SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended March 31, 2001
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from -- to --
Commission file number 0-23791
SONOSITE, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1405022
-------------------------------- ---------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification
of Incorporation or Organization) Number)
21919 - 30th Drive SE, Bothell, WA 98021-3904
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(Address of Principal Executive Offices) (Zip Code)
(425) 951-1200
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(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 [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.01 par value 9,632,704
----------------------------------- ------------------------------------
(Class) (Outstanding as of May 10, 2001)
1
SonoSite, Inc.
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 2001
Table of Contents
Page No.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed Balance Sheets -- March 31, 2001 and December 31, 2000......................... 3
Condensed Statements of Operations -- Quarters ended March 31, 2001 and 2000............. 4
Condensed Statements of Cash Flows -- Quarters ended March 31, 2001 and 2000............. 5
Notes to Condensed Financial Statements.................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................... 19
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................................... 19
SIGNATURE ................................................................................................ 20
2
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
SonoSite, Inc.
Condensed Balance Sheets
(unaudited)
Assets
(In thousands, except share data) March 31, December 31,
2001 2000
--------- ------------
Current assets:
Cash and cash equivalents $ 4,709 $ 11,067
Short-term investment securities 14,722 18,218
Accounts receivable, less allowance for doubtful
accounts of $723 for each period presented 9,094 7,303
Accrued interest receivable 286 330
Inventories 10,511 12,325
Prepaid expenses and other current assets 589 1,070
--------- ---------
Total current assets 39,911 50,313
Property and equipment, net 5,770 5,980
Investment in affiliates -- 112
Receivable from affiliates 822 880
Other assets 654 739
--------- ---------
Total assets $ 47,157 $ 58,024
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 1,717 $ 5,561
Accrued expenses 3,006 3,684
Current portion of long-term obligations 182 253
Deferred revenue 318 281
--------- ---------
Total current liabilities 5,223 9,779
Deferred rent 166 121
Long-term obligations, less current portion 285 316
--------- ---------
Total liabilities 5,674 10,216
Commitments and contingencies
Shareholders' equity:
Preferred stock, $1.00 par value
Authorized shares - 6,000,000
Issued and outstanding shares - none -- --
Common stock, $.01 par value:
Authorized shares - 50,000,000
Issued and outstanding shares:
As of March 31, 2001 - 9,615,416
As of December 31, 2000 - 9,551,596 96 96
Additional paid-in-capital 109,706 109,195
Accumulated deficit (68,217) (61,492)
Accumulated other comprehensive loss (102) 9
--------- ---------
Total shareholders' equity 41,483 47,808
--------- ---------
Total liabilities and shareholders' equity $ 47,157 $ 58,024
========= =========
See accompanying notes to condensed financial statements.
3
SonoSite, Inc.
Condensed Statements of Operations
(unaudited)
(In thousands, except loss per share) Quarters Ended
March 31,
--------------------------
2001 2000
---------- ----------
Sales $ 8,163 $ 8,015
Cost of sales 4,866 4,653
---------- ----------
Gross margin 3,297 3,362
Operating expenses:
Research and development 3,555 2,477
Sales and marketing 5,267 3,608
General and administrative 1,395 1,130
---------- ----------
Total operating expenses 10,217 7,215
Other income (loss):
Interest income 388 719
Interest expense (32) (38)
Equity in losses of affiliates (161) (72)
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Total other income 195 609
Net loss $ (6,725) $ (3,244)
========== ==========
Basic and diluted net loss per share $ (0.70) $ (0.35)
========== ==========
Weighted average common and potential common shares
used in computing net loss per share 9,567 9,225
========== ==========
See accompanying notes to condensed financial statements.
4
SonoSite, Inc.
Condensed Statements of Cash Flows
(unaudited)
(In thousands) Quarters Ended
March 31,
-----------------------------------
2001 2000
------------- ------------
Operating activities:
Net loss $ (6,725) $ (3,244)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 595 588
Equity in loss of affiliates 161 72
Amortization of premium on investment securities and deferred
compensation -- 9
Changes in operating assets and liabilities:
Increase in accounts receivable (1,791) (3,446)
Decrease (Increase) in receivable from affiliates 58 (39)
Decrease (Increase) in interest receivable 44 (347)
Decrease (Increase) in inventories 1,814 (1,905)
Decrease (Increase) in prepaid expenses and other current assets 481 (65)
Decrease (Increase) in other assets 36 (424)
(Decrease) Increase in accounts payable (3,844) 1,606
Decrease in accrued expenses (678) (471)
Increase (Decrease) in deferred rent 45 (1)
Increase (Decrease) in deferred revenue 37 (89)
---------- ----------
Net cash used in operating activities (9,767) (7,756)
Investing activities:
Purchase of investments (2,574) (26,981)
Proceeds from maturities of investments 5,959 5,275
Purchase of equipment (386) (1,176)
Proceeds on sale of equipment 1 21
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Net cash provided by (used in) investing activities 3,000 (22,861)
Financing activities:
Repayment of long-term obligations (102) (125)
Proceeds from sale of common stock, net of issuance costs -- (35)
Exercise of stock options 511 558
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Net cash provided by financing activities 409 398
Net change in cash (6,358) (30,219)
Cash and cash equivalents at beginning of period 11,067 33,252
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Cash and cash equivalents at end of period $ 4,709 $ 3,033
========== ==========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 42 $ 20
========== ==========
Supplemental disclosure of non-cash investing and financing activities:
Unrealized gain/(loss) on investment $ (111) $ --
========== ==========
See accompanying notes to condensed financial statements.
5
SonoSite, Inc.
Notes to Condensed Financial Statements
(unaudited)
Interim Financial Information
The information contained herein has been prepared in accordance with
instructions for Form 10-Q and Article 10 of Regulation S-X. The information
furnished reflects, in the opinion of SonoSite, Inc. management, all adjustments
necessary (which are of a normal and recurring nature) for a fair presentation
of the results for the interim period presented. The results of operations for
the quarter ended March 31, 2001 are not necessarily indicative of our expected
results for the entire year ending December 31, 2001 or for any other fiscal
period. These financial statements do not include all disclosures required by
generally accepted accounting principles. For a presentation including all
disclosures required by generally accepted accounting principles, these
financial statements should be read in conjunction with the audited financial
statements for the year ended December 31, 2000, included in our Annual Report
on Form 10-K. Certain amounts reported in previous years have been reclassified
to conform to current year presentation.
Business Overview
SonoSite commenced operations as a division of ATL Ultrasound, Inc., or ATL. We
were formed to develop the design and specifications for a highly portable
ultrasound device and other highly portable ultrasound products for diagnostic
imaging in a multitude of clinical and field settings. On April 6, 1998, we
became an independent, publicly owned company through a tax-free distribution of
one new share of our stock for every three shares of ATL stock held as of that
date. ATL retained no ownership in SonoSite following the spin-off.
We finalized the development and began commercialization of our first products
in 1999, recognizing our initial product sales revenue in September 1999.
Continuing to develop and enhance our products in 2000, we introduced the
SonoHeartTM system for cardiology and the high frequency SonoSite(R) 180 system,
along with three new transducers. As of March 31, 2001, our products were
comprised of two highly portable ultrasound systems, the SonoSite 180 and
SonoHeart systems, and five transducers. Subsequent to March, we announced the
release of our SonoSite 180PLUS and SonoHeart PLUS systems, both of which
include M-mode, Pulsed Wave Doppler and Tissue Harmonics Imaging capabilities.
Financial Instruments
Cash equivalents
Cash equivalents consist of money market and highly liquid debt instruments with
original or remaining maturities at purchase of three months or less.
Investment securities
Investment securities consist of high-grade corporate debt. While our intent is
to hold our securities until maturity, we classified all securities as
available-for-sale because the sale of such securities may be required prior to
maturity to implement management strategies. These securities are carried at
fair value, with the unrealized gains and losses reported as a component of
other comprehensive loss until realized. Realized gains and losses from the sale
of available-for-sale securities, if any, are determined on a specific
identification basis.
6
A decline in market value of any available-for-sale security below cost that is
determined to be other than temporary results in a revaluation of its carrying
amount to fair value. The impairment is charged to earnings and a new cost basis
for the security is established. Premiums and discounts are amortized or
accreted over the life of the related security as an adjustment to yield using
the effective interest method. Interest income is recognized when earned.
Foreign currency translations and transactions
The United States dollar is considered to be the functional currency of the
company and our subsidiary. Monetary assets and liabilities of our foreign
subsidiary are remeasured into United States dollars from the local currency at
rates in effect at period-end and non-monetary assets and liabilities are
remeasured at historical rates. Revenues and expenses are remeasured at average
rates during the period. Gains and losses arising from the remeasurement of
local currency financial statements are included in non-operating income.
Accounts receivable
In the ordinary course of business, we grant credit to a broad customer base. Of
the accounts receivable balance at March 31, 2001, 71% and 29% were receivable
from international and domestic parties, prior to any provision for doubtful
accounts, of which approximately $250,000 was classified as a long-term other
asset. The same percentages as of December 31, 2000 were 51% and 49%.
During the first quarter of 2001, sales revenue was 56% international and 44%
domestic. During the first quarter 2000, sales revenue was 79% international and
21% domestic.
The following table presents individual customers whose outstanding receivable
balance as a percentage of total trade receivables and/or revenue as a
percentage of total sales revenue exceeded 10%:
Accounts Receivable Sales Revenue
------------------------------------- ---------------------------------
As of For the Quarter Ended
------------------------------------- ---------------------------------
March 31, 2001 December 31, 2000 March 31, 2001 March 31, 2000
-------------- ------------------- -------------- --------------
Brazilian distributor 11%
Japanese distributor 13% 15% 26%
Middle Eastern distributor 16% 18%
United States distributor 14%
--------- ---------- ---------- ----------
Totals 29% 11% 33% 40%
========= ========== ========== ==========
Fair value of financial instruments
The carrying value of our financial instruments, including cash and cash
equivalents, accounts receivable, certain long-term other assets and debt,
approximates fair value. Cash and cash equivalents and accounts receivable
approximate fair value due to their short-term nature. Long-term other assets
and debt approximate fair value as interest rates on these notes approximate
market.
Inventories
Inventories are stated at the lower of cost, on a first-in, first-out method, or
market. Inventories consist of the following (in thousands):
March 31, December 31,
2001 2000
----------- -----------
Raw material $ 4,578 $ 4,172
Finished goods 5,933 8,153
----------- -----------
Total $10,511 $12,325
=========== ===========
7
Property and equipment
Property and equipment are stated at historical cost, less accumulated
depreciation and amortization. Maintenance and repair costs are expensed as
incurred, with additions and improvements to property and equipment capitalized.
Depreciation and amortization are calculated using the straight-line basis over
estimated useful lives as follows:
Asset Estimated Useful Lives
----- ----------------------
Equipment, other than computer 5-7 years
Software 3 years
Computer equipment 3-5 years
Furniture and fixtures 5 years
Leasehold improvements Lesser of estimated useful life or
expected remaining lease term
The carrying value of long-lived assets is evaluated for impairment when events
or changes in circumstances occur, which may indicate the carrying amount of the
asset may not be recoverable. We evaluate the carrying value of the assets by
comparing the estimated future cash flows generated from the use of the asset
and its eventual disposition with the assets' reported net book value.
Investment in affiliates
Where we have investments in which we have the ability to exercise significant
influence over operating and financial policies, these investments are accounted
for under the equity method. Accordingly, our share in the net income or loss in
these investments is included in other operating income or loss.
Concentration of credit risk
Financial instruments that potentially subject us to concentrations of credit
risk consist principally of cash equivalents, investments and accounts
receivable.
Accumulated Other Comprehensive Loss
Other comprehensive losses consist entirely of net unrealized losses on
investments.
The following presents the components of comprehensive loss for the quarter
ending March 31 (in thousands):
----------------------------------
2001 2000
-------------- --------------
Net loss $ (6,725) $ (3,244)
Other comprehensive loss:
Unrealized loss on investments (111) (109)
---------- ----------
Comprehensive loss $ (6,836) $ (3,353)
========== ==========
Net Loss per Share
Basic and diluted net loss per share was computed by dividing the net loss by
the weighted average shares outstanding exclusive of unvested restricted shares.
Outstanding options to purchase our shares and our unvested restricted shares
were not included in the computations of diluted net loss per share because to
do so would be antidilutive. As of March 31, 2001, our outstanding options and
unvested restricted shares totaled 2,285,832 and 642. As of March 31, 2000, our
outstanding options and unvested restricted shares totaled 2,111,460 and 11,931.
8
The following is a reconciliation of the numerator and denominator of the basic
and diluted loss per share calculations:
(in thousands, except loss per share)
March 31, March 31,
2001 2000
------------------------------------ ------------------------------------
Loss Shares LPS Loss Shares LPS
Weighted average shares
outstanding 9,568 9,237
Weighted average unvested
restricted stock (1) (12)
------------------------------------ -------------------------------------
Basic and diluted loss per share $(6,725) 9,567 $(.70) $(3,244) 9,225 $(.35)
==================================== =====================================
New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting
and reporting standards requiring that every derivative instrument, including
certain derivative instruments embedded in other contracts, be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement also requires that changes in the derivative instrument's fair value
be recognized in earnings unless specific hedge accounting criteria are met.
This statement became effective for us beginning January 1, 2001. Our adoption
of the standard did not have a material effect on our financial results.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Certain statements in this Quarterly Report on Form 10-Q are "forward-looking
statements." Forward-looking statements are based on the opinions and estimates
of our management at the time the statements are made and are subject to risks
and uncertainties that could cause our actual results to differ materially from
those expected or implied by the forward-looking statements. The words
"believe," "expect," "intend," "anticipate" and similar expressions are intended
to identify forward-looking statements, but their absence does not necessarily
mean that the statement is not forward-looking. These statements are not
guaranties of future performance and are subject to known and unknown risks and
uncertainties and are based upon potentially inaccurate assumptions. Factors
that could affect SonoSite's actual results include those described under the
heading "Important Factors That May Affect Our Business, Our Results of
Operations and Our Stock Price" in this Form 10-Q and in our filings from time
to time with the Securities and Exchange Commission, including our Annual Report
on Form 10-K for the year ended December 31, 2000. We caution readers not to
place undue reliance upon these forward-looking statements that speak only as to
the date of this report. We undertake no obligation to publicly revise any
forward-looking statements to reflect new information, events or circumstances
after the date of this Form 10-Q or to reflect the occurrence of unanticipated
events.
Overview
SonoSite commenced operations as a division of ATL. We were formed to develop
the design and specifications for a highly portable ultrasound device and other
highly portable ultrasound products for diagnostic imaging in a multitude of
clinical and field settings. On April 6, 1998, we became an independent,
publicly owned company through a tax-free distribution of one new share of our
stock for every three shares of ATL stock held as of that date. ATL retained no
ownership in SonoSite following the spin-off.
We finalized the development and began commercialization of our first products
in 1999 and recognized our initial product sales revenue in September 1999.
Continuing to develop and enhance our products in 2000, we introduced the
SonoHeart system for cardiology and the high frequency SonoSite 180 system,
along with three new transducers. As of March 31, 2001, our products were
comprised of two highly portable ultrasound systems, the SonoSite 180 and
SonoHeart systems, and five transducers. Subsequent to March 31 2001, we
introduced the SonoSite 180PLUS and SonoHeart PLUS systems. The PLUS systems
include M-mode and provide feature options of Pulsed Wave (PW) Doppler and
Tissue Harmonics Imaging.
9
Initially, we sold our products primarily through medical product distributors
worldwide. In 2000, we developed and introduced a contract direct sales force in
the United States market to supplement and eventually replace our distributors
in the United States. Recognizing the value of real-world experience, we
utilized sonographers, some of whom had no selling experience, and trained them
in selling our systems. As the year progressed, we saw significant increases in
revenue generated by this direct sales group in the United States. As a result,
we hired these sonographers onto our direct sales team in early 2001. Further,
we nearly doubled the number of sales consultants domestically by adding proven,
professional sales people, bringing our total to 40 by the end of March as we
continue to penetrate the key geographical and specialty segments that we
identified in 2000. We intend to continue to add sales consultants in the second
quarter and currently anticipate having approximately 50 sales consultants in
the United States by the end of the quarter.
Internationally, we continue to address other larger potential markets in the
world through our relationship with Olympus in Japan, our joint venture in China
and dedicated distributors in other traditionally large ultrasound markets.
Through these relationships, we anticipate that we can effectively address large
potential markets. In the first quarter of 2001, after seeing the success in the
United States, we established a subsidiary in the United Kingdom, SonoSite,
Ltd., which sells directly in the United Kingdom. We anticipate expanding our
direct selling efforts into Germany and France in the future.
In the future, our prospects and ability to grow a profitable business will
depend on our ability to effectively market and sell our products to a variety
of customers, both in terms of geography and medical segment. We identified
those markets where we believe that our products will generate sales and that we
possess a significant opportunity to have a positive medical impact. These
markets include obstetrics and gynecology, emergency medicine, radiology and
surgery. In addition, we believe that our products can be successfully marketed
and sold to address many other medical applications, of which many currently do
not use ultrasound.
Since operations began, we have incurred losses. We expect to continue to incur
operating losses unless and until our product sales generate sufficient revenue
to fund our continuing operations. We may be unable to generate sufficient
revenue to fund our operations in future periods.
Results of Operations
Sales
Sales increased to $8.2 million for the quarter ended March 31, 2001 compared to
$8.0 million for the quarter ended March 31, 2000, an increase of $200,000.
Coinciding with our increase in direct sales, current quarter sales represent a
growing number of end customer sales, as opposed to the comparable prior year
quarter that primarily consisted of orders to meet initial distributor demand.
Product revenues are generally recognized at the time of shipment.
We anticipate that sales revenue will increase in 2001 as compared to prior
years due to our expanded direct selling efforts, new product developments, new
corporate customer agreements and overall expansion of general market awareness
of the company and our products. As of March 31, 2001, our products included two
platforms, the SonoSite 180 and SonoHeart, which, when used in conjunction with
one of our five transducers, may be used in a variety of applications. Our
transducers include a curved array transducer, the C60, for abdominal imaging,
an intra-cavital transducer, the ICT, for transvaginal and intra-cavital
imaging, a microconvex transducer, the C15, for cardiac imaging, a linear array
transducer, the L38, for use in radiology, emergency medicine and vascular
imaging and a neonatal transducer, the C11, for pediatric applications.
Additionally, in April 2001, we released our PLUS systems, which offer M-mode,
Pulsed Wave Doppler and Tissue Harmonics Imaging. We anticipate that product
revenues in the second quarter will increase over the first quarter.
Gross margin on sales revenue
The gross margin on sales revenue for the quarters ended March 31, 2001 and 2000
was 40% and 42%. The decrease in gross margin is due to lower production line
utilization than anticipated when we began manufacturing our product in-house.
Prior to October 2000, third parties performed all of our manufacturing. We
anticipate that the gross margin on our product sales will increase in 2001 due
primarily to our increasing percentage of direct and domestic sales compared to
distributor sales, which include a standard discount. Additionally, with the
transfer of
10
manufacturing in-house, we anticipate product costs will decrease over 2001 as
prodcution volume increases and production line utilization increases.
Research and development expenses
Research and development expenses for the quarters ended March 31, 2001 and 2000
were $3.6 million and $2.5 million. The increase in research and development
expenses by $1.1 million was primarily the result of increased activities
surrounding the design, tooling and testing of the SonoSite 180PLUS and
SonoHeart PLUS systems, which were released in April 2001. We anticipate that
spending levels in research and development will decrease in the near term.
Sales and marketing expenses
Sales and marketing expenses for the quarters ended March 31, 2001 and 2000 were
$5.3 million and $3.6 million. The increase of $1.7 million in 2001 compared to
2000 is primarily due to increases in personnel and personnel-related expenses,
our direct sales force and related commissions and increases in advertising and
promotion activity to support both our new and existing products within our core
markets.
We continue to recognize the need to support our existing products and expect
marketing and selling costs to increase in 2001 as we increase the size of our
direct selling force and support our new PLUS system platform. This increase
includes expanding our direct selling efforts to certain European markets.
General and administrative expenses
General and administrative expenses for the quarters ended March 31, 2001 and
2000 were $1.4 million and $1.1 million. The increase of $300,000 in 2001
compared to 2000 was primarily the result of added personnel in our general and
administrative functions to support our growth.
Other income
Other income for the quarters ended March 31, 2001 and 2000 was $195,000 and
$609,000. In 2001, other income consisted of $388,000 of interest income, which
was partially offset by $32,000 of interest expense and $161,000 of losses from
equity method investees. In 2000, other income consisted of $719,000 of interest
income, which was partially offset by $38,000 of interest expense and $72,000 of
losses from equity method investees. The decrease in interest income between
2001 and 2000 of approximately $331,000 is due to our lower average investment
balance. The increase in equity in losses of affiliates was primarily the result
of operating losses by our equity investee.
Liquidity and Capital Resources
In the first quarter of 2001, our cash and cash equivalents balance decreased by
$6.4 million. This decrease was the result of $9.8 million used in operating
activities, which is offset by $3.0 million provided by investing activities.
The operating cash uses, consisting of our net loss of $6.7 million, usages in
our accounts receivable of $1.8 million and decreases in our accounts payable of
$3.8 million and accrued expenses of $678,000, were partially offset by
reductions in inventory of $1.8 million, prepaid expenses and other current
assets of $481,000 and depreciation expense of $595,000. Cash provided by
investing activities represented the net of proceeds from investment maturities
of $6.0 million and purchases of investments of $2.6 million.
During the year ended December 31, 2000, our primary source of operating capital
was obtained from our sales revenue and cash on hand that was obtained from
public and private capital financing in prior years. In April 1999, we raised
net proceeds of $35.4 million through the sale of 2,990,000 shares of our common
stock. In November 1999, we raised additional net proceeds of $29.3 million
through the sale of 1,250,000 shares of our common stock. We also received $30.0
million from ATL in connection with our spin-off, of which $18.0 million was
received in 1998 and $12.0 million in 1999.
We expect our cash requirements to continue in future periods as we continue to
fund losses until we can generate sufficient revenues to meet our operating
expenses. However, we expect our cash requirements to decrease in 2001 compared
to 2000 due to an increase in sales revenue. We expect operating expenses to
increase as we continue to
11
fund our manufacturing and research and development activities, increase our
direct selling efforts and targeted marketing plans, enhance our educational
offerings and provide adequate administrative support for these areas. We
believe that our existing cash will be sufficient to fund our operations through
2001. However, it is difficult to accurately predict the amount of cash that we
may require during 2001. Actual cash needs will depend in part upon factors
beyond our control, such as lower than anticipated revenues, technical
obstacles, market acceptance of our products, disruption in manufacturing or the
supply of raw materials, economic circumstances and cost overruns. If additional
capital is required, we may not be able to obtain adequate financing on a timely
basis, on terms acceptable to us, or at all.
Important Factors That May Affect Our Business, Our Results of Operations and
Our Stock Price
We have a limited history as a stand-alone company.
We commenced operations as a stand-alone company in April 1998. Prior to that,
we operated as a business unit of ATL. We shipped our first products in
September of 1999. Accordingly, we have a limited operating and sales history.
Additionally, we only recently brought manufacturing of our products in-house.
As a result, our prospects for success are difficult to determine. When
evaluating whether to invest in our common stock, you should consider our
business and prospects in light of the risks and uncertainties encountered by
new technology and manufacturing companies.
There are many reasons why we may be unsuccessful in implementing our strategy,
including:
. any inability to manufacture our products with the quality and
quantity necessary to achieve profitability;
. our dependence on the market acceptance of a new platform for
ultrasound imaging procedures;
. our inability to achieve market acceptance of our products for any
other reason;
. our reliance on third-party suppliers of material components;
. any failure in our newly developed and implemented in-house
manufacturing operations;
. our need to maintain and expand sales channels;
. our need to obtain governmental approvals in key foreign markets;
. any loss of key personnel;
. any inability to respond effectively to competitive pressures;
. any inability to manage rapid growth and expanding operations; and
. any failure to comply with governmental regulations.
We have a history of losses, we expect future losses and we may never be
profitable.
We incurred net losses in each quarter since we started operations and have a
limited history of product sales. As of March 31, 2001, we had an accumulated
deficit of approximately $68.2 million, including approximately $10.6 million
that was accumulated prior to our commencing operations as a separate company in
April 1998. We expect to incur substantial additional expenses in the future as
we continue to conduct research and development efforts on newer generation
products and increase sales and marketing efforts. We will need to generate
significant additional revenues in the future before we will be able to achieve
and maintain profitability. Our business strategies may not be successful and we
may not be profitable in any future period. If we do become profitable, we
cannot be certain that we can sustain or increase profitability on a quarterly
or annual basis.
Demand for our products is unknown.
Our products represent a new platform for ultrasound imaging procedures and we
have sold our products in limited quantities. The market for hand-carried, high-
performance ultrasound devices is new and largely undeveloped. We do not know
the rate at which physicians or other healthcare providers will adopt our
products or the rate at which
12
they will purchase them in the future. Acceptance of our products by physicians,
including physicians who do not currently use ultrasound, is essential to our
success and may require us to overcome resistance to a new platform for
ultrasound imaging.
Current users of ultrasound may resist change to established industry practices
and discourage widespread new users and uses.
Currently, patients requiring an ultrasound examination are generally referred
to a centralized testing location. Radiologists and other specialized providers
of ultrasound at these locations may have an incentive to discourage market
acceptance of our products in order to maintain these referrals.
Physicians and other healthcare providers will not purchase our products unless
they determine that they are preferable to other means of obtaining an
ultrasound examination and that the benefits to the patient and physician
outweigh the costs of purchasing our products. This determination will depend on
our products' image quality, cost-effectiveness, ease of use, reliability and
portability. Furthermore, acceptance of our products by physicians and other
healthcare providers may be more difficult if they are unable to obtain adequate
reimbursement from third-party payers for tests performed using our products. In
addition, while we priced our products to be competitive in the marketplace for
lower-end ultrasound machines, our pricing policies could limit market
acceptance compared to competing products or alternative testing methods.
Customer training and education may not be available, sufficient or accepted by
new users of ultrasound.
Use of our products will require training for physicians who currently do not
use ultrasound-imaging instruments. The time required to complete such training
might be substantial and could result in a delay or decrease in market
acceptance. We anticipate new users of ultrasound to provide us with future
revenue streams. If new users are not able or willing to be trained due to time
constraints or availability of courses, our ability to enter new markets will be
adversely impacted.
We only recently assumed some of the manufacture and assembly of our products.
In the second half of 2000, we began to transition the manufacturing operations
from ATL to our own facility under the control of our employees. This transition
was completed in December 2000. In order to make this transition, we built a
series of manufacturing lines and developed our own manufacturing processes and
procedures. The production of our products may be interrupted, resulting in harm
to our business, for any number of reasons, including line shutdowns, product
procurement issues, procedural issues, rework, quality control issues or
negative yield issues. Additionally, we may be unable to comply with regulations
applicable to manufacturers of ultrasound devices. We may be unable to
manufacture our products at a cost or in quantities necessary to achieve or
maintain profitability. Any of these risks may prevent us from meeting
production schedules and quality requirements.
If our vendors fail to supply us with the highly specialized parts and other
components we need for our products, we will be unable to effectively ship our
products.
We depend on vendors to supply highly specialized parts, such as custom-designed
integrated circuits, cable assemblies and transducer components. These vendors
may experience difficulty in manufacturing these parts or in meeting our high
quality standards. In addition, these parts may have long order lead-times,
which restrict our ability to respond quickly to changing market conditions. If
we are required to switch vendors, the manufacture and delivery of our products
could be interrupted for an extended period. We also rely on third-party vendors
to supply essential parts and components that are in high demand in other
industries such as electronics manufacturing and telecommunications equipment
manufacturing. Our ability to manufacture and deliver products in a timely
manner could be harmed if these vendors fail to maintain an adequate supply of
these components.
We depend on single-source vendors for some of our components that may be
difficult and costly to replace.
We depend on single-source vendors for some key components for our products,
including custom-designed integrated circuits, image displays, batteries,
capacitors, cables and transformers. There are relatively few alternative
sources of supply for some of these components. While these vendors have
generally produced our components with acceptable quality, quantity and cost in
the past, they have experienced periodic problems that have caused us delays
13
in production. To date, these problems have not been material. These suppliers
may be unable to meet our future demands or may experience quality and
specification problems, which might cause us to experience delays, incur
additional costs and possibly miss customer deliveries. Establishing additional
or replacement suppliers for these components may take a substantial amount of
time. If we have to switch to a replacement vendor, the manufacture and delivery
of our products could be interrupted.
Our future success could be impaired if the perception of our products is based
on any early performance problems.
We will not succeed unless the marketplace is confident that we can provide
high-quality products and deliver them in a timely manner. We have a limited
history of product sales. If these early product shipments or new product
releases fail to perform as expected or if they are perceived as being difficult
to use or causing discomfort to patients, the public image of our products may
be impaired. Public perception may also be impaired if we fail to deliver our
products in a timely manner due to difficulties with our suppliers and vendors
or due to our inability to efficiently manufacture, assemble and service our
products in-house. A tarnished reputation could result in the failure of our
products to gain market acceptance even after any quality or delivery problems
are resolved.
We may be unable to manage our growth, which could strain our resources and
impair our ability to deliver our products.
We expect significant growth in all areas of operations as we develop and market
our products. We will need to add personnel and expand our capabilities, which
may strain our existing management, operational, financial and other resources.
To compete effectively and manage future growth, we must
. accurately forecast demand for our products;
. effectively and efficiently manufacture and service our
products;
. manage our order fulfillment process;
. manage our inventory;
. train, manage and motivate a growing employee base;
. mitigate our receivables risk; and
. improve existing operational, financial and management
information systems.
We may be unable to complete necessary improvements to our systems, procedures
and controls to support our future operations in a timely manner. In addition,
we may be unable to attract or retain required personnel and our management may
be unable to develop the additional expertise required to manage any future
growth.
Our quarterly operating results are uncertain and may fluctuate significantly,
which could impair the value of your investment.
Our future operating results will depend on numerous factors, many of which we
do not control. Changes in any or all of these factors could cause our operating
results to fluctuate and increase the volatility of our stock. Some of these
factors are
. demand for our products;
. product and price competition;
. global economic conditions;
. changes in the component costs;
. success of our direct sales and distribution channels;
. successful development and commercialization of new and
enhanced products;
14
. timing of new product introductions and product enhancements
by us or our competitors; and
. timing and magnitude of our expenditures.
In addition, we manufacture our products and determine product mix based on
forecasts of sales in future periods. Our forecast in any particular period may
prove inaccurate, which could cause fluctuations in our manufacturing costs and
our operating results. Our future operating results could fall below the
expectations of securities analysts or investors and reduce the market price of
our stock. We believe that there may be some fluctuations caused by year-end
budgetary pressures on our customers, customer buying patterns and the efforts
of our direct sales and distribution network to meet or exceed annual sales
quotas. These factors make it difficult to forecast our revenues and operating
results.
The market for ultrasound imaging products is highly competitive and we may be
unable to compete.
The existing market for ultrasound imaging products is well established and
intensely competitive. In addition, we are seeking to develop new markets for
our hand-carried ultrasound imaging products. In response, we expect competition
to increase as potential and existing competitors begin to enter these new
markets or modify their existing products to compete directly with ours. Our
primary competitors have
. better name recognition;
. significantly greater financial resources; and
. existing relationships with some of our potential customers.
Our competitors may be able to use their existing relationships to discourage
customers from purchasing our products. In addition, our competitors may be able
to devote greater resources to the development, promotion and sale of new or
existing products, thereby allowing them to respond more quickly to new or
emerging technologies and changes in customer requirements.
We rely on an indirect sales and distribution network to sell our products
internationally.
Initially, we established an indirect sales and distribution network
internationally to sell our products. Our future revenue growth will depend in
part on our success in maintaining and expanding these indirect sales and
distribution channels. While we intend to establish direct selling forces in
targeted European markets, we currently depend on these distributors to help
promote market acceptance and demand for our products. Many of our foreign
distributors are in the business of distributing other, sometimes competing,
medical products. As a result, our products may not receive the resources and
support required within these countries to meet our sales objectives. Our
success is tied closely to the success of these distributors and their ability
to market and sell our products. Inherent in these international markets are
certain risks, including:
. the costs of localizing products for foreign markets;
. longer receivables collection periods and greater difficulty
in receivables collection, as compared to those experienced
in the United States;
. reduced protection for intellectual property rights in some
countries;
. fluctuations in the value of the United States dollar
relative to other currencies; and
. delays or failures in obtaining necessary regulatory
approvals.
If the distribution channels are negatively impacted by local economies,
unforeseen management issues, legal issues, or any number of adverse
circumstances, our distributors' willingness to promote and sell our products
may decrease. We intend to develop our own direct sales network in targeted
international markets and may elect to expand or replace our distributors in
other international markets. We cannot assure you that we will be able to
develop our own sales force in foreign markets, if at all, or change
distributors in these markets effectively or in a cost efficient manner.
15
Our direct selling force is new, and efforts to maintain and expand a qualified
sales force at a reasonable cost may not be successful.
We began direct sales of our products in the United States in February 2000 with
a contract sales force comprised of sonographers with little direct sales
experience. We nearly doubled the size of our direct sales force in the United
States and began direct selling in Western Europe in the first quarter of 2001.
This expansion requires extensive training and management as well as increasing
administrative activities. We may not be able to train qualified sales personnel
to meet our objectives. Further, they may not be ultimately successful. In
addition, costs associated with maintaining and growing a sales force are
difficult to control and manage and consequently may adversely affect our
results.
We have limited marketing experience.
As we market our products as a new platform within the established ultrasound
market and promote our products for new users, marketing will be critical to
generate awareness and consequently product sales. To be successful, our
marketing efforts need to identify the potential markets and also identify the
methods to reach and develop these markets. We must also be successful in
generating sales leads and processing these leads effectively to generate
product sales. We may not be successful in creating brand awareness sufficient
to positively impact product sales. In addition, we may not be successful in our
marketing efforts throughout the world. Our marketing efforts also must be
successful in removing barriers in the marketplace, including the efforts of our
competitors to discredit us, the availability and ease of educating users in the
use of our product and the resistance that may be shown by existing ultrasound
users.
If we do not retain key employees and attract additional highly skilled
employees, we will not be successful.
Our future performance will depend largely on the efforts and abilities of our
key technical, marketing, selling and managerial personnel and our ability to
retain them. We may be unable to attract qualified, highly skilled personnel
into key positions, in particular our sales representatives. Our success depends
on our ability to attract and retain additional key personnel in the future.
While we do not have any employment agreements with any of our employees, we do
have change in control agreements with certain of our executives, which prevent
them from working for a competitor within a designated period of time after
leaving us. Nevertheless, the loss of any of our key employees could harm our
business, particularly the loss of any of our key engineering or sales
personnel. We do not maintain key-person insurance on any of our employees.
We may be unable to adequately protect our intellectual property rights, which
could harm our business.
Our success and ability to compete depend on our licensed and internally
developed technology. We seek to protect our proprietary technology through a
combination of patent, copyright, trade secret and trademark laws. We also enter
into confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to, and the distribution of,
our product designs, documentation and other proprietary information, as well as
the designs, documentation and other information that we license from others.
Despite our efforts to protect these proprietary rights, unauthorized parties
may copy, develop independently or otherwise obtain and use our products or
technology.
We cannot be sure that our pending patent applications will result in issued
patents. In addition, our issued patents or pending applications may be
challenged or circumvented by our competitors. Policing unauthorized use of our
intellectual property will be difficult and we cannot be certain that we will be
able to prevent misappropriation of our technology, particularly in countries
where the laws may not protect our proprietary rights as fully as in the United
States. In addition, the cost of policing or defending our patent, copyright or
trademarks may be prohibitive.
Our products may infringe on the intellectual property rights of others, which
could subject us to significant liability.
Many of our competitors in the ultrasound imaging business hold issued patents
and have filed, or may file, patent applications. Our competitors may claim that
our technology or products infringe upon the technology covered by these patents
or patent applications. Any such claims, with or without merit, could
16
. be time-consuming to defend;
. result in costly litigation;
. divert management's attention and resources;
. cause product shipment delays;
. require us to enter into royalty or licensing agreements;
. prevent us from manufacturing or selling some or all of our
products; or
. result in our liability to one or more of these competitors.
If a third party makes a successful claim of patent infringement against us, we
may be unable to license the infringed or similar technology on acceptable
terms, if at all.
Our products may become obsolete.
Our competitors may develop and market ultrasound products that render our
products obsolete or noncompetitive. In addition, although diagnostic ultrasound
imaging products may have price and performance advantages over competing
medical imaging equipment, such as computed tomography and magnetic resonance
imaging, any price or performance advantages may not continue. Our products
could become obsolete or unmarketable if other products utilizing new
technologies are introduced or new industry standards emerge. As a result, the
life cycles of our products are difficult to estimate. To be successful, we will
need to continually enhance our products and to design, develop and market new
products that successfully respond to any competitive developments. In addition,
because our products are based on a single platform, we may be more vulnerable
to adverse events affecting the healthcare industry generally and the medical
ultrasound market specifically, than we would be if we offered products based on
more than one platform.
We may incur tax liability in connection with our spin-off from ATL
Our spin-off was treated by ATL as a tax-free spin-off under Section 355 of the
Internal Revenue Code of 1986. However, if ATL were to recognize taxable gain
from the spin-off, the Internal Revenue Service could impose that liability on
any member of the ATL consolidated group as constituted prior to the spin-off,
including us. ATL agreed to cover 85% of any such liability, unless the tax is
imposed due to our actions solely or by ATL solely; in which case, we have
agreed with ATL that the party who is solely at fault shall bear all of the tax
liability. We cannot guarantee that ATL would indemnify us or agree that it
caused the liability to be imposed. If we were required to pay all or a portion
of any taxes related to the spin-off, our business would be adversely affected.
Governmental regulation of our business could prevent us from introducing new
products in a timely manner.
All of our planned products and our manufacturing activities and the
manufacturing activities of our third-party medical device manufacturers are
subject to extensive regulation by a number of governmental agencies, including
the FDA and comparable international agencies. Our third-party manufacturers and
we are or will be required to
. undergo rigorous inspections by domestic and international
agencies;
. obtain the prior approval of these agencies before we can
market and sell our products; and
. satisfy content requirements for all of our sales and
promotional materials.
Compliance with the regulations of these agencies may delay or prevent us from
introducing new or improved products. We may be subject to sanctions, including
the temporary or permanent suspension of operations, product recalls and
marketing restrictions, if we fail to comply with the laws and regulations
pertaining to our business. Our third-party medical device manufacturers may
also be subject to the same sanctions and, as a result, may be unable to supply
components required to manufacture our products.
17
We may face product liability and warranty claims, which could result in
significant costs.
The sale and support of our products entail the risk of product liability,
malpractice or warranty claims, such as those based on claims that the failure
of one of our products, or our failure to properly train the users of our
products, resulted in a misdiagnosis. The medical instrument industry in general
has been subject to significant medical malpractice and product liability
litigation. We may incur significant liability in the event of such litigation.
Although we maintain product liability and incidental medical malpractice
insurance, we cannot be sure that this coverage is adequate or that it will
continue to be available on acceptable terms, if at all.
We also may face warranty exposure, which could adversely affect our operating
results. Our products generally carry a one-year warranty against defects in
materials and workmanship. We will be responsible for all claims, actions,
damages, liens, liabilities, costs and expenses for all product recalls, returns
and defects attributable to manufacturing. We established reserves for the
liability associated with product warranties. However, any unforeseen warranty
exposure could harm our operating results.
We may require additional funding to satisfy our future capital expenditure
needs and our prospects of obtaining such funding are uncertain.
Our future revenues may not be sufficient to support the expenses of our
operations and the expansion of our business. We may therefore need additional
equity or debt capital to finance our operations as we develop our products and
expand our sales. To date, our capital requirements have been met primarily by
the sale of equity, sales revenue and contributions by ATL in connection with
our spin-off. ATL's funding obligations have been met. As such, if we need
additional financing, we would need to explore other sources of financing,
including public equity or debt offerings, private placements of equity or debt
and collaborative or other arrangements with corporate partners. Financing may
not be available when needed or may not be available on acceptable terms. If we
are unable to obtain financing, we may be required to delay, reduce or eliminate
some or all of our research and development and sales and marketing efforts.
Our stock price has been and is likely to continue to be volatile.
The market price for our common stock and for securities of medical technology
companies generally has been volatile in the past and is likely to continue to
be volatile in the future. If you decide to purchase our shares, you may not be
able to resell them at or above the price you paid due to a number of factors,
including:
. actual or anticipated variations in quarterly operating
results;
. the loss of significant orders;
. changes in earnings estimates by analysts;
. announcements of technological innovations or new products by
our competitors;
. changes in the structure of the healthcare financing and
payment systems;
. general conditions in the medical industry or global economy;
and
. significant sales of our common stock by one or more of our
principal shareholders.
Our restated articles of incorporation, our bylaws, Washington law and some of
our agreements contain provisions that could discourage a takeover that may be
beneficial to shareholders.
There are provisions in our restated articles of incorporation, our bylaws and
Washington law that make it more difficult for a third party to obtain control
of us, even if doing so would be beneficial to our shareholders. Additionally,
our acquisition may be made more difficult or expensive by the following:
. a provision in our license agreement with ATL requiring a
significant cash payment to ATL upon a change in control of
SonoSite;
. a shareholder rights agreement; and
18
. acceleration provisions in benefit plans and change-in-
control agreements with our employees.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk relating to changes in interest rates, which could
adversely affect the value of our investments in marketable securities or
increase interest expense on outstanding obligations.
As of March 31, 2001, our portfolio consisted of $14.7 million of interest
bearing securities with maturities of less than one year. Our intent is to hold
these securities until maturity, but have classified them as available-for-sale
in the event of liquidation or unanticipated cash needs. The interest bearing
securities are subject to interest rate risk and will fall in value if market
interest rates increase. We believe that the impact on the fair market value of
our securities and related earnings for the remainder of 2001 from a
hypothetical 10% increase in market interest rates would not have a material
impact on either the investment portfolio or our obligations.
We distribute much of our product internationally through international
distributors. Although virtually all transactions currently are transacted
using United States dollars, economic and political risk exist within these
international markets, which we cannot control. In addition, we have an
affiliate that maintains certain accounts in a foreign currency. If the United
States dollar were to uniformly increase in strength by 10% in 2001 relative to
the currency of our affiliate, we believe the impact on our financial results
would not be significant.
Part II: OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit No. Description
----------- --------------------------------------------------------------
3.1* Restated Articles of Incorporation of the Company
3.2** Certificate of Designation of Series A Participating Cumulative
Preferred Stock
3.3 Amended and Restated Bylaws of the Company
4.1* Rights Agreement between First Chicago Trust Company and the
Company, dated April 6, 1998
4.2*** Form of Purchase Agreement
10.3 Amended 1998 Nonofficer Employee Stock Option Plan
------------------
* Incorporated by reference to the designated exhibit included in the
Company's Registration statement on Form S-1 (Registration No. 333-71457).
** Incorporated by reference to the designated exhibit included in the
Company's report on Form 10 (SEC File No. 000-23791).
*** Incorporated by reference to the designated exhibit included in the
Company's Registration Statement on Form S-3 (Registration No. 333-91083).
b) Reports on Form 8-K
No reports were filed on form 8-K during the quarter ended March 31, 2001.
19
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SONOSITE, INC.
(Registrant)
Dated: May 14, 2001 By: /s/ MICHAEL J. SCHUH
Michael J. Schuh
Vice President-Finance,
Chief Financial Officer
and Secretary
(Authorized Officer and Principal
Financial Officer)
20
INDEX TO EXHIBITS
Exhibit No. Description
----------- --------------------------------------------------------------
3.1* Restated Articles of Incorporation of the Company
3.2** Certificate of Designation of Series A Participating Cumulative
Preferred Stock
3.3 Amended and Restated Bylaws of the Company
4.1* Rights Agreement between First Chicago Trust Company and the
Company, dated April 6, 1998
4.2*** Form of Purchase Agreement
10.3 1998 Nonofficer Employee Stock Option Plan, as amended and
restated
------------------
* Incorporated by reference to the designated exhibit included in the
Company's Registration statement on Form S-1 (Registration No. 333-71457).
** Incorporated by reference to the designated exhibit included in the
Company's report on Form 10 (SEC File No. 000-23791).
*** Incorporated by reference to the designated exhibit included in the
Company's Registration Statement on Form S-3 (Registration No. 333-91083).