forth above in clause (a) or (b) of the preceding sentence and specifying the particulars thereof in detail. 8. Tax Treatment ------------- It is the intention of the parties that no portion of the payment made under Section 6 hereof (The "Termination Payment") or any other payment under this Agreement, or payments to or for the Executive's benefit under any other agreement or plan, be deemed to be an excess parachute payment as defined in Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), or its successors. However, should it be asserted that any amount to be received by Executive hereunder is an excess parachute payment, it is agreed that the present value of the Termination Payment and any other payment to or for the Executive's benefit in the nature of 5 compensation, receipt of which is contingent on the Change in Control of the Company, and to which Section 280G of the Code or any successor provision thereto applies (in the aggregate "Total Payments") exceeds an amount in excess of the maximum amount which the Executive may receive without becoming subject to the tax imposed by Section 4999 of the Code or any successor provisions thereto, Executive shall nevertheless be entitled to all such payments and the Company shall indemnify Executive for any tax imposed under Section 4999 of the Code or any successor provisions thereto, including payment of the tax due on any payments made to Executive or on behalf of Executive to pay such taxes (i.e. "gross up"). Within six (6) days following delivery of written notice by the Company to the Executive of the Company's belief that there is a payment or benefit due which will result in an excess parachute payment as defined in Section 280G of the Code or any successor provisions, the Company and the Executive, at the Company's expense, shall obtain the opinion of legal counsel and certified public accountants, as the Company and Executive may mutually agree upon, which opinions need not be unqualified, which sets forth (i) the amount of the Executive's Base Period Income, as defined in Section 280G of the Code, (ii) the present value of Total Payments, and (iii) the amount and present value of any excess parachute payments. In the event such opinions determine that there would be an excess parachute payment, included in the Termination Payment hereunder, or any other payment determined by such counsel to be includable in Total Payments, such opinions shall include the amount of tax due in relation thereto and the amount of the total gross up payment required for indemnification of the Executive by the Company. Such amounts shall then promptly be paid by the Company to the Executive or to the Internal Revenue Service on behalf of the Executive. The provisions of this Section, including the calculations, notices and opinions provided herein, shall be based upon the conclusive presumption that (i) the compensation and benefits provided herein and (ii) any other compensation, including but not limited to any accrued benefits, earned by the Executive prior to the Change in Control of the Company pursuant to the Company's compensation programs, would have been reasonable if made in the future in any event, even though the timing of such payment is triggered by the Change in Control of the Company. In the event such legal counsel so requests in connection with the Section 280G opinion required by this Section, the Company and Executive shall obtain, at the Company's expense, the advice of a firm of recognized executive compensation consultants concerning the reasonableness of any item of compensation to be received by the Executive, on which advice legal counsel may rely in providing their opinion. In the event that the provisions of Sections 280G and 4999 of the code for any successor provision are repealed without succession, this Section shall be of no further force or effect. 6 9. Miscellaneous ------------- (a) Intent. This Agreement is made by the Company in order to induce the Executive to remain in the Company's employ, with the Company's acknowledgment and intent that it will be relied upon by the Executive, and in consideration of the services to be performed by the Executive from time to time hereafter. However, this Agreement is not an agreement to employ the Executive for any period of time or at all, and the terms and conditions of the Executive's employment, other than those expressly addressed herein, shall be subject to and governed by a separate agreement of employment between the Company and the Executive. This Agreement is intended only as an agreement to provide the Executive with a specified compensation and benefits if he or she is terminated following a Change in Control. (b) Attorney's Fees. If any action at law or in equity is commenced to enforce any of the provisions or rights under this Agreement, the unsuccessful party to such litigation, as determined by the court in a final judgment or decree, shall pay the successful party all costs, expenses and reasonable attorneys' fees incurred by the successful party or parties (including, without limitation, costs, expenses and fees on any appeals), and if the successful party recovers judgment in any such action or proceeding, such costs, expenses and attorneys' fees shall be included as part of the judgment. (c) Governing Law. This Agreement shall be governed by and construed and interpreted in accordance with the laws of the State of Washington. (d) Successors and Assigns (i) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume expressly and agree in writing to perform this Agreement. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall require the Company to pay to the Executive compensation from the Company in the same amount and on the same terms as the Executive would be entitled hereunder in the event of a Termination Following Change in Control of the Company, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed to be the date on which the Executive shall receive such compensation from the Company. As used in this Agreement, "Company" shall mean the Company as herein above defined 7 and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation or law or otherwise. (ii) This Agreement shall inure to the benefit of, and be enforceable by, the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amount would still be payable to the Executive hereunder if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Executive's devisee, legatee, or other designee or, if there is no such designee, to Executive's estate. (e) Notices. Except as otherwise expressly provided herein, any notice, demand or payment required or permitted to be given or paid shall be deemed duly given or paid only if personally delivered or sent by United States mail and shall be deemed to have been given when personally delivered or two (2) days after having been deposited in the United States mail, certified mail, return receipt requested, properly addressed with postage prepaid. All notices or demands shall be effective only if given in writing. For the purpose hereof, the addresses of the parties hereto (until notice of a change thereof is given as provided in this Section 9(f), shall be as follows: The Company: PHYSIO-CONTROL INTERNATIONAL 11811 Willows Road, NE Redmond, WA 98052 Attn.: Corporate Secretary Executive: __________________ __________________ __________________ (f) Severability. In the event any provision in this Agreement shall be invalid, illegal or unenforceable, such provision shall be severed from the rest of this Agreement and the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. (g) Entirety. This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and supersedes any prior or contemporaneous agreement or understandings relating to the subject matter hereof. 8 (h) Amendment. This Agreement may be amended only by a written instrument signed by the parties hereto, which makes specific reference to this Agreement. (i) Setoff. There shall be no right of setoff or counterclaim, in respect of any claim, debt or obligation, against any payments to the Executive, his dependents, beneficiaries or estate provided for in this Agreement. IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date first set forth above. THE COMPANY: PHYSIO-CONTROL INTERNATIONAL By: EXECUTIVE: ____________________________ 9 EX-21.1 3 EXHIBIT 21.1 Exhibit 21.1 LIST OF SUBSIDIARIES OF PHYSIO-CONTROL INTERNATIONAL CORPORATION The following is a list of the entities that are wholly owned subsidiaries of Physio-Control International Corporation, a Washington corporation. If indented, the entity is a wholly owned subsidiary of the entity under which it is listed unless otherwise noted. The entities listed below all do business under the name "Physio-Control."
Name of Organization Jurisdiction of Organization -------------------- ---------------------------- Physio-Control Corporation Washington, USA Physio-Control Manufacturing Corporation Washington, USA Physio-Control International Sales Corporation Barbados Physio-Control GmbH Germany Physio-Control Netherlands Services B.V. Netherlands Physio-Control s.r.o. The Czech Republic Corporation Physio-Controle Canada Canada Physio-Control UK Limited United Kingdom Physio-Control Hungaria Kft. Hungary Physio-Control Poland, Sp.zo.o. Poland Physio-Control Italia, s.r.l(1) Italy Physio-Control Medizintechnik Handels, GmbH Austria
(1) Two percent of the outstanding common stock is owned by Physio-Control Netherlands Services B.V. EX-27.1 4 EXHIBIT 27.1
5 0001003088 PHYSIO CONTROL 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 4,340 0 39,916 (755) 38,711 85,912 21,632 (4,280) 106,659 33,873 0 0 0 173 56,031 106,659 175,311 175,311 88,320 88,320 71,068 0 1,640 14,371 5,039 9,332 0 0 0 9,332 0.54 0.53
EX-27.2 5 EXHIBIT 27.2 FINANCIAL DATA SCHEDULE
5 0001003088 PHYSIO CONTROL 1,000 YEAR 9-MOS 6-MOS 3-MOS DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 DEC-31-1996 SEP-30-1996 JUN-30-1996 MAR-31-1996 3,336 4,255 4,784 6,299 0 0 0 0 36,352 32,285 32,577 31,168 0 0 0 0 31,811 33,310 30,894 28,940 79,077 74,144 72,459 72,503 13,123 10,775 8,947 6,607 0 0 0 0 95,862 89,445 86,510 83,837 28,900 27,560 28,043 26,865 0 0 0 0 0 0 0 0 0 0 0 0 170 169 168 168 44,050 37,127 33,859 29,847 95,862 89,445 86,510 83,837 173,165 127,372 85,678 42,755 173,165 127,372 85,678 42,755 84,360 62,288 42,147 21,432 84,360 62,288 42,147 21,432 63,016 47,547 31,163 15,475 0 0 0 0 1,844 1,333 874 426 23,598 15,415 11,036 5,146 8,259 5,241 3,753 1,750 15,339 10,174 7,283 3,396 0 0 0 0 0 0 0 0 0 0 0 0 15,339 10,174 7,283 3,396 0.90 0.60 0.43 0.20 0.86 0.57 0.41 0.19
EX-27.3 6 EXHIBIT 27.3
5 0001003088 PHYSIO CONTROL 1,000 9-MOS 6-MOS 3-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 JAN-01-1997 JAN-01-1997 JAN-01-1997 SEP-30-1997 JUN-30-1997 MAR-31-1997 3,514 2,742 4,324 0 0 0 38,042 42,037 38,934 0 752 (747) 40,637 37,552 34,843 85,721 85,114 82,343 16,402 17,931 16,555 0 2,811 (2,061) 105,121 103,418 100,098 29,956 28,470 28,121 0 0 0 0 0 0 0 0 0 173 173 172 53,262 51,711 48,129 105,121 103,418 100,098 129,847 85,738 40,727 129,847 85,738 40,727 64,947 41,805 19,846 64,947 41,805 19,846 0 0 16,105 0 0 0 1,284 860 459 10,792 8,671 4,081 3,777 3,035 1,428 7,015 5,636 2,653 0 0 0 0 0 0 0 0 0 7,015 5,636 2,653 0.41 0.33 0.16 0.40 0.32 0.15
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