10-Q 1 b47201zme10vq.txt ZOLL MEDICAL CORPORATION UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934. FOR THE THREE MONTH PERIOD FROM MARCH 31, 2003 TO JUNE 29, 2003. Or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from to . Commission file number 0-20225 ZOLL MEDICAL CORPORATION --------------------------------------------------- (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2711626 --------------------------------- -------------------------- (State or other jurisdiction (IRS Employer of incorporation or organization) Identification number) 269 MILL ROAD, CHELMSFORD, MA 01824-4105 --------------------------------- -------------------------- (Address of principal executive (Zip Code) offices) (978) 421-9655 -------------- (Registrant's telephone number, including area code) 32 SECOND AVENUE, BURLINGTON, MA 01803-4420 ---------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ---- ---- Indicate the number of shares outstanding of each of the issuer's classes of common stock: Class Outstanding at August 1, 2003 Common Stock, $0.02 par value 9,059,060 This document consists of 27 pages. 1 ZOLL MEDICAL CORPORATION INDEX
PAGE NO. PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements: Consolidated Balance Sheets (unaudited) 3 June 29, 2003 and September 29, 2002 Consolidated Income Statements (unaudited) 4 Three and Nine Months Ended June 29, 2003 and June 30, 2002 Consolidated Statements of Cash Flows (unaudited) 5 Nine Months Ended June 29, 2003 and June 30, 2002 Notes to Consolidated Financial Statements (unaudited) 6 ITEM 2. Management's Discussion and Analysis of Financial Condition 10 and Results of Operations ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 22 ITEM 4. Controls and Procedures 23 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 24 ITEM 2. Changes in Securities and Use of Proceeds 24 ITEM 3. Defaults Upon Senior Securities 24 ITEM 4. Submission of Matters to a Vote of Security-Holders 24 ITEM 5. Other Information 24 ITEM 6. Exhibits and Reports on Form 8-K 24 Signatures 25 Certifications 26
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ZOLL MEDICAL CORPORATION CONSOLIDATED BALANCE SHEETS (000's omitted, except per share data) (Unaudited)
JUNE 29, SEPTEMBER 29, 2003 2002 ASSETS Current assets: Cash and cash equivalents $ 56,050 $ 55,658 Marketable securities 10,331 10,130 Accounts receivable, less allowance of $4,272 at June 29, 2003, and $3,462 at September 29, 2002 42,288 42,927 Inventories: Raw materials 11,978 8,936 Work-in-process 5,125 4,610 Finished goods 18,723 15,594 --------- --------- 35,826 29,140 Prepaid expenses and other current assets 3,889 4,049 --------- --------- Total current assets 148,384 141,904 Property and equipment, at cost: Land and building 3,527 3,517 Machinery and equipment 33,181 28,543 Construction in progress 2,076 1,692 Tooling 7,642 7,265 Furniture and fixtures 1,950 1,738 Leasehold improvements 1,309 1,336 --------- --------- 49,685 44,091 Less accumulated depreciation 28,977 24,549 --------- --------- Net property and equipment 20,708 19,542 Other assets, net 8,610 4,408 --------- --------- $ 177,702 $ 165,854 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 7,992 $ 10,014 Accrued expenses and other liabilities 17,112 12,780 --------- --------- Total current liabilities 25,104 22,794 Deferred income taxes 1,148 1,148 Commitments and contingencies Stockholders' equity: Preferred stock, $0.01 par value, authorized 1,000 shares, none issued and outstanding Common stock, $0.02 par value, authorized 19,000 shares, 9,058 and 8,942 issued and outstanding at June 29, 2003 and September 29, 2002, respectively 182 179 Capital in excess of par value 99,616 97,512 Accumulated other comprehensive loss (1,386) (835) Retained earnings 53,038 45,056 --------- --------- Total stockholders' equity 151,450 141,912 --------- --------- $ 177,702 $ 165,854 ========= =========
See notes to unaudited consolidated financial statements. 3 ZOLL MEDICAL CORPORATION CONSOLIDATED INCOME STATEMENTS (000's omitted, except per share data) (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 29, JUNE 30, JUNE 29, JUNE 30, 2003 2002 2003 2002 Net sales $ 44,716 $ 34,792 $134,397 $102,850 Cost of goods sold 19,353 14,810 60,541 44,716 -------- -------- -------- -------- Gross profit 25,363 19,982 73,856 58,134 Expenses: Selling and marketing 14,817 12,056 44,214 34,488 General and administrative 3,088 2,997 9,298 8,015 Research and development 3,575 2,922 10,275 8,572 -------- -------- -------- -------- Total expenses 21,480 17,975 63,787 51,075 Income from operations 3,883 2,007 10,069 7,059 Investment and other income 515 866 1,845 1,557 -------- -------- -------- -------- Income before income taxes 4,398 2,873 11,914 8,616 Provision for income taxes 1,451 974 3,931 2,926 -------- -------- -------- -------- Net income $ 2,947 $ 1,899 $ 7,983 $ 5,690 ======== ======== ======== ======== Basic earnings per common share $ 0.33 $ 0.21 $ 0.89 $ 0.64 ======== ======== ======== ======== Weighted average common shares 9,056 8,929 9,019 8,912 outstanding Diluted earnings per common and common equivalent share $ 0.32 $ 0.21 $ 0.87 $ 0.62 ======== ======== ======== ======== Weighted average number of common and common equivalent shares outstanding 9,220 9,181 9,203 9,157
See notes to unaudited consolidated financial statements. 4 ZOLL MEDICAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (000's omitted) (Unaudited)
NINE MONTHS ENDED JUNE 29, JUNE 30, 2003 2002 OPERATING ACTIVITIES: Net income $ 7,983 $ 5,690 Charges not affecting cash: Depreciation and amortization 5,768 4,895 Tax benefit from the exercise of stock options 1,018 453 Changes in current assets and liabilities: Accounts receivable 1,773 3,402 Inventories (8,495) (8,446) Prepaid expenses and other current assets (393) (584) Accounts payable and accrued expenses 555 6,492 -------- -------- Cash provided by operating activities 8,209 11,902 INVESTING ACTIVITIES: Purchases of marketable securities (15,580) (17,653) Sales of marketable securities 15,258 23,109 Additions to property and equipment (5,063) (6,367) Other assets, net (3,962) 81 -------- -------- Cash used for investing activities (9,347) (830) FINANCING ACTIVITIES: Exercise of stock options 1,088 561 -------- -------- Cash provided by financing activities 1,088 561 Effect of exchange rates on cash and cash equivalents 442 (220) -------- -------- Net increase in cash and cash equivalents 392 11,413 Cash and cash equivalents at beginning of period 55,658 45,303 -------- -------- Cash and cash equivalents at end of period $ 56,050 $ 56,716 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period: Income taxes $ 2,962 $ 1,638
See notes to unaudited consolidated financial statements. 5 ZOLL MEDICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Basis of Presentation The Consolidated Balance Sheet as of June 29, 2003, the Consolidated Income Statements for the three and nine months ended June 29, 2003 and June 30, 2002, and the Consolidated Statements of Cash Flows for the nine months ended June 29, 2003 and June 30, 2002 are unaudited, but in the opinion of management include all adjustments, consisting of normal recurring items, necessary for a fair presentation of results for these interim periods. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Examples include provisions for returns, bad debts and the estimated lives of fixed assets. Actual results may differ from these estimates. The results for the interim periods are not necessarily indicative of results to be expected for the entire year. The information contained in the interim financial statements should be read in conjunction with the Company's audited financial statements as of and for the year ended September 29, 2002 included in its Form 10-K filed with the Securities and Exchange Commission ("SEC") on December 30, 2002. Certain reclassifications may have been made to the prior years' unaudited consolidated financial statements to conform to the current period presentation with no impact on net income. 2. Segment and Geographic Information Segment information: The Company operates in a single business segment: the design, manufacture and marketing of an integrated line of proprietary non-invasive cardiac resuscitation devices, and systems used for emergency resuscitation of cardiac arrest victims. In order to make operating and strategic decisions, ZOLL's chief operating decision maker evaluates revenue performance based on the worldwide revenues of four customer/product categories but, due to shared infrastructures, profitability based on an enterprise-wide measure. These customer/product categories consist of (1) the sale of cardiac resuscitation devices and accessories to the North American hospital market, (2) the sale of the same items and data collection management software to the North American pre-hospital market, (3) the sale of disposable/other products in North America, (4) the sale of cardiac resuscitation devices, accessories, disposable electrodes and data collection management software to the international market. Net sales by customer/product categories were as follows: (000's omitted)
THREE MONTHS ENDED NINE MONTHS ENDED ------------------ ----------------- JUNE 29, JUNE 30, JUNE 29, JUNE 30, 2003 2002 2003 2002 Hospital Market - North America $13,691 $11,925 $ 44,784 $ 35,686 Pre-hospital Market - North America 15,134 10,442 39,588 30,709 Other - North America 4,992 4,836 14,784 14,499 International Market 10,899 7,589 35,241 21,956 ------- ------- -------- -------- $44,716 $34,792 $134,397 $102,850 ======= ======= ======== ========
The Company reports assets on a consolidated basis to the chief operating decision maker. Geographic information: Net sales by major geographical area, determined on the basis of destination of the goods, are as follows: (000's omitted)
THREE MONTHS ENDED NINE MONTHS ENDED ------------------ ----------------- JUNE 29, JUNE 30, JUNE 29, JUNE 30, 2003 2002 2003 2002 United States $32,666 $25,601 $ 94,988 $ 76,717 Foreign 12,050 9,191 39,409 26,133 ------- ------- ------- ------- $44,716 $34,792 $134,397 $102,850 ======= ======= ======= =======
6 3. Comprehensive Income The Company computes comprehensive income in accordance with Statement of Financial Accounting Standards No. 130 "REPORTING COMPREHENSIVE INCOME" (SFAS 130). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Other comprehensive income, as defined, includes all changes in equity during a period from non-owner sources, such as unrealized gains and losses on available-for-sale securities and foreign currency translation. Total comprehensive income for the three months and nine months ended June 29, 2003 and June 30, 2002 were as follows: (000's omitted)
THREE MONTHS ENDED NINE MONTHS ENDED ------------------ ----------------- JUNE 29, JUNE 30, JUNE 29, JUNE 30, 2003 2002 2003 2002 Net income $ 2,947 $ 1,899 $ 7,983 $ 5,690 Unrealized gain (loss) on (36) 39 (28) (181) available-for-sales securities, net of tax Foreign currency translation (396) (366) (523) (403) adjustment ------- ------- ------- ------- Total comprehensive income $ 2,515 $ 1,572 $ 7,432 $ 5,106 ======= ======= ======= =======
4. Stock Option Plans At June 29, 2003, the Company had three stock-based compensation plans. The Company's 1992 and 2001 stock option plans provide for the granting of options to officers and other key employees to purchase the Company's Common Stock at a purchase price, in the case of incentive stock options, at least equal to the fair market value per share of the outstanding Common Stock of the Company at the time the option is granted, as determined by the Compensation Committee of the Board of Directors. Options are no longer granted under the 1992 plan. The options become exercisable ratably over two or four years and have a maximum life of 10 years. The Company's Non-employee Director Stock Option Plan provides for the grant of options to purchase 10,000 shares of Common Stock to Directors of the Company who are not also employees of the Company or any of its subsidiaries upon the Directors' initial appointment to the Board of Directors. The Non-employee Director options vest in equal annual installments over a four year period. The Non-employee Director options are granted at an exercise price equal to the fair market value of the Common Stock on the date the option is granted. In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE - AN AMENDMENT OF SFAS NO. 123", which provides optional transition guidance for those companies electing to voluntarily adopt the accounting provisions of SFAS No. 123. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for the plans under the recognition and measurement provisions of Accounting Principles Board No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", to the stock-based employee compensation. The estimated fair value of each option is calculated using the Black-Scholes option-pricing model: 7 (000's omitted, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED ------------------ ----------------- JUNE 29, JUNE 30, JUNE 29, JUNE 30, 2003 2002 2003 2002 Net income-as reported $ 2,947 $ 1,899 $ 7,983 $ 5,690 Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects (760) (636) (2,174) (1,774) ------- ------- ------- ------- Net income-pro forma $ 2,187 $ 1,263 $ 5,809 $ 3,916 ======= ======= ======= ======= Earnings per share: Basic - as reported $ 0.33 $ 0.21 $ 0.89 $ 0.64 ======= ======= ======= ======= Basic - pro forma $ 0.24 $ 0.14 $ 0.64 $ 0.44 ======= ======= ======= ======= Diluted - as reported $ 0.32 $ 0.21 $ 0.87 $ 0.62 ======= ======= ======= ======= Diluted - pro forma $ 0.24 $ 0.14 $ 0.63 $ 0.43 ======= ======= ======= =======
5. Earnings per Share The shares used for calculating basic earnings per common share were the average shares outstanding of common stock and the shares used for calculating diluted earnings per common share were the average shares outstanding of common stock plus the dilutive effect of stock options.
Three Months Ended Nine Months Ended ------------------ ----------------- (000's omitted) June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002 Average shares outstanding for basic earnings per share 9,056 8,929 9,019 8,912 Dilutive effect of stock options 164 252 184 245 ----- ----- ----- ----- Average shares outstanding for diluted earnings per share 9,220 9,181 9,203 9,157 ===== ===== ===== =====
6. Derivative Instruments and Hedging Activities The Company recognizes all derivative financial instruments in the consolidated financial statements at fair value, regardless of the purpose or intent for holding the instrument, in accordance with FASB Statement No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES." Changes in the fair value of derivative instruments are recorded in earnings unless hedge accounting criteria are met. For derivative instruments designated as fair value hedges, the changes in fair value of both the derivative instrument and the hedged item are recorded in earnings under investment and other income. The Company does not enter into any derivative transaction for speculative purposes. The Company has international offices in Canada, United Kingdom, Netherlands, France, Germany, and Australia. These subsidiaries transact business in their functional or local currency. Therefore, we are exposed to foreign currency exchange risks and fluctuations in foreign currencies, along with economic and political instability in the foreign countries in which we operate, all of which could adversely impact our results of operations and financial condition. The Company uses forward contracts to reduce our exposure to foreign currency risk due to fluctuations in exchange rates underlying the value of intercompany accounts receivable denominated in foreign currencies. A forward contract obligates us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates. These forward contracts are denominated in the same currency in which the underlying foreign currency receivables are denominated and bear a contract value and maturity date that approximate the value and expected settlement date, respectively, of the underlying transactions. Unrealized gains and losses on open contracts at the end of each accounting period, resulting from changes in the fair value of these contracts, are recognized in earnings generally in the same period as exchange gains and losses on the underlying foreign denominated receivables are recognized. Gains and losses on forward contracts and foreign denominated receivables are included in investment and other income. 8 The Company had two forward exchange contracts outstanding in the notional amount of approximately $5.0 million at June 29, 2003, and zero at June 30, 2002. These contracts serve as a hedge of a substantial portion of our Euro-denominated and Canadian Dollar-denominated intercompany balances and mature in three months. The fair value of these foreign currency derivative contracts outstanding at June 29, 2003 and June 30, 2002 were approximately $5.3 million and zero, respectively. Net foreign exchange losses recognized to date on these forward exchange contracts totaled approximately $331,000. 7. Product Warranties The Company typically offers one-year and five-year product warranties for most of its products. The Company provides for the estimated cost of product warranties at the time product revenue is recognized. Factors that affect the Company's warranty reserves include the number of units sold, historical and anticipated rates of warranty repairs and the cost per repair. The Company periodically assesses the adequacy of the warranty reserve and adjusts the amount as necessary. Product warrant activity for the nine months ended June 29, 2003 is as follows: (000's omitted)
ACCRUALS FOR WARRANTIES DECREASE TO BALANCE AT ISSUED DURING PREEXISTING BALANCE AT SEPTEMBER 29, 2002 THE PERIOD WARRANTIES JUNE 29, 2003 ------------------ ---------- ---------- --------------- $1,723 $678 $447 $1,954
8. Recent Accounting Pronouncements In December 2002, the FASB issued Interpretation No. 45, "GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS", which requires the disclosure of any guarantees in place prior to December 31, 2002 and the recognition of a liability for the fair value of any guarantees entered into or modified after that date. The Company is not a guarantor in arrangements that require the recognition of a liability or disclosure under Interpretation No. 45, therefore the application of this statement did not have an impact the Company's consolidated financial statements. In January 2003, the FASB issued Interpretation No. 46, "CONSOLIDATION OF VARIABLE INTEREST ENTITIES", to clarify the conditions under which the assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. Interpretation No. 46 requires the consolidation of a variable interest entity by a company that bears the majority of the risk of loss from the variable interest entity's activities or is entitled to receive the majority of the variable interest entity's residual returns. The provisions of Interpretation No. 46 are required to be adopted by the Company in the fourth quarter of fiscal 2003. The Company currently has minor equity investments in LifeCor, Inc., Advanced Circulatory Systems, Inc. (formerly ResQSystems, Inc.) and AED@Home with a carrying value of approximately $5.0 million. The Company is in the process of determining the effect of adoption of Interpretation No. 46, but does not believe it will materially impact the Company's consolidated results of operations. In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES", which is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. SFAS No. 149 amends and clarifies the accounting for derivative instruments and hedging activities under SFAS No. 133 "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING Activities", as amended by SFAS No. 137 and SFAS No. 138. The Company is in the process of determining the effect of adoption of SFAS No. 149, but does not believe it will materially impact the Company's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY." SFAS No. 150 changes the accounting for certain financial instruments that, under previous guidance, could be classified as equity or "mezzanine" equity, by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position. Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. The guidance in SFAS 150 generally is effective for all financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. We have evaluated SFAS No. 150 and determined that it does not have an impact on our Company's consolidated financial statements. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 29, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002 Net sales increased 29% to $44.7 million for the three months ended June 29, 2003, as compared to $34.8 million for the same period a year earlier. The increase in sales over the prior quarter in 2002 can be attributed to increased market share gains with our AED Plus product and a prior year production problem which led to lower shipments in the prior comparable period of approximately $3 million. Sales to the North American hospital market amounted to $13.7 million, a 15% increase in comparison to $11.9 million for the same period a year prior. Sales to the North American pre-hospital market increased 45% to $15.1 million, up from $10.4 million in the previous year. Total North American sales increased 24% to $33.8 million in comparison to $27.2 million for the same period a year earlier. Total sales of the AED Plus product amounted to $4.8 million in comparison to $0.8 million for the same period last year. International sales increased 44% to $10.9 million in comparison to $7.6 million for the same period a year earlier. International direct sales operations continue to perform well as compared to the prior year period, particularly in the United Kingdom and Germany which approximately doubled their sales. Distributor operations also exceeded the prior year, with continued growth in China and the Middle East. Gross margin for the three months ended June 29, 2003 decreased to 56.7% as compared to 57.4% for the comparable prior year quarter. The lower margin from the prior comparable period is due to increased shipments to the military market, including the balance of the United States military order and shipments to the German Army. These shipments have lower margins due to volume pricing. Selling and marketing expenses decreased as a percentage of net sales to 33.1% as compared to 34.7% for the same period a year earlier. Selling and marketing expenses in total increased $2.8 million or 23% for the three months ended June 29, 2003 compared to the three months ended June 30, 2002. The increase in selling and marketing expense reflects our continued investment in our international operations, expansion of our AED Plus sales force, additions to the U.S. sales management team, and new U.S. training resources. General and administrative expenses decreased as a percentage of net sales to 6.9% from 8.6%. General and administrative expenses increased $91,000 or 3% for the three months ended June 29, 2003 compared to the three months ended June 30, 2002. This increase was due primarily to staffing and related personnel costs. Research and development expenses remained relatively constant as a percentage of net sales at 8%. Research and development expenses increased $653,000 or 22% for the three months ended June 29, 2003 compared to the three months ended June 30, 2002. This change reflects additional personnel we have hired to support ongoing future product development. Our effective tax rate decreased from 34% to 33% for the three months ended June 29, 2003 as compared to the same period in fiscal 2002, reflecting increased use of research and development credits stemming from the development of our CCT and AED Plus products. NINE MONTHS ENDED JUNE 29, 2003 COMPARED TO NINE MONTHS ENDED JUNE 30, 2002 Our net sales increased 31% to $134.4 million for the nine months ended June 29, 2003 as compared to $102.9 million for the same period a year earlier. Sales to the North American hospital market amounted to $44.8 million, a 25% increase in comparison to $35.7 million for the same period a year prior. Sales to the North American pre-hospital market increased 29% to $39.6 million, up from $30.7 million in the previous year. Total North American sales increased 23% to $99.2 million in comparison to $80.9 million for the same period a year earlier. The increase in North American sales over the prior comparable period reflected increased defibrillator sales, particularly the shipments to the United States military; the addition of our AED Plus product; and stronger software sales to EMS customers. Total sales of the AED Plus product amounted to $13.6 million in comparison to $0.8 million for the same period last year. International sales increased 60% to $35.2 million in comparison to $22.0 million for the same period a year earlier. International sales reflected strength from both our direct and distributor operations. Our direct subsidiaries' growth was driven by the United Kingdom and Germany, nearly doubling sales for the same period in the prior year. Our distributor operations continue to perform well, particularly in the Middle East, China, and Europe. 10 Gross margin for the nine months ended June 29, 2003 was 55.0% compared to 56.5% for the comparable prior period. The lower margin was driven by a shift in our geographic mix, as our International sales (which generally have lower margins) growth outpaced North American sales growth during the period. International shipments during the nine months ended June 29, 2003 have increased approximately 60% from the prior year and accounted for 26% of our consolidated sales. In addition, increased shipments to the United States military reduced margins as these shipments reflect volume pricing. Selling and marketing expenses decreased as a percentage of net sales to 32.9% as compared to 33.5% for the same period a year earlier. Selling and marketing expenses increased $9.7 million or 28% for the nine months ended June 29, 2003 compared to the nine months ended June 30, 2002. This increase reflects expansion of our international sales force, worldwide public access defibrillation distribution expansion, increases to the North America sales management team, new North America training resources and normal additions to our North America direct sales force. Also contributing to the increase were additional resources dedicated to our global marketing effort for our AED Plus product. General and administrative expenses decreased as a percentage of net sales to 6.9% from 7.8%. General and administrative expenses increased $1.3 million or 16% for the nine months ended June 29, 2003 compared to the nine months ended June 30, 2002. The increase from the comparable prior period primarily reflects additional personnel and related costs to support our growth, increased employer contributions to our defined contribution 401k Plan, higher insurance premiums, and legal fees associated with settlement of a patent infringement suit. Research and development expenses decreased as a percentage of net sales to 7.6% from 8.3%. Research and development expenses increased $1.7 million or 19.9% for the nine months ended June 29, 2003 compared to the nine months ended June 30, 2002. This change reflects additional personnel we have hired to support ongoing future product development. Our effective tax rate decreased from 34% to 33% for the nine months ended June 29, 2003 as compared to the same period in fiscal 2002, reflecting increased research and development credits stemming from the development of our CCT and AED Plus products. LIQUIDITY AND CAPITAL RESOURCES Our total cash, cash equivalents and marketable securities increased $593,000 for the nine months ended June 29, 2003. Our cash and cash equivalents at June 29, 2003 totaled $56.0 million compared with $55.7 million at September 29, 2002. In addition, we had marketable securities amounting to $10.3 million at June 29, 2003 in comparison to $10.1 million at September 29, 2002. Cash provided by operating activities for the nine months ended June 29, 2003 was $8.2 million as compared to $11.9 million during the same period in fiscal year 2002. This decrease was primarily attributable to increases in early payment of vendor invoices in order to take advantage of early payment discount opportunities, offset by improved net earnings, stock option tax benefits, increased depreciation expense, and fluctuations in accounts receivable directly related to our sales growth. Cash used for investing activities amounted to $9.3 million during the nine months ended June 29, 2003 compared to $830,000 during the nine months ended June 30, 2002. This change reflects equity investments totaling approximately $3.0 million in Lifecor, Inc., Advanced Circulatory Systems, Inc. (formerly ResQSystems, Inc.), and AED@Home, which were offset by fewer fixed asset additions and an increased number of sales of marketable securities than in the same period a year ago. Cash provided by financing activities was $1.1 million for the nine months ended June 29, 2003 compared to $561,000 for the same period in fiscal year 2002 reflecting increased stock option activity. We maintain a working capital line of credit with our bank. Under this working capital line, we may borrow on a demand basis. Currently, we may borrow up to $12.0 million at an interest rate equal to the bank's base rate. No borrowings were outstanding on this line at the end of the third quarter of fiscal 2003. Our only contractual obligations consist of operating lease commitments. Our total lease commitments are approximately $9.3 million, of which $1.0 million is due in less than one year, $4.8 million is due in one to four years, and $3.5 million is due in five to eight years. In March 2003, we executed a long-term lease on a new facility in Chelmsford, Massachusetts, which was effective in July 2003. 11 We believe that our cash and investment balances, the cash generated by operations, and amounts available under our existing line of credit will be sufficient to meet our ongoing operating and capital expenditure requirements for at least the remainder of the fiscal year. LEGAL AND REGULATORY AFFAIRS We are involved in the normal course of our business in various litigation matters and regulatory issues, including product recalls. Although we are unable to determine at the present time the exact amount of any impact in any pending matters, we believe that none of the pending matters will have an outcome material to our financial condition or business. CRITICAL ACCOUNTING POLICIES Our most critical accounting policies include revenue recognition and those that are reflective of significant judgments and uncertainties, and may potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies are limited to those described below. For a detailed discussion on the application of these and other accounting policies, see Note A in the notes to the fiscal 2002 consolidated financial statements, included in our Form 10-K filed with the SEC on December 30, 2002. REVENUE RECOGNITION Revenues from sales of cardiac resuscitation devices, disposable electrodes and accessories are recognized when a signed non-cancelable purchase order exists, the product is shipped, title and risk of loss have passed to the customer, the fee is fixed and determinable, and collection is considered probable. Revenues are recorded net of estimated returns. We also license software under non-cancelable license agreements and provide services including training, installation, consulting and maintenance, which consist of product support services, periodic updates and unspecified upgrade rights (collectively, post-contract customer support ("PCS")). Revenue from the sale of software is recognized in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended. License fee revenues are recognized when a non-cancelable license agreement has been signed, the software product has been shipped, there are no uncertainties surrounding product acceptance, the fees are fixed and determinable, and collection is considered probable. Revenues from maintenance agreements and upgrade rights are recognized ratably over the period of service. Our software arrangements contain multiple elements, which include software products, services and PCS. In general, we do not have vendor specific objective evidence of fair value for our software products. Accordingly, for transactions where vendor specific objective evidence exists for undelivered elements but not for delivered elements, we use the residual method as discussed in SOP 98-9, "Modification of SOP 97-2, With Respect to Certain Transactions." Under the residual method, the total fair value of the undelivered elements, as indicated by vendor specific objective evidence, is deferred and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. ALLOWANCE FOR DOUBTFUL ACCOUNTS / SALES RETURNS AND ALLOWANCES We maintain an allowance for doubtful accounts for estimated losses, which is included in bad debt expense, resulting from the inability of our customers to make required payments. We determine the adequacy of this allowance by regularly reviewing the aging of our accounts receivable and evaluating individual customer receivables, considering customers' financial condition, credit history and current economic condition. We also maintain an estimate of potential future product returns and discounts given related to trade-ins and to current period product receivables. We analyze the rate of historical returns when evaluating the adequacy of the allowance for sales returns, which is included with the allowance for doubtful accounts on our balance sheet. As of June 29, 2003 our accounts receivable balance of $42.3 million is reported net of allowances for doubtful accounts and sales returns of $4.3 million. We believe our reported allowances at June 29, 2003 are adequate. If the financial conditions of our customers were to deteriorate, resulting in their inability to make payments, we may need to record additional allowances, resulting in additional expenses being recorded for the period in which such determination was made. WARRANTY RESERVES 12 Our products are sold with warranty provisions that require us to remedy deficiencies in quality or performance over a specified period of time, usually one to five years. We provide for the estimated cost of product warranties at the time revenue is recognized. While we engage in product quality programs and processes, our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. We believe that our recorded liability of $2.0 million at June 29, 2003 is adequate to cover future costs for the servicing of our products sold through that date. If actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. INVENTORY RESERVES Significant management judgment is required to determine the reserve for obsolete or excess inventory. Inventory on hand may exceed future demand either because the product is outdated, obsolete, or because the amount on hand is in excess of future needs. We provide for the total value of inventories that we determine to be obsolete based on criteria such as customer demand and changing technologies. At June 29, 2003, our inventory reserves were $2.4 million, or 6.3% of our $38.2 million gross inventories. We value our inventories at the lower of cost or market. Cost is determined by the first-in, first-out ("FIFO") method, including material, labor and factory overhead. SAFE HARBOR STATEMENTS Except for the historical information contained herein, the matters set forth herein are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in the forward looking statements. Such risks and uncertainties include, but are not limited to: product demand and market acceptance risks, the effect of economic conditions, results of pending or future litigation, the impact of competitive products and pricing, product development and commercialization, technological difficulties, the government regulatory environment and actions, trade environment, capacity and supply constraints or difficulties, the results of financing efforts, actual purchases under agreements, potential warranty issues, the effect of the Company's accounting policies, and those items set forth in the following section entitled "Risk Factors." RISK FACTORS IF WE FAIL TO COMPETE SUCCESSFULLY IN THE FUTURE AGAINST EXISTING OR POTENTIAL COMPETITORS, OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED Our principal global competitors with respect to our entire cardiac resuscitation equipment product line are Physio-Control Corporation and Royal Philips Electronics. Physio-Control is a subsidiary of Medtronic, Inc., a leading medical technology company and Agilent Technologies' Healthcare Solutions Group is now part of the Medical Systems division of Royal Philips Electronics. Physio-Control has been the market leader in the defibrillator industry for over twenty years. As a result of Physio-Control's dominant position in this industry, many potential customers have relationships with Physio-Control that could make it difficult for us to continue to penetrate the markets for our products. In addition, Physio-Control, its parent and Royal Philips Electronics and other competitors each have significantly greater resources than we do. Accordingly, Physio-Control, Royal Philips Electronics and other competitors could substantially increase the resources they devote to the development and marketing of products that are competitive with ours. These and other competitors may develop and successfully commercialize medical devices that directly or indirectly accomplish what our products are designed to accomplish in a superior and/or less expensive manner. For example, we expect our competitors to develop and sell devices in the future that will compete directly with our M Series product line and although our biphasic waveform technology is unique, our competitors have devised alternative biphasic waveform technology. We have also licensed our biphasic waveform technology to GE Medical Systems Information Technologies. There are a number of smaller competitors in the United States, which include Welch Allyn, Inc. (formerly MRL), Cardiac Science, Inc., Cardio Access and Defibtech. It is possible the market may embrace these competitors' products which could negatively impact our market share. In addition to external defibrillation and external pacing with cardiac resuscitation equipment, it is possible that other alternative therapeutic approaches to the treatment of sudden cardiac arrest may be developed. These alternative therapies or approaches, including pharmaceutical or other alternatives, could prove to be superior to our products. 13 There is significant competition in the business of developing and marketing software for data collection, billing and data management in the emergency medical system market. Our principal competitors in this business include Healthware Technologies, Inc., Tritech Software Systems, Inc., Sweet Computer Services, Inc., RAM Software Systems, Inc., Intergraph Corporation and AmbPac, Inc., some of which have greater financial, technical, research and development and marketing resources than we do. Because the barriers to entry in this business are relatively low, additional competitors may easily enter this market in the future. It is possible that systems developed by competitors could be superior to our data management system. Consequently, our ability to sell our data management system could be materially impacted and our financial results could be materially and adversely affected. OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE WHICH COULD CAUSE OUR STOCK PRICE TO BE VOLATILE, AND THE ANTICIPATION OF A VOLATILE STOCK PRICE CAN CAUSE GREATER VOLATILITY Our quarterly and annual operating results have fluctuated and may continue to fluctuate. Various factors have and may continue to affect our operating results, including: - high demand for our products which could disrupt our normal factory utilization and cause shipments to occur in uneven patterns; - variations in product orders; - timing of new product introductions; - temporary disruptions on buying behavior due to changes in technology (e.g. shift to biphasic technology); - changes in distribution channels; - actions taken by our competitors such as the introduction of new products or the offering of sales incentives; - the ability of our sales forces to effectively market our products; - supply interruptions from our single source vendors; - temporary manufacturing disruptions; - regulatory actions, including actions taken by the FDA or similar agencies; and - delays in obtaining domestic or foreign regulatory approvals. A large percentage of our sales are made toward the end of each quarter. As a consequence, our quarterly financial results are often dependent on the receipt of large customer orders in the last weeks of a quarter. The absence of these large orders could cause us to fall short of our quarterly sales targets, which in turn could cause our stock price to decline sharply. As we grow in size, and these large orders are received closer to the end of a period, we may not be able to manufacture, test, and ship all orders in time to recognize as revenue for that quarter. Based on these factors, period-to-period comparisons should not be relied upon as indications of future performance. In anticipation of less successful quarterly results, parties may take short positions in our stock. The actions of parties shorting our stock might cause even more volatility in our stock price. The volatility of our stock may cause the value of a stockholder's investment to decline rapidly. THE AED PAD (PUBLIC ACCESS DEFIBRILLATION) BUSINESS IS NEW TO US. IF WE ARE NOT SUCCESSFUL IN ENTERING THIS BUSINESS SEGMENT, OUR OPERATING RESULTS MAY BE AFFECTED. The PAD market is a new market for us and has many new dynamics. This market involves many new types of non-traditional healthcare distributors, and the efficiency of these distributors may not be as robust as we expect. Payment from these distributors for products they purchase from us may be questionable if these distributors are unable to sell the product on to end users. These new types of distributors may present credit risks since they may not be well established and may not have the necessary business 14 volumes. In addition, we may not be successful in gaining market acceptance of our AED Plus into alternative PAD markets if our PAD Distributors are not successful. Also, our focus upon the PAD market may distract our operations from our core M Series business. All of these items could cause our operating results to be unfavorably impacted. We have noticed that as the PAD market has grown, there have been an increasing number of smaller, start-up companies entering the market. In order to gain market share, these companies compete mainly on price. If these companies are able to capture a larger market share with lower prices, this may cause declining prices and negatively affect our operating results. Two of our major competitors have announced plans to enter the home market. We have also announced such a plan and if our plan turns out to be less effective or efficient, we might have difficulty building market share. WE MAY BE REQUIRED TO IMPLEMENT A COSTLY PRODUCT RECALL In the event that any of our products proves to be defective, we can voluntarily recall, or the FDA could require us to redesign or implement a recall of, any of our products. Both our competitors and we have, on numerous occasions, voluntarily recalled products in the past, and based on this experience, we believe that future recalls could result in significant costs to us and significant adverse publicity, which could harm our ability to market our products in the future. Though it is not possible to quantify the economic impact of a recall, it could have a material adverse effect on our business, financial condition and results of operations. For example, on June 25, 2003, we initiated a recall of approximately 8,000 M Series units to correct a potential fault with a vendors' component that can occur during its operation. Very few of these units are expected to contain the faulty component. We are currently testing the units in the field to determine which units may be defective. We anticipate very few actual unit failures and currently estimate the cost of implementing this corrective action to be less than $100,000. CHANGES IN THE HEALTH CARE INDUSTRY MAY REQUIRE US TO DECREASE THE SELLING PRICE FOR OUR PRODUCTS OR COULD RESULT IN A REDUCTION IN THE SIZE OF THE MARKET FOR OUR PRODUCTS, EACH OF WHICH COULD HAVE A NEGATIVE IMPACT ON OUR FINANCIAL PERFORMANCE Trends toward managed care, health care cost containment, and other changes in government and private sector initiatives in the United States and other countries in which we do business are placing increased emphasis on the delivery of more cost-effective medical therapies which could adversely affect the sale and/or the prices of our products. For example: - major third-party payers of hospital and pre-hospital services, including Medicare, Medicaid and private health care insurers, have substantially revised their payment methodologies during the last few years which has resulted in stricter standards for reimbursement of hospital and pre-hospital charges for certain medical procedures; - Medicare, Medicaid and private health care insurer cutbacks could create downward price pressure in the cardiac resuscitation pre-hospital market; - numerous legislative proposals have been considered that would result in major reforms in the U.S. health care system that could have an adverse effect on our business; - there has been a consolidation among health care facilities and purchasers of medical devices in the United States who prefer to limit the number of suppliers from whom they purchase medical products, and these entities may decide to stop purchasing our products or demand discounts on our prices; - there is economic pressure to contain health care costs in international markets; - there are proposed and existing laws and regulations in domestic and international markets regulating pricing and profitability of companies in the health care industry; and - there have been initiatives by third party payers to challenge the prices charged for medical products which could affect our ability to sell products on a competitive basis. 15 Both the pressure to reduce prices for our products in response to these trends and the decrease in the size of the market as a result of these trends could adversely affect our levels of revenues and profitability of sales, which could have a material adverse effect on our business. GENERAL ECONOMIC CONDITIONS MAY CAUSE OUR CUSTOMERS TO DELAY BUYING OUR PRODUCTS RESULTING IN LOWER REVENUES The national economy of the United States and the global economy are both subject to economic downturns. An economic downturn in any market in which we sell our products may have a significant impact on the ability of our customers, in both the hospital and pre-hospital markets, to secure adequate funding to buy our products or might cause purchasing decisions to be delayed. Any delay in purchasing our products may result in decreased revenues and also allow our competitors additional time to develop products which may have a competitive edge over our M Series products, making future sales of our products more difficult. For example, as the current economic climate in the U.S. continues to soften, many states are experiencing deficits and shortfalls of revenue to cover expenditures. As a result, states have cut their spending and support to local cities and towns, who then in-turn might continue to reduce their spending for capital equipment purchases for their EMS services. If this continues to occur, we may experience a greater reduction in the expected sales from this customer segment. THE WAR ON TERRORISM AND THE IMPACT OF A BIO-TERROR THREAT MAY CAUSE OUR CUSTOMERS TO STOP OR DELAY BUYING OUR PRODUCTS, RESULTING IN LOWER REVENUES The current war on terrorism and a threat of a bio-terror attack may have a significant impact on our customers' ability or willingness to buy our products, as well as our ability to timely deliver the product to the customers. Our customers may have to divert their funding, earmarked for capital equipment purchases to the purchase of other medical equipment and supplies to fight any potential bio-terror attack. The war on terrorism may cause the diversion of any government funding of hospitals and EMS services for capital equipment purchases to the war effort. Such implications may result in decreased revenues. WE CAN BE SUED FOR PRODUCING DEFECTIVE PRODUCTS AND WE MAY BE REQUIRED TO PAY SIGNIFICANT AMOUNTS TO THOSE HARMED IF WE ARE FOUND LIABLE, AND OUR BUSINESS COULD SUFFER FROM ADVERSE PUBLICITY The manufacture and sale of medical products such as ours entail significant risk of product liability claims. Our quality control standards comply with FDA requirements and we believe that the amount of product liability insurance we maintain is adequate based on past product liability claims in our industry. We cannot be assured that the amount of such insurance will be sufficient to satisfy claims made against us in the future or that we will be able to maintain insurance in the future at satisfactory rates or in adequate amounts. Product liability claims could result in significant costs or litigation. A successful claim brought against us in excess of our available insurance coverage or any claim that results in significant adverse publicity against us could have a material adverse effect on our business, financial condition and results of operations. RECURRING SALES OF ELECTRODES TO OUR CUSTOMERS MAY DECLINE We typically have recurring sales of electrodes to our customers. Other vendors have developed electrode adaptors which allow generic electrodes to be compatible with our defibrillators. If we are unable to continue to differentiate the superiority of our electrodes over these generic electrodes, our future revenue from the sale of electrodes could be reduced. FAILURE TO PRODUCE NEW PRODUCTS OR OBTAIN MARKET ACCEPTANCE FOR OUR NEW PRODUCTS IN A TIMELY MANNER COULD HARM OUR BUSINESS Because substantially all of our revenue comes from the sale of cardiac resuscitation devices and related products, our financial performance will depend upon market acceptance of, and our ability to deliver and support, new products. We cannot be assured that we will be able to produce viable products in the time frames we currently estimate. Factors which could cause delay in these schedules or even cancellation of our projects to produce and market these new products include: research and development delays, the actions of our competitors producing competing products and the actions of other parties who may provide alternative therapies or solutions which could reduce or eliminate the markets for pending products. The degree of market acceptance of any of our products will depend on a number of factors, including: 16 - our ability to develop and introduce new products in a timely manner; - our ability to successfully implement new product technologies; - the market's readiness to accept new products such as our data management products; - the standardization of an automated platform for data management systems; - the clinical efficacy of our products and the outcome of clinical trials; - the ability to obtain timely regulatory approval for new products; and - the prices of our products compared to the prices of our competitors' products. If our new products do not achieve market acceptance, our financial performance could be adversely affected. WE MAY EXPERIENCE SHORT TERM OPERATING FLUCTUATIONS AS WE CONTINUE TO INTRODUCE OUR BIPHASIC TECHNOLOGY While we believe our biphasic technology offers substantial opportunity for future growth, there can be no guarantee that this will occur. In addition, in the short term, an industry shift towards biphasic technology could cause a lengthening of buying cycles, take additional sales time, and reduce the salability of existing inventory and trade-in products. As more customers convert to biphasic technology, it may become more difficult for us to sell the older monophasic technology products resulting in inventory obsolescence. This risk related to a shift towards biphasic technology could also be affected by the uncertainty of the governing bodies' recommendations concerning biphasic technology. OUR DEPENDENCE ON SOLE AND SINGLE SOURCE SUPPLIERS EXPOSES US TO SUPPLY INTERRUPTIONS AND MANUFACTURING DELAYS CAUSED BY FAULTY COMPONENTS THAT COULD RESULT IN PRODUCT DELIVERY DELAYS AND SUBSTANTIAL COSTS TO REDESIGN OUR PRODUCTS Although we use many standard parts and components for our products, some key components are purchased from sole or single source vendors for which alternative sources at present are not readily available. For example, we currently purchase proprietary components, including capacitors, display screens, gate arrays and integrated circuits, for which there are no direct substitutes. Our inability to obtain sufficient quantities of these components as well as our limited ability to deal with faulty components may result in future delays or reductions in product shipments which could cause a fluctuation in our results of operations. These components could be replaced with alternatives from other suppliers, which could involve a redesign of our products. Such a redesign could involve considerable time and expense. If our manufacturers are unable or unwilling to continue manufacturing our components in required volumes, we will have to transfer manufacturing to acceptable alternative manufacturers whom we have identified, which could result in significant interruptions of supply. The manufacture of these components is complex, and our reliance on the suppliers of these components exposes us to potential production difficulties and quality variations, which could negatively impact the cost and timely delivery of our products. Accordingly, any significant interruption in the supply, or degradation in the quality, of any component would have a material adverse effect on our business, financial condition and results of operations. WE MAY NOT BE ABLE TO OBTAIN APPROPRIATE REGULATORY APPROVALS FOR OUR NEW PRODUCTS The manufacture and sale of our products are subject to regulation by numerous governmental authorities, principally the FDA and corresponding state and foreign agencies. The FDA administers the Federal Food, Drug and Cosmetic Act, as amended, and the rules and regulations promulgated hereunder. Some of our products have been classified by the FDA as Class II devices and others, such as our automated external defibrillators, have been classified as Class III devices. All of these devices must secure a 510(k) pre-market notification clearance before they can be introduced into the U.S. market. The process of obtaining 510(k) clearance typically takes several months and may involve the submission of limited clinical data supporting assertions that the product is substantially equivalent to another medical device on the market prior to 1976. Delays in obtaining 510(k) clearance could have an 17 adverse effect on the introduction of future products. Moreover, approvals, if granted, may limit the uses for which a product may be marketed, which could reduce or eliminate the commercial benefit of manufacturing any such product. We are also subject to regulation in each of the foreign countries in which we sell products. Many of the regulations applicable to our products in such countries are similar to those of the FDA. However, the national health or social security organizations of certain countries require our products to be qualified before they can be marketed in those countries. We cannot be assured that such clearances will be obtained. IF WE FAIL TO COMPLY WITH APPLICABLE REGULATORY LAWS AND REGULATIONS, THE FDA AND OTHER FOREIGN REGULATORY AGENCIES COULD EXERCISE ANY OF THEIR REGULATORY POWERS, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS Every company that manufactures or assembles medical devices is required to register with the FDA and to adhere to certain quality systems, which regulate the manufacture of medical devices and prescribe record keeping procedures and provide for the routine inspection of facilities for compliance with such regulations. The FDA also has broad regulatory powers in the areas of clinical testing, marketing and advertising of medical devices. To ensure that manufacturers adhere to good manufacturing practices, 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 could take any of the following actions: - place the company under observation and re-inspect the facilities; - issue a warning letter apprising of violating 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. We, like most of our U.S. competitors, have received warning letters from the FDA in the past, and may receive warning letters in the future. We have always complied with the warning letters we have received. However, our failure to comply with FDA regulations could result in sanctions being imposed on us, including restrictions on the marketing or recall of our products. These sanctions could have a material adverse effect on our business. If a foreign regulatory agency believes that the Company may not be operating in compliance with their laws and regulations, they could prevent us from selling our products in their country, which could have a material adverse effect on our business. WE ARE DEPENDENT UPON LICENSED AND PURCHASED TECHNOLOGY FOR UPGRADEABLE FEATURES IN OUR PRODUCTS, AND WE MAY NOT BE ABLE TO RENEW THESE LICENSES OR PURCHASE AGREEMENTS IN THE FUTURE We license and purchase technology from third parties for upgradeable features in our products, including 12 lead analysis program, pulse oximetry, EtCO2, and NIBP technologies. We anticipate that we will need to license and purchase additional technology to remain competitive. We may not be able to renew our existing licenses and purchase agreements or to license and purchase other technologies on commercially reasonable terms or at all. If we are unable to renew our existing licenses and purchase agreements or we are unable to license or purchase new technologies, we may not be able to offer competitive products. FLUCTUATIONS IN CURRENCY EXCHANGE RATES MAY ADVERSELY AFFECT OUR INTERNATIONAL SALES Our revenue from international operations can be denominated in or significantly influenced by the currency and general economic climate of the country in which we make sales. A decrease in the value of such foreign currencies relative to the U.S. dollar could result in downward price pressure for our products or losses from currency exchange rate fluctuations. As we continue to expand our international operations, downward price pressure and exposure to gains and losses on foreign currency transactions may increase. 18 We may continue our use of forward contracts and other instruments in the future to reduce our exposure to exchange rate fluctuations from intercompany accounts receivable denominated in foreign currencies, and we may not be able to do this successfully. Accordingly, we may experience economic loss and a negative impact on our results of operations and equity as a result of foreign currency exchange rate fluctuations. WE HAVE LICENSED OUR BIPHASIC TECHNOLOGY TO GE MEDICAL SYSTEMS INFORMATION TECHNOLOGIES In 2001, we entered into a five-year license agreement with GE Medical Systems Information Technologies that permits GE to incorporate our patented biphasic waveform technology into their defibrillator and monitoring systems. At this time GE has taken only limited action to incorporate our technology into their products. However, GE has significantly greater resources than we do. If they bring our technology to market, it could impact our ability to market and sell our products, potentially lowering our revenues. OUR CURRENT AND FUTURE INVESTMENTS MAY LOSE VALUE IN THE FUTURE We have made a $3.5 million investment in LifeCor, Inc., a development stage company and have agreed in certain circumstances to invest another $1.5 million. In addition, we hold minor investments in Advanced Circulatory Systems, Inc. (formerly ResQSystems, Inc.) and AED@Home and may in the future invest in the securities of other companies and participate in joint venture agreements. These investments and future investments are subject to the risks that the entities in which we invest will become bankrupt or lose money. Investing in securities involves risks and no assurance can be made as to the profitability of any investment. Our inability to identify profitable investments could adversely affect our financial condition and results of operations. Unless we hold a majority position in an investment or joint venture, we will not be able to control all of the activities of the companies in which we invest or the joint ventures in which we are participating. Because of this, such entities may take actions against our wishes and not in furtherance of, and even opposed to, our business plans and objectives. These investments are also subject to the risk of impasse if no one party exercises ultimate control over the business decisions. FUTURE CHANGES IN APPLICABLE LAWS AND REGULATIONS COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS Although we are not aware of any pending changes in applicable laws and regulations governing our industry, we cannot be assured that federal, state or foreign governments will not change existing laws or regulations or adopt new laws or regulations that regulate our industry. Changes in or adoption of new laws or regulations could result in the following consequences that would have an adverse effect on our business: - regulatory clearance previously received for our products could be revoked; - costs of compliance could increase; or - we may be unable to comply with such laws and regulations so that we would be unable to sell our products. UNCERTAIN CUSTOMER DECISION PROCESSES MAY RESULT IN LONG SALES CYCLES WHICH COULD RESULT IN UNPREDICTABLE FLUCTUATIONS IN REVENUES AND DELAY THE REPLACEMENT OF CARDIAC RESUSCITATION DEVICES Many of the customers in the pre-hospital market consist of municipal fire and emergency medical systems departments. As a result, there are numerous decision-makers and governmental procedures in the decision-making process. In addition, decisions at hospitals concerning the purchase of new medical devices are sometimes made on a department-by-department basis. Accordingly, we believe the purchasing decisions of many of our customers may be characterized by long decision-making processes, which have resulted in and may continue to result in long sales cycles for our products. For example, the sales cycles for cardiac resuscitation products typically have been between six and nine months, although some sales efforts have taken as long as two years. OUR INTERNATIONAL SALES EXPOSE OUR BUSINESS TO A VARIETY OF RISKS THAT COULD RESULT IN SIGNIFICANT FLUCTUATIONS IN OUR RESULTS OF OPERATIONS Approximately 29% of our sales for the nine months ended June 29, 2003 were made to foreign purchasers and we plan to increase the sale of our products to foreign purchasers in the future. As a result, a significant portion of our sales is and will continue to be subject to the risks of international business, including: 19 - fluctuations in foreign currencies; - trade disputes; - changes in regulatory requirements, tariffs and other barriers; - the possibility of quotas, duties, taxes or other changes or restrictions upon the importation or exportation of the products being implemented by the United States or these foreign countries; - timing and availability of import/export licenses; - political and economic instability; - difficulties in accounts receivable collections; - difficulties in managing laws; - increased tax exposure if our revenues in foreign countries are subject to taxation by more than one jurisdiction; - accepting customer purchase orders governed by foreign laws which may differ significantly from U.S. laws and limit our ability to enforce our rights under such agreements and to collect damages, if awarded; - war on terrorism; - disruption in the international transportation industry; and - the general economies of these countries in which we transact business. As international sales become a larger portion of our total sales, these risks could create significant fluctuations in our results of operations. These risks could affect our ability to resell trade-in products to domestic distributors, who in turn often resell the trade-in products in international markets. Our inability to sell trade-in products might require us to offer lower trade-in values, which might impact our ability to sell new products to customers desiring to trade in older models and then purchase newer products. We have recently expanded the size and number of our direct sales forces and our marketing support for these sales forces. We intend to continue to expand these areas, but if our sales forces are not effective, or if there is a sudden decrease in the markets where we have direct operations, the profitability of these operations and our Company as a whole could be adversely affected. WE MAY FAIL TO ADEQUATELY PROTECT OR ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS OR SECURE RIGHTS TO THIRD PARTY INTELLECTUAL PROPERTY, AND OUR COMPETITORS CAN USE SOME OF OUR PREVIOUSLY PROPRIETARY TECHNOLOGY Our success will depend in part on our ability to obtain and maintain patent protection for our products, methods, processes and other technologies, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. To date, we have been issued 23 U.S. patents for our various inventions and technologies. Additional patent applications have been filed with the U.S. Patent and Trademark Office and are currently pending. The patents that have been granted to us are for a definitive period of time and will expire. We have filed certain corresponding foreign patent applications and intend to file additional foreign and U.S. patent applications as appropriate. We cannot be assured as to: - the degree and range of protection any patents will afford against competitors with similar products; - if and when patents will be issued; - whether or not others will obtain patents claiming aspects similar to those covered by our patent applications; - whether or not competitors will use information contained in our expired patents; 20 - whether or not others will design around our patents or obtain access to our know-how; or - the extent to which we will be successful in avoiding any patents granted to others. We have, for example, patents and pending patent applications for our proprietary biphasic technology. Our competitors could develop biphasic technology that has comparable or superior clinical efficacy to our biphasic technology and if our patents do not adequately protect our technology, our competitors would be able to obtain patents claiming aspects similar to our biphasic technology or our competitors could design around our patents. If certain patents issued to others are upheld or if certain patent applications filed by others issue and are upheld, we may be: - required to obtain licenses or redesign our products or processes to avoid infringement; - prevented from practicing the subject matter claimed in those patents; or - required to pay damages. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Litigation or administrative proceedings, including interference proceedings before the U.S. Patent and Trademark Office, related to intellectual property rights could be brought against us or be initiated by us. Adverse determinations in any patent litigation could subject us to significant liabilities to third parties, could require us to seek licenses from third parties and could, if licenses are not available, prevent us from manufacturing, selling or using certain of our products, some of which could have a material adverse effect on the Company. In addition, the costs of any such proceedings may be substantial whether or not we are successful. For example in fiscal 2002, we spent significant amounts in legal costs responding to a lawsuit filed by Cardiac Science, Inc. alleging patent infringement. Our success is also dependent upon the skills, knowledge and experience, none of which is patentable, of our scientific and technical personnel. To help protect our rights, we require all U.S. employees, consultants and advisors to enter into confidentiality agreements, which prohibit the disclosure of confidential information to anyone outside of our Company and require disclosure and assignment to us of their ideas, developments, discoveries and inventions. We cannot be assured that these agreements will provide adequate protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure of the lawful development by others of such information. RELIANCE ON OVERSEAS VENDORS FOR SOME OF THE COMPONENTS FOR OUR PRODUCTS EXPOSES US TO INTERNATIONAL BUSINESS RISKS, WHICH COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS Some of the components we use in our products are acquired from foreign manufacturers, particularly countries located in Europe and Asia. As a result, a significant portion of our purchases of components is subject to the risks of international business. The failure to obtain these components as a result of any of these risks can result in significant delivery delays of our products, which could have an adverse effect on our business. WE MAY ACQUIRE OTHER BUSINESSES, AND WE MAY HAVE DIFFICULTY INTEGRATING THESE BUSINESSES OR GENERATING AN ACCEPTABLE RETURN FROM ACQUISITIONS We may attempt to acquire or make strategic investments in businesses and other assets. Such acquisitions will involve risks, including: - the inability to achieve the strategic and operating goals of the acquisition; - the inability to raise the required capital to fund the acquisition; - difficulty in assimilating the acquired operations and personnel; - disruption of our ongoing business; and 21 - inability to successfully incorporate acquired technology into our existing product lines and maintain uniform standards, controls, procedures and policies. PROVISIONS IN OUR CHARTER DOCUMENTS, OUR SHAREHOLDER RIGHTS AGREEMENT AND STATE LAW MAY MAKE IT HARDER FOR OTHERS TO OBTAIN CONTROL OF ZOLL EVEN THOUGH SOME STOCKHOLDERS MIGHT CONSIDER SUCH A DEVELOPMENT TO BE FAVORABLE Our board of directors has the authority to issue up to 1,000,000 shares of undesignated preferred stock and to determine the rights, preferences, privileges and restrictions of such shares without further vote or action by our stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock could have the effect of making it more difficult for third parties to acquire a majority of our outstanding voting stock. In addition, our restated articles of organization provide for staggered terms for the members of the board of directors which could delay or impede the removal of incumbent directors and could make a merger, tender offer or proxy contest involving the Company more difficult. Our restated articles of organization, restated by-laws and applicable Massachusetts law also impose various procedural and other requirements that could delay or make a merger, tender offer or proxy contest involving us more difficult. We have also implemented a so-called poison pill by adopting our shareholders rights agreement. This poison pill significantly increases the costs that would be incurred by an unwanted third party acquirer if such party owns or announces its intent to commence a tender offer for more than 15% of our outstanding common stock. The existence of this poison pill could delay, deter or prevent a takeover of the Company. All of these provisions could limit the price that investors might be willing to pay in the future for shares of our common stock which could preclude our shareholders from recognizing a premium over the prevailing market price of our stock. WE HAVE ONLY ONE MANUFACTURING FACILITY FOR EACH OF OUR MAJOR PRODUCTS AND ANY DAMAGE OR INCAPACITATION OF EITHER OF THE FACILITIES COULD IMPEDE OUR ABILITY TO PRODUCE THESE PRODUCTS We have only one manufacturing facility, which produces defibrillators and one separate manufacturing facility which produces electrodes. Damage to either facility could render us unable to manufacture the relevant product or require us to reduce the output of products at the damaged facility. This could materially and adversely impact our business, financial condition and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have cash equivalents and marketable securities that primarily consist of money market accounts and fixed rate asset-backed corporate securities. The majority of these investments have maturities within one to five years. We believe that our exposure to interest rate risk is minimal due to the nature of our investments and that fluctuations in interest rates would not have a material adverse effect on our results of operations. We have international offices in Canada, United Kingdom, Netherlands, France, Germany, and Australia. These subsidiaries transact business in their functional or local currency. Therefore, we are exposed to foreign currency exchange risks and fluctuations in foreign currencies, along with economic and political instability in the foreign countries in which we operate, all of which could adversely impact our results of operations and financial condition. We use forward contracts to reduce our exposure to foreign currency risk due to fluctuations in exchange rates underlying the value of intercompany accounts receivable denominated in foreign currencies. A forward contract obligates us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates. These forward contracts are denominated in the same currency in which the underlying foreign currency receivables are denominated and bear a contract value and maturity date that approximate the value and expected settlement date, respectively, of the underlying transactions. Unrealized gains and losses on open contracts at the end of each accounting period, resulting from changes in the fair value of these contracts, are recognized in earnings generally in the same period as exchange gains and losses on the underlying foreign denominated receivables are recognized. Gains and losses on forward contracts and foreign denominated receivables are included in investment and other income. 22 We had two forward exchange contracts outstanding in the notional amount of approximately $5.0 million at June 29, 2003. These contracts serve as a hedge of a substantial portion of our Euro-denominated and Canadian Dollar-denominated intercompany balances. The fair value of these foreign currency derivative contracts outstanding at June 29, 2003 were approximately $5.3 million. A sensitivity analysis of a change in the fair value of the Euro derivative foreign exchange contract outstanding at June 29, 2003 indicates that, if the U.S. dollar weakened by 10% against the Euro, the fair value of this contract would decrease by $457,000. Conversely, if the U.S. dollar strengthened by 10% against the Euro, the fair value of this contract would increase by $416,000. A sensitivity analysis of a change in the fair value of the Canadian Dollar derivative foreign exchange contract outstanding at June 29, 2003 indicates that, if the U.S. dollar weakened by 10% against the Canadian Dollar, the fair value of this contract would decrease by $74,000. Conversely, if the U.S. dollar strengthened by 10% against the Canadian Dollar, the fair value of this contract would increase by $68,000. Any gains and losses on the fair value of the derivative contract would be largely offset by losses and gains on the underlying transaction. These offsetting gains and losses are not reflected in the analysis above. EXCHANGE RATE SENSITIVITY: JUNE 29, 2003 (AMOUNTS IN $) EXPECTED MATURITY DATES
2003 2004 2005 2006 2007 THEREAFTER TOTAL FAIR VALUE ---- ---- ---- ---- ---- ---------- ----- ---------- FORWARD EXCHANGE AGREEMENTS (RECEIVE $/PAY EURO) CONTRACT AMOUNT $4,296,000 $4,296,000 $4,572,000 ------------------------------------------------------------------------------------------------------------------- AVERAGE CONTRACT EXCHANGE RATE 1.0740 -- -- -- -- -- 1.0740 -- ------------------------------------------------------------------------------------------------------------------- FORWARD EXCHANGE AGREEMENTS (RECEIVE $/PAY CANADIAN DOLLAR) CONTRACT AMOUNT $ 688,000 $ 688,000 $ 743,000 ------------------------------------------------------------------------------------------------------------------- AVERAGE CONTRACT EXCHANGE RATE 0.6875 -- -- -- -- -- 0.6875 -- -------------------------------------------------------------------------------------------------------------------
ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, an evaluation had been performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of June 29, 2003. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to June 29, 2003. 23 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. In the course of normal operations the Company is involved in litigation arising from commercial disputes, claims of former employees, and product litigation claims, none of which management believes will have a material effect on the Company's consolidated financial position or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS. Not Applicable ITEM 5. OTHER INFORMATION. Not Applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) 1. Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 2. Exhibit 31.2 - .Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 3. Exhibit 32.1* - Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 4. Exhibit 32.2* - Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K. Form 8-K, filed on July 17, 2003 related to the press release discussing the results of the three and nine months ended June 29, 2003. * This certification shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, nor shall it be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. 24 SIGNATURES Pursuant to the requirements 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 August 13, 2003. ZOLL MEDICAL CORPORATION (Registrant) Date: August 13, 2003 By: /s/ Richard A. Packer ------------------------ Richard A. Packer, Chairman and Chief Executive Officer (Principal Executive Officer) Date: August 13, 2003 By: /s/ A. Ernest Whiton ------------------------ A. Ernest Whiton, Vice President of Administration and Chief Financial Officer (Principal Financial and Accounting Officer) 25