UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


 

FORM 10-Q

 

(Mark One)

 

 

 

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

 

For the quarterly period ended September 30, 2004

 

 

Or

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

 

For the transition period from       to       

 

 

Commission File Number 000-33043

 


 

Omnicell, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

94-3166458

(State or other jurisdiction
of incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

1201 Charleston Road
Mountain View, CA 94043
(650) 251-6100

(Address, including zip code, of registrant’s principal executive
offices and registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

 

Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

 

As of October 31, 2004 there were 25,287,153 shares of the Registrant’s Common Stock outstanding.

 

 



 

OMNICELL, INC.

 

FORM 10-Q

 

INDEX

 

 

PART I—FINANCIAL INFORMATION

 

ITEM 1.

Financial Statements:

 

 

Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003

 

 

Notes to Condensed Consolidated Financial Statements

 

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

 

ITEM 4.

Controls and Procedures

 

PART II—OTHER INFORMATION

 

ITEM 1.

Legal Proceedings

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

ITEM 3.

Defaults Upon Senior Securities

 

ITEM 4.

Submission of Matters to a Vote of Security Holders

 

ITEM 5.

Other Information

 

ITEM 6.

Exhibits and Reports on Form 8-K

 

SIGNATURES

 

 

EXHIBIT INDEX

 

 

2



 

PART I—FINANCIAL INFORMATION

 

ITEM I. Financial Statements

 

OMNICELL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

 

 

September 30,
2004

 

December 31,
2003 (1)

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

21,373

 

$

24,499

 

Short-term investments

 

11,210

 

9,025

 

Accounts receivable, net

 

17,420

 

14,529

 

Inventories

 

17,197

 

8,783

 

Receivables subject to a sales agreement

 

2,737

 

2,737

 

Prepaid expenses and other current assets

 

7,066

 

3,966

 

Total current assets

 

77,003

 

63,539

 

Property and equipment, net

 

5,764

 

4,833

 

Long-term receivables subject to sales agreement

 

3,247

 

4,985

 

Purchased intangibles

 

4,003

 

4,195

 

Goodwill

 

2,127

 

2,127

 

Other assets

 

6,561

 

4,788

 

Total assets

 

$

98,705

 

$

84,467

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

8,334

 

$

2,921

 

Accrued liabilities

 

9,827

 

15,403

 

Deferred service revenue

 

14,861

 

12,650

 

Deferred gross profit

 

8,223

 

10,125

 

Obligation resulting from sale of receivables

 

2,737

 

2,737

 

Current portion of note payable

 

 

305

 

Total current liabilities

 

43,982

 

44,141

 

Long-term obligation resulting from sale of receivables

 

3,247

 

4,985

 

Other long-term liabilities

 

543

 

583

 

Stockholders’ equity

 

50,933

 

34,758

 

Total liabilities and stockholders’ equity

 

$

98,705

 

$

84,467

 

 


(1)                                  Derived from the December 31, 2003 audited consolidated balance sheet.

 

See accompanying notes.

 

3



 

OMNICELL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenues

 

$

26,767

 

$

21,157

 

$

72,374

 

$

59,161

 

Service and other revenues

 

5,967

 

5,202

 

17,396

 

14,414

 

Total revenues

 

32,734

 

26,359

 

89,770

 

73,575

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Cost of product revenues

 

11,344

 

8,683

 

29,881

 

25,208

 

Cost of service and other revenues

 

2,302

 

2,117

 

6,508

 

5,542

 

Total cost of revenues

 

13,646

 

10,800

 

36,389

 

30,750

 

Gross profit

 

19,088

 

15,559

 

53,381

 

42,825

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

2,476

 

2,256

 

6,679

 

6,731

 

Selling, general and administrative

 

13,325

 

10,794

 

38,419

 

31,216

 

Restructuring and severance charges

 

 

 

171

 

630

 

Total operating expenses

 

15,801

 

13,050

 

45,269

 

38,577

 

Income from operations

 

3,287

 

2,509

 

8,112

 

4,248

 

Interest and other income

 

105

 

116

 

266

 

376

 

Interest and other expense

 

(12

)

(41

)

(70

)

(118

)

Income before provision for income taxes

 

3,380

 

2,584

 

8,308

 

4,506

 

Provision for income taxes

 

124

 

257

 

325

 

442

 

Net income

 

$

3,256

 

$

2,327

 

$

7,983

 

$

4,064

 

 

 

 

 

 

 

 

 

 

 

Net income per share—basic

 

$

0.13

 

$

0.10

 

$

0.32

 

$

0.18

 

 

 

 

 

 

 

 

 

 

 

Net income per share—diluted

 

$

0.12

 

$

0.09

 

$

0.29

 

$

0.17

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—basic

 

25,038

 

22,961

 

24,697

 

22,482

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—diluted

 

27,571

 

26,658

 

27,809

 

24,620

 

 

See accompanying notes.

 

4



 

OMNICELL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

Operating activities:

 

 

 

 

 

Net income

 

$

7,983

 

$

4,064

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

2,923

 

2,337

 

Loss on sale of property and equipment

 

61

 

 

Stock-based compensation

 

70

 

231

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(2,891

)

(635

)

Inventories

 

(8,414

)

4,107

 

Prepaid expenses and other current assets

 

(3,100

)

(628

)

Other assets

 

(973

)

2,845

 

Accounts payable

 

5,413

 

(1,890

)

Accrued liabilities

 

(4,252

)

1,079

 

Deferred service revenue

 

2,211

 

1,333

 

Deferred gross profit

 

(1,902

)

(6,498

)

Other long-term liabilities

 

(125

)

 

Net cash provided by operating activities

 

(2,996

)

6,345

 

Investing activities:

 

 

 

 

 

Investment in privately held company

 

(63

)

 

Acquisition of intangible assets and intellectual property

 

(1,352

)

 

Acquisition of privately held company, net of cash acquired

 

(1,000

)

(2,689

)

Purchases of short-term investments

 

(20,135

)

(5,889

)

Maturities of short-term investments

 

17,942

 

1,900

 

Purchases of property and equipment

 

(3,046

)

(1,531

)

Proceeds from the sale of property and equipment

 

23

 

 

Net cash used in investing activities

 

(7,631

)

(8,209

)

Financing activities:

 

 

 

 

 

Proceeds from issuance of common stock

 

7,806

 

5,061

 

Proceeds from stockholders’ notes receivable

 

 

3,119

 

Repayment of note payable

 

(305

)

(894

)

Net cash provided by financing activities

 

7,501

 

7,286

 

Net increase (decrease) in cash and cash equivalents

 

(3,126

)

5,422

 

Cash and cash equivalents at beginning of period

 

24,499

 

21,400

 

Cash and cash equivalents at end of period

 

$

21,373

 

$

26,822

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Cash paid for taxes

 

$

567

 

$

65

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing activities:

 

 

 

 

 

Liabilities recorded in connection with acquisition of privately held company

 

$

 

$

498

 

 

See accompanying notes.

 

5



 

OMNICELL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Organization and Summary of Significant Accounting Policies

 

Description of the Company

 

Omnicell, Inc. (“Omnicell” or the “Company”) was incorporated in the State of California in September 1992 under the name OmniCell Technologies, Inc. In August 2001, the Company reincorporated in Delaware and changed its name to Omnicell, Inc.

 

The Company’s solutions enable healthcare facilities to acquire, manage, dispense and deliver pharmaceuticals and medical supplies. Omnicell’s medication and supply dispensing systems facilitate the distribution of pharmaceuticals and medical supplies at the point of care. These systems interface with healthcare facilities’ existing information systems to accurately capture and display critical patient data. In 2002, Omnicell acquired two additional products, PharmacyCentral, a central pharmacy carousel storage and retrieval solution, and SafetyMed, a bedside automation solution.  In August 2003, Omnicell acquired BCX Technology, Inc., a provider of open bar code supply management systems branded ScanREQ, to complement its cabinet-based supply solutions. Omnicell’s physician order management system streamlines communication between nursing and pharmacy staff. Omnicell’s decision support solution allows healthcare facilities to monitor trends in drug utilization and diversion, improve regulatory compliance and reduce costs by monitoring usage patterns and optimizing product management. Omnicell’s Internet-based procurement application automates and integrates healthcare facilities’ requisition and approval processes. In March 2004, Omnicell acquired Ariel Distributing, Inc.’s closed-loop, controlled substance inventory management software for healthcare system pharmacies, used and marketed by Omnicell under the product name SecureVault.  This solution further enables Omnicell to provide comprehensive, end-to-end solutions for the medication-use process.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial information has been prepared by management, in accordance with accounting principles generally accepted in the United States pursuant to instructions to Form 10-Q and Article 10 of Regulation S-X related to interim financial information.  Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the Securities and Exchange Commission’s rules and regulations. The consolidated financial statements include the Company and its wholly-owned subsidiaries, APRS, Inc., Omnicell HealthCare Canada, Inc., and BCX Technology, Inc.  All significant intercompany accounts and transactions are eliminated in consolidation. In the opinion of management, all adjustments (which would include only normal recurring adjustments) necessary to present fairly the financial position as of September 30, 2004 and the results of operations and cash flows for all periods presented have been made. The condensed consolidated balance sheet as of December 31, 2003 has been derived from the audited financial statements as of that date.

 

The condensed consolidated financial statements should be read in conjunction with the Company’s December 31, 2003 audited consolidated financial statements included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission. The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire fiscal year ending December 31, 2004.

 

Use of Estimates in Preparation of Financial Statements

 

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the period reported. Actual results could differ from those estimates. Estimates are used in accounting for, but not limited to, the allowance for doubtful accounts, inventory valuation, purchased residual interests, asset and goodwill impairments, accrued liabilities, and taxes. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of investments in a money market account and trade receivables, including receivables with multi-year payment terms.

 

6



 

The Company’s products are primarily sold to customers and to distributors. The Company performs ongoing credit evaluations of its customers and maintains reserves for credit losses. Credit is extended based on such evaluations and collateral is generally not required. Credit losses have not traditionally been material and such losses have been within management’s expectations. The majority of the Company’s receivables with multi-year payment terms are sold to a financing company. The Company maintains a reserve for potentially uncollectible accounts receivable based on its assessment of collectibility. The Company assesses collectibility based on a number of factors, including past history, the number of days an amount is past due (based on invoice due date), credit ratings of the Company’s customers, current events and circumstances regarding the business of the Company’s customers and other factors that the Company believes are relevant.

 

Revenues generated from customers in North America for the three months ended September 30, 2004 and 2003 totaled 99.8% and 97.0% of total revenues, respectively.  No single customer accounted for more than 10.0% of total revenues, while one particular group of affiliated hospitals accounted for 11.4% of total revenues for the three months ended September 30, 2004. There was no customer that accounted for more than 10% of total revenues in the same period last year. Revenues generated from customers in North America for the nine months ended September 30, 2004 and 2003 totaled 98.1% and 97.3% of total revenues, respectively. One leasing company accounted for 26.0% of accounts receivable at September 30, 2004. The same leasing company accounted for 18.0% of accounts receivable at December 31, 2003.

 

Goodwill and Purchased Intangible Assets

 

The Company measures goodwill and intangible assets with an indefinite life for impairment when indicators of impairment exist and at least on an annual basis. The intangible asset with an indefinite life consists of the trade name acquired as part of the BCX Technology, Inc. acquisition. No impairment of goodwill or the intangible asset with an indefinite life was recognized for the three and nine months ended September 30, 2004 and 2003. The Company had goodwill of $2.1 million and an intangible asset with an indefinite life of $0.2 million as of September 30, 2004.

 

Purchased intangible assets with finite lives include acquired developed software technology, service contracts, customer relationships and backlog acquired in a business combination. Purchased intangible assets with finite lives are amortized on a straight-line basis over their useful lives of three to six years. Additionally, purchased intangible assets with finite lives are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. No impairment of purchased intangible assets with finite lives was recognized for the three and nine months ended September 30, 2004 and 2003.

 

Revenue Recognition

 

Revenues are derived primarily from sales of medication and supply dispensing systems and subsequent service agreements. The Company markets these systems for sale.  Sales may include multi-year payment terms. Medication and supply dispensing system sales, which are accounted for in accordance with American Institute of Certified Public Accountant’s Statement of Position 97-2, “Software Revenue Recognition” (“SOP 97-2”), are recognized when persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered and installations are complete; Omnicell’s price to the customer is fixed and determinable; and collectibility is reasonably assured. The majority of the Company’s product revenue is derived from the sale and installation of medication and supply dispensing systems.  Omnicell ships its systems based on customer requested installation dates. Field operations employees generally perform system installations. The installations are considered complete and revenue is recognizable when the database files are complete, the systems are configured and labeled, the software is installed and deemed functional, the basic interfaces are complete, the systems are in the customer-designated locations and the systems have been tested.  Prior to recognizing revenue, the Company requires the customer to provide an installation confirmation letter that the Company has completed its obligations.  The Company also sells its medication and supply dispensing systems through distributors in Canada, Europe, the Middle East, Asia and Australia.  The Company recognizes revenue upon shipment of its systems to distributors, when the distributors have orders from identified end-users and the Company has no further performance obligations related to these sales.

 

Revenues from multi-year payment arrangements are recognized upon completion of the Company’s installation obligation, if any, and at the beginning of the noncancelable payment term. The Company records revenue at the net present value of the payment stream utilizing an implicit interest rate comparable to those charged by a third-party leasing company.

 

Deferred gross profit represents the profit to be earned by the Company, exclusive of installation costs, on medication and supply dispensing systems shipped and invoiced to the customer but not yet installed at the customer site.

 

The Company provides post-installation technical support, such as phone support, on-site service, parts and access to software upgrades, under separate support services terms. When support services are sold under multiple element arrangements, the Company allocates revenue to support services based on its fair value. It recognizes revenue for support services ratably over the related support

 

7



 

services contract period. In addition, the Company enters into professional services and training arrangements.  The Company recognizes revenue for these arrangements upon performance of such services. Deferred service revenue represents amounts received under service agreements for which the services have not yet been performed.

 

Revenues from the Company’s Web-based procurement application are recognized ratably over the subscription period. Web-based procurement application revenues were not significant (less than 1.5% of total revenues) for the three and nine months ended September 30, 2004 and 2003, and are included in product and service and other revenue.

 

Sales of Accounts Receivable

 

The Company offers its customers multi-year, non-cancelable payment terms. The Company records revenue on these sales when all revenue recognition requirements under SOP 97-2 are met, at an amount equal to the cash to be received from the leasing company. The amount is the net present value of the payment streams, utilizing the implicit interest rate under the leasing company’s funding agreements so no gain is recorded on the transfer. The Company typically sells its customers’ multi-year payment agreements to a third-party leasing company on a non-recourse basis. In these non-recourse transfers, the Company removes the sold receivable from the Company’s assets and records no liability relating to the transfer as it has assessed that the sales should be accounted for as “true sales” in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). If the sold receivables are transferred subject to recourse clauses, the receivable is reclassified to receivable subject to a sales agreement and an obligation resulting from sale of receivables is recorded.

 

Research and Development Expenses

 

The Company’s policy is to expense research and development costs as incurred, other than certain software development costs. The Company’s research and development expenses include engineering and development salaries, wages and benefits, prototyping and laboratory expenses, consulting expenses and engineering-related facilities and overhead charges. Most of the research and development expenses are personnel-or facilities-related and are relatively fixed. Prototyping and consulting expenses vary depending on the stage of completion of various engineering and development projects.

 

Software Development Costs

 

Development costs related to software implemented in the Company’s medication and supply dispensing systems and incurred subsequent to the establishment of technological feasibility are capitalized and amortized over the estimated lives of the related products ranging from 3 to 5 years. Technological feasibility is established upon completion of a working model, which is a matter of judgment using the guidelines of SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” All such development costs incurred prior to the completion of a working model are recognized as research and development expense. As of September 30, 2004 and December 31, 2003, the balance of capitalized software development costs was approximately $1.5 million and $0.1 million, respectively. These costs are reported as a component of other assets. Amortization of capitalized software development costs was $0.0 million and $0.3 million for the three months ended September 30, 2004 and 2003, respectively. Amortization of capitalized software development costs for the nine months ended September 30, 2004 and 2003 was $0.1 million and $1.0 million, respectively.

 

Stock-Based Compensation

 

 SFAS No. 123, “Accounting for Stock-Based Compensation”  (“SFAS 123”), permits the use of either a fair value based method or the intrinsic value method defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion 25”), to account for stock-based compensation arrangements. Companies that elect to employ the intrinsic value method provided in APB Opinion 25 are required to disclose the pro forma net income that would have resulted from the use of the fair value based method provided under SFAS 123. As permitted by SFAS 123, Omnicell has elected to determine the value of stock-based compensation arrangements under the intrinsic value based method of APB Opinion 25. Accordingly, Omnicell only recognizes compensation expense when options are granted to employees and directors with an exercise price below fair value at the date of grant. Any resulting compensation expense is recognized ratably over the vesting period. The following table (in thousands, except per share amounts) sets forth pro forma information as if compensation expense had been determined using the fair value method under SFAS 123:

 

8



 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net income as reported

 

$

3,256

 

$

2,327

 

$

7,983

 

$

4,064

 

Add: Total stock-based employee compensation expense included in reported net income, net of related tax effects

 

57

 

12

 

67

 

222

 

Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects

 

(1,912

)

(1,297

)

(6,043

)

(3,053

)

Net income pro forma

 

$

1,401

 

$

1,042

 

$

2,007

 

$

1,233

 

Net income per share - basic as reported

 

$

0.13

 

$

0.10

 

$

0.32

 

$

0.18

 

Net income per share - basic pro forma

 

$

0.06

 

$

0.05

 

$

0.08

 

$

0.05

 

Net income per share - diluted as reported

 

$

0.12

 

$

0.09

 

$

0.29

 

$

0.17

 

Net income per share - diluted pro forma

 

$

0.05

 

$

0.04

 

$

0.07

 

$

0.05

 

 

Segment Information

 

The Company reports segments in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” SFAS 131 requires the use of a management approach in identifying segments of an enterprise. The Company derives the majority of its revenues from medication and supply cabinet-based systems, which are treated as one segment for purposes of SFAS 131. These systems are similar in terms of their shared multiple common assemblies and subassemblies, as well as their basic operation and visual characteristics, and are used by hospitals and healthcare facilities to improve patient safety and care and enhance operational efficiency. The Company has two operating segments: the medication and supply dispensing systems and the e-commerce business. The Company’s chief operating decision-maker reviews information pertaining to reportable segments to the operating income level. There are no significant inter-segment sales or transfers. Assets of the operating segments are not segregated and substantially all of the Company’s long-lived assets are located in the United States. For the three and nine months ended September 30, 2004 and 2003, substantially all of the Company’s total revenues and gross profits were generated by the medication and supply dispensing systems operating segment. The Web-based e-commerce business operating segment generated less than 1.5% of consolidated revenues in the three and nine months ended September 30, 2004 and 2003. The operating loss generated by the Web-based e-commerce segment was approximately $0.2 million and $0.1 million for the three months ended September 30, 2004 and 2003, respectively. The operating loss generated by the Web-based e-commerce segment was approximately $0.4 million and $0.5 million for the nine months ended September 30, 2004 and 2003, respectively.

 

Net Income Per Share

 

Basic net income per share is computed by dividing net income for the period by the weighted average number of shares outstanding during the period, less shares subject to repurchase. Diluted net income per share is computed by dividing net income for the period by the weighted average number of shares and, if dilutive, common stock equivalent shares outstanding during the period. Common stock equivalents include the effect of outstanding dilutive stock options and warrants, computed using the treasury stock method. For the nine months ended September 30, 2004 and 2003, options to purchase 492,078 and 1,726,170 shares, respectively, with an exercise price greater than $15.60 and $7.52, the average fair market value per share for the period, respectively, were excluded from the calculation of diluted net income per share as their effect was antidilutive.

 

9



 

The calculation of basic and diluted net income per share is as follows (in thousands, except per share amounts):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Basic:

 

 

 

 

 

 

 

 

 

Net income

 

$

3,256

 

$

2,327

 

$

7,983

 

$

4,064

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares of common stock outstanding

 

25,038

 

22,961

 

24,697

 

22,500

 

Less: Weighted average shares subject to repurchase

 

 

 

 

(18

)

Weighted average shares outstanding-basic

 

25,038

 

22,961

 

24,697

 

22,482

 

 

 

 

 

 

 

 

 

 

 

Net income per share

 

$

0.13

 

$

0.10

 

$

0.32

 

$

0.18

 

Diluted:

 

 

 

 

 

 

 

 

 

Net income

 

$

3,256

 

$

2,327

 

$

7,983

 

$

4,064

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares of common stock outstanding

 

25,038

 

22,961

 

24,697

 

22,500

 

Add: Dilutive effect of employee stock options and warrants

 

2,533

 

3,697

 

3,112

 

2,120

 

Weighted average shares outstanding-diluted

 

27,571

 

26,658

 

27,809

 

24,620

 

 

 

 

 

 

 

 

 

 

 

Net income per share

 

$

0.12

 

$

0.09

 

$

0.29

 

$

0.17

 

 

Emerging Accounting Developments

 

On October 13, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123R, “Share-Based Payment,” which requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value and is effective for all public companies for interim or annual periods beginning after June 15, 2005. Retroactive application of the requirements of FASB Statement No. 123 to the beginning of the fiscal year that includes the effective date would be permitted, but not required. Early adoption of Statement 123R is encouraged  The pro forma impact of the adoption of FASB Statement No. 123 on our historical financial statements is included in the footnotes to the financial statements. The Company expects to continue to grant stock options to employees and the impact of the adoption of the new standard is likely to have a material impact on its future results of operations.

 

Note 2. Acquisitions

 

SecureVault

 

On March 11, 2004, Omnicell acquired Ariel Distributing, Inc.’s closed-loop, controlled substance inventory management software for healthcare system pharmacies, used and marketed by Omnicell as SecureVault.  The total purchase price was $0.7 million, which included $0.5 million paid at the date of purchase, $0.1 million paid in May 2004 after completion of certain obligations by Ariel Distributing, Inc., and up to a maximum of $0.1 million in guaranteed minimum royalty payments, due quarterly and calculated as a percentage of license fees recognized by Omnicell for up to a maximum of two years.  The total purchase price of $0.7 million will be amortized over five years using the straight-line method.

 

BCX Technology, Inc.

 

On August 15, 2003, Omnicell acquired 100% of the outstanding common shares of BCX Technology, Inc., a privately held company headquartered in Lebanon, Tennessee.  BCX Technology, Inc., formed in 1995, is a software provider for inventory management solutions in acute care hospital settings. As part of the acquisition, Omnicell acquired the rights to ScanREQ, a state-of-the-art touch screen monitor and bar code scanning system. The financial results of BCX Technology, Inc. have been included in the consolidated financial statements since the date of acquisition. Pro forma results for 2003 as if BCX Technology, Inc. was acquired on January 1, 2003 are not materially different from Omnicell’s reported 2003 results. The acquisition was accounted for as a business combination with a total purchase price of $4.0 million, which included $3.0 million paid at the time of purchase, and $1.0 million paid in January 2004 pursuant to the achievement of performance milestones in 2003. In connection with the acquisition, Omnicell also assumed certain liabilities of BCX Technology, Inc. totaling $0.1 million and incurred approximately $60,000 of acquisition related costs.  Additionally, the acquisition agreement requires Omnicell to pay up to $1.0 million before January 1, 2006 if certain performance milestones are achieved in 2004 and 2005. The Company allocated the purchase price to the tangible assets acquired based on management’s estimate of their fair values.  The fair values of the intangible assets, including the acquired current technology and trade name, were based upon the income approach to valuation. Under the income approach, the Company assumed a cash flow period of five years, revenue growth rates of 5% to 25% on an annual basis and a discount rate of 20%.  The purchase price allocation was as follows (in thousands):

 

10



 

Current assets

 

$

593

 

Property, plant and equipment

 

38

 

Intangible assets (1)

 

1,820

 

Goodwill

 

1,745

 

Total assets acquired

 

4,196

 

Current liabilities assumed

 

(134

)

Net assets acquired

 

$

4,062

 

 


(1)           Includes tradename of $231,000

 

Medisafe

 

 On December 6, 2002, Omnicell purchased substantially all of the intellectual property assets of Medisafe, a provider of point-of-care patient safety solutions. As part of the transaction, Omnicell acquired technology for a new bedside medication management solution called SafetyMed. This solution automates the nursing workflow process associated with medication administration and uses bar code technology to help ensure patient safety. The total purchase price was $3.0 million, which included $1.5 million paid at the date of purchase, $1.0 million paid in June 2003 after completion of certain obligations by Medisafe, and $0.5 million in guaranteed minimum royalties due in equal annual installments of $0.1 million beginning in January 2005. In addition, the Company incurred approximately $20,000 of acquisition related costs.  The Company allocated the purchase price to the acquired intangible assets and purchased in-process research and development based on the income approach to valuation.  Under the income approach, the Company assumed a cash flow period of five years, revenue growth rates of 33% to 210% on an annual basis and discount rates of 25% to 35%.  The purchase price allocation was as follows (in thousands):

 

Intangible assets

 

$

2,354

 

Contracted services

 

79

 

Purchased in-process research and development

 

588

 

Purchase price

 

$

3,021

 

 

As part of the purchase, Omnicell agreed to a royalty fee of 10% of related Medisafe product net revenues with a maximum limit of $2.5 million over a five-year period from the date of purchase. Payments made under the royalty arrangement that exceed the guaranteed minimum royalties will be expensed as incurred. There have been no royalty payments since the acquisition.

 

APRS, Inc.

 

On August 30, 2002, Omnicell acquired 100% of the outstanding common shares of APRS, Inc., a privately held company headquartered in Houston, Texas. APRS, Inc. was formed in 1997 to support, develop, and market integrated system solutions to health system pharmacies. The financial results of APRS, Inc. have been included in the consolidated financial statements since the date of acquisition. Pro forma results for Omnicell for 2002 as if APRS, Inc. was acquired on January 1, 2002 are not materially different from Omnicell’s reported 2002 results. In connection with the acquisition, Omnicell paid cash of $1.0 million, assumed certain liabilities of APRS, Inc. totaling $0.5 million and incurred approximately $20,000 of acquisition related costs.  The Company allocated the purchase price to the intangible assets and purchased in-process research and development based on the income approach to valuation. Under the income approach, the Company assumed a cash flow period of five years, revenue growth rates of 13% to 21% on an annual basis and a discount rate of 30%.  The purchase price allocation was as follows (in thousands):

 

Current assets

 

$

294

 

Property, plant and equipment

 

43

 

Other assets

 

2

 

Intangible assets

 

716

 

Goodwill

 

382

 

Total assets acquired

 

1,437

 

Current liabilities assumed

 

(500

)

Net assets acquired

 

937

 

Purchased in-process research and development

 

128

 

 

 

$

1,065

 

 

11



 

Intangible Assets from SecureVault, BCX Technology, Inc., Medisafe, and APRS, Inc.

 

Intangible assets resulting from the SecureVault, BCX Technology, Inc., Medisafe, and APRS, Inc. acquisitions are included in other assets and consist of the following (in thousands):

 

 

 

September 30,
2004

 

Amortization
Life

 

Customer base

 

$

244

 

5 years

 

Backlog

 

163

 

6 months

 

Service contracts

 

268

 

5 years

 

Acquired technology

 

4,684

 

3-6 years

 

Total purchased intangible assets with finite lives

 

5,359

 

 

 

Accumulated amortization

 

(1,587

)

 

 

Net purchased intangible assets

 

3,772

 

 

 

 

 

 

 

 

 

Trade name

 

231

 

Indefinite

 

Net purchase intangible asset with indefinite lives

 

231

 

 

 

Net total purchased intangible assets

 

$

4,003

 

 

 

 

Estimated future amortization expense of the purchased intangible assets at September 30, 2004 is as follows (in thousands):

 

2004 (remaining 3 months)

 

$

295

 

2005

 

1,182

 

2006

 

1,034

 

2007

 

770

 

2008

 

456

 

2009

 

35

 

Total

 

$

3,772

 

 

Note 3. Sales of Accounts Receivable

 

The Company offers customers multi-year, non-cancelable payment terms.  For the three and nine months ended September 30, 2004, sales of medication and supply dispensing systems sold with multi-year payment terms totaled approximately $13.1 million and $29.5 million, respectively. For the three and nine months ended September 30, 2003, sales of medication and supply dispensing systems sold with multi-year payment terms totaled approximately $6.9 million and $22.0 million, respectively. The Company typically sells the customers’ multi-year payment agreements to a third-party leasing company.  For the three and nine months ended September 30, 2004, customer multi-year payment term agreements sold to third-party leasing companies totaled approximately $12.6 million and $27.7 million, respectively.  For the three and nine months ended September 30, 2003, customer multi-year payment term agreements sold to third-party leasing companies totaled approximately $6.8 million and $22.9 million, respectively.  The Company has no obligation under a multi-year payment agreement once it is sold to the finance company. Revenue is recognized upon completion of the Company’s installation obligation, if any, and commencement of the noncancelable multi-year payment term. At September 30, 2004 and December 31, 2003, accounts receivable included $4.5 million and $3.1 million, respectively, from the finance companies for multi-year payment term agreements sold.

 

12



 

Note 4. Inventories

 

Inventories consist of the following (in thousands):

 

 

 

September 30,
2004

 

December 31,
2003

 

 

 

 

 

 

 

Raw materials

 

$

10,406

 

$

5,996

 

Work-in-process

 

717

 

432

 

Finished goods

 

6,074

 

2,355

 

Total

 

$

17,197

 

$

8,783

 

 

Note 5. Purchased Residuals

 

 Although the Company had no contractual obligation to do so, in July 2002, it executed an agreement to purchase from Americorp Financial, Inc. (“AFI”) all residual interests in Omnicell equipment covered by multi-year payment agreements financed by AFI. The total purchase price was $3.1 million. The purchase price was assigned to the acquired payment residuals based on the original implied payment residual value, equipment type, and the Company’s assessment of the customers’ likelihood of renewal at the end of the payment term. As equipment is renewed or upgraded, the Company charges the assigned value to cost of product revenues. When equipment is not renewed or upgraded at the end of the lease contract or when the Company believes a renewal is unlikely, the assigned value is written off. The payment streams associated with the purchased residuals expire at various dates within four years from the date of the purchase agreement. The value of purchased residuals as of September 30, 2004 and December 31, 2003 was $1.0 million and $2.3 million, respectively, and is recorded in other assets.

 

Note 6. Accrued Facility Costs

 

In December 2003, the Company recorded facility costs of $0.4 million related to the move of its corporate headquarters and manufacturing facility to its current location in Mountain View, California. This move was initiated to reduce costs and improve operational efficiencies. The facility costs consisted of remaining rent expense and the write-off of the remaining leasehold improvements related to the Company’s former facilities in Palo Alto, California. The lease related to Omnicell’s former manufacturing facility expired in February 2004. The lease related to Omnicell’s former corporate headquarters expired in June 2004.

 

The following table sets forth the facility costs reserve activity for the nine months ended September 30, 2004 (in thousands):

 

 

 

Accrued Facility Costs

 

 

 

 

 

Balance at December 31, 2003

 

$

420

 

Cash payments

 

(404

)

Facility charge

 

(16

)

Balance at September 30, 2004

 

$

 

 

Note 7. Deferred Gross Profit

 

Deferred gross profit consists of the following (in thousands):

 

 

 

September 30,
2004

 

December 31,
2003

 

 

 

 

 

 

 

Sales of medication and supply dispensing systems, which have been accepted but not yet installed

 

$

12,107

 

$

12,912

 

Cost of sales, excluding installation costs

 

(3,884

)

(2,787

)

Total

 

$

8,223

 

$

10,125

 

 

Note 8. Indemnification Arrangements and Guarantees

 

As permitted under Delaware law and the Company’s bylaws and certificate of incorporation, Omnicell has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was serving, at Omnicell’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments Omnicell could be required to make under these indemnification agreements is unlimited; however, it has a directors’ and officers’ insurance policy that may enable it to recover a portion of any future amounts paid. Assuming the applicability of coverage and the willingness of the insurer to assume coverage and subject to certain retention, loss limits and other policy provisions, the Company believes it is unlikely that it will be required to pay any material amounts pursuant to this

 

13



 

indemnification obligation. However, no assurances can be given that the insurers will not attempt to dispute the validity, applicability or amount of coverage without expensive and time-consuming litigation against the insurers.

 

Additionally, the Company undertakes indemnification obligations in its ordinary course of business in connection with, among other things, the licensing of its products and the provision by the Company of technical services. Pursuant to these agreements, the Company may indemnify the other party for certain losses suffered or incurred by the indemnified party, generally its business partners or customers, in connection with various types of claims, which may include, without limitation, claims of intellectual property infringement, certain tax liabilities, negligence and intentional acts in the performance of services and violations of laws. The term of these indemnification obligations is generally perpetual. In general, the Company attempts to limit the maximum potential amount of future payments it could be required to make under these indemnification obligations to the purchase price paid, but in some cases the obligation may not be so limited. In addition, the Company may, in certain situations, warrant that, for a certain period of time from the date of delivery, their software products will be free from defects in media or workmanship. From time to time, it may also warrant that the Company’s professional services will be performed in a good and workmanlike manner. In addition, it is its standard policy to seek to disclaim most warranties, including any implied or statutory warranties such as warranties of merchantability, fitness for a particular purpose, quality and non-infringement, as well as any liability with respect to incidental, consequential, special, exemplary, punitive or similar damages. In some states, such disclaimers may not be enforceable. If necessary, the Company would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history. However, in the recent past, the Company has not been subject to any significant claims for such losses and has not incurred any material costs in defending or settling claims related to these indemnification obligations. Accordingly, the Company believes it is unlikely that it will be required to pay any material amounts pursuant to this indemnification obligation.

 

Note 9. Comprehensive Income

 

The following are the components of comprehensive income (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Net income

 

$

3,256

 

$

2,327

 

$

7,983

 

$

4,064

 

Unrealized gain (loss) on short-term investments

 

16

 

 

(8

)

 

Comprehensive income

 

$

3,272

 

$

2,327

 

$

7,975

 

$

4,064

 

 

Note 10. Registration Statement on Form S-3

 

In July 2004, Omnicell filed a registration statement on Form S-3 which, when effective, will enable the Company to offer and sell, from time to time, its securities in one or more offerings up to a total dollar amount of $100 million.

 

14



 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

In addition to historical information, this report contains predictions, estimates and other forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from any future performance suggested in this report as a result of many factors, including those referred to in “Factors That May Affect Future Operating Results” contained elsewhere in this report. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes included elsewhere in this report

 

Overview

 

We started our business in 1992 and began offering our supply automation systems for sale in 1993. In late 1996, we introduced our Omnicell medication dispensing system. In January 1999, we expanded our line of medication dispensing systems and customer base with the acquisition of the Sure-Med product line from Baxter Healthcare Corporation. In August 2002, we acquired APRS, Inc. to support, develop, and market integrated system solutions to health system pharmacies.  This central pharmacy carousel storage and retrieval solution is sold under our Omnicell Pharmacy Central product name. In December 2002, we purchased the intellectual property assets of Medisafe, a provider of point-of-care bedside automation solutions called SafetyMed. In August 2003, we acquired BCX Technology, Inc., a provider of open bar code supply management systems branded ScanREQ, to complement our cabinet-based supply solutions. In March 2004, we acquired Ariel Distributing, Inc.’s closed-loop, controlled substance inventory management software for healthcare system pharmacies, used and marketed by us under the product name SecureVault.  From inception through September 30, 2004, we had completed our installation obligations, if any, for an aggregate of 31,104 of our medication and supply dispensing systems at 1,534 healthcare facilities.

 

We sell our medication and supply dispensing systems primarily in the United States. We have a direct sales force organized into five regions in the United States and Canada. We sell through distributors in Canada, Europe, the Middle East, Asia and Australia. We manufacture the majority of our systems in our production facility in Mountain View, California, with refurbishment and spare parts activities conducted in our Waukegan, Illinois facility.

 

 We recognize revenue when our medication and supply dispensing systems are installed. Installation generally takes place three to six months after our systems are ordered since the acceptance process of our customers includes internal procedures associated with large capital expenditures and the time associated with adopting new technologies. Given the length of time for our customers to accept installation of our systems and to be more predictable and efficient in our manufacturing and installation processes, our focus is on shipping products based on the installation dates as requested by our customers and on growing product backlog. Product backlog is defined as the amount of medication and supply dispensing systems that have shipped to customers but have not yet been installed at the customer site plus the amount of such systems that have not shipped but for which we have purchase orders, and which we believe will be installed within the next 12 months. We increased our product backlog by $3.3 million during the quarter to $49.7 million as of September 30, 2004.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions.

 

Management believes there have been no significant changes during the three and nine months ended September 30, 2004, to the items which we disclosed as our critical accounting policies in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2003.

 

15



 

Results of Operations

 

The following table sets forth certain items included in our results of operations for the three and nine months ended September 30, 2004 and 2003, expressed as a percentage of total revenues for these periods:

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenues

 

81.8

%

80.3

%

80.6

%

80.4

%

Service and other revenues

 

18.2

 

19.7

 

19.4

 

19.6

 

Total revenues

 

100.0

 

100.0

 

100.0

 

100.0

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Cost of product revenues

 

34.7

 

33.0

 

33.3

 

34.3

 

Cost of service and other revenues

 

7.0

 

8.0

 

7.2

 

7.5

 

Total cost of revenues

 

41.7

 

41.0

 

40.5

 

41.8

 

Gross profit

 

58.3

 

59.0

 

59.5

 

58.2

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

7.6

 

8.6

 

7.4

 

9.1

 

Selling, general, and administrative

 

40.7

 

40.9

 

42.8

 

42.4

 

Restructuring and severance charges

 

0.0

 

0.0

 

0.2

 

0.9

 

Total operating expenses

 

48.3

 

49.5

 

50.4

 

52.4

 

Income from operations

 

10.0

 

9.5

 

9.1

 

5.8

 

Interest and other income

 

0.3

 

0.4

 

0.3

 

0.5

 

Interest and other expense

 

0.0

 

(0.1

)

0.0

 

(0.2

)

Income before provision for income taxes

 

10.3

 

9.8

 

9.4

 

6.1

 

Provision for income taxes

 

0.4

 

1.0

 

0.4

 

0.6

 

Net income

 

9.9

%

8.8

%

9.0

%

5.5

%

 

Product Revenue, Cost of Product Revenues, and Gross Profit

 

Year over year comparison for the three and nine months ended September 30, 2004 (in thousands):

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenues

 

$

26,767

 

$

21,157

 

$

72,374

 

$

59,161

 

Cost of product revenues

 

11,344

 

8,683

 

29,881

 

25,208

 

Gross Profit

 

$

15,423

 

$

12,474

 

$

42,493

 

$

33,953

 

 

Product Revenues. Product revenues increased 26.5% to $26.8 million for the three months ended September 30, 2004 from $21.2 million in the same period in 2003. Product revenues increased 22.3% to $72.4 million for the nine months ended September 30, 2004 from $59.2 million in the same period in 2003. The increase in product revenues for the three and nine months ended September 30, 2004 was due to an increase in the number of medication and supply dispensing system installations, an increase in revenue associated with our provision of software programs that interface our system with our customers’ system, and an increase in revenue from multi-year payment arrangements resulting in an increase in the size of the average customer deal. Part of this increase can be attributed to our emphasis on closing larger and more complex deals with larger healthcare facilities. Product revenues for the three and nine months ended September 30, 2004 also included revenues of BCX Technologies, Inc. acquired in the third quarter of 2003. We expect product revenues to experience modest growth throughout the remainder of 2004.

 

16



 

Cost of Product Revenues. Cost of product revenues consists primarily of direct materials, labor and overhead required to manufacture medication and supply dispensing systems and also includes costs required to install our systems and develop interfaces with our customer’s systems.

 

Cost of product revenues increased 30.6% to $11.3 million for the three months ended September 30, 2004 from $8.7 million in the same period in 2003. Cost of product revenues increased 18.5% to $29.9 million for the nine months ended September 30, 2004 from $25.2 million in the same period in 2003. The increase in cost of product revenues was attributable to the increase in headcount and temporary labor, in part required by the installation of units near the end of the quarter that had only been ordered earlier in the same quarter, as well as the increase in charges related to the renewal of existing multi-year payment term agreements related to purchased residuals.

 

Gross profit on product revenue was $15.4 million, or 57.6% of product revenues for the three months ended September 30, 2004, as compared to $12.5 million, or 59.0% of product revenues in the same period in 2003. The decrease in gross profit on product revenue during the three-month period is a result of higher costs due to a change in product mix as well as the recognition of costs associated with purchased residual interests in Omnicell equipment covered by multi-year payment agreements financed by a third party. Gross profit on product revenue was $42.5 million, or 58.7% of product revenues for the nine months ended September 30, 2004, as compared to $34.0 million, or 57.4% of product revenues in the same period in 2003. The increase in the gross profit on product revenues during the nine-month period is a result of increased efficiencies in operations, manufacturing and installation services. We expect the cost of product revenues to increase consistently with product revenue growth, maintaining approximately the same level of gross profit margin throughout the rest of 2004.

 

Service and Other Revenue, Cost of Service and Other Revenues and Gross Profit

 

Year over year comparison for the three and nine months ended September 30, 2004 (in thousands):

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Service and other revenues

 

$

5,967

 

$

5,202

 

$

17,396

 

$

14,414

 

Cost of service and other revenues

 

2,302

 

2,117

 

6,508

 

5,542

 

Gross Profit

 

$

3,665

 

$

3,085

 

$

10,888

 

$

8,872

 

 

Service and Other Revenues. Service and other revenues includes revenues from service and maintenance contracts and rentals of automation systems. Service and other revenues increased 14.7% to $6.0 million for the three months ended September 30, 2004 from $5.2 million in the same period in 2003. Service and other revenues increased 20.7% to $17.4 million for the nine months ended September 30, 2004 from $14.4 million in the same period in 2003. The increase in service and other revenues was primarily due to the increase in our installed base of automation systems and an increase in support service contracts. We expect a slight increase in service and other revenues for the remainder of 2004.

 

Cost of Service and Other Revenues. Cost of service and other revenues increased 8.7% to $2.3 million for the three months ended September 30, 2004 from $2.1 million in the same period in 2003. Cost of service and other revenues increased 17.4% to $6.5 million for the nine months ended September 30, 2004 from $5.5 million in the same period in 2003. For the three months ended September 30, 2004, gross margin on service and other revenues was $3.7 million, or 61.4% of service and other revenues as compared to $3.1 million, or 59.3% of service and other revenues in the same period in 2003. The increase in gross margin on services and other revenues for the three months ended September 30, 2004 was a result of increased revenues from the roll out of multi-tiered pricing packages for premium services. For the nine months ended September 30, 2004, gross margin on service and other revenues was $10.9 million, or 62.6% of service and other revenues as compared to $8.9 million, or 61.6% of service and other revenues in the same period in 2003. The increase in gross margin on service and other revenues for the nine months ended September 30, 2004 reflects a reduction in cost from the transition from an outsourced service model to an internal service organization, partially offset by increased costs due to the change to the service call center model which provides extended hours of coverage to customers. We expect the cost of services and other revenues will continue to fluctuate based on our ability to improve cost efficiencies from our internal service organization.

 

17



 

Operating Expenses

 

Year over year comparison for the three and nine months ended September 30, 2004 (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Research and development

 

$

2,476

 

$

2,256

 

$

6,679

 

$

6,731

 

Selling, general and administrative

 

13,325

 

10,794

 

38,419

 

31,216

 

Restructuring, severance and facility charges

 

 

 

171

 

630

 

Total operating expenses

 

$

15,801

 

$

13,050

 

$

45,269

 

$

38,577

 

 

Research and Development. Research and development expenses increased 9.8% to $2.5 million for the three months ended September 30, 2004, from $2.3 million in the same period in 2003. The increase was due primarily to increased spending on software development, cost reduction initiatives for which we will receive future benefits, product documentation and integration of acquired technology, and engineering endeavors to improve on product quality and reliability. Research and development expenses remained flat at $6.7 million for the nine months ended September 30, 2004 and 2003. Research and development expenses decreased as a percentage of total revenues to 7.6% in the three months ended September 30, 2004 compared to 8.6% in the same period in 2003. Research and development expenses decreased as a percentage of total revenues to 7.4% in the nine months ended September 30, 2004 compared to 9.1% in the same period in 2003. We expect research and development expense to increase during the remainder of 2004 in order to support continued new product development and research activities.

 

Selling, General and Administrative. Selling, general and administrative costs increased 23.4% to $13.3 million for the three months ended September 30, 2004 from $10.8 million in the same period in 2003. Selling, general and administrative costs increased 23.1% to $38.4 million for the nine months ended September 30, 2004 from $31.2 million in the same period in 2003. The increase in selling, general and administrative expenses is a result of increased headcount to support the targeted increases in revenue and bookings and continued business growth. We increased headcount in our selling, general and administrative areas by approximately 22.0% from September 30, 2003 to September 30 2004, with half of the growth concentrated in sales and customer service functions. Selling, general and administrative costs decreased as a percentage of total revenues to 40.7% in the three months ended September 30, 2004 compared to 40.9% in the same period in 2003. Selling, general and administrative costs increased as a percentage of total revenues to 42.8% in the nine months ended September 30, 2004 compared to 42.4% in the same period in 2003. We expect selling, general and administrative expenses will continue to increase slightly during the remainder of 2004 in order to support our continued business growth.

 

Restructuring and Severance Charges. In fiscal 2004 and 2003, we restructured our organization to reduce costs and improve operational efficiencies. As part of this restructuring, we reduced headcount by 3 employees in 2004 and by 14 employees in 2003. As a result, we recorded restructuring and severance charges of $0.2 million in the second quarter of 2004 and $0.6 million in the second quarter of 2003, primarily related to employee severance and benefits.

 

Provision for Income Taxes

 

Year over year comparison for the three and nine months ended September 30, 2004 (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

$

124

 

$

257

 

$

325

 

$

442

 

 

Provisions for income taxes were recorded for the three and nine months ended September 30, 2004 and 2003. These provisions were attributable to federal and state alternative minimum taxes and other state taxes. The amounts provided were at rates less than the combined U.S. federal and state statutory rates due to the recognition of federal and state net operating loss carry forwards.

 

18



 

Backlog

 

Product backlog is the dollar value of medication and supply dispensing systems that have shipped to customers but are not yet installed at the customer site plus the dollar value of such systems that have not shipped but for which we have purchase orders, and which we believe will be installed within the next 12 months. We have made significant efforts to increase our backlog each quarter and reduce our reliance on “turns” business. Turns business represents customer orders received and installed in the same quarter. We believe a material reduction in turns business will reduce the cost of product revenues, produce more predictable and sustainable quarterly growth and facilitate improved customer service. Reliance on turns business creates inefficiencies in the underlying operating model for the company, adding expenses in planning, building, and installing product. It also can increase finished goods inventory and reduce visibility of future revenues, since it often involves accelerating normal installation schedules from a future quarter. We intend to continue to build our product backlog and work to reduce our reliance on turns business. Our product backlog increased $3.3 million to $49.7 million as of September 30, 2004, from $46.4 million as of June 30, 2004.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity, which include cash, cash equivalents and short-term investments, totaled approximately $32.6 million as of September 30, 2004 compared to $36.3 million as of June 30, 2004, $36.2 million as of March 31, 2004 and $33.5 million as of December 31, 2003. Our funds are currently invested in institutional money market funds, U.S. commercial and government debt securities.

 

Net cash used by operating activities was $3.0 million during the first nine months of 2004 compared to $6.3 million provided in the same period in 2003. Net income was $8.0 million during the first nine months of 2004 compared to $4.1 million in the same period in 2003. The decrease in cash flow from operating activities resulted primarily from the reduction in accrued liabilities, increased inventories, accounts receivables, prepaid expenses, and other assets which included an increase of $1.9 million for internally-billed receivables with multi-year sales agreements, offset by increases in accounts payable and deferred services. Inventories increased by $8.4 million for the nine months ended September 30, 2004 as a result of inventory build up for expected customer orders that were not shipped during the period. We expect that most of these orders will be shipped during the fourth quarter of 2004.

 

We used $7.6 million of cash in investing activities in the nine months ended September 30, 2004 compared to $8.2 million in the same period in 2003. The decrease in cash used in investing activities during the nine months ended September 30, 2004 compared to September 30, 2003 resulted from net $2.2 million purchases of short-term investments, the payment of $0.6 million for the acquisition of the SecureVault product line from Ariel Distributing, the payment of $0.7 million for a product development agreement with Integra Group, Inc., $1.0 million paid as part of the BCX acquisition, including $0.5 million paid as part of the purchase price and $0.5 million paid relating to the achievement of performance milestones in 2003. Cash used for capital expenditures, which included expenditures for leasehold improvements, computer equipment, and software, increased to $3.0 million for the nine months ended September 30, 2004 from $1.5 million for the same period in 2003. Additionally, the nine months ended September 30, 2003 includes higher levels of spending related to the BCX acquisition.

 

We generated $7.5 million from financing activities in the nine months ended September 30, 2004 compared to $7.3 million generated in the first nine months of 2003. Financing activities consisted of raising funds through issuances of our common stock primarily as a result of the exercise of employee stock options and stock issuances under the employee stock purchase plan. Although the cash generated from financing activities increased only slightly year-to-year, the proceeds from the issuance of common stock increased by $2.7 million from 2003 to 2004. This increase was offset, however, by approximately $3.1 million in proceeds from stockholder’s notes receivable during the nine months ended September 30, 2003.

 

We believe our current cash balances and cash flows generated by operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, if demand for our products and services does not continue as currently anticipated, we may be required to raise additional capital through the public equity market, private financings, collaborative arrangements or debt. In addition, in certain circumstances we may decide that it is in our best interests to raise additional capital to take advantage of opportunities in the marketplace. We have filed a registration statement on Form S-3 which, when effective, will enable us to offer and sell, from time to time, our securities in one or more offerings up to a total dollar amount of $100 million. If additional capital is raised through the issuance of equity or securities convertible into equity, our stockholders may experience dilution, and such securities may have rights, preferences or privileges senior to those of the holders of the common stock. Additional financing may not be available to us on favorable terms, if at all. If we are unable to obtain financing, or to obtain it on acceptable terms, we may be unable to execute our business plan.

 

19



 

We have net operating lease commitments of $6.7 million payable when due through 2009 as follows (in thousands):

 

2004

 

$

98

 

2005

 

1,189

 

2006

 

1,631

 

2007

 

1,504

 

2008

 

1,588

 

2009

 

680

 

Total minimum lease payment

 

$

6,690

 

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There were no significant changes in the quantitative and qualitative disclosures in market risk related to changes in interest rates, foreign currency exchange rates, commodity prices, and equity prices from the Company’s Form 10-K as filed with the Securities and Exchange Commission for the fiscal year ended December 31, 2003.

 

Factors That May Affect Future Operating Results

 

Any reduction in the demand for or adoption of our medication and supply dispensing systems and related services would reduce our revenues.

 

Our medication and supply dispensing systems represent a relatively new approach to managing the distribution of pharmaceuticals and supplies at healthcare facilities. Many healthcare facilities still use traditional approaches that do not include automated methods of medication and supply dispensing management. As a result, we must continuously educate existing and prospective customers about the advantages of our products. Our medication and supply dispensing systems typically represent a sizeable initial capital expenditure for healthcare organizations. Changes in the budgets of these organizations and the timing of spending under these budgets can have a significant effect on the demand for our medication and supply dispensing systems and related services. In addition, these budgets are often characterized by limited resources and conflicting spending priorities among different departments. Any decrease in expenditures by these healthcare facilities, particularly our significant customers, could decrease demand for our medication and supply dispensing systems and related services and reduce our revenues. We cannot assure you that we will continue to be successful in marketing our medication and supply dispensing systems or that the level of market acceptance of such systems will be sufficient to generate operating income.

 

If we experience delays in or loss of sales of, delays in installations of, or delays in the recognition of revenue associated with our medication and supply dispensing systems, our competitive position, results of operations and financial condition could be harmed.

 

The purchase of our medication and supply dispensing systems is often part of a customer’s larger initiative to re-engineer its pharmacy, distribution and materials management systems. As a result, the purchase of our medication and supply dispensing systems has recently translated into larger, strategic purchases by customers that frequently require more complex and stringent contractual requirements and generally involve a significant commitment of management attention and resources by prospective customers. These larger and more complex deals often require the input and approval of many decision-makers, including pharmacy directors, materials managers, nurse managers, financial managers, information systems managers, administrators, lawyers and boards of directors. For these and other reasons, the sales cycle associated with the sale of our medication and supply dispensing systems is often lengthy and subject to a number of delays over which we have little or no control. We cannot assure you that we will not experience delays in the future. A delay in, or loss of, sales of our medication and supply dispensing systems could cause our operating results to vary significantly from quarter to quarter and could harm our business.

 

Also, and in part as a result of the aforementioned complexities inherent in larger transactions, our average installation times have increased for reasons that are often outside of our control. Since we recognize revenue only upon installation of our systems at a customer’s site, any delay in installation by our customers could also cause a reduction in our revenue for a given quarter. In addition, the larger, more complex deals often require us to include negotiated contractual terms that have the affect of delaying revenue recognition under the accounting rules that apply to us.

 

For all the above reasons, we believe that period-to-period comparisons of our operating results are not necessarily indicative of our future performance. Fluctuation in our quarterly operating results may cause our stock price to decline.

 

20



 

Our quarterly operating results may fluctuate and may cause our stock price to decline.

 

Our quarterly operating results may vary in the future depending on many factors that include, but are not limited to, the following:

 

                  the ability to successfully install our products on a timely basis and meet other contractual obligations necessary to recognize revenue;

 

                  the size and timing of orders for our medication and supply dispensing systems, and their installation and integration;

 

                  the overall demand for healthcare medication management and supply chain solutions;

 

                  changes in pricing policies by us or our competitors;

 

                  the number, timing and significance of product enhancements and new product announcements by us or our competitors;

 

                  the relative proportions of revenues we derive from products and services;

 

                  our customers’ budget cycles;

 

                  changes in our operating expenses;

 

                  the performance of our products;

 

                  changes in our business strategy; and

 

                  economic and political conditions, including fluctuations in interest rates and tax increases.

 

Due to the foregoing factors, our quarterly revenues and operating results are difficult to predict and fluctuate, which in turn may cause the market price of our stock to decline.

 

The healthcare industry faces financial constraints and consolidation that could adversely affect the demand for our products and services.

 

The healthcare industry has faced, and will likely continue to face, significant financial constraints. For example, the shift to managed care in the 1990s put pressure on healthcare organizations to reduce costs, and the Balanced Budget Act of 1997 significantly reduced Medicare reimbursement to healthcare organizations. Our automation solutions often involve a significant financial commitment by our customers, and, as a result, our ability to grow our business is largely dependent on our customers’ information technology budgets. To the extent healthcare information technology spending declines or increases more slowly than we anticipate, demand for our products and services would be negatively affected.

 

Many healthcare providers have consolidated to create larger healthcare delivery organizations with greater market power. If this consolidation continues, it could erode our customer base and reduce the size of our target market. In addition, the resulting organizations could have greater bargaining power, which may lead to price erosion.

 

The medication management and supply chain solutions market is highly competitive and we may be unable to compete successfully against new entrants and established companies with greater resources.

 

The medication management and supply chain solutions market is intensely competitive and is characterized by evolving technologies and industry standards, frequent new product introductions and dynamic customer requirements. We expect continued and increased competition from current and future competitors, many of whom have significantly greater financial, technical, marketing and other resources than we do. Our current direct competitors in the medication management and supply chain solutions market include Pyxis Corporation (a division of Cardinal Health, Inc.), McKesson Automation Inc. (a business unit of McKesson Corporation) and AmerisourceBergen Drug Corporation (through its acquisition of MedSelect, Inc.). Pyxis Corporation, in particular, has a significantly larger installed base of customers than we do and over the last few years has developed and introduced to the market a significantly larger number of new products. With the acquisition of Omnicell PharmacyCentral, SafetyMed and ScanREQ and the development of our open systems solutions, we have gained additional competitors. They include AutoMed, Inc. and Bridge Medical, Inc. (both AmerisourceBergen Drug Corporation companies), the Baxter Medication Delivery business of Baxter International Inc., Care Fusion, Incorporated, Cerner Corporation, Eclipsys Corporation, IDX Systems Corporation and Siemens Medical Solutions (a division of Siemens AG).

 

21



 

The competitive challenges we face in the medication management and supply chain solutions market include, but are not limited to the following:

 

                  our competitors may develop, license or incorporate new or emerging technologies or devote greater resources to the development, promotion and sale of their products and services;

 

                  certain competitors have greater name recognition and a more extensive installed base of medication and supply dispensing systems or other products and services than we do, and such advantages could be used to increase their market share;

 

                  other established or emerging companies may enter the medication management and supply chain solutions market;

 

                  current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties, including larger, more established healthcare supply companies, thereby increasing their ability to develop and offer products and services to address the needs of our prospective customers; and

 

                  our competitors may secure products and services from suppliers on more favorable terms or secure exclusive arrangements with suppliers or buyers that may impede the sales of our products and services. Competitive pressures could result in price reductions of our products and services, fewer customer orders and reduced gross margins, any of which could harm our business.

 

Competitive pressures could result in price reductions of our products and services, fewer customer orders and reduced gross margins, any of which could harm our business.

 

Our current and potential customers may have other business relationships with our competitors and consider those relationships when deciding between our products and services and those of our competitors.

 

Many of our competitors are large drug and medical-surgical supply distribution companies that sell their distribution services to our current and potential customers. As a result, if a customer is a distribution customer of one of our competitors, the customer may be motivated to purchase medication and supply dispensing systems or other automation solutions from our competitor in order to maintain or enhance their business relationship with that competitor.

 

We have a history of operating losses and we cannot assure you that we will maintain profitability.

 

We had net losses of $1.2 million and $5.0 million in 2001 and 2002 respectively. While we were profitable with net income of $7.3 million for the year ended December 31, 2003 and $8.0 million for the nine months ended September 30, 2004, we cannot assure you that we will be profitable in the future. Furthermore, we cannot assure you that we will be able to maintain or increase profitability in the future on a quarterly or annual basis.

 

If the market price of our stock continues to be highly volatile, the value of an investment in our common stock may decline.

 

For the 12 months prior to September 30, 2004 and for the period between October 1, 2004 and November 3, 2004, our common stock has traded between $8.95 and $22.64 per share. The market price for shares of our common stock has been and may continue to be highly volatile. In addition, our announcements or external events may have a significant impact on the market price of our stock. These announcements or external events may include:

 

                  our operating results;

 

                  developments in our relationships with corporate customers;

 

                  changes in the ratings of our stock by securities analysts;

 

                  announcements by us or our competitors of technological innovations or new products; or

 

                  general economic and market conditions.

 

Furthermore, the stock market as a whole from time to time has experienced extreme price and volume fluctuations, which have particularly affected the market prices for emerging companies. These broad market fluctuations may cause the market price of our common stock to decline irrespective of our performance. In addition, sales of substantial amounts of our common stock in the public market could lower the market price of our common stock.

 

22



 

We may not be able to successfully integrate acquired businesses or technologies into our existing business, which could negatively impact our operating results.

 

As a part of our business strategy, we recently acquired SafetyMed, Omnicell PharmacyCentral and SecureVault and we may seek to acquire other businesses, technologies or products in the future. While we expect to analyze carefully all potential transactions before committing to them, we cannot assure you that any transaction that is completed will result in long-term benefits to us or our stockholders, or that our management will be able to integrate or manage the acquired business effectively. Acquisitions entail numerous risks, including difficulties associated with the integration of operations, technologies, products and personnel that, if realized, could harm our operating results. Risks related to potential acquisitions include, but are not limited to:

 

                  uncertain availability of suitable businesses, products or technologies for acquisition on terms acceptable to us;

 

                  difficulties in combining previously separate businesses into a single unit;

 

                  substantial diversion of management’s attention from day-to-day business when evaluating and negotiating such transactions and then integrating an acquired business;

 

                  discovery, after completion of the acquisition, of liabilities assumed from the acquired business or of assets acquired that are not realizable;

 

                  failure to achieve anticipated benefits such as cost savings and revenue enhancements;

 

                  difficulties related to assimilating the products of an acquired business; and

 

                  failure to understand and compete effectively in markets in which we have limited previous experience.

 

If our U.S. government customers do not receive their annual funding, our ability to recognize revenues on future sales to U.S. government customers, to sell our U.S. government receivables to third-party leasing companies or to collect payments on unsold receivables from U.S. government customers could be impaired.

 

U.S. government customers sign five-year non-cancelable payment terms but are subject to one-year government budget funding cycles. In our judgment and based on our history with these accounts, we believe these receivables are collectible. However, in the future, the failure of any of our U.S. government customers to receive their annual funding could impair our ability to sell to these customers or to sell our U.S. government receivables to third-party leasing companies. In addition, the ability to collect payments on unsold receivables could be impaired and may result in a write down of our unsold receivables to U.S. government customers. As of September 30, 2004 the balance of our unsold leases to U.S. government customers was $3.9 million.

 

If we are unable to recruit and retain skilled and motivated personnel, our competitive position, results of operations and financial condition could be harmed.

 

Our success is highly dependent upon the continuing contributions of our key management, sales, technical and engineering staff. We believe that our future success will depend upon our ability to attract, train and retain highly skilled and motivated personnel. As our products are installed in increasingly complex environments, greater technical expertise will be required. As our installed base of customers increases, we will also face additional demands on our customer service and support personnel, requiring additional resources to meet these demands. We may experience difficulty in recruiting qualified personnel. Competition for qualified technical, engineering, managerial, sales, marketing, financial reporting and other personnel can be intense and we cannot assure you that we will be successful in attracting and retaining qualified personnel. Competitors have in the past attempted, and may in the future attempt, to recruit our employees. Failure to attract and retain key personnel could harm our competitive position, results of operations and financial condition.

 

If we are unable to maintain our relationships with group purchasing organizations or other similar organizations, we may have difficulty selling our products and services.

 

We have agreements with various group purchasing organizations, such as Premier, Inc., Novation, LLC, AmeriNet, Inc., HealthTrust Purchasing Group, L.P., Consorta, Inc. and Broadlane, Inc., which enable us to sell more readily our products and services to customers represented by these organizations. Our relationships with these organizations are terminable at the convenience of either party. The loss of any of these relationships could impact the breadth of our customer base and could impair our ability to increase our revenues. We cannot guarantee that these organizations will renew our contracts on similar terms, if at all, and they may choose to terminate our contracts before they expire.

 

23



 

We depend on a limited number of suppliers for our medication and supply dispensing systems, and our business may suffer if we are unable to obtain an adequate supply of components and equipment on a timely basis.

 

Our production strategy for our medication and supply dispensing systems is to work closely with several key sub-assembly manufacturers and equipment providers and utilize lower cost manufacturers whenever possible. Although many of the components of our systems are standardized and available from multiple sources, certain components or subsystems are fabricated according to our specifications. At any given point in time, we may only use a single source of supply for certain components. Our failure to obtain alternative vendors, if required, for any of the numerous components used to manufacture our products would limit our ability to manufacture our products and could reduce our revenues.

 

If we are unable to successfully integrate our automation solutions with the existing information systems of our customers, they may choose not to use our products and services.

 

For healthcare facilities to fully benefit from our automation solutions, our systems must integrate with their existing information systems. This may require substantial cooperation, investment and coordination on the part of our customers. There is little uniformity in the systems currently used by our customers, which complicates the integration process. If these systems are not successfully integrated, our customers could choose not to use or to reduce their use of our automation solutions, which would harm our business.

 

Our failure to protect our intellectual property rights could negatively affect our ability to compete.

 

We believe that our success depends in part on our ability to obtain patent protection for technology and processes and our ability to preserve our trademarks, copyrights and trade secrets. We have pursued patent protection in the United States and foreign jurisdictions for technology that we believe to be proprietary and for technology that offers us a potential competitive advantage for our products and we intend to continue to pursue such protection in the future. Our issued patents relate to various features of our medication and supply dispensing systems. There can be no assurance that we will file any patent applications in the future, that any of our patent applications will result in issued patents or that, if issued, such patents will provide significant protection for our technology and processes. Furthermore, there can be no assurance that others will not develop technologies that are similar or superior to our technology or that others will not design around the patents we own. All of our system software is copyrighted and subject to the protection of applicable copyright laws. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary.

 

Intellectual property claims against us could harm our competitive position, results of operations and financial condition.

 

We are aware of one third-party patent issued several years ago that may relate to certain of our products. Although we have received no notice alleging infringement from this third party to date, there can be no assurance that such third party will not assert an infringement claim against us in the future. Other than this patent, we do not believe that any of our products infringe upon the proprietary rights of any third parties. In the future, third parties may claim that we have infringed upon their intellectual property rights with respect to current or future products. We expect that developers of medication and supply dispensing systems will be increasingly subject to infringement claims as the number of products and competitors in our industry grows and the functionality of products in different industry segments overlaps. We do not possess special insurance that covers intellectual property infringement claims; however, such claims may be covered under our traditional insurance policies. These policies contain terms, conditions and exclusions that make recovery for intellectual infringement claims difficult to guarantee. Any infringement claims, with or without merit, could be time-consuming to defend, result in costly litigation, divert management’s attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. These royalty or licensing agreements, if required, may not be available on terms acceptable to us, or at all, which could harm our competitive position, results of operations and financial condition.

 

Product liability claims against us could harm our competitive position, results of operations and financial condition.

 

Our products provide medication management and supply chain solutions for the healthcare industry. Despite the presence of healthcare professionals as intermediaries between our products and patients, if our products fail to provide accurate and timely information or operate as designed, customers, patients or their family members could assert claims against us for product liability. Also, in the event that any of our products are defective, we may be required to recall or redesign those products. Litigation with respect to liability claims, regardless of its outcome, could result in substantial cost to us, divert management’s attention from operations and decrease market acceptance of our products. Although we have not experienced any product liability claims to date, the sale and support of our products entail the risk of product liability claims. We possess a variety of insurance policies that include coverage for general commercial liability and technology errors and omissions liability. However, these policies may not be adequate against product liability claims. A successful claim brought against us, or any claim or product recall that results in negative publicity about us, could harm our competitive position, results of operations and financial condition.

 

24



 

Changing customer requirements could decrease the demand for our products and services.

 

The medication management and supply chain solutions market is intensely competitive and is characterized by evolving technologies and industry standards, frequent new product introductions and dynamic customer requirements that may render existing products obsolete or less competitive. As a result, our position in the medication management and supply chain solutions market could erode rapidly due to unforeseen changes in the features and functions of competing products, as well as the pricing models for such products. Our future success will depend in part upon our ability to enhance our existing products and services and to develop and introduce new products and services to meet changing customer requirements. The process of developing products and services such as those we offer is extremely complex and is expected to become increasingly more complex and expensive in the future as new technologies are introduced. If we are unable to enhance our existing products or develop new products to meet changing customer requirements, demand for our products could decrease.

 

We may need additional financing in the future to meet our capital needs; such financing may not be available on favorable terms and may be dilutive to existing stockholders.

 

We intend to continue to expend substantial funds for research and development activities, product development, expansion of sales and marketing activities and the potential acquisition and integration of complementary products and businesses. As a consequence, in the future we may need to seek additional financing to meet our working capital needs and to finance capital expenditures, as well as to fund operations or potential acquisitions. We may be unable to obtain any desired additional financing on terms favorable to us, if at all. If adequate funds are not available on acceptable terms, we may be unable to fund our expansion, successfully develop or enhance products, respond to competitive pressures or take advantage of acquisition opportunities, any of which could negatively affect our business. If we raise additional funds through the issuance of equity securities, our stockholders will experience dilution of their ownership interest. If we raise additional funds by issuing debt, we may be subject to limitations on our operations. We have recently filed a “shelf” registration statement which, when effective, will enable us to offer and sell, from time to time, up to a total dollar amount of $100 million of our common stock in one or more offerings, which could cause our stockholders to experience dilution of their ownership interest and may cause our stock price to decline.

 

If our Omnicell PharmacyCentral, SafetyMed and ScanREQ products do not achieve market acceptance, our sales and operating results will be affected.

 

We acquired two new products in the second half of 2002 and one new product in the third quarter of 2003, Omnicell PharmacyCentral, SafetyMed and ScanREQ, all of which we believe are competitive in their respective markets and will meet the demands of our customers for central pharmacy storage and retrieval, bedside automation and open supply management. Our current business goals are dependent in part on customer acceptance of these new products. We cannot assure you that we will be successful in marketing these products, that these products will compete effectively with similar products sold by our competitors or that the level of market acceptance of such products will be sufficient to generate expected revenues and synergies with our other products.

 

In addition, deployment of Omnicell PharmacyCentral, SafetyMed and ScanREQ requires interoperability with other Omnicell products as well as with healthcare facilities’ existing information management systems. If these products fail to satisfy these demanding technological objectives, our customers will be dissatisfied and we may be unable to generate future sales. Failure to establish a significant base of customer references will significantly reduce our ability to sell these products to additional customers.

 

We are dependent on technologies provided by third party vendors, such as Commerce One.

 

Some of our products incorporate technologies owned by third parties that are licensed to us for use, modification and/or distribution, including but not limited to certain Commerce One procurement software products for use in our Web-based procurement product, OmniBuyer. If we lose access to, or the ongoing rights to modify and distribute, these technologies with our products we will either have to devote resources to independently develop, maintain and support the technologies ourselves or transition to another vendor. Any independent development, maintenance or support of these technologies by us or the transition to alternative technologies could be costly, time consuming and could delay our product releases and upgrade schedules. These factors could negatively and materially affect our ability to market, sell or distribute our products and in turn our business and prospects.

 

Our international operations may subject us to additional risks that can adversely affect our operating results.

 

We currently have operations outside of the United States, consisting of primarily software development and customer support, and in the future we may expand our international operations, particularly in India. Our international operations introduce a variety of risks, including:

 

25



 

                  the difficulty of managing an organization operating in various countries;

 

                  growing political sentiment against international outsourcing of support services and development;

 

                  reduced protection for intellectual property rights in some countries

 

                  changes in regulatory requirements;

 

                  the requirement to comply with a variety of international laws and regulations, including local labor ordinances and changes in tariff rates;

 

                  fluctuations in currency exchange rates and difficulties in transferring funds from certain countries; and

 

                  political unrest, terrorism and the potential for other hostilities in areas in which we have facilities.

 

Our success depends, in part, on our ability to anticipate and address these risks. We cannot guarantee that these or other factors will not adversely affect our business or operating results.

 

Government regulation of the healthcare industry could reduce demand for our products.

 

While the manufacture and sale of our current products are not regulated by the United States Food and Drug Administration, or FDA, these products, or our future products, if any, may be regulated in the future. A requirement for FDA approval could reduce the demand for our products. Pharmacies are regulated by individual state boards of pharmacy that issue rules for pharmacy licensure in their respective jurisdictions. State boards of pharmacy do not license or approve our medication and supply dispensing systems; however, pharmacies using our equipment are subject to state board approval. The failure of such pharmacies to meet differing requirements from a significant number of state boards of pharmacy could decrease demand for our products and harm our competitive position, results of operations and financial condition. Similarly, hospitals must be accredited by the Joint Commission on Accreditation of Healthcare Organizations, or JCAHO, in order to be eligible for Medicaid and Medicare funds. JCAHO does not approve or accredit medication and supply dispensing systems; however, disapproval of our customers’ medication and supply dispensing management methods and their failure to meet JCAHO requirements could decrease demand for our products and harm our competitive position, results of operations and financial condition.

 

While we have implemented a Privacy and Use of Information Policy and strictly adhere to established privacy principles, use of customer information guidelines and federal and state statutes and regulations regarding privacy and confidentiality, we cannot assure you that we will be in compliance with the Health Insurance Portability and Accountability Act of 1996, or HIPAA. This legislation required the Secretary of Health and Human Services, or HHS, to adopt national standards for some types of electronic health information transactions and the data elements used in those transactions, to adopt standards to ensure the integrity and confidentiality of health information and to establish a schedule for implementing national health data privacy legislation or regulations. In August 2002, HHS published final modifications to its privacy regulations that took effect on April 14, 2003. These regulations restrict the use and disclosure of personally identifiable health information by our customers who are ‘‘covered entities’’ under HIPAA. Because Omnicell may be considered a ‘‘business associate’’ under HIPAA, many of our customers have required that we enter into written agreements governing the way we handle any patient information we may encounter in providing our products and services. In February 2003, HHS issued final security rules requiring covered entities to implement appropriate technical and physical safeguards of electronically transmitted personal health information by April 2005. We cannot predict the potential impact of these rules, rules that have not yet been proposed or any other rules that might be finally adopted on our customers or on Omnicell. In addition, other federal and/or state privacy legislation may be enacted at any time. These laws and regulations could restrict the ability of our customers to obtain, use or disseminate patient information. This could reduce the demand for our products or force us to redesign our products in order to meet regulatory requirements.

 

We adopted a stockholder rights plan that may discourage, delay or prevent a merger or acquisition that is beneficial to our stockholders.

 

In February 2003, our Board of Directors adopted a stockholder rights plan that may have the effect of discouraging, delaying or preventing a change in control of our company that is beneficial to our stockholders. Pursuant to the terms of the plan, when a person or group, except under certain circumstances, acquires 15% or more of our outstanding common stock (other than two current stockholders and their affiliated entities, which will not trigger the rights plan unless they acquire beneficial ownership of 17.5% and 22.5% or more, respectively, of our outstanding common stock) or ten business days after commencement or announcement of a tender

 

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or exchange offer for 15% or more of our outstanding common stock, the rights (except those rights held by the person or group who has acquired or announced an offer to acquire 15% or more of our outstanding common stock) would generally become exercisable for shares of our common stock at a discount. Because the potential acquiror’s rights would not become exercisable for our shares of common stock at a discount, the potential acquiror would suffer substantial dilution and may lose its ability to acquire us. In addition, the existence of the plan itself may deter a potential acquiror from acquiring us. As a result, either by operation of the plan or by its potential deterrent effect, a change in control of our company that our stockholders may consider in their best interests may not occur.

 

Our facilities are located near known earthquake fault zones, and the occurrence of an earthquake or other natural disaster or any other catastrophic event could cause damage to our facilities and equipment, which could require us to cease or curtail operations.

 

Our facilities are located near known earthquake fault zones and are vulnerable to significant damage from earthquakes. We are also vulnerable to damage from other types of disasters, including fires, floods, power loss, communications failures and similar events including the effects of war or acts of terrorism. If any disaster were to occur, our ability to operate our business at our facilities could be seriously or completely impaired or destroyed. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions.

 

Item 4. CONTROLS AND PROCEDURES

 

Evaluation of disclosure controls and procedures. We conducted an evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (“Disclosure Controls”) as of September 30, 2004. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Based on the evaluation as of September 30, 2004, our CEO and CFO have concluded that Omnicell’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were sufficiently effective to ensure that the information required to be disclosed by Omnicell in the reports that we file under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness.

 

Changes in Internal Controls Over Financial Reporting. There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

Limitations on the Effectiveness of Controls. The company’s management, including CEO and CFO, does not expect that our Disclosure Controls or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Accordingly, our Disclosure Controls and our internal controls over financial reporting are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our CEO and CFO have concluded, based on their evaluation, that our Disclosure Controls and procedures were sufficiently effective as of September 30, 2004.

 

PART II—OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

On June 30, 2004, ePlus Government Inc., a leasing company which has purchased some of the Company’s receivables with recourse, filed a lawsuit against the Company in the Circuit Court of Fairfax County, Commonwealth of Virginia, seeking payment of approximately $1.7 million in connection with a customer’s failure to pay ePlus amounts owed under a contract with such customer that have been assigned to ePlus. The Company recorded the transaction as receivable subject to a sales agreement in compliance with SFAS 140 requirements as discussed in “Sales of Accounts Receivable” under Note 1 to Consolidated Financial Statements.

 

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The Company’s management believes that this matter will be resolved between the customer and ePlus in a manner that does not require any payments by the Company. However, there can be no assurance that this claim will be so resolved or that the Company will not be required to defend itself in litigation which could have an adverse effect on our financial position, results of operations or cash flows.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

ITEM 5. OTHER INFORMATION

 

In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, (the “Act”), we are required to disclose the non-audit services approved by our Audit Committee to be performed by our external auditor. During the three months ended September 30, 2004, our Audit Committee approved the engagement of Ernst & Young LLP to perform services related to the review of the Company’s compliance with Section 404 of the Sarbanes-Oxley Act of 2002 which constitute in part non-audit services within the meaning of Section 10A(i) of the Act.

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a)           Exhibits.

 

INDEX TO EXHIBITS

 

Exhibit No.

 

Exhibit Description

3.1(1)

 

Amended and Restated Certificate of Incorporation of Omnicell.

3.2 (2)

 

Certificate of Designation of Series A Junior Participating Preferred Stock.

3.3(3)

 

Bylaws of Omnicell.

4.1

 

Reference is made to Exhibits 3.1 and 3.2.

4.2(4)

 

Form of Common Stock Certificate.

31.1

 

Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2

 

Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1

 

Certifications required by Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. Section 1350).

 


(1)                                  Previously filed as the like-numbered Exhibit to our report on Form 10-Q for the quarter ended June 30, 2001, as filed with the Securities Exchange Commission on September 20, 2001.

 

(2)                                  Previous filed as the like-numbered Exhibit to our report on Form 10-K for the fiscal year ended December 31, 2002, as filed with the Securities Exchange Commission on March 28, 2003.

 

(3)                                  Previously filed as Exhibit 3.6 to our Registration Statement on Form S-1, as amended, as filed with the Securities Exchange Commission on March 14, 2001.

 

(4)                                  Previously filed as Exhibit 4.1 to our Registration Statement on Form S-1, as amended, as filed with the Securities Exchange Commission on March 14, 2001.

 

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(b)           Reports on Form 8-K.

 

The following reports on Form 8-K were filed during the three month period ended September 30, 2004:

 

(i)            On July 22, 2004, we filed a current report on Form 8-K relating to the issuance of a press release announcing Omnicell’s financial results for the quarter ended June 30, 2004.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed in its behalf by the undersigned thereunto duly authorized.

 

 

 

 

OMNICELL, INC.

 

 

 

 

 

 

Date: November 9, 2004

 

 

 

 

/s/ DENNIS P. WOLF

 

 

Dennis P. Wolf

 

 

Executive Vice President of Operations, Finance and
Administration, and Chief Financial Officer
(Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit No.

 

Exhibit Description

3.1(1)

 

Amended and Restated Certificate of Incorporation of Omnicell.

3.2 (2)

 

Certificate of Designation of Series A Junior Participating Preferred Stock.

3.3(3)

 

Bylaws of Omnicell.

4.1

 

Reference is made to Exhibits 3.1 and 3.2.

4.2(4)

 

Form of Common Stock Certificate.

31.1

 

Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2

 

Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1

 

Certifications required by Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350).

 


(1)                                  Previously filed as the like-numbered Exhibit to our report on Form 10-Q for the quarter ended June 30, 2001, as filed with the Securities Exchange Commission on September 20, 2001.

 

(2)                                  Previous filed as the like-numbered Exhibit to our report on Form 10-K for the fiscal year ended December 31, 2002, as filed with the Securities Exchange Commission on March 28, 2003.

 

(3)                                  Previously filed as Exhibit 3.6 to our Registration Statement on Form S-1, as amended, as filed with the Security Exchange Commission on March 14, 2001.

 

(4)                                  Previously filed as Exhibit 4.1 to our Registration Statement on Form S-1, as amended, as filed with the Security Exchange Commission on March 14, 2001.