Item 1. Business
This Business section and other parts of this Annual Report on Form 10-K, which we refer to as this Annual Report, contain forward-looking statements that involve risk and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those set forth in “Item 1A.
Item 1A. Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below together with all of the other information contained in Item 8 of this Annual Report, including the financial statements and the related notes appearing at the end of this Annual Report, before deciding whether to purchase any shares of our common stock. If any of the following risks occurs, our business, financial condition or operating results could materially suffer. In that event, the trading price of our common stock could decline and you may lose all or part of your investment.
If our eICU Program is not widely accepted, we will be unable to generate significant revenue growth.
We derive substantially all of our revenues from sales of our eICU Program and associated services, and we expect that we will continue to do so for the foreseeable future. As a result, widespread market acceptance of our eICU Program is critical to our future success. However, we are in a new and developing sector of the healthcare information technology industry and our future prospects are difficult to evaluate.
Factors that may negatively affect market acceptance of our program and that are beyond our control, include:
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reluctance by hospitals to reduce their reliance on traditional ICU practices, monitoring systems and on-site personnel;
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inability of hospitals to successfully integrate our eICU Program into an ICU due to lack of on-site physician adoption, including the resulting harm to our reputation;
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financial and budget constraints of hospitals; and
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the availability, price, performance and reliability of competing products and services;
In addition, the price, performance and reliability of our products and services will be key factors for market acceptance of our eICU Program. If we are not successful in achieving and maintaining widespread market acceptance of our eICU Program, we may never become profitable.
The loss of our U.S. patent or any significant limitation in its scope could provide less legal protection for our business and products by permitting competitors to more easily enter the market and to utilize methods developed by us.
Our issued U.S. patent has been and may in the future be challenged by third parties. One of our competitors, iMDsoft, Ltd., has asked the U.S. Patent Office to declare an interference and revoke our issued U.S. patent, and it has filed a second request with the U.S. Patent Office for a reexamination of all 26 claims of our patent. During the second reexamination proceeding, we amended our patent claims and presented arguments to the U.S. Patent Office, and are awaiting the official office action response from the U.S. Patent Office. In addition, Cerner Corporation has filed a lawsuit against us seeking a declaration that our patent is invalid and unenforceable. We cannot predict the outcome of these or any future proceedings that may challenge our rights in or the validity or enforceability of our patent. The loss of our patent or any significant limitation in the scope of its claims would make it easier for third parties to imitate, copy or reverse engineer the techniques and methods reflected in the claims of our patent.
If our products are alleged or found to infringe the intellectual property rights of others, we could be involved in costly disputes or disruptions and be required to redesign our products or methods, pay royalties or enter into license agreements with third parties.
From time to time, third parties may initiate legal proceedings against us, alleging that our products or technologies infringe their intellectual property rights. As the number of products in our target market increases and the functionality of these products overlaps, we believe that technology owners, users and other parties may become increasingly subject to infringement claims. If a patent with claims identical or substantially similar to our issued U.S. patent were to be issued to iMDsoft as a result of the interference proceeding in the U.S. Patent Office or as a result of iMDsoft’s second reexamination request, iMDsoft might attempt to bring an infringement claim against us to enforce its patent. Any allegation of infringement against us could be time consuming and expensive to defend or resolve, result in substantial diversion of management resources, cause product shipment delays, or force us to redesign our products or methods or enter into royalty or license agreements rather than dispute the merits of the allegations. We may not be able to obtain any required royalty or license agreements on terms acceptable to us, or at all, particularly if the third party is developing or marketing a product competitive with our products or technology. Even if we are able to obtain a license, the rights may be nonexclusive, which would give our competitors access to the same intellectual property. If we are not successful in defending any allegations of infringement or procuring a royalty or license agreement, we could be required to pay substantial damages and be foreclosed from marketing our current product.
Third parties may also assert infringement claims against our customers. These claims may require us to initiate or defend protracted and costly litigation on behalf of our customers, regardless of the merits of these claims. If any of these claims succeed, we may be forced to pay damages on behalf of our customers or may be required to obtain licenses for the products they use. If we cannot obtain all necessary licenses on commercially reasonable terms, our customers may be forced to stop using our products and we could be liable for damages to our customers.
Any failure to protect our intellectual property rights could materially and adversely affect our business and financial condition.
Our success will depend in part on our ability to protect our intellectual property rights. We rely on a combination of trade secrets, copyrights, trademarks, patents and patent applications, licenses and employee and third-party nondisclosure agreements and other protective measures to protect our intellectual property rights. However, these protections may not be adequate to prevent our competitors from copying or reverse-engineering our products and technologies. In addition, our competitors may independently develop technologies that are substantially similar or superior to our technology. To protect our trade secrets and other proprietary information, we generally require our employees, consultants, contractors and outside collaborators to enter into written nondisclosure agreements. These agreements may not provide meaningful protection to prevent any unauthorized use, misappropriation or disclosure of our trade secrets, know-how or other proprietary information. If we are unable to protect our intellectual property rights, our business and financial condition could suffer materially.
Our issued patents or any patents that we may obtain in the future might not provide us with any competitive advantages, or may be challenged by third parties. We cannot guarantee that any patents will issue from our pending patent applications or any future patent applications that we might make. In addition, patents may not protect our products and technologies if competitors devise ways of making these or similar products without infringing our patents. Furthermore, even if valid and enforceable patents cover our products and technologies, the patents will provide protection only for a limited period of time.
Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which we might market our offerings. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States, and domestic and international mechanisms for enforcement of intellectual property rights may be inadequate.
We have been sued by Cerner Corporation over our U.S. patent. A ruling by the court in favor of Cerner on one or more of its claims could materially and adversely affect our business and financial condition.
Cerner Corporation, a supplier of healthcare information technology, including a solution related to the delivery of care to patients in ICUs, has filed a lawsuit against us over our only issued U.S. patent. In this matter, Cerner requests a declaration that, among other things: our patent is invalid and unenforceable; our patent has not been infringed by Cerner; and actions that we have taken have threatened Cerner and its customers with infringement of our patent and constituted unfair competition and tortious interference with Cerner’s customer contracts and expected business. Cerner has also alleged that we have engaged in patent misuse by making statements, assertions and representations that are false, misleading and misrepresent the scope and substance of our patent and that, as a result, our patent is unenforceable.
Among other things, Cerner has asked the court for an award of unspecified damages and an injunction preventing us from threatening or initiating infringement litigation under our patent against Cerner. We are unable to predict the amount of monetary damages or other relief the court may award Cerner if the court were to rule in favor of Cerner on one or more of its claims. A significant monetary judgment against us could materially and adversely affect our business and financial condition. This litigation and any other litigation we may face in the future, whether or not it is ultimately resolved in our favor, could result in a significant expense to us and divert the efforts of our management. We have filed a counterclaim against Cerner alleging that, among other things, they have infringed our patent. If the court issues an injunction against us and we are unsuccessful in the pursuit of our infringement claim against Cerner, we will be unable to use our patent to prevent Cerner from marketing and selling its competing product offerings to our customers and potential customers. If we did not adequately respond to this competition, our business, financial condition and operating results could be harmed.
Increasing competition for our products and services could make it harder for us to sell our eICU Program.
The market for healthcare information technology solutions and services is intensely competitive and rapidly evolving. In particular, the healthcare information technology systems market is characterized by frequent software product introductions and enhancements and evolving industry standards and requirements. Although the market for software products that provide an advanced remote monitoring technology for hospital ICU beds is relatively new and still developing, we face increasing competition from other companies in the healthcare information technology market. Our actual and potential competitors include companies that provide critical care information systems or enterprise clinical and hospital information systems.
Many of our actual and potential competitors have significantly greater financial, technological and other resources and name recognition than we do and more established distribution networks and relationships with healthcare providers. Because of their greater resources, many of these companies can respond more quickly to new or emerging technologies and standards and changes in customer requirements. These companies may be able to invest more resources in research and development, strategic acquisitions, sales and marketing, patent prosecution and litigation and finance capital equipment acquisitions for their customers. Our actual and potential competitors may develop new products, services or technologies that could render our products or technologies obsolete or noncompetitive. If our actual or potential competitors incorporate a competing product or service into their existing product offerings, the incremental cost to potential customers for that competing product or service may be lower than the price for our program. Because we do not and for the foreseeable future will not have the financial, technological and other resources and marketing, distribution and support capabilities of our actual or potential competitors, we may not be able to compete successfully. If we do not adequately respond to competitive pressures, our business, financial position and operating results may be harmed.
If we are required to change the way in which we recognize revenue in the future, our financial results could fluctuate significantly, which may result in volatility in the price of our common stock.
We provide our customers with a perpetual license of our software, clinical and technical implementation services and ongoing support services under a three-year support agreement. We do not yet have objective and reliable evidence of the fair value of each of the elements of our arrangements with our customers, including our ongoing support services. Accordingly, we recognize revenue from customer arrangements ratably over the term of the support agreement.
If, in the future, we are able to objectively and reliably determine the fair value of the elements of our customer arrangements, we will begin to recognize all of the revenue from delivered software and implementation services immediately upon customer acceptance. If a significant number of customers whose support agreements are scheduled for renewal do, in fact, renew at a consistent renewal rate with similar terms, we may be able to objectively and reliably determine the fair value of the elements of our customer agreements as early as 2008.
Accordingly, our future financial results may vary significantly from our historical financial results. In addition, a change in our revenue recognition policy combined with our lengthy sales cycle may cause our financial results to fluctuate significantly from quarter to quarter, which may result in volatility in the price of our common stock.
We have a relatively short operating history and a limited number of customers. We are unable to predict whether our customers will renew their support agreements after the initial term, and low renewal rates could adversely affect our revenues and our business.
Our support agreements with our customers typically have a term of three years and are subject to renewal. Because of our relatively short operating history and our limited number of customers, the initial term of most of our support agreements has not yet expired. Accordingly, we have limited historical data with respect to renewal rates, including the renewal and non-renewal of support agreements whose initial terms have expired, and are unable to predict the extent to which our customers will renew their support agreements in the future after the expiration of their initial terms. Renewal rates for our support agreements may fluctuate as a result of a number of factors, including the level of customer satisfaction with our program and our customers’ ability to continue their operations and spending levels. If a significant number of our customers fail to renew their support agreements, our revenues may be harmed and our business may suffer.
A downturn or upturn in our sales may not be immediately reflected in our operating results because we recognize revenues from license fees and implementation fees ratably over the term of our agreements.
We recognize revenues from license fees and implementation fees ratably over the term of our support agreements with our customers, which is typically three years. As a result, most of the revenues that we report in each quarter reflect our recognition of deferred revenues from agreements entered into during previous periods. Because of this revenue recognition policy, a decline in new customer sales or renewals of support agreements in any quarter or series of quarters may not be immediately reflected in our operating results and may negatively affect our revenues in future quarters. In addition, it is difficult for us to rapidly increase our revenues as of result of entering into new customer agreements in any period because revenues from new customers must be recognized over the term of our support agreements.
Our revenues from existing customers may decrease and we may be required to provide refunds to existing customers if we offer lower pricing terms for comparable purchases to another customer.
Under most of our existing customer agreements, if we offer a lower price on license fees to new customers making comparable purchases from us, we must offer that same lower price to those existing customers. Some of our existing customer agreements also expressly require us to refund or credit license fees previously paid by the existing customer if we offer a lower price on license fees to new customers making comparable purchases. These pricing terms limit our ability to negotiate discounted license rates to new customers without triggering an obligation to provide the same discount to many of our existing customers who previously entered into agreements for comparable purchases. These pricing terms may decrease the revenue that we receive from our existing customers, limit our potential revenue growth and negatively affect our ability to compete with other companies based on pricing. We expect that we will continue to include these pricing terms in our new customer contracts.
We have incurred significant operating losses in the past and may incur significant operating losses in the future.
We had operating income in 2006, but from our inception in March 1998 to 2005 we incurred significant operating losses and we could incur significant operating losses again in the future. Our accumulated deficit was approximately $28.9 million as of December 31, 2006. In addition, we expect our operating expenses to increase substantially in the future as we expand our sales and marketing activities, increase our product development efforts, hire additional personnel and comply with the requirements related to being a public company. If we cannot increase our revenues enough to offset these expected increased expenses, or the increase in expenses exceeds our expectations, we may have additional operating losses in the future.
Defects in or performance problems with our eICU Program could diminish demand for our products and services and harm our reputation.
Any errors, defects or other performance problems with our eICU Program could affect critical aspects of patient care. Our program may have errors or defects that customers identify after they begin using it. In that event, our customers may elect not to renew our support agreements after the expiration of their initial terms or delay or withhold payment to us. In addition, because our program depends on the proper functioning of our customers’ hardware and internal network and third-party software products, any associated defects or malfunctions could leave our customers unable to access or use our program or lead to errors. Even though the performance of our customers’ hardware and network connections and third-party software products are outside our control, any associated defects or malfunctions could make our customers less likely to renew their support agreements with us after the expiration of their initial terms, negatively affect patient care, adversely affect future sales of our eICU program and harm our reputation.
Product liability claims may require us to pay damages, reduce the demand for our eICU Program and harm our reputation.
Our business exposes us to a risk of product liability claims and other adverse effects of product failures. We provide products that, among other things, assist intensivists and nurses in monitoring and making treatment decisions regarding the care given to acutely ill patients. Our customers or their patients may assert claims against us in the future alleging that they suffered damages due to a defect, error or other failure of our products or services. A product liability claim could subject us to significant legal defense costs and adverse publicity regardless of the merits or eventual outcome of the claim. Although we attempt to limit by contract our liability for damages arising from negligence, errors or mistakes, these contractual provisions may not be enforceable or may not otherwise protect us from liability for damages. For example, we recently were named as a co-defendant in a lawsuit filed against one of our customers and several physicians claiming negligent treatment and care of a patient in the customer’s intensive care unit. We presently are unable to predict the outcome of the claims against us, however, or to quantify any effect that they might have on our business, financial condition or operating results. In addition, we maintain general liability insurance, including product liability insurance. However, this coverage may not be sufficient for one or more claims against us or otherwise continue to be available on terms acceptable to us. The insurer also could disclaim coverage as to any future claim. A successful claim brought against us that is uninsured or under-insured could materially harm our business, financial condition or operating results. A product liability claim also could harm our reputation, adversely affect future sales of our eICU program and lead to a decline in revenues.
Our inability to effectively manage our growth could adversely affect our business and our operating results.
We have expanded our operations rapidly in recent years and expect continued growth in our operations. In addition, a component of our growth strategy is to acquire and form strategic partnerships with complementary businesses. We are still in the process of developing and implementing our operating and financial systems, including our internal systems and controls. Our management will be required to devote considerable time to this process, which will reduce the time they will have to implement our business and expansion plans. To manage our business and planned growth effectively, we must successfully develop, implement, maintain and enhance our financial and accounting systems and controls, integrate new personnel and businesses and manage expanded operations. Our growth could require significant capital expenditures and may divert financial resources from other projects, such as the development of new services or product enhancements. If our management is unable to effectively manage our growth, our expenses may increase more than expected, our revenues could decline or grow more slowly than expected and we may be unable to implement our business strategy.
Our inability to successfully introduce new, enhanced and competitive products that keep pace with rapidly changing technology, industry standards and customer requirements could adversely affect our ability to compete effectively.
The markets for our products and services are characterized by rapidly changing technology and evolving industry standards, including developments in required regulatory certifications. The introduction of products embodying new technology and the emergence of new industry standards could render our existing products obsolete or noncompetitive and could exert pricing pressures on our existing products. It is critical to our success for us to anticipate changes in technology, industry standards and customer requirements and to successfully acquire, develop and introduce new, enhanced and competitive products on a timely basis. We may not have adequate resources available to develop new technologies or products or be able to successfully develop new products or introduce new applications for existing products. Any new products and applications that we develop may not achieve market acceptance and the introduction of new products or technological developments by others may render our products obsolete. In addition, uncertainties about the timing and nature of new and enhanced products or technologies could increase our development expenses. If we fail to develop products that are competitive in technology and price, satisfy certification standards and meet customer needs, our market share will decline materially and our business, revenues, financial condition and operating results would suffer materially.
Any loss of the third-party intellectual property and technology licenses on which we rely in providing our eICU Program could result in additional costs or interruptions in the functionality of our products and services.
We rely on intellectual property and technology, such as software and content, which we license from third parties and incorporate into our eICU Program. If any of our third-party suppliers were to change product offerings, increase prices or terminate our licenses or supply contracts, then we might need to seek alternative suppliers and incur additional internal or external development costs to ensure continued performance of our eICU Program. These alternatives may not be available on attractive terms, or may not be as widely accepted or as effective as the intellectual property or technology of our existing suppliers. Any loss of the right to use any of this intellectual property or technology could result in interruptions in the full functionality of our eICU Program.
We are dependent on our senior executive management, and the loss of any member of our senior executive management may prevent us from managing and growing our business effectively.
Our future success depends largely on the continued service of our senior executive management, especially Mr. Frank T. Sample, our President, Chief Executive Officer and Chairman of our board of directors, Dr. Brian Rosenfeld, our Executive Vice President and Chief Medical Officer, and Dr. Michael Breslow, our Executive Vice President, Clinical Research and Development. Other than Mr. Sample, none of our senior executives has an employment agreement. The loss of any member of our senior executive management could materially harm our ability to manage and grow our business effectively. In that event, we might not be able to replace any member of our senior executive management in a timely manner, or at all, on acceptable terms.
We depend on highly specialized personnel, and the loss or failure to identify, hire, develop, motivate and retain these personnel could adversely affect our ability to grow our business.
Our future success and the execution of our growth strategy depend on our continued ability to identify, hire, develop, motivate and retain highly specialized personnel for technical, clinical, management and sales positions within our organization. For example, we must identify experienced candidates for sales positions who can effectively communicate the costs and clinical and information technology benefits of our products and services to our customers. In addition, we rely on software engineers with high levels of experience in designing and developing our software solutions. Our potential competitors, employers in other industries, academic institutions and governmental entities and organizations also often seek persons with similar qualifications. Many of these potential competitors have greater financial resources than we do. As a result, we may not be able to identify and hire the personnel we need in a timely manner.
In addition, to hire, motivate and retain these personnel, we believe we must provide them with a competitive compensation package, which may include stock-based incentives, such as restricted stock or options. Increases in shares available for issuances under our equity incentive plan generally may require stockholder approval, and our stockholders may not approve future increases. Recent changes in the accounting for stock options may cause us to issue fewer stock options and rely more on restricted stock grants instead, which may be less attractive to potential employees. If this occurs, we may find it more difficult to hire, motivate and retain highly specialized personnel, which could adversely affect our ability to grow our business.
Any efforts we may make in the future to expand our eICU Program beyond the adult ICU market may not yield a sufficient return on our investment.
To date, we have focused our business on providing our eICU Program primarily to multi-hospital systems. However, part of our strategy is to evaluate opportunities to offer our eICU Program to hospitals to monitor lower acuity beds, emergency departments, and other special care units. Any efforts we make to expand beyond the adult ICU market may never result in significant revenue growth for us. In addition, our efforts to expand our eICU Program beyond the adult ICU market may divert management resources from existing operations and require us to commit significant financial resources to an unproven business.
We intend to increase sales of our eICU Program to government agencies, which subjects us to risks inherent in government contracts.
We intend to increase sales of our eICU Program to healthcare facilities operated by the U.S. federal and state government and government agencies, including by acting as subcontractor under government prime contracts. Traditionally, the opportunities to generate significant profit margins under government contracts are limited. Furthermore, as a party to government contracts, we are subject to complex laws and regulations relating to the formation, administration and performance of government contracts. Failure to comply with these laws and regulations may subject us to civil and criminal penalties and administrative sanctions. In addition, government customers are subject to stringent budgetary constraints and political considerations. Our future business, revenues and operating results may be adversely affected if levels of government expenditures and authorizations for spending on healthcare information technology decrease, remain constant or shift to programs in areas where we do not provide products and services.
Furthermore, government parties under government contracts, as well as the prime contractor, typically enjoy broad discretion to terminate contracts for their convenience. Changes in government programs, adoption of new laws or regulations and delays or changes in the annual process for appropriating government funding, among other factors, may cause government agencies or prime contractors to reduce purchases under existing contracts, terminate existing contracts for convenience or decline to renew contracts or exercise contract options, any of which could impair our future business, financial position and operating results.
As a government contractor, we may be subject to frequent government audits. If any of our costs are found to be unallowable, non-allocable or unreasonable, the costs may not be reimbursed and any costs already reimbursed may need to be refunded. These adjustments may materially impair our revenues. If, during the course of an audit, the government discovers any improper or illegal activities, we may be subject to civil, criminal or administrative penalties.
We intend to expand our international sales efforts, which exposes us to risks inherent in international operations, and we do not have substantial experience in international markets.
We plan to expand sales of our eICU Program in markets outside the United States. We have very limited experience in marketing, selling and supporting our program abroad. Expansion of our international operations will require a significant amount of attention from our management and substantial financial resources and will subject us to risks and challenges that we would not otherwise face if we conducted our business only in the United States. The risks and challenges associated with operations outside the United States may include:
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localization of our program, including translation into foreign languages and associated expenses;
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laws and business practices favoring local competitors;
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compliance with multiple, conflicting and changing governmental laws and regulations, including healthcare, employment, tax, privacy, healthcare information technology and data protection laws and regulations;
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laws regulating exports of technology products from the United States and foreign government restrictions on acquisitions of U.S.-origin products;
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fluctuations in foreign currency exchange rates;
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difficulties in staffing and managing foreign operations; and
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longer accounts receivable payment cycles and other collection difficulties.
If one or more of these risks materialize in connection with the planned expansion of our international sales and operations, our planned expansion may be unsuccessful and our financial condition and operating results could be materially harmed.
The long sales cycles for our eICU Program may cause our operating results to fluctuate significantly, which may result in volatility in the price of our common stock.
Our eICU Program has a lengthy sales cycle, which is at least nine months and typically takes longer. A customer’s decision to implement our eICU Program involves a significant commitment of its resources and a lengthy product evaluation and qualification process. These sales may be subject to delays based on a customer’s internal procedures for approving large expenditures and other factors beyond our control. We may incur substantial sales and marketing expense and expend significant management efforts during the sales cycle, regardless of whether we make a sale. As a result of the lengthy sales cycles for our eICU Program, it is difficult for us to predict the quarter in which a particular sale may occur. Accordingly, our operating results may vary significantly, which in turn could create volatility in the price of our common stock.
Acquisitions and investments could result in integration difficulties, dilution or other adverse financial consequences.
We may acquire other businesses that we believe are complementary to our business. The pursuit of acquisitions may divert the attention of management and cause us to incur various expenses identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated. If we acquire additional businesses, we may not be able to integrate the acquired operations successfully with our business and we may not achieve the anticipated benefits from the acquired business. If we are unable to integrate any new business successfully, we could be required either to dispose of the acquired operations or to undertake changes to the acquired operations in an effort to integrate them with our business. The acquired business may never generate sufficient revenues to offset acquisition costs. Future acquisitions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could harm our financial condition. Acquisition financing, if needed, may not be available on favorable terms.
The requirements related to being a public company will subject us to increased costs and may strain our resources and distract our management. If we do not comply with these requirements, we may be subject to penalties and investors may lose confidence in us.
As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, the Sarbanes-Oxley Act of 2002 and the rules and regulations of the NASDAQ Stock Market. These requirements and our anticipated growth are likely to place a considerable strain on our financial and management systems, processes and internal controls, as well as on our personnel. Accordingly, our management’s attention may be diverted from other business concerns. We will be required to document and test our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, which will require us to document and possibly make significant changes to our internal control over financial reporting. We may be required to improve our financial and managerial controls, reporting systems and procedures, to incur significant expenses to make such improvements and to hire additional personnel. We also expect these new rules and regulations to make it more difficult and expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to obtain the same or similar coverage.
We may not be able to complete our evaluation, testing and remediation actions required by Section 404 in a timely manner. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, including the Securities and Exchange Commission or the NASDAQ Stock Market. This type of action could adversely affect our financial results or investors’ confidence in our company and our ability to access the capital markets. In addition, the controls and procedures that we implement may not comply with all of the relevant rules and regulations of the Securities and Exchange Commission and the NASDAQ Stock Market. If we fail to develop and maintain adequate controls and procedures, we may be unable to provide the required financial information in a timely and reliable manner, which could cause a decline in our stock price and adversely affect our ability to raise capital.
Because our operating results may fluctuate significantly and may be below the expectations of analysts and investors, the market price for our stock may be volatile.
Our operating results are difficult to predict and may fluctuate significantly in the future. As a result, our stock price may be volatile. The following factors, many of which are outside our control, can cause fluctuations in our operating results and volatility in our stock price:
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the size, timing, terms and conditions of orders from our customers;
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changes in hospitals’ budgets and procurement policies and priorities, and funding delays;
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new competitors and the introduction of enhanced products from new or existing competitors;
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expenses incurred in pursuing and closing acquisitions and in follow-up integration efforts;
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unforeseen legal expenses, including litigation costs;
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unanticipated delays or problems in releasing new products and services; and
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the amount and timing of our investments in research and development activities.
The deferral or loss of one or more significant contracts could materially and adversely affect our operating results, particularly if there are significant sales and marketing expenses associated with the deferred or lost contracts. Additionally, we base our current and future expense levels on our internal operating plans and sales forecasts, and our operating costs are to a large extent fixed. As a result, we may not be able to sufficiently reduce our costs to compensate for an unexpected near-term shortfall in revenues.
Actual or anticipated fluctuations in our operating results could cause our stock price to decline. Due to fluctuations in our operating results, a period-to-period comparison of our operating results may not be a good indication of our future performance. In any particular quarter or quarters, our operating results could be below the expectations of securities analysts or investors and our stock price could decline as a result.
We might require additional capital to support our business growth, and this capital might not be available.
We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the acquisition and integration of additional businesses, enhancing existing products and services, accelerating our research and development efforts and further developing our sales and marketing channels and capabilities. Accordingly, we may need to engage in private or public equity or debt financings to secure additional funds. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock, including shares of common stock sold in this offering. Any debt financing obtained by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain required financing on terms satisfactory to us, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.
If we fail to obtain and maintain necessary U.S. FDA clearances for our products and indications or if clearances for future products and indications are delayed or not issued, our business would be harmed.
Our eICU Program and related products are classified as medical devices and are subject to extensive regulation in the United States by the FDA and other federal, state and local authorities. These regulations relate to manufacturing, labeling, sale, promotion, distribution, importing and exporting and shipping of our products. In the United States, before we can market a new medical device, or a new use of or claim for an existing product, we must first receive either 510(k) clearance or premarket approval from the FDA, unless an exemption applies. Both of these processes can be expensive and lengthy and entail significant user fees, unless exempt. The FDA’s 510(k) clearance process usually takes from 90 days to over a year from the date of a complete filing, depending on the number of questions the FDA has concerning the submission. The process of obtaining premarket approval is much more costly and uncertain than the 510(k) clearance process. It generally takes from one to three years, or even longer, from the time the premarket approval application is submitted to the FDA until an approval is obtained. The FDA cleared our eICU Program through the 510(k) notification process.
Medical devices may be marketed only for the indications for which they are approved or cleared. The FDA may not approve or clear indications that are necessary or desirable for successful commercialization. Indeed, the FDA may refuse our requests for 510(k) clearance or premarket approval of new products, new intended uses or modifications to existing products. Our clearances can be revoked if safety or effectiveness problems develop.
After clearance or approval of our products, we are subject to continuing regulation by the FDA. If we fail to comply with these FDA regulations, our business could suffer.
The FDA could object to our post-market activities. We are subject to continuing regulation by the FDA, including the requirements that our facilities be registered and our devices listed with the agency. We are subject to Medical Device Reporting regulations, which require us to report to the FDA if our products may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur. We also are subject to the notices of correction or removal and recall regulations, which require us to report to the FDA about corrections and removals in cases in which the correction or removal was initiated to reduce a risk to health posed by the device or to remedy a violation of the FDA Act caused by the device that may present a risk to health, and maintain records of other corrections or removals. The FDA closely regulates promotion and advertising and our promotional and advertising activities could come under scrutiny. If the FDA objects to our promotional and advertising activities or finds that we failed to submit reports under the Medical Device Reporting regulations, for example, the FDA may allege our activities resulted in violations.
The FDA has broad enforcement powers. Our failure to comply with applicable regulatory requirements could result in enforcement action by the FDA, which may include any of the following sanctions:
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untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;
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repair, replacement, refunds, recall, seizure or removal of authority to distribute our products;
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operating restrictions, partial suspension or total shutdown of production;
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refusing a request for 510(k) clearance of new products;
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withdrawing 510(k) clearance or premarket approvals that have already been granted; and
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criminal prosecution.
If any of these events were to occur, they could harm our business.
The FDA could retroactively determine that modifications that we have made to our eICU Program following FDA clearance were improper and require us to stop marketing and recall the modified products.
Any modification to an FDA-cleared device that could significantly affect its safety or effectiveness or that would constitute a major change in its intended use requires a new 510(k) clearance or a premarket approval. We may be required to submit extensive pre-clinical and clinical data depending on the nature of the changes to our products. We may not be able to obtain additional 510(k) clearances or premarket approvals for modifications to, or additional indications for, our existing products in a timely fashion, or at all. Delays in obtaining future clearances or approvals would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our revenues and operating results. We have made modifications to our eICU Program in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. We are not required to notify the FDA of modifications to our eICU Program that do not require additional clearances or approvals. However, the FDA may become aware of these modifications in connection with a periodic inspection or a proposed modification that requires additional FDA clearance or approval. If the FDA requires new clearances or approvals for the modifications that we have made, we may be required to recall and to stop marketing the modified devices, which could harm our operating results and require us to redesign our products. In addition, we could be subject to fines, penalties and other sanctions authorized by the FDA Act.
Federal regulatory reforms may adversely affect our ability to sell our products profitably.
From time to time, legislation is drafted and introduced in the U.S. Congress that could significantly change the statutory provisions governing the clearance or approval, manufacture and marketing of a medical device. In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products. It is impossible to accurately predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of any changes may be.
If we fail to comply with the FDA’s Quality System Regulation, our manufacturing operations could be halted and our business would suffer.
We are currently required to demonstrate and maintain compliance with the FDA’s Quality System Regulation. The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products. The FDA enforces the QSR through periodic unannounced inspections. We have been, and anticipate in the future being, subject to these inspections. Our failure to comply with the QSR or to take satisfactory corrective action in response to an adverse QSR inspection could result in enforcement actions, including a public warning letter, a shutdown of or restrictions on our manufacturing operations, delays in approving or clearing a product, a recall or seizure of our products, fines, injunctions, civil or criminal penalties, or other sanctions, any of which could cause our business and operating results to suffer.
We may face additional compliance costs and liability risks under HIPAA.
Our eICU Program involves the storage and transmission of patients’ personal information, much of which is subject to regulation under HIPAA. Federal regulations issued in accordance with HIPAA impose national health data standards on healthcare providers that conduct electronic health transactions, healthcare clearinghouses that convert health data between HIPAA-compliant and non-compliant formats and health plans. Failure to comply with these standards under HIPAA may subject our customers to civil monetary penalties and, in some circumstances, criminal penalties. These HIPAA standards include:
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transaction and code set standards that prescribe specific transaction formats and data code sets for specified electronic healthcare transactions;
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privacy standards that protect individual privacy by limiting the uses and disclosures of individually identifiable health information; and
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data security standards that require covered entities to implement administrative, physical and technological safeguards to ensure the confidentiality, integrity, availability and security of individually identifiable health information in electronic form.
Under HIPAA, covered entities may be subject to civil monetary penalties in the amount of $100 per violation, capped at a maximum of $25,000 per year for violation of any particular standard. Also, the U.S. Department of Justice may seek to impose criminal penalties for some violations of HIPAA. Criminal penalties under the statute vary depending upon the nature of the violation but could include fines of not more than $250,000 and imprisonment. In addition, criminal penalties could be imposed under other federal statutes.
Although we are not directly regulated by HIPAA, our customers are mandated by HIPAA to enter into written agreements with us, known as business associate agreements, that require us to safeguard individually identifiable health information. Business associate agreements typically include:
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a description of our permitted uses of individually identifiable health information;
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a covenant not to disclose the information other than as permitted under the agreement and to make our subcontractors, if any, subject to the same restrictions;
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assurances that appropriate administrative, physical and technical safeguards are in place to prevent misuse of the information;
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an obligation to report to our customer any use or disclosure of the information not provided for in the agreement;
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a prohibition against our use or disclosure of the information if a similar use or disclosure by our customer would violate the HIPAA standards;
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the ability for our customers to terminate the underlying support agreement if we breach a material term of the business associate agreement and are unable to cure the breach;
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the requirement to return or destroy all individually identifiable health information at the end of our support agreement; and
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access by the Secretary of the Department of Health and Human Services to our internal practices, books and records to validate that we are safeguarding individually identifiable health information.
We have agreed in many of our customer contracts to indemnify our customers for civil liabilities that they may incur as a result of our breach of the business associate agreement or our HIPAA-related obligations under the customer contract.
Legal and industry standards regarding compliance with HIPAA, including procedures and safeguards that companies like ours will be required to implement, are likely to continue to evolve. In addition, the HIPAA security rules allow covered entities a flexible approach in deciding what security measures to use, taking into account the size, complexity and capabilities of the covered entity, the covered entity’s technical infrastructure, hardware, and software security capabilities, the costs of security measures and the probability and criticality of potential risks to electronic individually identifiable health information. Thus the standard for compliance may vary from one customer to another. As a result, we may not be able to adequately address the business risks created by HIPAA and its implementation. Furthermore, we are unable to predict what changes to HIPAA, or the regulations issued pursuant to HIPAA, might be made in the future or how those changes could affect our business or the costs of compliance with HIPAA.
We may face compliance costs and liability risks under other privacy protection laws and regulations.
Other regions or countries in which we plan to do business also regulate the storage, transfer and disclosure of patient information, which may require us to take different or additional compliance measures that may involve material costs or may otherwise affect our ability to provide our program. We are unable to predict what, if any, the impact the introduction or amendment of privacy laws and regulations outside the United States will have on our compliance costs or our ability to obtain and retain customers outside of the United States.
If our security measures are breached and unauthorized access is obtained to patient data, we may face liabilities and our program may be perceived as not being secure, causing customers to curtail or stop using our program, which may lead to a decline in revenues.
We are required to implement administrative, physical and technological safeguards to ensure the security of the patient data that we store. These safeguards may fail to ensure security of patient data, thereby subjecting us to liability, including civil monetary penalties and possible criminal penalties. If our security measures are breached, whether as a result of third-party action, employee error, malfeasance or otherwise, and, as a result, someone obtains unauthorized access to patient data, our reputation will be damaged, our business may suffer and we could incur significant liability. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures.
Our stock price may be volatile, and your investment in our common stock could suffer a decline in value.
Our stock price nevertheless may be volatile. The following factors, in addition to the other risks described in this report, may have a significant impact on the market price of our common stock:
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regulatory developments and funding priorities;
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market conditions for our products and services in general;
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announcements of technological innovations or new products by us or our competitors;
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adoption of industry standards that our products and services do not satisfy;
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the loss of any of our key management or technical personnel;
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restatements of our financial results and material weaknesses in our internal controls;
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changes in financial estimates or recommendations by securities analysts;
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the results of the pending, and any future, intellectual property-related lawsuits, claims or actions involving us;
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sales of large blocks of our common stock; and
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sales of our common stock by our executive officers, directors and significant stockholders.
The stock markets generally and the market for technology stocks in particular have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These fluctuations may adversely affect the trading price of our common stock. In the past, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Securities litigation brought against us could result in substantial costs, which would hurt our financial condition and operating results, and divert management’s attention and resources from our business.
If securities analysts downgrade our stock or discontinue coverage of our company, our stock price could decline.
The trading market for our common stock depends in part on the research and reports that industry or financial analysts publish about us or our business. We do not control these analysts. If one or more of the analysts who do cover us downgrade our stock, or if our performance is not in line with estimates published by those analysts, our stock price would likely decline rapidly. As a newly public company, the analysts who publish information about our common stock have had relatively little experience with our company, which could affect their ability to accurately forecast our results and make it more likely that we fail to meet their estimates. If one or more of these analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.
Our executive officers, directors and principal stockholders own a significant percentage of our company and could exert significant influence over matters requiring stockholder approval.
Our executive officers, directors, principal stockholders and their affiliates beneficially own a significant percentage of our outstanding common stock. Accordingly, these executive officers, directors, principal stockholders and their affiliates, acting as a group, will have substantial influence over the outcome of corporate actions requiring stockholder approval, including the election of directors and the approval of significant corporate transactions, and they may in some instances exercise this influence in a manner that advances their best interests and not necessarily those of other stockholders. This concentration of ownership may have the effect of delaying, preventing or deterring a change in control, could deprive you of the opportunity to receive a premium for your common stock as part of a sale and could adversely affect the market price of our common stock.
Because we do not intend to pay dividends, our stockholders will benefit from their investment in shares of our common stock only if it appreciates in value.
We intend to retain our future earnings, if any, to finance the operation and growth of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in shares of our common stock will depend upon any future appreciation in its value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.
Provisions of our certificate of incorporation, bylaws and Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove the current members of our board and management.
Our corporate charter documents that will be in place upon the completion of this offering will, and provisions of Delaware law to which we are subject, contain provisions that could discourage, delay or prevent a change in control of our company or changes in our board and management that the stockholders of our company may deem advantageous. Because we are significantly smaller than most of our potential competitors and many of the other companies in our industry, we may be more likely than other companies in our industry to be the target of a takeover attempt.
Our certificate of incorporation will allow our board of directors to issue up to 10,000,000 shares of preferred stock. The board can determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. As a result, our board of directors could make it difficult for a third party to acquire a majority of our outstanding voting stock, for example by adopting a stockholders’ rights plan.
Our certificate of incorporation will also provide that the members of the board are divided into three classes. Each year the terms of approximately one-third of the directors will expire. Our bylaws will not permit our stockholders to call a special meeting of stockholders. Under the bylaws, only our Chief Executive Officer, Chairman of the board of directors, President or a majority of the board of directors will be able to call special meetings of stockholders. The staggering of directors’ terms of office and the limitation on the ability of stockholders to call a special meeting may make it difficult for stockholders to remove or replace the board of directors should they desire to do so. Since management is appointed by the board of directors, any inability to effect a change in the board may result in the entrenchment of management. The bylaws will also require that stockholders give advance notice to our Secretary of any nominations for director at any stockholders’ meeting. These provisions may delay or prevent changes of control or management, either by third parties or by stockholders seeking to change control or management.
Moreover, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of 15% of our outstanding voting stock from merging or combining with us for a period of three years after the date of the transaction in which the person acquired in excess of 15% of our outstanding voting stock, unless the merger or combination is approved in a prescribed manner.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our principal offices occupy approximately 17,030 square feet of leased office space in Baltimore, Maryland. The lease expires in September 2010. We believe our current facilities are adequate for our current needs and that suitable additional space will be available as and when needed.
Item 3.
Item 3. Legal Proceedings
In November 2004, Cerner Corporation, a supplier of healthcare information technology, including a solution related to the delivery of care to patients in ICUs, filed a lawsuit against us in the United States District Court for the Western District of Missouri. In this matter, Cerner requests a declaration that, among other things: (1) our issued U.S. patent is invalid and unenforceable; (2) Cerner has not infringed our patent; and (3) certain actions that we have taken have threatened Cerner and its customers with infringement of our patent and constituted unfair competition and tortious interference with Cerner’s customer contracts and expected business. Cerner has asked the court for an award of damages in an unspecified amount and an injunction preventing us from threatening or initiating infringement litigation under our patent against Cerner, its customers or potential customers and from misrepresenting the scope and substance of our patent to Cerner’s customer or potential customers. Cerner has also alleged that we have engaged in patent misuse by making statements, assertions and representations that are false and misleading and misrepresent the scope and substance of our patent and as a result our patent is unenforceable.
In October 2005, we filed an answer, affirmative defenses and counterclaims with respect to Cerner’s complaint. In our answer we deny and provide affirmative defenses for the claims made by Cerner. In addition, we have asserted counterclaims alleging that Cerner has, among other things: (1) infringed, induced others to infringe, or contributed to the infringement of our patent; (2) misappropriated our trade secrets; (3) breached its contractual obligations to us in non-disclosure agreements; (4) engaged in unfair competition; and (5) tortiously interfered with our customer contracts and expected business. We have asked the court for an award of damages in an unspecified amount and an injunction preventing Cerner from infringing the our patent, using or disclosing our trade secrets, making false or misleading statements regarding the company or tortiously interfering with our customer contracts or expected business. We have also asked the court for an order instructing Cerner to publicly retract all false and misleading statements about our products. In November 2005, Cerner filed an answer to our counterclaim in which Cerner denies and provides affirmative defenses for the claims made by us.
In December 2005, the court stayed the litigation until the completion of the reexamination of our U.S. patent by the U.S. Patent Office and any appeals. We expect that the stay will be lifted and the litigation will resume following the issuance by the U.S. Patent Office of a reexamination certificate in the current patent reexamination proceeding.
In January 2005, iMDsoft, Ltd, a software company that develops and implements clinical information systems that can be used in a remote ICU monitoring system, filed a request with the U.S. Patent Office, requesting a reexamination of all of the twenty-six claims previously allowed under our issued U.S. patent. In response to iMDsoft’s request, the U.S. Patent Office initiated an ex parte proceeding in which it reexamined all of the claims of our patent. During the reexamination proceeding, we amended our patent claims. In September 2006, the U.S. Patent Office issued a reexamination certificate allowing all 26 claims of our U.S. patent as amended. In November 2006, iMDsoft filed a second request with the U.S. Patent Office, requesting another reexamination of all the claims of our patent. In January 2007, the U.S. Patent Office initiated a second reexamination of our issued patent pursuant to iMDsoft’s second request. During the second reexamination proceeding, we amended our patent claims and presented arguments to the U.S. Patent Office intended to overcome the references cited in the second reexamination request. We are awaiting the official action response from the U.S. Patent Office.
In November 2004, iMDsoft filed an application with the U.S. Patent Office for the purpose of having the U.S. Patent Office declare an interference and requesting that our patent be revoked and a patent with identical claims be issued to iMDsoft. To our knowledge, as of the date of this filing, the U.S. Patent Office has taken no action with respect to the iMDsoft filing.
In May 2006, we were named a co-defendant in a lawsuit filed against a customer and several physicians claiming negligent treatment and care of a patient in the customer’s intensive care unit.
Other than the foregoing, we are not currently a party to any material legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders through solicitation of proxies or otherwise, during the fourth quarter of 2006.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Stock Market Information
Our common stock has been traded on the NASDAQ Global Market (formerly the NASDAQ National Market) under the symbol “EICU” since April 5, 2006. Prior to that time, there was no public market for our common stock. The following table sets forth the high and low sales prices of our common stock on the NASDAQ Global Market (formerly the NASDAQ National Market), as reported by NASDAQ:
Holders
As of March 5, 2007 there were approximately 146 stockholders of record of our common stock based on the records of our transfer agent.
Dividends
In October 2005, we declared and paid a special cash dividend of approximately $7.8 million, or $0.33 per share, to all holders of our outstanding shares of common and preferred stock on October 14, 2005. Since January 1, 2005, we have not declared or paid any other cash dividends on our common stock. We currently intend to retain any future earnings to support operations and to finance the growth and development of our business, and we do not anticipate paying any additional cash dividends on our common stock in the foreseeable future.
Rule 10b5-1 Trading Plans
In July 2006, our board of directors approved our insider trading policy that includes a provision allowing our directors, officers, and employees to sell shares of our common stock pursuant to trading plans or arrangements complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Rule 10b5-1 trading plans generally provide for sales of common stock on specified dates or from time to time, subject to price parameters, daily limits and other contingencies.
Securities Authorized for Issuance under Equity Compensation Plans
We are authorized to issue equity compensation to our employees, officers, directors and certain other persons providing bona fide services to us under the Visicu, Inc. Equity Compensation Plan, which has been previously approved by our stockholders. The following table sets forth information about our equity compensation plan as of December 31, 2006:
Our equity incentive plan provides that the shares underlying stock options and other stock-based awards granted under the plan in each calendar year may not exceed two percent of the number of shares of common stock outstanding on the first day of that year plus the number of shares that remained available for awards at the end of the previous calendar year.
Performance Graph
The following graph compares the cumulative total stockholder return on our common stock with the cumulative total return on the NASDAQ Composite Index (U.S. Companies) and the NASDAQ Computer and Data Processing Index over the period April 5, 2006 (the first trading date of our common stock following our initial public offering) through December 31, 2006. The graph assumes $100 invested at April 5, 2006 in our common stock (at the public offering price of $16 per share) and in each of the market indices, with reinvestment of all dividends. We have not paid or declared any cash dividends on our common stock since April 5, 2006. Stockholder returns over the indicated period should not be considered indicative of future stock prices or stockholder returns.
Comparison of Cumulative Total Return
For the Period April 5, 2006 Through December 31, 2006
This performance graph and the related information shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities under that section, and shall not be deemed to be incorporated by reference into any filing that we make under the Securities Act or under the Exchange Act.
Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities.
Issuance of Common Stock upon Exercise of Warrant
In April 2006, we issued 41,285 shares of our common stock upon the exercise of a warrant held by Comerica Bank. The warrant, which was issued in July 2003 in connection with a financing agreement, was exercised on a net issue election basis and accordingly we did not receive any cash proceeds in consideration of the issuance of the shares. This issuance was made in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act (and/or Regulation D promulgated thereunder) for transactions by an issuer not involving a public offering. Upon issuance these shares were deemed restricted securities for the purposes of the Securities Act.
Item 6.
Item 6. Selected Financial Data
The selected financial data set forth below as of December 31, 2005 and 2006, and for the years ended December 31, 2004, 2005 and 2006 are derived from our financial statements audited by Ernst & Young LLP, our independent registered public accounting firm, and included elsewhere in this Annual Report. The selected financial data as of December 31, 2002, 2003 and 2004 and for the years ended December 31, 2002 and 2003 are derived from our audited financial statements not included in this Annual Report.
The following selected financial data should be read in conjunction with our financial statements, the related notes and “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The information contained in this section has been derived from our financial statements and should be read together with our financial statements and related notes included elsewhere in this Annual Report. This Annual Report contains 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. You can identify these statements by forward-looking words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” “may,” or the negative of these words, variations thereof or similar expressions. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial condition, or state other “forward-looking” information. We believe that it is important to communicate our future expectation to our investors. However, there may be events in the future that we are not able to accurately predict or control and that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Investors are cautioned that all forward-looking statements involve risks and uncertainties, and actual results may differ materially from those discussed as a result of various factors, including those factors described in “Risk Factors” in Item 1A on this Annual Report. Readers should not place undue reliance on our forward-looking statements, and we assume no obligation and do not intend to update any forward-looking statements.
Overview
We are a healthcare information technology and clinical solutions company focused on transforming the delivery of care to the highest acuity patients in the hospital through our eICU Program. Our eICU Program is an advanced remote monitoring system for ICUs that allows hospitals to help improve patient outcomes, reduce costs, increase capacity, improve the quality of life of critical care professionals and increase revenue potential. We sell our eICU Program primarily to multi-hospital systems and networks of community and rural hospitals. We have implemented our eICU Program with some of the largest multi-facility healthcare providers in the United States.
Our eICU Program consists of our eCareManager suite of software products and clinical solutions and services. We supplement the eCareManager software with comprehensive technical and clinical implementation services and ongoing product and program support and reporting services.
We were founded in March 1998. We implemented our first eICU Program in June 2000. Our revenue growth has been driven by the increase in our customer base and from additional sales to existing customers to expand their use of our eICU Program. As of December 31, 2006, we had contractual commitments for approximately 9% of the estimated 60,000 adult ICU beds in over 180 hospitals in the United States.
Our current strategy for long-term, sustained growth in our revenue consists of increasing our sales and marketing efforts to both new and current customers in the United States, enhancing our solution offerings, evaluating opportunities to expand the eICU Program model within the hospital setting and pursuing international market opportunities.
Sources of Revenue
Our principal sources of revenues are license, implementation and customer support service fees. We derive our revenues under multiple element arrangements with our customers. Under these arrangements, we provide our customers with a perpetual license of our software, professional services over a scheduled implementation plan and support services following implementation over a three-year support agreement. Our scheduled implementation plan ranges from seven to nine months for an initial implementation for a new customer and from four to nine months for an additional implementation for an existing customer. Our support agreements are typically renewable for additional three-year terms.
Our software license fees typically are based on a combination of the number of eICU Centers a customer operates and the number of ICU beds that the customer monitors with the eICU Program. Our implementation fees typically are based on an implementation plan developed in conjunction with the customer. Our support fees typically are calculated as a percentage of license fees. Under most of our existing customer agreements, if we offer a lower price on license fees to new customers making comparable purchases from us, we must offer that same lower price to those existing customers. Some of our existing customer agreements also expressly require us to refund or credit license fees previously paid by the existing customer if we offer a lower price on license fees to new customers making comparable purchases. We expect to maintain the principal terms of our existing customer contracts and include our standard principal contract terms in contracts that we sign with new customers.
We typically invoice our license fees based on contract milestones that trigger license payment obligations by our customers. These milestones typically include execution of the contract and customer activation of our eICU Program. We typically invoice our professional service implementation fees based on contract milestones that trigger implementation payment obligations by our customers. These milestones typically include execution of the contract, interim implementation milestones and achievement of fully operational status of our eICU Program. We typically invoice our customer support service fees quarterly in advance throughout the three-year term of the support agreement, commencing upon the expiration of the warranty period which is typically sixty days after activation. Our customer agreements typically require payment within 30 days to 45 days from the date of invoice. As described below in “-Critical Accounting Policies-Revenue Recognition,” we recognize revenues from license, implementation and support service fees ratably over the term of the customer’s support agreement, beginning when our eICU Program is fully operational at the customer site. As a result, to the extent we have not yet recognized any of the invoiced fees described above as revenue, we record those unrecognized amounts on our balance sheet as deferred revenues.
Our eICU Program has a lengthy sales cycle, which is at least nine months and typically takes longer. As a result, it is difficult for us to predict the quarter in which a particular sale may occur. We believe that many of our current customers would be considered early adopters of innovative technologies. As we seek more widespread market acceptance of the eICU Program, we are experiencing a longer sales cycle. Accordingly, our sales may vary significantly from quarter to quarter. In addition, because we recognize revenues from customer contracts ratably over the term of our support agreements, a change in new customer sales or renewals of support agreements in any one quarter or series of quarters may not be immediately reflected in our financial results and may negatively affect our revenue in future quarters.
Our backlog of contractually committed future revenues is a result of our multi-year customer support agreements combined with our ratable revenue recognition methodology. As of December 31, 2006, our revenue backlog, which we determine by totaling the minimum fees payable over the term of each customer contract and subtracting revenues recognized to date, amounted to $71.6 million. We expect to recognize approximately 49% of this backlog in 2007. As of December 31, 2005, our revenue backlog amounted to $70.2 million. We recognized approximately 40% of this backlog in 2006. Our backlog will decrease as we recognize revenues under existing contracts, and it will increase as we sign more contracts for new customers and additional beds for existing customers. Our backlog would also decrease if any of our customers are unable to fulfill their obligations under their agreements with us or terminate their agreement with us prior to expiration. Our customers may terminate their agreements if we breach any material term and fail to cure the breach within a specified time after receipt of written notice of the breach, which is typically 30 days.
Direct Cost of Revenues
The direct cost of our revenues consists primarily of:
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salaries, benefits and stock-based compensation for personnel to provide professional and support services to customers;
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cost of customer-related services provided by subcontractors;
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billable and non-billable travel, lodging and other out-of -pocket customer-related expenses; and
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license fees for third-party software used to enhance our program.
We capitalize direct and incremental costs of revenues for which revenue has been deferred, primarily labor costs for professional implementation service fees, and recognize those costs ratably over the related period of revenue recognition.
Operating Expenses
Sales and Marketing. Sales and marketing expense consists primarily of:
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salaries, benefits and stock-based compensation related to sales and marketing personnel;
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commissions;
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travel, lodging and other out-of -pocket expenses; and
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marketing programs such as trade shows and advertising campaigns.
Although we recognize substantially all of our revenues ratably over the term of our customer support agreements, we recognize sales commissions at the time a customer agreement is executed. Accordingly, we incur a portion of our sales and marketing expense prior to the recognition of the corresponding revenue. We plan to continue to invest in sales and marketing by increasing the number of direct sales personnel in order to add new customers and increase sales to our existing customers. We also plan to expand our marketing activities. As a result, we expect that in the future, sales and marketing expenses will increase in absolute terms but will decrease as a percentage of revenues.
Research and Development. Research and development expense consists primarily of salaries, benefits and stock-based compensation related to personnel who work on the development of new products, enhancement of existing products, quality control and testing. We expect that in the future, research and development expenses will increase in absolute terms but will decrease as a percentage of revenues.
General and Administrative. General and administrative expense consists primarily of:
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salaries, benefits and stock-based compensation related to general and administrative personnel;
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professional fees; and
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facilities and other related overhead.
We expect that general and administrative expenses will increase in absolute terms and as a percentage of revenue in the foreseeable future as we invest in infrastructure to support our growth and incur additional expenses related to being a publicly traded company, including increased audit fees and costs of compliance, primarily resulting from the Sarbanes-Oxley Act of 2002.
Legal and Regulatory Proceedings
Our only issued U.S. patent is the subject of ongoing legal and regulatory proceedings. iMDsoft Ltd. has requested that the U.S. Patent Office declare an interference and that the patent be revoked and a patent with identical claims be issued to iMDsoft, and has filed a second request asking the U.S. Patent Office to reexamine all 26 claims of our patent. During the second reexamination proceeding, we amended our patent claims and presented arguments to the U.S. Patent Office intended to overcome the references cited in the second reexamination request. We are currently awaiting the official office action response from the U.S. Patent Office. In addition, Cerner Corporation has filed a lawsuit against us in which it seeks as one of its remedies a declaration that the patent is invalid and unenforceable. Also, we are a co-defendant in a lawsuit filed against a customer and several physicians claiming negligent treatment and care of a patient in the customer’s intensive care unit. We believe that the claims against us in the foregoing lawsuits are without merit and we are defending the lawsuits vigorously. We are unable to predict the outcome of any of the foregoing lawsuits and proceedings, or to quantify any effect that they might have on our business, financial condition or operating results. If the outcome of one or more of these lawsuits or proceedings is unfavorable to us, our business and financial results could be materially adversely affected.
Critical Accounting Policies
We prepare our financial statements in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.
We believe that of our significant accounting policies, which are described in Note 1 to our financial statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical in fully understanding and evaluating our financial condition and results of operations.
Revenue Recognition
We derive our revenues under multiple element arrangements with our customers. Under these arrangements, we license software, provide professional services and provide post-contract customer support services for our eICU Program. We recognize revenue for software licenses and services in accordance with the American Institute of Certified Public Accountants’ Statement of Position, or SOP, No. 97-2, Software Revenue Recognition , as amended. Under SOP No. 97-2, revenues from software license and service agreements are recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable. We allocate the total arrangement fee among each deliverable based on the relative fair value of each of the deliverables based on vendor specific objective evidence. Evidence of fair value is limited to the price or fee for the deliverable when we sell it separately from other deliverables. In the absence of evidence of the fair value of a delivered element, we allocate revenue first to the undelivered elements based on evidence of fair value, and then allocate residual revenue to the delivered elements. If evidence of the fair value of the undelivered elements is not known, we defer the revenue until such time as the only remaining undelivered element is post-contract customer support services, at which time we recognize revenue ratably over the term of the support agreement.
License revenues consist of contracted license fees for our eICU Program as well as third-party software embedded in our eICU Program. Service revenues consist of contracted implementation service fees, post-contract support fees, travel and other direct cost reimbursements.
We do not yet have objective and reliable evidence of the fair value of each of the elements of our arrangements with customers, including our post-contract customer support services. Accordingly, we recognize revenue from customer arrangements ratably over the post-contract customer support service period, which is typically three years. If we are able to objectively and reliably determine the fair value of the post-contract customer support services, we will begin to recognize revenue from the delivered software and implementation services upon customer acceptance. Through 2006, support agreements for three eICU Centers were renewed for additional three-year terms. Support agreements are subject to renewal for seven eICU Centers in 2007 and 13 eICU Centers in 2008. If a significant number of these customers renew their support agreements at a consistant renewal rate with similar terms, we may be able to objectively and reliably determine the fair value of the post-contract customer support services as early as 2008.
Allowance for Doubtful Accounts
Our accounts receivable consist primarily of payments due from customers under license and support agreements. We specifically analyze accounts receivable for collectibility based on the creditworthiness of each customer and our customer payment history. We provide an allowance for doubtful accounts when we determine that the collection of an outstanding customer receivable is not probable.
Historically, we have recorded insignificant amounts of bad debt expense, and at December 31, 2006, we estimated that all accounts receivable were likely to be collected. We may determine in future periods that allowances for uncollectible accounts receivable are required, based on changes in conditions and trends or customer payment history.
Deferred Contract Costs
We capitalize direct and incremental implementation costs specifically attributable to customer contracts for which revenue has been deferred. These costs consist principally of labor costs related to the implementation of our eICU Program. We recognize these costs ratably over the related period of revenue recognition.
Software Development Costs
We account for costs of software developed to be sold or licensed to our customers under SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Under SFAS No. 86, we expense the costs of research, including our predevelopment efforts prior to establishing technological feasibility and costs incurred for training and maintenance. We capitalize software development costs when technological feasibility has been established until the product is available for general release and anticipated future revenues assure recovery of the capitalized amounts. Our determination of when technological feasibility has been established requires a judgment in assessing a number of complex factors involving the technical status of our development projects. We amortize capitalized costs over the estimated useful life of the asset.
We reported approximately $177,000 of capitalized software costs, net of accumulated amortization, in other assets in our balance sheet as of December 31, 2006 and approximately $155,000 as of December 31, 2005. We are generally amortizing these costs over a three-year period.
Stock-Based Compensation
For stock option grants prior to November 29, 2005, the date that we originally filed our registration statement for the initial public offering of our shares, we accounted for our employee stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, we recorded compensation expense for stock options issued to employees in fixed amounts and with fixed exercise prices only to the extent that the exercise prices were less than the fair value of our common stock at the date of the grant. We made disclosure in our financial statements regarding employee stock-based compensation using the minimum value method in accordance with Statement of Financial Accounting Standards, or SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. All stock-based awards to non-employees are accounted for at their fair value in accordance with SFAS 123 and related interpretations.
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS No. 123(R), which is a revision of SFAS No. 123. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their estimated fair values. Pro forma disclosure is no longer an alternative. We adopted the provisions of SFAS No. 123(R) on January 1, 2006 using the prospective transition method, which will be applied to the awards issued after November 29, 2005. We did not grant any stock options between November 29, 2005 and December 31, 2005. We will continue to account for unvested stock-based awards issued prior to November 29, 2005 using the intrinsic value method originally applied to those awards. Our adoption of SFAS No. 123(R) fair value method may have a significant impact on our results of operations, although it will have no impact on our overall financial position. For more information regarding our accounting for stock option grants, see Note 2 to the accompanying financial statements, “Stock-Based Compensation.”
Prior to January 31, 2006, we granted our employees options to purchase our common stock at exercise prices equal to the fair value of the underlying common stock at the date of each grant, as determined by either our board of directors or retrospective or contemporaneous valuations by an unrelated valuation specialist. In connection with our preparation of our 2005 audited financial statements and solely for the purposes of accounting for stock-based compensation, our board of directors and management reconsidered the fair value of the common stock underlying the stock options that we granted to employees after January 1, 2004. Our board and management reexamined the approaches that had been taken and the assumptions that had been relied upon in our valuation specialist’s valuation reports in light of our business achievements and our progress in connection with our pending IPO at that time. In particular, our board and management noted the disparities between the fair values of the common stock as determined in the retrospective and contemporaneous valuations prepared by our valuation specialist and the original midpoint of the price range published for the IPO. As a result, our board and management reviewed and, where appropriate, reassessed the estimates of fair value of our common stock after January 1, 2004.
As a result of our reassessment of the fair value of our common stock underlying stock option grants to employees, we will record stock-based compensation expense ratably for each stock option granted during the reassessed periods based upon the difference between the retrospectively determined fair value of our common stock at the date of the stock option grant and the exercise price of the stock option. For the year ended December 31, 2006, we recorded $2.5 million of stock-based compensation expense compared to $1.1 for the year ended December 31, 2005. Additionally, we account for stock-based compensation relating to stock options granted to non-employees based on the fair value of the options granted, using the Black-Scholes-Merton option-pricing model. We measure the fair value of the option issued to a non-employee as of the earlier of the performance commitment date or the date the services required under the arrangement with the non-employee have been completed. We recognize estimated amounts of stock-based compensation expense as the non-employee performs under the arrangement. We adjust our estimates as of the final measurement date.
Determining the appropriate fair value model and calculating the fair value of stock-based payment awards require the input of highly subjective assumptions, including the expected life of the stock-based payment awards and stock price volatility. We use the Black-Scholes-Merton option-pricing model to value stock-based compensation expense for all options granted subsequent to 2005. The assumptions used in calculating the fair value of post-2005 stock-based payment awards represent management’s best estimates, but the estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future (see Note 2 to the Financial Statements for further discussion of stock-based compensation).
Income Taxes
We record income tax liabilities utilizing known obligations and estimates of potential obligations. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. When we determine that deferred tax assets could be realized in greater or lesser amounts than recorded, the asset balance and income statement reflects the change in the period such determination is made.
We have concluded that it is more likely than not that we will realize the $14.1 million of net deferred tax assets that we reported at December 31, 2006. In order to realize these assets, we will need to generate sufficient taxable income in the periods in which the deductible temporary differences or tax credit and loss carryforwards represented by these deferred tax assets are reported in our income tax returns. We only recently began to report taxable income, and accordingly our estimates of the realization of these assets could change in future periods if our operating results deteriorate.
Our tax positions are also subject to review and audit by tax authorities. Although we believe that our tax filings comply with the tax laws and regulations in the jurisdictions in which we operate, tax laws and regulations are frequently complex and subject to new and varying interpretations by relevant authorities. Accordingly, our estimates of taxes payable from our operations may change in future periods as additional information becomes known to us.
Results of Operations
The following table sets forth selected statement of operations data expressed as a percentage of total revenues for each of the periods indicated.
Years Ended December 31, 2006 and 2005
Revenues. Total revenues for 2006 were $30.2 million, an increase of $11.9 million, or 65%, over total revenues of $18.4 million for 2005.
The increase in revenues was attributable to an increase in the number of activated customer eICU Centers and additional activated ICU beds by existing customers expanding their use of our eICU Program. The increase in revenue from eICU Centers results primarily from the increase in the number of customers activated in 2003, 2004, 2005 and 2006 versus the number of customers activated in 2002, 2003, 2004 and 2005. The increase in activated customer eICU Centers during this period was the result of the addition of sales personnel, increased marketing activity and broader market recognition and acceptance of our eICU Program. The increase in revenue from additional activated beds was the result of our customers expanding the use of our eICU Program throughout their health systems.
We record revenue attributable to our eICU Centers monthly, on a pro rata basis, over the initial post-contract customer support period, which typically is three years and begins after the eICU Center is activated. An eICU Center that is activated early in any reporting period contributes more to revenues during that period than a comparable eICU Center that is activated late in that reporting period. In addition, when the initial post-contract customer support period for an eICU Center expires, revenues recognized in future support periods for the eICU Center typically represent only the ongoing support fees. As a result, the increase in revenues for any reporting period does not directly correlate to the increase in the number of total activated eICU Centers.
In addition, we record revenue attributable to additional activations by existing customers who expand their use of our eICU Program over the remaining life of the support agreement in place at the time of the order for the expansion. As a result, the increase in revenues from additional activations for any period compared to the prior period depends upon when additional activations occur relative to the remaining term of the support agreement in place at the time of the order for the expansion.
Total deferred revenue increased from $47.6 million as of December 31, 2005 to $49.4 million as of December 31, 2006. This increase was primarily due to the increase in the number of contractually committed eICU Centers, activated eICU Centers and activated beds offset by the increased recognition of revenue during the year ended December 31, 2006. We consider an eICU Center to be contractually committed once a customer has signed a contract ordering our eICU Program. We consider a contractually committed eICU Center and beds to be activated once the implementation of our eICU Program has been completed and the eICU Center and beds are operational. The increase in contractually committed and activated eICU Centers and beds resulted in an increase in deferred revenue because we invoice our fees before we recognize revenue.
Direct Cost of Revenues. Total direct cost of revenues for 2006 was $5.8 million, an increase of $1.9 million, or 49%, over total direct cost of revenues of $3.9 million for 2005. The increase was primarily due to increased implementation costs of $604,000, increased support costs of $826,000, including non-cash stock-based compensation expense of $131,000, and increased costs of $461,000 for third-party licenses. All of these increases were a direct result of the growth in the number of activated eICU Centers and beds and our increased headcount. We had 39 full-time equivalent employees who provided technical, clinical and post-contract support services at December 31, 2006 compared to 35 full-time equivalent employees at December 31, 2005 as we hired additional personnel to provide technical and clinical and post-contract support services to our growing customer base.
Total deferred contract costs remained level at $4.5 million as of December 31, 2005 and 2006.
Gross Profit. Gross profit increased from $14.5 million, or 79% of total revenues, for 2005 to $24.5 million, or 81% of total revenues, for 2006. The increase in gross profit as a percentage of total revenues was primarily due to two factors. First, we realized efficiency gains in the cost of ongoing support services as a result of an increasing customer and revenue base. Second, our costs of implementation declined as a percentage of revenue as we became more experienced in the implementation process.
Sales and Marketing Expense. Sales and marketing expenses for 2006 were $4.6 million, an increase of $448,000, or 11%, over sales and marketing expenses of $4.1 million for 2005. The increase was primarily due to increased employee-related expenses of $493,000, including increased sales commissions and increased non-cash stock-based compensation expense of $318,000, offset by decreased third party consulting expenses. We had 13 full-time equivalent sales and marketing employees at December 31, 2006 compared to 11 full-time equivalent employees at December 31, 2005 as we hired additional sales personnel to market our solution.
Research and Development Expense. Research and development expenses for 2006 were $5.5 million, an increase of $251,000, or 5%, over research and development expenses of $5.3 million for 2005. The increase was primarily due to increased employee and contractor related expenses of $230,000, including increased non-cash stock-based compensation expense of $145,000. We had 38 full-time equivalent research and development employees at December 31, 2006 compared to 35 full-time equivalent employees at December 31, 2005 as we hired additional personnel to upgrade and expand our software programs.
General and Administrative Expense. General and administrative expenses for 2006 were $9.2 million, an increase of $2.4 million, or 36%, over general and administrative expenses of $6.8 million for 2005. The increase in general and administrative expenses was primarily due to increased employee-related expenses of $1.5 million, including increased non-cash stock-based compensation expense of $881,000, increased insurance expenses of $347,000, increased depreciation expense of $179,000, and increased facility and public company compliance expenses of $283,000. We had 14 full-time equivalent general and administrative employees at December 31, 2006 compared to 13 full-time equivalent employees at December 31, 2005 as we hired additional accounting personnel to support our growth.
Other Income. Other income for 2006 was $4.4 million, compared to $331,000 for 2005. The increase was due to interest income earned on our cash, cash equivalents and marketable securities balances, which increased significantly during 2006 as a result of our initial public offering.
Income Taxes. Our income tax expense for 2006 was $3.6 million, compared to a benefit of $11.4 million for 2005. The transition from a tax benefit to a tax expense is due to two factors. First, during 2005, we recorded a tax benefit of $11.4 million resulting from the reversal of our valuation allowances for deferred tax assets based on changes in our estimates of ultimate realization. Second, in 2005 we had a loss before income taxes of $1.4 million, while in 2006 we had income before income taxes of $9.6 million. Our 2006 income tax expense was net of an $859,000 tax benefit for research and development credits we recorded based on a study we recently performed for the eight year period from 1998 through 2005. See Note 7 to the financial statements for a reconciliation of our effective tax rates to the U.S. statutory income tax rate.
Years Ended December 31, 2005 and 2004
Revenues. Total revenues for 2005 were $18.4 million, an increase of $12.8 million, or 233%, over total revenues of $5.5 million for 2004.
The increase in revenues was attributable to an increase in the number of activated customer eICU Centers and additional activated ICU beds by existing customers expanding their use of our eICU Program. The increase in revenue from eICU Centers results primarily from the increase in the number of customers activated in 2002, 2003, 2004 and 2005 versus the number of customers activated in 2001, 2002, 2003 and 2004. The increase in activated customer eICU Centers during this period was the result of the addition of sales personnel, increased marketing activity and broader market recognition and acceptance of our eICU Program. The increase in revenue from additional activated beds was the result of our customers expanding the use of our eICU Program throughout their health systems.
We record revenue attributable to our eICU Centers monthly, on a pro rata basis, over the initial post-contract customer support period, which typically is three years and begins after the eICU Center is activated. An eICU Center that is activated early in any reporting period contributes more to revenues during that period than a comparable eICU Center that is activated late in that reporting period. In addition, when the initial post-contract customer support period for an eICU Center expires, revenues recognized in future support periods for the eICU Center typically represent only the ongoing support fees. As a result, the increase in revenues for any reporting period does not directly correlate to the increase in the number of total activated eICU Centers.
In addition, we record revenue attributable to additional activations by existing customers who expand their use of our eICU Program over the remaining life of the support agreement in place at the time of the order for the expansion. As a result, the increase in revenues from additional activations for any period compared to the prior period depends upon when additional activations occur relative to the remaining term of the support agreement in place at the time of the order for the expansion.
Total deferred revenue increased from $33.1 million as of December 31, 2004 to $47.6 million as of December 31, 2005. This increase was primarily due to the increase in the number of contractually committed eICU Centers, activated eICU Centers and activated beds offset by the increased recognition of revenue during the year ended December 31, 2005. We consider an eICU Center to be contractually committed once a customer has signed a contract ordering our eICU Program. We consider a contractually committed eICU Center and beds to be activated once the implementation of our eICU Program has been completed and the eICU Center and beds are operational. The increase in contractually committed and activated eICU Centers and beds resulted in an increase in deferred revenue because we invoice our fees before we recognize revenue.
Direct Cost of Revenues. Total direct cost of revenues for 2005 was $3.9 million, an increase of $2.4 million, or 164%, over total direct cost of revenues of $1.5 million for 2004. The increase was primarily due to increased implementation costs of $1.1 million from the growth in the number of activated eICU Centers and beds, increased support costs of $949,000, including non-cash stock-based compensation expense of $48,000, for ongoing support services and increased costs of $284,000 for third-party licenses. We had 35 full-time equivalent employees who provided technical, clinical and post-contract support services at December 31, 2005 compared to 29 full-time equivalent employees at December 31, 2004 as we hired additional personnel to provide technical and clinical and post-contract support services to our growing customer base. The increase in third-party license costs was primarily due to the additional licenses needed to support our growing customer base.
Total deferred contract costs increased from $3.8 million as of December 31, 2004 to $4.5 million as of December 31, 2005. The increase in deferred costs was due to the increase in our customer base during this period.
Gross Profit. Gross profit increased from $4.0 million, or 73% of total revenues, for 2004 to $14.5 million, or 79% of total revenues, for 2005. The increase in gross profit as a percentage of total revenues was primarily due to efficiency gains in the cost of ongoing support services as a result of an increasing customer and revenue base.
Sales and Marketing Expense. Sales and marketing expenses for 2005 were $4.1 million, an increase of $856,000, or 26%, over sales and marketing expenses of $3.3 million for 2004. The increase was primarily due to increased employee-related expenses of $543,000, including sales commissions and non-cash stock-based compensation expense of $322,000, and increased expenses of $213,000 for marketing programs, including trade shows. We had 11 full-time equivalent sales and marketing employees at December 31, 2005 compared to 10 full-time equivalent employees at December 31, 2004.
Research and Development Expense. Research and development expenses for 2005 were $5.3 million, an increase of $1.0 million, or 24%, over research and development expenses of $4.3 million for 2004. The increase was primarily due to increased employee and contractor related expenses of $904,000, including non-cash stock-based compensation expense of $266,000. We had 35 full-time equivalent research and development employees at December 31, 2005 compared to 32 full-time equivalent employees at December 31, 2004 as we hired additional personnel to upgrade and expand our software programs in an effort to release a software upgrade approximately once every six to nine months.
General and Administrative Expense. General and administrative expenses for 2005 were $6.8 million, an increase of $2.1 million, or 46%, over general and administrative expenses of $4.6 million for 2004. The increase in general and administrative expenses was primarily due to increased employee-related expenses, including non-cash stock-based compensation expense of $421,000, training and administrative expenses for our implementation personnel of $847,000, and increased professional services expenses of $973,000, consisting of legal fees primarily related to the defense of a lawsuit filed against us and the preparation for our initial public offering as well as increased accounting expenses associated with the growth of our operations and the preparation for becoming a public company. We had 13 full-time equivalent general and administrative employees at December 31, 2005 compared to 10 full-time equivalent employees at December 31, 2004 as we hired additional administrative, technical support and accounting personnel to support our growth.
Other Income. Other income for 2005 was $331,000, compared to $19,000 for 2004. The increase was due to interest income earned on our cash balances, which increased during 2005.
Income Taxes. Our income tax benefit for 2005 was $11.4 million, compared to $4.0 million for 2004. The increase in the income tax benefit consists primarily of the reversal of valuation allowances for our deferred tax assets based on changes in our estimates of ultimate realization.
Quarterly Results of Operations
The following table sets forth selected unaudited quarterly statement of operations data for the eight most recent quarters. The information for each of these quarters has been prepared on the same basis as the audited financial statements included in this filing and, in the opinion of management, includes all adjustments necessary for the fair presentation of the results of operations for such periods. This data should be read in conjunction with the audited financial statements and the related notes included in this filing. These quarterly operating results are not necessarily indicative of our operating results for any future period.
Liquidity and Capital Resources
At December 31, 2006, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $123.2 million and accounts receivable of $11.5 million.
On October 14, 2005, our board of directors declared a special cash dividend of approximately $7.8 million, or $0.33 per share, to all holders of our outstanding shares of common and preferred stock. We paid the special cash dividend on October 27, 2005. Prior to this special cash dividend, we had never declared or paid any cash dividends on our common or preferred stock. We currently intend to retain any future earnings to support operations and to finance the growth and development of our business, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future.
From our inception in March 1998 through late 2003 we did not generate sufficient cash flow to fund our operations and the growth in our business. Accordingly, we funded our business primarily through issuances of preferred stock that provided us with gross proceeds of approximately $24.9 million. In 2004, 2005 and 2006, we funded our operations through cash flow generated by the operating activities of our business. Net cash provided by operating activities was $9.9 million during 2006, $10.8 million during 2005 and $7.2 million during 2004. Net cash provided by operating activities in 2004 and 2005 consisted primarily of increases in deferred revenues offset by net losses from operations. Historically, net cash used by operating activities consisted primarily of net losses from operations and increases in accounts receivable, offset by increases in deferred revenues.
Our total deferred revenue was $49.4 million as of December 31, 2006, $47.6 million as of December 31, 2005 and $33.1 million as of December 31, 2004. This increase reflects growth in the invoiced amounts to our customers. We record amounts that have been invoiced in accounts receivable and deferred revenue, which we then recognize ratably over the term of the customer support agreement.
In 2006 we made income tax payments of $1.0 million. As of December 31, 2006, we had remaining federal net operating loss carryforwards of $2.3 million, state net operating loss carryforwards of $1.2 million and research and development credits of $1.2 million available to reduce future taxable income.
Net cash used in investing activities was $49.8 million during 2006, $1.2 million during 2005 and $1.2 million during 2004. Net cash used in investing activities consisted primarily of purchases of marketable securities in 2006, net of maturities, and purchases of fixed assets for network infrastructure, development tools and equipment, and computer equipment for our employees in 2005 and 2004. Additional purchases of marketable securities may be made to maximize our returns in accordance with our investment policy and based upon available cash determined by projected cash uses.
Net cash provided by financing activities was $102.8 million during 2006, consisting primarily of net proceeds from our initial public offering. Net cash used in financing activities was $6.9 million during 2005, consisting primarily of the special dividend payment of $7.8 million to common and preferred stockholders partially offset by proceeds from the exercise of options of $965,000. Net cash provided by financing activities was $111,000 during 2004, consisting primarily of proceeds from the exercise of options to purchase our common stock.
Contractual Obligations
We have contractual obligations for noncancelable office space and computer equipment under operating leases and office equipment under a capital lease. The following table discloses aggregate information about our contractual obligations and periods in which payments are due as of December 31, 2006 (in thousands):
Off-Balance Sheet Arrangements
As of December 31, 2006, 2005 and 2004, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not exposed to any financing, liquidity, market or credit risk that could arise if we engaged in such relationships. Other than our operating leases for office space and computer equipment, we do not engage in off-balance sheet financing arrangements.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value and provides guidance for measuring fair value and the necessary disclosures. This statement does not require any new fair value measurements and applies to all other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 will be effective for our year ending December 31, 2008. Based upon our current evaluation as of December 31, 2006, we do not believe that the adoption of SFAS No. 157 will have a material effect on our financial position or results of operations.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes,” which provides additional guidance and clarifies the accounting for uncertainty in income tax positions. FIN 48 defines the threshold for recognizing tax return positions in the financial statements as “more likely than not” that the position is sustainable, based on its technical merits. FIN 48 also provides guidance on the measurement, classification and disclosure of tax return positions in the financial statements. FIN 48 is effective as of January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to the beginning balance of retained earnings in the period of adoption. Based upon our current evaluation as of December 31, 2006, we do not believe that the adoption of FIN 48 will have a material effect on our beginning balance of retained earnings.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
At December 31, 2006, we had cash and cash equivalents totaling $74.2 million and marketable securities totaling $49.0 million. These amounts were invested primarily in money market funds and debt securities issued by the U.S. Treasury and other government corporations and agencies. We do not enter into investments for trading or speculative purposes. Due to the short-term nature of these investments, we believe that we do not have material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future investment income.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Balance Sheets as of December 31, 2005 and 2006
Statements of Operations for each of the three years in the period ended December 31, 2006
Statements of Stockholders’ Equity (Deficit) for each of the three years in the period ended December 31, 2006
Statements of Cash Flows for each of the three years in the period ended December 31, 2006
Notes to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors of
Visicu, Inc.
We have audited the accompanying balance sheets of Visicu, Inc. as of December 31, 2005 and 2006, and the related statements of operations, stockholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Visicu, Inc. as of December 31, 2005 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
As discussed in Notes 1 and 2 to the financial statements, on January 1, 2006 Visicu, Inc. adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, and changed its method of accounting for share-based payments.
/s/ Ernst & Young LLP
Baltimore, Maryland
March 8, 2007
VISICU, INC.
BALANCE SHEETS
(in thousands, except share and per share data)
See accompanying notes to financial statements.
VISICU, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
See accompanying notes to financial statements.
VISICU, INC.
STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in thousands)
See accompanying notes to financial statements.
VISICU, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to financial statements.
VISICU, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 2006
1.
Organization and Summary of Significant Accounting Policies
Organization and Description of Business
Visicu, Inc. (the “Company”) was incorporated in Delaware on March 19, 1998. The Company is headquartered in Baltimore, Maryland and is a healthcare information technology and clinical solutions company focused on transforming the delivery of hospital-based critical care. The Company’s primary product is its eICU ® Program, an advanced remote monitoring system for intensive care units that allows hospitals to help improve patient treatment outcomes by leveraging their scarce critical care trained staff to monitor intensive care unit patients more frequently and to intervene earlier to prevent or manage crises.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and related disclosures. Actual results could differ from those estimates.
Cash, Cash Equivalents and Marketable Securities
The Company considers all highly liquid investments with original maturities of 90 days or less at the time of purchase to be cash equivalents and investments with original maturities of greater than 90 days to be marketable securities. Cash and cash equivalents generally consist of cash, money market funds and federal agency notes. At December 31, 2006, the Company had marketable securities that were classified as held-to-maturity and reported at amortized cost. Held-to-maturity securities consist of debt securities issued by the U.S. Treasury and other government corporations and agencies.
These marketable securities have expiration dates ranging from January 2007 to January 2008. At December 31, 2006, the estimated fair value of each investment approximated its amortized cost, and, therefore there were no significant unrealized gains or losses.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximated their fair values due to the short-term maturities of these instruments.
Revenue Recognition and Direct Costs
The Company derives revenue under multiple element arrangements with its customers to license software, provide implementation services and provide post-contract customer support services (“PCS”) for its eICU software. Revenue for software and services sold by the Company is recognized when persuasive evidence of an arrangement exists, delivery has occurred and the fee is fixed or determinable and probable of collection. In any arrangement where extended payment terms have been provided, revenue is not recognized before payment from the customer is due. The Company allocates the total arrangement fee among each deliverable based on the relative fair value of each of the deliverables based on vendor specific objective evidence. In the absence of evidence of the fair value of a delivered element, revenue is first allocated to the undelivered elements based on evidence of fair value, and the residual revenue is then allocated to the delivered elements. If evidence of the fair value of the undelivered elements is not known, revenue is deferred until such time as the only remaining undelivered element is PCS, upon which time revenue is recognized ratably over the PCS period.
Direct and incremental costs of contracts for which revenue has been deferred are capitalized and recognized ratably over the related period of revenue recognition. These costs consist principally of labor costs for implementation services.
Because the Company has yet to sell PCS separately to its customers through significant renewals or otherwise, the Company has not objectively determined the fair value of the PCS element of its arrangements. Accordingly, revenue and related direct costs from all arrangements entered into through December 31, 2006 are being recognized ratably over the PCS period.
Commencing in July 2005, PCS renewals became exercisable by customers. The renewal of PCS at consistent rates with similar terms in future periods may allow the Company to establish the fair value of PCS and the residual value of delivered software elements as early as 2008.
Accounts Receivable
The Company’s accounts receivable consist primarily of payments due from customers under license and support agreements.
The Company routinely assesses its accounts receivable for collectibility. Judgment is required in assessing the ultimate realization of these receivables, including the credit-worthiness of each customer. Based on the Company’s analysis, an allowance at the end of each period presented in these financial statements was not deemed necessary. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, future allowances may be required. Past due balances are determined based on the date of the invoice. Uncollectible accounts receivable balances, if any, are charged to bad debt expense. Accounts receivable balances are not collateralized.
Included in accounts receivable at December 31, 2005 and 2006 is $178,000 and $189,000, respectively, due from a customer under a note receivable in consideration for license fees and services. During 2005, the Company signed a note receivable with a customer for a portion of the total fees required under the contract. The current portion of the note is included in accounts receivable on the accompanying balance sheet. The long-term portion of $472,000 and $283,000 as of December 31, 2005 and 2006, respectively, is included in other assets.
Property and Equipment
Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Computer equipment and software are depreciated over three years. Office furniture and equipment are depreciated over three to seven years. Leasehold improvements are amortized over the lesser of the estimated useful life of the asset or the remaining lease term.
Other Assets
Costs for the development of new software products to be marketed or enhancements to existing products are expensed as research and development costs as incurred until technological feasibility has been established, at which time any additional development costs are capitalized until the product or enhancement is available for general release to customers. At December 31, 2005, the Company reported in other assets $155,000 of capitalized software costs, net of accumulated amortization of $169,000. At December 31, 2006, the Company reported in other assets $177,000 of capitalized software costs, net of accumulated amortization of $288,000. Capitalized software costs are generally amortized over a three-year period.
As of December 31, 2005, the Company had deferred approximately $916,000 of common stock issuance costs that were reported in other assets. Upon completion of the Company’s initial public offering on April 5, 2006, these costs were applied against additional paid-in capital.
Advertising Costs
All advertising costs are expensed when incurred. Advertising costs included in selling, general and administrative expense for the years ended December 31, 2004, 2005 and 2006 were $100,000, $179,000 and $109,000, respectively.
Income Taxes
The Company uses the liability method to account for income taxes. Under the liability method, deferred income taxes are provided for temporary differences between the basis of the Company’s assets and liabilities for financial reporting and income tax purposes. The Company records valuation allowances for deferred tax assets that are not more likely than not to be realized.
Share-Based Payments
Prior to January 1, 2006, the Company recorded compensation expense for its employee stock-based compensation plan using the intrinsic value method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Under the intrinsic value method, stock-based compensation expense is generally only recognized to the extent the estimated fair value of the underlying common stock on the date of grant exceeds the exercise price of the award. Expense related to employee stock-based compensation was recorded over the vesting period using the straight line method. During the periods the Company used the intrinsic value method, disclosure of pro forma stock-based compensation expense and the effects on net income was reported in the notes to the financial statements as if the minimum value method of measuring stock-based compensation was used.
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment.” This statement requires the Company to expense the fair value of grants of various stock-based compensation programs over the vesting period of the awards. The Company adopted SFAS No. 123(R) using the prospective transition method, which does not result in the restatement of previously issued financial statements. Under the prospective transition method, unvested stock-based awards issued prior to November 29, 2005, the date the Company filed a registration statement to publicly sell its equity securities, are accounted for pursuant to APB No. 25 using the intrinsic value method originally applied to those awards. Stock-based awards issued subsequent to December 31, 2005, the date of adoption, are measured at their fair value at the date of grant and adjusted for an estimated forfeiture rate which is based on historical data and current assumptions. The resulting compensation expense is recognized in the statement of operations ratably over the vesting periods of the awards.
The Company accounts for stock options granted to non-employees based on their estimated fair value, which the Company believes is a more reliable measure than estimating the fair value of the services provided in exchange for these stock options. The fair value of an option issued to a non-employee is measured on the earlier of the performance commitment date or the date the services required under the arrangement have been completed. Estimated fair value is determined using the Black-Scholes-Merton option pricing model. Estimated amounts of expense are recognized as the non-employee performs under the arrangement. Those estimates are adjusted on the final measurement date.
Segment Data
The Company manages its operations as one business unit for purposes of assessing performance and making operating decisions. Accordingly, the Company does not have reportable segments of its business.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value and provides guidance for measuring fair value and the necessary disclosures. This statement does not require any new fair value measurements and applies to all other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 will be effective for the year ending December 31, 2008. Based upon the Company’s current evaluation as of December 31, 2006, the Company does not believe that the adoption of SFAS No. 157 will have a material effect on financial position or results of operations.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes,” which provides additional guidance and clarifies the accounting for uncertainty in income tax positions. FIN 48 defines the threshold for recognizing tax return positions in the financial statements as “more likely than not” that the position is sustainable, based on its technical merits. FIN 48 also provides guidance on the measurement, classification and disclosure of tax return positions in the financial statements. FIN 48 is effective as of January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to the beginning balance of retained earnings in the period of adoption. Based upon the Company’s current evaluation as of December 31, 2006, the Company does not believe that the adoption of FIN 48 will have a material effect on its beginning balance of retained earnings.
2.
Stock-Based Compensation
Description and Terms of the Plan
The Company’s 1998 Stock Option Plan (the “Plan”), as amended, authorizes options to purchase 5.5 million shares of the Company’s common stock to employees, directors, and consultants of the Company. The Plan allows for the granting of nonqualified stock options or stock purchase rights to service providers at an exercise price of not less than 85% of fair market value, as estimated by the board of directors on the date of grant. In addition, employees of the Company may be granted qualified incentive stock options at an exercise price of not less than fair market value on the date of grant, subject to the provisions of the Internal Revenue Code. Options are granted with vesting periods of up to four years and maximum option terms of ten years.
In 2005, the board of directors adopted and the stockholders approved an amendment and restatement of the Plan, revising certain of the terms and conditions of the Plan and changing the name of the Plan to the Visicu, Inc. Equity Incentive Plan (the “Equity Incentive Plan”). The Equity Incentive Plan provides that the shares underlying stock options and other stock-based awards granted in each calendar year may not exceed two percent of the number of shares of common stock outstanding on the first day of that year plus the number of shares that remained available for awards at the end of the previous calendar year. Effective January 1, 2007, the Equity Incentive Plan authorizes the issuance of up to 8.24 million aggregate shares of common stock (including shares already issued and outstanding).
Summary of Stock-Based Compensation Expense and Pro Forma Stock-Based Compensation Expense
Total stock-based compensation expense was $29,000, $1.1 million and $2.5 million for the years ended December 31, 2004, 2005 and 2006, respectively. As discussed in Note 1, stock-based compensation expense for 2004 and 2005 was accounted for using the intrinsic value method prescribed by APB Opinion No. 25. On January 1, 2006, the Company adopted the fair value method of accounting for share-based payments prescribed by SFAS No. 123(R). Accordingly, stock-based compensation expense in 2006 includes expense associated with unvested awards at December 31, 2005 measured using the grant-date intrinsic value originally applied to those awards, and the expense associated with 2006 grants measured using the fair value method. As a result of adopting SFAS No. 123(R), income before income taxes was $199,000 lower, net income was $125,000 lower, basic earnings per share was $0.01 lower, and diluted earnings per share remained unchanged. Further, in connection with the adoption of SFAS No. 123(R) in 2006, the Company eliminated $4.9 million of unearned stock based compensation against additional paid-in capital and commenced recording the excess income tax benefit from stock option exercises as a financing activity in the statement of cash flows, rather than as an operating cash flow as previously required. Excess tax benefits were $0 in 2004, $29,000 in 2005, and $1.0 million in 2006.
In applying the fair value accounting provisions of SFAS No. 123(R), the Company uses a generally accepted option valuation model, the Black-Scholes-Merton option pricing model. This model requires specified inputs to determine the fair value of stock-based awards, consisting of (i) the fair value of the Company’s common stock on the grant date, (ii) the expected volatility of the Company’s common stock over the expected option life, (iii) the risk-free interest rate, (iv) the expected dividend yield, and (v) the expected option life. The minimum value method used for pro forma disclosure purposes in 2004 and 2005 assumes that the value of a stock option is equal to the excess of the fair value of the underlying common stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the expected life of the option.
An explanation of these inputs is as follows:
Fair-Value of Common Stock-Prior to issuing publicly traded common stock on April 5, 2006, the Company estimated the fair value of its common stock principally using common stock valuations performed by an appraiser. Subsequent to April 5, 2006, the date the Company first issued publicly-traded common stock, the Company uses the closing quoted market price of its common stock on the grant date.
Volatility - A measure of the amount by which the share price is expected to fluctuate over a period commensurate with the expected life of the award. Because of limited or no historical information regarding its own historical stock volatility during the financial statement periods, the Company considered the expected volatility of similar entities in developing this input. In selecting guideline companies, the Company considered factors such as industry, stage of life cycle, size, and financial leverage.
Risk-Free Interest Rate - An assumption to take into account, among other things, the time value of money. The risk-free interest rate is the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life of the award at the grant date.
Dividend Yield - Dividends paid on the underlying common stock will impact an award’s value. The Company does not expect to pay dividends in the foreseeable future.
Expected Life of Stock-based Awards - The period of time for which the stock-based award is expected to be outstanding, or the period of time from the service inception date to the date of expected exercise or other expected settlement. For a variety of reasons, including the fact that employees of the Company could only recently exercise options and sell the common stock in a public market, the Company concluded that its historical stock option exercise experience does not provide a reasonable basis upon which to estimate expected life. Accordingly, the Company made estimates of the expected life based on the expected terms of options granted by other, similar companies with similarly structured awards.
The following is a summary of the inputs used to estimate the fair value or minimum value, as applicable of stock-based awards:
N/A-Assumption is not applicable to minimum value method used in 2004 and 2005.
The minimum value method derived the following pro forma amounts in 2004 and 2005, as follows (in thousands, except per share amounts):
Pro forma stock-based compensation expense in 2004 and 2005 does not consider potential forfeitures and amortizes the stock-based compensation expense ratably over the vesting period. These computational differences and the differences in the terms and nature of 2006 stock-based compensation awards create incomparability between the pro forma stock-based compensation presented above and the stock-based compensation expense recognized in 2006.
Summary of 2006 Stock Option Activity
A summary of option activity for the year ended December 31, 2006 is presented below:
The weighted-average fair value of options granted in 2006 was $7.22. The total fair value of shares vested during the year ended December 31, 2006 was $2.1 million.
Restricted Common Stock
In 2005, the Company issued 350,000 options to purchase shares of common stock to certain members of the board of directors. The exercise price was less than the estimated fair value of the common stock at the date of grant, and accordingly, compensation expense of $118,000 and $265,000 was recognized in 2005 and 2006, respectively, related to these grants. These options contained an “early exercise” provision. Upon early exercise of the option, the members of the board of directors receive restricted common stock. All grants vested 25% in 2006, then ratably each month thereafter for an additional 36 months if the director continues to provide service to the Company. If the restricted stock does not vest because the required service period is unmet, the Company has the option to reacquire the restricted common stock for the lesser of the amount paid by the director to acquire it or the fair value of the common stock at the call date.
During 2005, the Company received $501,000 in cash resulting from the exercise of options to purchase 250,000 shares of restricted common stock. During 2006, the Company received $180,000 in cash resulting from the exercise of options to purchase 100,000 shares of restricted common stock. Because the unvested portion of this common stock is subject to forfeiture and the Company’s call right, the Company has recorded in other liabilities as of December 31, 2006 the cash payment due to the holders of restricted stock in the event the Company’s call right is exercised, or $421,000.
A summary of activity related to restricted common stock is as follows:
Summary of Unrecognized Stock-Based Compensation
Total unrecognized compensation expense from stock options and restricted shares at December 31, 2006 was $6.6 million. This compensation expense is expected to be recognized over a weighted-average period of 2.91 years.
3.
Net Income (Loss) Attributable to Common Stockholders Per Share
A reconciliation of basic and diluted income (loss) attributable to common stockholders per share is as follows (in thousands, except per share amounts):
For the year ended December 31, 2004, if outstanding options and preferred stock were exercised or converted into common stock, the result would be anti-dilutive and, accordingly, basic and diluted net loss attributable to common stockholders per share are identical for this period. These potentially dilutive shares aggregated 23.5 million shares at December 31, 2004.
Subsequent to December 31, 2006 and through March 5, 2007, 501,000 options to purchase common stock were issued.
Prior to the initial public offering in April 2006, the Company had three series of preferred stock outstanding: Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock (collectively, the “Preferred Stock”). The stated price of the Series A Preferred Stock, the Series B Preferred Stock and the Series C Preferred Stock is $1.00, $1.37 and $1.37, respectively, subject to adjustment for any recapitalization of the Company. The Preferred Stock was subject to redemption rights that expired on March 4, 2005. Upon expiration, the Preferred Stock was reclassified to permanent equity.
The Preferred Stock was convertible into common stock at the option of the holder at any time, at the ratio of one share of common stock for each share of Preferred Stock, subject to certain adjustments for dilution. Upon completion of the Company’s initial public offering in April 2006, the Preferred Stock was automatically converted into 19.4 million shares of common stock.
5.
Common Shares Reserved for Future Issuance
As of December 31, 2006, the Company has reserved shares of common stock for future issuance as follows (in thousands):
As of January 1, 2007, an additional 650,000 shares of common stock became available for awards of stock options and other stock-based compensation under the terms of the Equity Incentive Plan.
The Company rents various office space and computer equipment under noncancelable operating leases expiring at various dates through 2010. Future minimum lease payments for operating leases for each of the years ending December 31 are as follows (in thousands):
Rent expense totaled $259,000, $266,000 and $288,000 for the years ended December 31, 2004, 2005 and 2006, respectively.
In 2004, the Company executed a lease for office space for a term of six years with an option to renew for two three-year terms. Under the terms of this lease, the Company received a 100% rent holiday for the first six months and an additional 17% rent holiday for the next six months. The total cost of the lease, including rent escalations of 2% per annum, are being expensed ratably over the term of the lease agreement. In 2005, the Company increased its space under this lease by approximately 20% with no other changes in the terms of the lease.
Significant components of the provision (benefit) for income taxes are as follows (in thousands):
The significant components of the Company’s deferred tax assets and liabilities are as follows (in thousands):
A reconciliation of income tax expense (benefit) to the amount computed by applying the statutory U.S. federal income tax rate of 35% for 2006 and 34% for 2004 and 2005 to income (loss) before income taxes is as follows (in thousands):
At December 31, 2006, the Company had federal net operating loss carryforwards of approximately $2.3 million and state net operating loss carryforwards of approximately $1.2 million, which expire in 2021. The Company has an alternative minimum tax carryforward of $204,000 with no expiration date. In addition, the Company has research and development credits of $1.2 million, which begin expiring in 2019. Income tax regulations contain provisions that limit the net operating loss carryforwards and other attributes available to be used in any given year. The Company has determined a limitation based on ownership changes in 1998 and 2000 and is applying the appropriate limitations to the carryforward items.
During 2006, the Company filed amended and original tax returns for the years 1998 through 2005 to claim research and development credits of $1.4 million. As a result of filing these returns, the net operating loss carryforwards generated in years 1998 through 2002 and 2004 were reduced by the amount of the credit generated in accordance with applicable tax law.
During 2006, the Company recognized excess tax deductions of $2.5 million related to the exercise or sale of certain stock options. The after-tax benefits that were recorded as an increase in additional paid-in-capital were approximately $1.0 million.
The Company has unrecognized tax benefits related to U.S. research and development credits and various state tax matters. The unrecognized tax benefits related to research and development credits were recorded through a reduction of the correlating deferred tax asset, and the state income tax liability is recorded within current taxes payable.
The Company decreased its valuation allowance for deferred tax assets in 2004 based on the estimate that approximately $10.1 million of net operating loss carryforwards at December 31, 2004 were more likely than not be used to reduce future taxable income. The tax benefit recorded for the year ended December 31, 2005 includes the reversal of previously recorded valuation allowances of $11.4 million. These deferred tax valuation allowances were reversed in 2005 when it became apparent based on available evidence that it was more likely than not that the deferred tax assets would be realized in future periods.
On October 14, 2005, the Company’s board of directors declared a special cash dividend of approximately $7.8 million, or $0.33 per share, to all holders of outstanding shares of common and preferred stock. The Company paid the special cash dividend on October 27, 2005, except for $66,000 payable to holders of restricted common stock, which will be paid in four annual installments from 2006 to 2009. During 2006, the first annual installment of $16,000 was paid to the holders of restricted common stock. As such, as of December 31, 2006, $50,000 remains payable to holders of restricted common stock and is included in accounts payable and accrued expenses.
9.
Concentrations of Credit Risk and Customer Concentrations
Throughout 2005 and 2006, the Company had deposits in a financial institution in excess of federally insured amounts, primarily in a repurchase agreement that is collateralized by U.S. Government securities and federal agency securities. The Company has not experienced any losses on its deposits.
The Company has three customers that represent 13%, 13% and 12% of accounts receivable as of December 31, 2006.
The following customers represent 10% or more of revenue for the years indicated:
The Company made discretionary employer contributions to its Visicu 401(k) Plan during 2004, 2005 and 2006 of $0, $79,000 and $88,000, respectively.
The Company’s only issued U.S. patent is the subject of ongoing legal and regulatory proceedings. iMDsoft Ltd. has requested that the U.S. Patent Office declare an interference and that the patent be revoked and a patent with identical claims be issued to iMDsoft, and has filed a second request asking the U.S. Patent Office to reexamine all 26 claims of the Company’s patent. During the second reexamination proceeding, the Company amended its patent claims and presented arguments to the U.S. Patent Office intended to overcome the references cited in the second reexamination request. In addition, Cerner Corporation has filed a lawsuit against the Company in which it seeks as one of its remedies a declaration that the patent is invalid and unenforceable. Also, the Company is a co-defendant in a lawsuit filed against a customer and several physicians claiming negligent treatment and care of a patient in the customer’s intensive care unit. The Company believes that the claims against it in the foregoing lawsuits are without merit and the Company is defending the lawsuits vigorously. The Company is unable to predict the outcome of any of the foregoing lawsuits and proceedings, or to quantify any effect that they might have on its business, financial condition or operating results. If the outcome of one or more of these lawsuits or proceedings is unfavorable to the Company, its business and financial results could be materially adversely affected.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective at the reasonable assurance level in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item will be set forth in our Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 2006.
Item 11.
Item 11. Executive Compensation
The information required by this item will be set forth in our Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 2006.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item will be set forth in our Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 2006.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item will be set forth in our Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 2006.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this item will be set forth in our Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 2006.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)
1. The following financial statements of Visicu, Inc. are filed as part of this Annual Report under Item Item 8. Financial Statements and Supplementary Data:
Report of Independent Registered Public Accounting Firm
Balance Sheets as of December 31, 2005 and 2006
Statements of Operations for each of the three years in the period ended December 31, 2006
Statements of Stockholders’ Equity (Deficit) for each of the three years in the period ended December 31, 2006
Statements of Cash Flows for each of the three years in the period ended December 31, 2006
Notes to Financial Statements
(a)
2. Financial statement schedules have been omitted because the information required to be set forth therein is not applicable.
(a)
3. The following exhibits are filed herewith or are incorporated by reference to exhibits previously filed with the SEC:
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.
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on March 13, 2007.
/s/ Frank T. Sample
President, Chief Executive Officer and Chairman of the Board
(principal executive officer)
/s/ Vincent E. Estrada
Executive Vice President and Chief Financial Officer
(principal accounting and financial officer)
/s/ Michael J. Breslow, M.D.
Executive Vice President, Clinical Research and Development and Director
/s/ Stuart H. Altman
Director
/s/ Michael G. Bronfein
Director
/s/ John K. Clarke
Director
/s/ Frances M. Keenan
Director
/s/ James A. Oakey
Director
/s/ Thomas G. McKinley
Director
/s/ Ralph C. Sabin
Director