10-Q 1 a72686e10-q.txt FORM 10-Q PERIOD ENDED MARCH 31, 2001 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended MARCH 31, 2001 ------------------------ 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 0-27588 ----------------- VITALCOM INC. (Exact name of registrant as specified in its charter) DELAWARE 33-0538926 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 15222 DEL AMO AVENUE TUSTIN, CALIFORNIA 92780 (Address of principal executive offices and zip code) (714) 546-0147 (Registrant's telephone number, including area code) 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 $0.0001 PER SHARE 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 [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: As of May 4, 2001, there were 8,330,933 shares outstanding of the issuer's common stock. 2 VITALCOM INC. INDEX PART I

~~-------------------------------~~Page ~~SEPTEMBER 30, DECEMBER 31, 2000 1999~~ ----~~---------~~ ~~------------~~Item ~~(UNAUDITED)~~1. ~~(AUDITED)~~Financial ~~ASSETS~~Statements ~~Current~~3 ~~assets~~Item ~~Cash and cash equivalents $ 4,452,108 $ 7,107,420 Restricted cash~~ 2~~,563,583~~. 0Management's ~~Short-term~~Discussion ~~investments~~and 0Analysis ~~5,273,037~~of ~~Accounts~~Financial ~~receivable,~~Condition ~~net~~and ~~4,410,383~~Results ~~2,309,392~~of ~~Inventories~~Operations ~~1,652,738~~9 ~~1,504,952~~Item ~~Prepaid~~3. ~~expenses~~Quantitative ~~177,071 530,833 ------------ ------------ Total current assets 13,255,883 16,725,634 Property Machinery~~ and ~~equipment~~Qualitative ~~2,045,447~~Disclosures ~~1,560,013~~about ~~Office~~Market ~~furniture~~Risk ~~and~~12 ~~computer~~PART ~~equipment~~II ~~2,741,902~~Item ~~2,558,815~~5. ~~Leasehold~~Other ~~improvements~~Information ~~200,419~~12 ~~181,778~~Item ~~------------~~6. ~~------------~~Exhibits ~~4,987,768 4,300,606 Less accumulated amortization~~ and ~~depreciation~~Reports ~~(3,239,994)~~on ~~(2,831,090)~~Form 8-~~-----------~~K ~~------------ Property, net 1,747,774 1,469,516 Other assets 74,396 68,237 Goodwill, net 398,620 423,025 ------------ ------------ $ 15,476,673 $ 18,686,412 ============ ============~~12

2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS VITALCOM INC. BALANCE SHEETS

-------------------------------- ~~SEPTEMBER~~MARCH 3031, DECEMBER 31, 2000 ~~1999~~2000 ------------- ------------ (UNAUDITED) (AUDITED) ~~LIABILITIES~~ASSETS ~~AND~~Current ~~STOCKHOLDERS'~~assets ~~EQUITY~~Cash ~~Current~~and ~~liabilities:~~cash ~~Accounts~~equivalents ~~payable~~ $ 1,~~387~~004,~~514~~888 $ ~~508~~3,~~322~~657,100 ~~Accrued~~Restricted ~~payroll~~cash ~~and related costs 1~~2,~~019~~500,~~107~~000 ~~959~~2,~~862~~500,000 ~~Accrued~~Accounts ~~warranty~~receivable, ~~costs~~net ~~511~~5,~~855~~451,261 ~~516~~3,~~297~~828,821 ~~Other~~Inventories ~~accrued liabilities 751~~1,~~959~~667,101 ~~568~~1,~~336~~644,181 ~~Current~~Prepaid ~~portion~~expenses ~~of capital lease obligations 8~~157,~~152~~158 28134,~~796~~396 ------------ ------------ Total current ~~liabilities~~assets 310,~~678~~780,~~587~~408 211,~~581~~764,~~613~~498 ~~Stockholders'~~Property ~~equity~~Machinery ~~(deficit):~~and ~~Common~~equipment ~~stock~~1, ~~including paid-in capital~~814,829 ~~$0.0001 par value; 25~~1,~~000~~777,~~000~~578 ~~shares~~Office ~~authorized,~~furniture ~~8,401,536 shares issued~~ and ~~8,037,986~~computer ~~outstanding~~equipment ~~at September 30~~2, ~~2000; 8~~258,~~281,112~~901 ~~shares issued and 7~~2,~~917~~266,~~562~~527 ~~shares~~Leasehold ~~outstanding~~improvements ~~at December 31~~200,278 ~~1999 37~~200,~~967,071~~419 ~~37,665,468~~------------ ~~Note~~------------ ~~receivable for common stock sales (30~~4,~~590) (30~~274,~~590)~~008 ~~Paid in Capital~~4, ~~Stock Options 33~~244,~~760~~524 0Less ~~Treasury~~accumulated ~~stock,~~amortization atand ~~cost~~depreciation (~~740~~2,~~154) (740~~685,~~154~~694) ~~Accumulated deficit~~ (252,~~432~~536,~~001~~061) ~~(20,789,925)~~ ------------ ------------ ~~Net~~Property, ~~stockholders'~~net ~~equity~~1,588,314 111,~~798~~708,~~086~~463 16Other assets 63,~~104~~476 75,~~799~~872 Goodwill, net 382,350 390,485 ------------ ------------ $ 1512,~~476~~814,~~673~~547 $ 1813,~~686~~939,~~412~~318 ============ ============

The accompanying notes are an integral part of these financial statements. 3 4 VITALCOM INC. BALANCE SHEETS - (CONTINUED)

-------------------------------~~------------------------------------~~ ~~THREE~~MARCH ~~MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30~~31, ~~SEPTEMBER~~DECEMBER 3031, 2000 ~~1999~~ 2000 ~~1999~~ ----------- -~~----------~~ ------------ ~~------------~~ (UNAUDITED) (~~UNAUDITED~~AUDITED) ~~Revenues~~LIABILITIES $AND ~~5,337,853~~STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 31,~~764~~515,~~575~~866 $ 121,~~529~~609,~~942~~559 $Accrued 12payroll and related costs 669,~~174~~519 999,~~929~~488 ~~Cost~~Accrued ofwarranty ~~revenues~~costs 2528,~~383,471~~316 2532,~~133,145~~898 5Other accrued liabilities 700,~~717,855~~136 5573,~~936,133~~395 ----------- -~~----------~~ ------------ ~~------------~~Total ~~Gross~~current ~~profit~~liabilities 23,~~954~~413,~~382~~837 13,~~631~~715,~~430~~340 ~~6,812,087~~Stockholders' 6equity: Common stock,~~238,796~~ ~~Operating~~including ~~expenses~~paid-in ~~Sales~~capital, ~~and~~$0.0001 ~~marketing~~par ~~1,455,781~~value; 125,~~449~~000,~~137~~000 4shares authorized,~~687,967~~ 48,~~506~~462,~~763~~453 ~~Research~~shares issued and ~~development 1~~8,~~725~~098,~~570~~903 1shares outstanding at December 31,~~335,532~~ 52000; 8,~~524~~462,~~634~~453 3shares issued and 8,~~742~~266,~~498~~419 ~~General~~shares ~~and~~outstanding ~~administration~~at ~~572,272~~March ~~558~~31,~~000~~ 12001 38,~~641~~160,~~739~~751 138,~~690~~160,~~199~~751 ~~-----------~~Note ~~-----------~~receivable ~~------------~~for ~~------------~~common ~~Total~~stock ~~operating~~sales ~~expenses 3~~(30,~~753,623~~590) 3(30,~~342,669~~590) ~~11,854,340~~Treasury 9stock,~~939,460~~ ~~Operating~~at ~~loss~~cost (~~799~~397,~~241~~334) (1740,~~711,239~~154) Accumulated deficit (528,~~042~~332,~~253~~117) (327,~~700~~166,~~664~~029) ~~Other income, net 128,696 288,943 427,177 676,699~~ ----------- -~~----------~~ ------------ ~~------------~~Net ~~Loss~~stockholders' ~~before~~equity ~~provision for income taxes (670,545) (1,422,296) (4,615,076) (3,023,965) Provision for income taxes~~ 9,~~000 9~~400,~~000~~710 2710,~~000 27~~223,~~000~~978 ----------- -~~----------~~ ------------ ~~------------ Net loss~~ $ ~~(679~~12,~~545) $(1~~814,~~431,296)~~547 $ (413,~~642~~939,~~076)~~318 ~~$ (3,050,965)~~ =========== =~~==========~~ ============ ============ Net loss per basic and diluted common share $ (0.08) $ (0.18) $ (0.58) $ (0.37) =========== =========== ============ ============ Weighted average basic and diluted common shares 8,037,366 8,115,767 8,001,401 8,169,576

The accompanying notes are an integral part of these financial statements. 4 5 VITALCOM INC. STATEMENTS OF OPERATIONS

------------------------------ ~~NINE~~THREE MONTHS ENDED ~~SEPTEMBER~~MARCH 3031, 2001 2000 ~~1999~~ ----------- ------------ (UNAUDITED) ~~Cash~~Revenues ~~flows from operating activities: Net loss~~ $(4 5,~~642~~201,~~076)~~338 $ (3,~~050~~102,~~965)~~884 ~~Adjustments~~Cost ~~to reconcile net loss to net cash used in operating activities: Depreciation and amortization 433,309 473,639 Loss on disposal~~ of ~~property~~revenues ~~0 5,299 Changes in operating assets and liabilities: Accounts receivable (~~2,~~100~~498,~~991)~~283 1,~~251~~838,~~143~~126 ~~Unbilled accounts receivable 0 (237,216) Inventories (147,786) 43,339 Prepaid expenses and other assets 347,603 18,264 Long~~-term installments receivable 0 (927,124) Accounts payable 879,192 (84,025) Accrued payroll and related costs 59,245 (54,073) Accrued warranty costs (4,442) (100,703) Income taxes payable (70,357) (59,814) Accrued liabilities 253,980 266,532 ----------- ------------ ~~Net~~Gross ~~cash~~profit ~~used in operating activities (4~~2,~~992~~703,~~323)~~055 (21,~~455~~264,~~704)~~758 ~~Cash~~Operating ~~flows from investing activities~~expenses: ~~Purchases~~Sales ofand ~~property~~marketing ~~(687~~1,~~162) (304~~493,~~084)~~839 ~~Increase in long-term deferred revenue 0 871~~1,~~652~~611,526 ~~Proceeds~~Research ~~from~~and ~~sale~~development ~~of short-term investments 5~~1,~~273~~539,~~037~~774 21,~~141~~808,~~918~~503 ~~Increase~~General inand ~~other~~administrative ~~assets~~877,822 ~~0 (350~~578,~~658)~~487 ----------- ------------ ~~Net~~Total ~~cash~~operating ~~provided~~expenses ~~by investing activities 4~~3,~~585~~911,~~875~~435 23,~~358~~998,~~828~~516 ~~Cash flows from financing activities: Repayment of capital lease obligation and long~~-~~term debt (20,644) (20,357) Restricted cash for compensating balance on line of credit (2,563,583) 0 Net proceeds from issuance of common stock 335,363 128,132 Repurchase of common stock 0 (740,154)~~ ----------- ------------ ~~Net~~Operating ~~cash~~loss ~~used in financing activities~~ (21,~~248~~208,~~864~~380) (~~632,559) Net decrease in cash and cash equivalents (~~2,~~655~~733,~~312~~758) ~~(729,435)~~Other ~~Cash and cash equivalents~~income, ~~beginning~~net ~~of period 7~~51,~~107,420~~292 10166,~~460,810~~314 ----------- ------------ ~~Cash~~Loss ~~and~~before ~~cash~~provision ~~equivalents~~for income taxes (1,157,088) ~~end~~(2,567,444) ofProvision ~~period~~for $income 4taxes 9,~~452~~000 9,~~108~~000 Net loss $(1,166,088) 9$(2,~~731~~576,~~375~~444) =========== ============ ~~Supplemental~~Net ~~disclosures~~loss ofper ~~cash~~basic ~~flow~~and ~~information:~~diluted ~~Interest~~common ~~paid~~share $ ~~13,175~~(0.14) $ ~~3,324~~(0.32) =========== ============ ~~Income~~Weighted ~~taxes~~average ~~paid~~basic $and ~~13,080~~diluted $common 19shares 8,~~610~~180,800 7,934,416 =========== ============

The accompanying notes are an integral part of these financial statements. 5 6 VITALCOM INC. STATEMENTS OF CASH FLOWS

~~NUMBER~~------------------------------- OFTHREE ~~NUMBER~~MONTHS OFENDED ~~PRICE~~MARCH ~~PER~~31, ~~OPTIONS~~2001 ~~SHARES~~2000 ~~SHARE~~------------ ~~EXERCISABLE~~ ------------ (UNAUDITED) Cash flows from operating activities: Net loss $ (1,166,088) $ (2,576,443) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 157,730 174,434 Loss on disposal of property 38 -- Changes in operating assets and liabilities: Accounts receivable (1,622,440) 205,266 Inventories (22,921) 154,199 Prepaid expenses and other assets (10,366) 96,046 Accounts payable (93,692) (124,893) Accrued payroll and related costs(1) 12,851 (325,968) Income tax payable 2,634 -- Accrued warranty costs (4,582) (15,551) Accrued liabilities 124,108 213,725 ------------ ------------ ~~Balance,~~Net ~~December~~cash ~~31,~~used ~~1999~~in 1operating activities (2,~~680~~622,~~116~~728) ~~$0.60~~(2,199,185) toCash ~~$6.00~~flows ~~601~~from investing activities: Purchases of property (29,~~094~~485) ~~Granted~~(182,115) ~~352~~Proceeds from sale of short-term investments -- 5,~~675~~273,037 ~~$1.63~~------------ to------------ ~~$2.47~~Net ~~Exercised~~cash (71used in) provided by investing activities (29,~~784~~485) ~~$1.88~~5,090,922 toCash ~~$4.00~~flows ~~Canceled~~from financing activities: Repayment of capital lease obligation and long-term debt -- (~~238~~7,~~251~~388) ~~$1.50~~Net toproceeds ~~$6.00~~from issuance of common stock -- 113,992 ------------ ~~Balance~~------------ Net cash provided in financing activities -- 106,604 ~~September~~Net 30increase (decrease) in cash and cash equivalents (2,652,213) ~~2000~~2,998,341 Cash and cash equivalents, beginning of period 3,657,100 7,107,420 ------------ ------------ Cash and cash equivalents, end of period $ 1,~~722~~004,~~756~~888 $~~0.60~~ to10,105,761 ============ ============ Supplemental disclosures of cash flow information: Interest paid $~~4.75~~ ~~799~~6,~~012~~282 $ 624 ============ ============ Income taxes paid $ 6,366 $ 4,900 ============ ============

(1) Includes a non-cash reduction of $342,820 from the issuance of treasury stock used for the Company's matching contribution to its 401(k) plan. The accompanying notes are an integral part of these financial statements. 6 7 VITALCOM INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The interim condensed financial statements included herein have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures, normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such SEC rules and regulations; nevertheless, the management of the Company believes that the disclosures herein are adequate to make the information presented not misleading. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 2000 and filed with the SEC. In the opinion of management, the condensed financial statements included herein reflect all normal, recurring adjustments necessary to present fairly the financial position of the Company as of March 31, 20001 and the results of its operations and its cash flows for the three-month period ended March 31, 2001 and 2000. The results of operations for the interim periods are not necessarily indicative of the results of operations for the full year. For the year ended December 31, 2000, the Company incurred a net loss of $6,376,104 and experienced a significant decrease in working capital. For the first quarter ended March 31, 2001 the Company incurred a net loss, including expenses related to its proposed merger with Data Critical, of $1,166,088. In 2000, the Company's cost structure and operating results were negatively impacted by both continued increases in research and development expenses and the delay in the release of its PatientNet Wireless Network (PatientNet) product. The PatientNet product was released during the third quarter of 2000. The Company believes that the release of its PatientNet product will enable the Company to improve its operating performance during fiscal 2001. The Company began this quarter to reduce research and development expenses for fiscal 2001 and is presently re-negotiating the terms of its line of credit. However, if management is unable to execute its business plan, the Company may need to obtain additional financing or restructure its operations. The Company believes that existing cash resources, cash flows from operations and line of credit facility will be sufficient to fund the Company's operations for at least the next twelve months. 2. PENDING MERGER On March 12, 2001, we entered into a definitive agreement to merge with a wholly owned subsidiary of Data Critical Corporation, a leading provider of wireless patient monitoring systems. Under the merger agreement, VitalCom will become a wholly owned subsidiary of Data Critical, and our stockholders will receive 0.62 shares of Data Critical common stock for each share of VitalCom common stock held (other than shares with respect to which appraisal rights under Delaware law have been properly exercised). This exchange ratio is fixed, and will not be adjusted to reflect any increase or decrease in the market value of our common stock, or any increase or decrease in the market value of Data Critical's common stock, that may occur between the date on which the merger agreement was signed and the effective date of the merger. Consummation of the merger is conditioned on approval by the respective stockholders of both companies, as well as certain other events. However, certain of our stockholders, who hold an aggregate of approximately 61% of our outstanding common stock, have entered into voting agreements with Data Critical. Under these voting agreements they have agreed to vote in favor of the proposed merger. These stockholders have also granted Data Critical irrevocable proxies to vote their shares in favor of the merger. Meetings of Data Critical stockholders and VitalCom stockholders for the purpose of obtaining the necessary stockholder approvals have been scheduled to be held on June 7, 2001. Additional information concerning the proposed merger is contained in the joint proxy statement/prospectus pertaining to those meetings. 7 8 3. NET LOSS PER SHARE Net loss per share is computed by dividing net loss by the weighted average number of common and common equivalent shares outstanding. For the three-month periods ended March 31, 2001 and 2000, the diluted weighted average shares were equal to the basic weighted average shares due to the anti-dilutive effect the conversion of options would have given the Company's net loss for the period. 4. STOCK PLANS AND STOCKHOLDERS' EQUITY Stock Option Plans - The following is a summary of stock option transactions under the 1993 Stock Option Plan (the "1993 Plan") and 1996 Stock Option Plan (the "1996 Plan") for the three months ended March 31, 2001:

~~Enterprise-Wide~~NUMBER ~~OEM~~OF ~~Products~~NUMBER ~~Systems~~OF ~~Total~~PRICE PER OPTIONS SHARES SHARE EXERCISABLE ------------ --------------- ----------- ~~Three~~Balance, ~~months~~December ~~ended September 30~~31, 2000 ~~Revenues ....................... $~~1,~~517~~655,~~238~~626 $~~3,820,615 $ 5,337,853 Cost of revenues~~ 0.~~..............~~60 ~~806,786~~to ~~1,576,685 2,383,471 ---------- ---------- ----------- Gross profit ...................~~ $ ~~710,452 $2,243,930 $ 2,954,382 ========== ========== =========== Three months ended September 30, 1999 Revenues~~ 4.~~......................~~75 $3858,~~205,192~~449 $Granted ~~559~~7,~~383~~000 $ ~~3,764,575 Cost of revenues~~ 1.~~..............~~94 ~~1,615,487~~to ~~517,658~~ $2~~,133,145~~.00 ~~----------~~Exercised ~~----------~~0 --~~---------~~ ~~Gross~~Canceled ~~profit ................... $1~~(17,~~589,705~~526) $ ~~41,725 $~~ 1~~,631,430 ========== ========== =========== Enterprise-Wide OEM Products Systems Total ------------ --------------- ----------- Nine months ended September 30, 2000 Revenues~~ .~~......................~~88 ~~$6,205,215~~to $~~6,324,727 $12,529,942 Cost of revenues~~ 4.~~..............~~00 ~~3,105,806 2,612,049 5,717,855~~ ---------- --~~--------~~ ~~----------- Gross profit ................... $3~~Balance,~~099,409~~ ~~$3,712,678~~March ~~$ 6~~31,~~812,087~~ ~~==========~~2001 ~~========== =========== Nine months ended September 30~~1, ~~1999 Revenues ....................... $8~~645,~~428,759~~100 $~~3,746,170 $12,174,929 Cost of revenues~~ 0.~~..............~~60 ~~4,254,065~~to ~~1,682,068 5,936,133 ---------- ---------- ----------- Gross profit ...................~~ $4~~,174,694~~.75 $2937,~~064,102~~188 ~~$ 6,238,796~~ ========== ==~~======== ===========~~

At March 31, 2001, 780,785 shares were available for the grant of additional options under the 1993 Plan and 1996 Plan. There were no stock transactions under the 1996 Director Option Plan (the "Director Plan") for the three months ended March 31, 2001. At March 31, 2001, 60,000 shares were available for the grant of additional options under the Director Plan and no options were exercisable. The Company has reserved an aggregate of 450,000 shares of Common Stock for issuance under its 1996 Employee Stock Purchase Plan (the "ESPP"). The ESPP was adopted by the Board of Directors in January 1996 and approved by the Company's stockholders prior to the consummation of the Company's initial public offering in February 1996. The ESPP is intended to qualify under Section 423 of the Internal Revenue Code of 1986, as amended, and permits eligible employees of the Company to purchase Common Stock through payroll deductions of up to 10% of their compensation provided that no employee may purchase more than $25,000 worth of stock in any calendar year. The ESPP was implemented by an offering period commencing on February 14, 1996 and ending on the last business day in the period ending October 31, 1996. Each subsequent offering period (an "Offering Period") commences on the day following the end of the prior Offering Period and has a duration of six months. The price of Common Stock purchased under the ESPP is 85% of the lower of the fair market value of the Common Stock on the first or last day of each offering period. The ESPP will expire in the year 2006 In the years ended December 31, 1998, 1999 and 2000 the Company issued 52,703, 74,334 and 80,021 shares of Common Stock, under the ESPP for $145,264, $88,240 and $125,034 respectively. During the three months ended March 31, 2001, $57,083 has been withheld from employee earnings for stock purchases under the ESPP. 5. SEGMENT REPORTING Utilizing the management approach, the Company has broken down its business based upon sales through its two distribution channels. The Company does not allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, segment information reported includes only net sales, cost of sales and gross profit. Selected information regarding the Company's product sectors is as follows:

8 9 Cost of revenues ..................... 998,090 1,500,193 2,498,283 ---------- ---------- ---------- Gross profit ......................... $1,042,308 $1,660,747 $2,703,055 ========== ========== ========== Three months ended March 31, 2000 Revenues ............................. $2,354,675 $ 748,209 $3,102,884 Cost of revenues ..................... 1,296,174 541,952 1,838,126 ---------- ---------- ---------- Gross profit ......................... $1,058,501 $ 206,257 $1,264,758 ========== ========== ==========

6. RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, is effective for all fiscal years beginning after June 15, 2000. SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments embedded in other contracts and for hedging activities. Under SFAS 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company adopted SFAS 133 effective January 1, 2001. The adoption of SFAS 133 did not have a significant impact on the Company's financial position, results of operations, or cash flows. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CERTAIN STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q CONSTITUTE 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. ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL FACT MADE IN THIS FORM 10-Q ARE FORWARD-LOOKING. IN PARTICULAR, THE STATEMENTS HEREIN REGARDING INDUSTRY PROSPECTS AND FUTURE RESULTS OF OPERATIONS OR FINANCIAL POSITION ARE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS REFLECT THE COMPANY'S CURRENT EXPECTATIONS AND ARE INHERENTLY UNCERTAIN. ACTUAL RESULTS MAY VARY SUBSTANTIALLY FROM THESE FORWARD-LOOKING STATEMENTS. THE COMPANY DOES NOT UNDERTAKE AN OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, WHICH SPEAK ONLY AS OF THIS DATE, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW, AS WELL AS THOSE DISCUSSED IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2000. GENERAL Our solutions provide information that help large healthcare organizations improve care quality and more efficiently manage the care process, helping to reduce care-related expenditures. Our solutions include an advanced technical infrastructure based upon three fundamentals: (1) collection of time critical patient information through an open, wireless network; (2) data analysis using sophisticated software to reduce false alarms, provide a common look/feel and patient history analysis; and (3) real-time data distribution using LAN, WAN, wireless, and Internet based technologies. In addition to creating the technical infrastructure, we use information gathered from a clinical assessment process to recommend care process changes that optimize the value of the technology and help to standardize monitoring quality across the health system, and improve the flow of critical patient information to care providers. The result is faster access to information critical to making informed care decisions, and an improved ability to manage patient flow problems including bottlenecks and transfers, which can lead to improved care satisfaction, and reduced costs. Our solution called PatientNet(TM), collects patient monitoring or life support data from our proprietary ECG monitors and other manufacturers' bedside devices, sending the data over a RF network to a mission control-style central surveillance room. Trained technicians manning the mission control central surveillance room evaluate information acquired from ambulatory and point-of-care monitors for 48 to 56 patients each. In case of a patient emergency or other significant event, technicians use an integrated paging system to immediately contact the appropriate caregiver. Because the networks continuously distribute real-time patient information to patient viewers located throughout the healthcare enterprise, caregivers have immediate access to a patient's status. We believe that our PatientNet system enables hospitals to shorten patient stays in costly intensive care units, increase medical staff productivity, reduce costly patient transfers 9 10 and improve facility utilization. Since its introduction in 1991, our Enterprise-wide Monitoring Systems have been installed in more than 100 acute care facilities, with the largest network providing central surveillance of up to 300 patients located in multiple buildings. Our direct sales force sells the PatientNet system to large acute care hospitals and integrated health delivery networks ("IHDNs"). Our original equipment manufacturer ("OEM") channel sells central monitoring systems as well as individual components for use in equipment manufacturers and/or integrators' monitoring products. OEM products that we offer acquire data from our ambulatory ECG monitor and from the OEM customer's bedside monitoring devices or life support equipment. The central monitoring system and display software for each OEM customer is developed specifically to meet the specifications of a client. RESULTS OF OPERATIONS - THREE-MONTH PERIODS ENDED MARCH 31, 2001 AND MARCH 31, 2000 TOTAL REVENUES - Total revenues consist of revenue from sales of Enterprise-Wide Systems and support, and OEM products, together with fees for installation and servicing of Enterprise-Wide Systems. Total revenues increased 68% to $5.2 million in the three months ended March 31, 2001 from $3.1 million for the three months ended March 31, 2000. This increase in revenues was primarily due to an increase in shipments of Enterprise-Wide Systems products as compared to the same three months last year. Most of these revenues were from our new wireless networking product PatientNet(TM), which the Company began shipping in the third quarter of last year. GROSS MARGIN - Cost of goods sold generally includes material, direct labor, overhead and for Enterprise Wide Systems, installation and training expenses. The Company's overall gross margin depends on its sales mix in any given period, as certain products generate a higher gross margin than other products. Gross margin increased to 52.0% of revenues in the first quarter of 2001 compared to 40.8% of revenues for the first quarter of 2000. The increase in gross margin was primarily the result of a greater percentage of Enterprise-Wide Systems sold, which tend to have a higher content of software and generally generate a higher gross margin. Gross profit on OEM products also increased from 45% to 51% due to the mix of products shipped with higher contents of software. SALES AND MARKETING EXPENSES - Sales and marketing expenses include payroll, commissions and related costs attributable to Enterprise-Wide Systems and OEM revenues and marketing personnel, travel and entertainment expenses and other promotional expenses. Sales and marketing expenses were $1.5 million, or 29% of total revenues, in the three months ended March 31, 2001, compared to $1.6 million, or 52% of total revenues, for the three months ended March 31, 2000. The $117,687 decrease in sales and marketing expenses in the first quarter of 2001 compared to the first quarter of 2000 was primarily due to cost cutting efforts including a decrease in salary and related expenses from a reduction in headcount, along with maximizing the effectiveness of our direct sales team. These cost savings were slightly offset by an increase in sales commissions based on higher revenues for the first quarter of 2001. RESEARCH AND DEVELOPMENT EXPENSES - Research and development expenses include payroll and related costs attributable to research and development personnel, prototyping expenses, consulting and other costs. Research and development expenses were $1.5 million, or 30% of total revenues, in the three months ended March 31, 2001, compared to $1.8 million, or 58% of total revenues, in the three months ended March 31, 2000. The $268,729 decrease in the first quarter of 2001 compared to the first quarter of 2000 was primarily due to lower third party contractor expenses, partially offset by an increase in salary and related costs and outside legal fees in connection with patents. The Company has been decreasing its use of third party contractors for research and development since the Company introduced its new software, wireless and Internet-related technology products such as PatientNet(TM), PatientBrowser(TM), and MobilePatientViewer(TM) late last year. The Company expects that these outside contractor costs will continue to decline as these new products mature. GENERAL AND ADMINISTRATIVE EXPENSES - General and administrative expenses include accounting, finance, information systems, human resources, general administration, executive officers and professional fee expenses. General and administrative expenses were $877,822, or 17% of total revenues, in the three months ended March 31, 2001, compared to $578,487, or 19% of total revenues, in the three months ended March 31, 2000. The $299,335 increase in general and administrative expenses in the first quarter of 2001 compared to the first quarter of 2000 was primarily attributable to expenses incurred in relation to our proposed merger with Data Critical. 10 11 OTHER INCOME, NET - Other income, net, consists primarily of interest income earned on proceeds from the Company's initial public offering, net of payments made in respect of outstanding indebtedness. Other income, net, decreased to $51,292 in the three months ended March 31, 2001 compared to $166,314 in the three months ended March 31, 2000. The decrease resulted from a decrease in the Company's interest-earned on a decreased balance of cash and cash equivalents. PROVISION FOR INCOME TAXES: The Company recorded a minimum state tax provision of $9,000 for both of the three month periods ended March 31, 2001 and 2000. LIQUIDITY AND CAPITAL RESOURCES The Company has financed its operations (including capital expenditures) through net proceeds from the Company's February 1996 initial public offering, cash flow from operations, cash and cash equivalent balances, a bank line of credit and long-term debt. During the year ended December 31, 1996, the Company issued 2,300,000 shares of common stock in its initial public offering, raising $25.6 million, net of expenses. At March 31, 2001, the Company had $3.5 million in cash, cash equivalents and restricted cash, as compared to $6.2 million at December 31, 2000. At March 31, 2001, our principal sources of liquidity consisted of $3.5 million of cash, cash equivalents, and restricted cash and $5.0 million of available credit facilities. In March 2000, the Company renewed a secured lending arrangement (the "Agreement") with Silicon Valley Bank, providing for up to $5.0 million in total borrowings bearing interest at the bank's prime rate plus .50%. The Agreement, when it was entered into, required that the Company maintain, as a compensating balance, at least $2,500,000 in a money market fund designated by the bank. The Agreement, which would have expired in March 2001, has been extended for an additional 90 days pending completion of our proposed merger with Data Critical or, in the event that the merger is not completed, negotiation of a new lending arrangement with the bank. The Agreement imposes financial covenants that require that we maintain minimum liquidity levels and total liabilities to tangible net worth ratios, as well as specified annual and quarterly net loss (after taxes) amounts. The Company had no outstanding borrowings with the bank under the Agreement as of March 31, 2001 and, as of that date, was in compliance with all covenants under the Agreement except for a profitability covenant for which we have received a waiver. The bank has also waived the portion of the Agreement requiring the Company to maintain at least $2,500,000 in a money market fund that is designated by the bank. In the first three months of 2001, the Company used cash from operating activities of $2.6 million that primarily resulted from a $1.2 million net loss and an increase in accounts receivable of $1.6 million, which was due to an increase in revenue in the first quarter of this year of $528,798 compared to the fourth quarter of 2000. The Company used cash from investing activities of $29,485 that was used for the purchase of capital equipment. The Company provided no cash from financing activities in the first quarter of this year. In the first three months of 2000, the Company used cash in operating activities of $2.2 million that resulted from a $2.6 million net loss. The cash used in operating activities included $325,968 used for payroll and related costs, and $124,893 used for the decrease in accounts payable. This was partially offset by the $213,725 increase in accrued liabilities, $205,266 reduction in accounts receivable, and $174,434 in non-cash adjustments provided by depreciation and amortization of fixed assets and intangible assets. In the first three months of 2000, the Company provided $5.1 million in cash from investing activities of which $5.2 million was provided by the sale of short-term investments. Cash used for investing activities was $182,115 for the purchase of capital equipment. In addition, in the first three months of 2000, $106,604 in cash was provided by financing activities, principally, $113,992 in net proceeds from the exercise of employee stock options. The Company's principal commitment at March 31, 2001 consisted of a lease on its office and manufacturing facility. The Company believes that existing cash resources, cash flows from operations, if any, and line of credit facilities will be sufficient to fund the Company's operations for at least the next twelve months. 11 12 RECENT ACCOUNTING PRONOUNCEMENTS See Note 6 to the accompanying financial statements for a discussion of recent accounting pronouncements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our current policy is to not use derivative financial instruments. We do not currently have any significant foreign currency exposure because we do not transact business in foreign currencies. Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investments, if any, and on the increase or decrease in the amount of interest expense we must pay on our outstanding debt obligations. However, the risk associated with fluctuating interest expense is limited to the exposure related to those debt obligations and credit facilities that are tied to market rates. We do not believe that this risk is material. PART II. OTHER INFORMATION ITEM 5. OTHER INFORMATION On March 12, 2001, we entered into a definitive agreement to merge with a wholly owned subsidiary of Data Critical Corporation, a leading provider of wireless patient monitoring systems. Under the merger agreement, VitalCom will become a wholly owned subsidiary of Data Critical, and our stockholders will receive 0.62 shares of Data Critical common stock for each share of VitalCom common stock held (other than shares with respect to which appraisal rights under Delaware law have been properly exercised). This exchange ratio is fixed, and will not be adjusted to reflect any increase or decrease in the market value of our common stock, or any increase or decrease in the market value of Data Critical's common stock, that may occur between the date on which the merger agreement was signed and the effective date of the merger. Consummation of the merger is conditioned on approval by the respective stockholders of both companies, as well as certain other events. However, certain of our stockholders, who hold an aggregate of approximately 61% of our outstanding common stock, have entered into voting agreements with Data Critical. Under these voting agreements they have agreed to vote in favor of the proposed merger. These stockholders have also granted Data Critical irrevocable proxies to vote their shares in favor of the merger. Meetings of Data Critical stockholders and VitalCom stockholders for the purpose of obtaining the necessary stockholder approvals have been scheduled to be held on June 7, 2001. Additional information concerning the proposed merger is contained in the joint proxy statement/prospectus pertaining to those meetings. We believe the proposed merger, if completed, will integrate the technologies of two hospital wireless market leaders and will result in a broader alarm notification and networking portfolio of products for the combined companies and their partners and customers. The proposed merger involves certain significant risks. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Not applicable. (b) Reports on Form 8-K No reports on Form 8-K were filed during the reporting period. 12 13 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. VITALCOM INC. Dated: May 14, 2001 /s/ Frank T. Sample ---------------------------------------- Frank T. Sample Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) Dated: May 14, 2001 /s/ Scott E. Lamb ---------------------------------------- Scott E. Lamb Senior Director of Finance and Controller (Principal Financial and Accounting Officer) 13

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