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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2011
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 0-22229
VITAL IMAGES, INC.
State of Incorporation:
Minnesota
 
I.R.S. Employer Identification No.:
42-1321776
Address of principal executive offices: 5850 Opus Parkway, Suite 300, Minnetonka, MN 55343-4414
Registrant’s telephone number: (952) 487-9500
 
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   o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No   x
On May 4, 2011, there were 14,028,133 shares of the Registrant's common stock, par value $.01 per share, outstanding.
 
 

 

Vital Images, Inc.
Form 10-Q
March 31, 2011
 
Table of Contents
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

Part I. Financial Information
 
Item 1.     Financial Statements
 
Vital Images, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except per share amounts)
(Unaudited)
 
March 31,
2011
 
December 31,
2010
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
68,225
 
 
$
87,697
 
Marketable securities
50,257
 
 
46,519
 
Accounts receivable, net
13,080
 
 
14,089
 
Prepaid expenses and other current assets
3,151
 
 
3,579
 
Total current assets
134,713
 
 
151,884
 
Marketable securities
22,039
 
 
5,685
 
Property and equipment, net
3,347
 
 
3,849
 
Other intangible assets, net
 
 
22
 
Goodwill
9,089
 
 
9,089
 
Total assets
$
169,188
 
 
$
170,529
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
1,944
 
 
$
2,311
 
Accrued compensation
2,325
 
 
2,827
 
Accrued royalties
583
 
 
892
 
Other current liabilities
1,880
 
 
2,223
 
Deferred revenue
16,554
 
 
16,409
 
Total current liabilities
23,286
 
 
24,662
 
Deferred revenue
991
 
 
1,085
 
Deferred rent
 
 
36
 
Total liabilities
24,277
 
 
25,783
 
 
 
 
 
Commitments and contingencies (Note 11)
 
 
 
 
 
 
 
Stockholders’ equity:
 
 
 
Preferred stock: $0.01 par value; 5,000 shares authorized; none issued or outstanding
 
 
 
Common stock: $0.01 par value; 40,000 shares authorized; 14,002 issued and
outstanding as of March 31, 2011; and 14,034 shares issued and outstanding as of
December 31, 2010
140
 
 
140
 
Additional paid-in capital
167,219
 
 
167,071
 
Accumulated deficit
(22,555
)
 
(22,598
)
Accumulated other comprehensive income
107
 
 
133
 
Total stockholders’ equity
144,911
 
 
144,746
 
Total liabilities and stockholders' equity
$
169,188
 
 
$
170,529
 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.
 

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Vital Images, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Revenue:
 
 
 
License fees
$
5,440
 
 
$
5,521
 
Maintenance and services
8,715
 
 
8,804
 
Hardware
697
 
 
434
 
Total revenue
14,852
 
 
14,759
 
 
 
 
 
Cost of revenue:
 
 
 
License fees
853
 
 
917
 
Maintenance and services
2,891
 
 
2,347
 
Hardware
553
 
 
440
 
Total cost of revenue
4,297
 
 
3,704
 
 
 
 
 
Gross profit
10,555
 
 
11,055
 
 
 
 
 
Operating expenses:
 
 
 
Sales and marketing
4,695
 
 
5,479
 
Research and development
3,336
 
 
4,030
 
General and administrative
2,585
 
 
2,722
 
Total operating expenses
10,616
 
 
12,231
 
 
 
 
 
Operating loss
(61
)
 
(1,176
)
 
 
 
 
Interest income
128
 
 
108
 
Income (loss) before income taxes
67
 
 
(1,068
)
Provision for income taxes
24
 
 
24
 
Net income (loss)
$
43
 
 
$
(1,092
)
 
 
 
 
Net income (loss) per share – basic
$
0.00
 
 
$
(0.08
)
Net income (loss) per share – diluted
$
0.00
 
 
$
(0.08
)
 
 
 
 
Weighted average common shares outstanding – basic
14,021
 
 
14,332
 
Weighted average common shares outstanding – diluted
14,120
 
 
14,332
 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.
 

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Table of Contents

Vital Images, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Cash flows from operating activities:
 
 
 
Net income (loss)
$
43
 
 
$
(1,092
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization of property and equipment
715
 
 
927
 
Amortization of identified intangible assets
22
 
 
90
 
Provision for doubtful accounts
(125
)
 
66
 
Amortization of discount and accretion of premium on marketable securities
132
 
 
(3
)
Equity-based compensation
619
 
 
1,487
 
Amortization of deferred rent
(107
)
 
(102
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
1,134
 
 
(938
)
Prepaid expenses and other assets
428
 
 
140
 
Accounts payable
(316
)
 
44
 
Accrued expenses and other liabilities
(1,084
)
 
(1,041
)
Deferred revenue
51
 
 
318
 
Net cash provided by (used in) operating activities
1,512
 
 
(104
)
 
 
 
 
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(264
)
 
(230
)
Purchases of marketable securities
(37,999
)
 
 
Proceeds from maturities of marketable securities
9,750
 
 
 
Proceeds from sales of marketable securities
7,999
 
 
 
Net cash used in investing activities
(20,514
)
 
(230
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Repurchases of common stock
(1,046
)
 
 
Proceeds from sale of common stock under stock plans
576
 
 
1,332
 
Payment for options tendered
 
 
(194
)
Net cash (used in) provided by financing activities
(470
)
 
1,138
 
 
 
 
 
Net (decrease) increase in cash and cash equivalents
(19,472
)
 
804
 
Cash and cash equivalents, beginning of period
87,697
 
 
120,317
 
Cash and cash equivalents, end of period
$
68,225
 
 
$
121,121
 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.
 

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Table of Contents

Vital Images, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
1.    Basis of presentation
The accompanying unaudited Condensed Consolidated Financial Statements of Vital Images, Inc. (the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, for a fair statement have been included. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for any subsequent quarter or for the year ending December 31, 2011. The December 31, 2010 condensed consolidated balance sheet information was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2010.
The Condensed Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The Company views its operations and manages its business as one reportable segment - the development and marketing of software and related products and services for advanced visualization and analysis solutions for use by medical professionals in clinical analysis and therapy planning. Factors used to identify the Company's single operating segment include the financial information available for evaluation by the chief operating decision maker in making decisions about how to allocate resources and assess performance. The Company markets its products and services through a direct sales force, resellers and independent distributors in the United States and international markets.
 
2.    Significant customers and geographic data
Significant customer revenue (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Toshiba Medical Systems Corporation
$
6,661
 
 
$
8,220
 
Percentage of total revenue
45
%
 
56
%
McKesson Information Solutions LLC
$
1,636
 
 
*
 
Percentage of total revenue
11
%
 
*
 
___________________________________________
*Less than 10%.
 
Customers accounting for more than 10% of the Company's accounts receivable were as follows:
 
March 31,
2011
 
December 31,
2010
Toshiba Medical Systems Corporation
44
%
 
58
%
McKesson Information Solutions LLC
16
%
 
*
 
___________________________________________
*Less than 10%.
 
Sales to customers located by geographic area are as follows (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
United States
$
10,439
 
 
$
9,644
 
Europe
2,371
 
 
2,681
 
Asia and Pacific
1,220
 
 
1,604
 
Other foreign
822
 
 
830
 
Total revenue
$
14,852
 
 
$
14,759
 
Export revenue as a percent of total revenue
30
%
 
35
%
 

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Table of Contents

The Company's export sales are primarily negotiated, invoiced and paid in U.S. dollars, with a portion of sales transactions denominated in foreign currencies.
 
3.    Revenue
In September 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to exclude tangible products containing software components and non-software components that function together to deliver the product's essential functionality from the scope of industry specific software revenue recognition guidance. Additionally, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to provide for how the deliverables in an arrangement should be separated including how the consideration should be allocated using the relative selling price method between software and non-software components prior to the application of specific software revenue recognition guidance. This guidance requires an entity to allocate revenue in an arrangement using relative estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (“VSOE”) or third-party evidence of selling price (“TPE”) and eliminates use of the residual method in such cases.
The Company adopted this accounting guidance at the beginning of its first quarter of 2011 on a prospective basis for applicable transactions originating or materially modified on or after January 1, 2011.
For the year ended December 31, 2010, pursuant to the previous guidance of revenue arrangements with multiple deliverables, the Company allocated revenue to each undelivered element based upon VSOE of fair value and then allocated the residual revenue to the delivered elements.
Pursuant to the new revenue recognition guidance, hardware systems are no longer included in the scope of the software revenue recognition guidance. All other product and service offerings are still within the scope of software revenue recognition guidance. Prior to the new guidance, the Company used the residual method to allocate revenue to hardware systems. Under the new guidance, hardware is now considered a non-software component of the multiple element arrangement and consideration is allocated based on ESP. As such, any discount is allocated to all elements based on the relative selling price of both delivered and undelivered elements. The new accounting guidance for revenue recognition is not expected to have a significant effect on revenue when applied to the Company's multiple element arrangements based on its current go-to-market strategies as sales of hardware systems are not core its strategy due to the existence of VSOE of fair value for the undelivered elements in its product and service offerings.
The new accounting guidance did not have a material impact on the Company's financial position or results of operations for the three months ended March 31, 2011 and does not change the units of accounting for its revenue transactions. Specifically, for product sales that contain software components and non-software components that function together to deliver the product's essential functionality, the difference between applying the relative selling price method to such transactions under the new guidance and the residual method under the previous guidance was insignificant. Undelivered elements are typically software-related services which the Company accounts for utilizing VSOE to determine fair value.
The new accounting standards, if applied to the year ended December 31, 2010, would not have had a material impact on the Company's total revenue for that year.
 
 
4.    Research and development
In January 2009, the Company and Toshiba Medical Systems Corporation ("Toshiba") entered into a development agreement under which Toshiba provides funding in support of the Company’s research and development efforts, and the parties work collaboratively to develop and deliver innovative technology advancements for Toshiba’s medical equipment and the Company’s advanced visualization software solutions. Software developed under the agreement is owned by the Company, and intellectual property in either party’s possession that may be useful in the development efforts or that is produced during the development activities is subject to cross-licenses. For payments received under the agreement, the Company’s policy is to offset research and development expense in the period in which the related costs are incurred. The agreement does not provide Toshiba with recourse for payments previously offset against incurred expenses.

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Table of Contents

Amounts billed by the Company to Toshiba and recognition of offsets to the Company's research and development expense for reimbursement from Toshiba to offset the development costs the Company incurred during the period under the agreement were as follows (in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Unrecognized balance, beginning of period
$
525
 
 
$
 
Amounts billed to Toshiba
 
 
481
 
Offsets recognized
(263
)
 
(241
)
Unrecognized balance, end of period
$
262
 
 
$
240
 
 
5.     Equity-based compensation
During the three months ended March 31, 2010, the Company initiated a cash tender offer for certain employee stock options in an effort to reduce its stock option overhang. The tender offer expired on March 19, 2010. Pursuant to the tender offer, employees tendered for purchase 360,000 options, and the Company accepted for purchase all such options. As a result, the Company paid an aggregate of $194,000 to the participating employees and incurred equity-based compensation expense of $692,000 related to the remaining unamortized equity-based compensation expense associated with the options tendered in the offer, which is included in total equity-based compensation of $1.5 million for the three months ended March 31, 2010. The tender offer applied to outstanding stock options held by employees with an exercise price equal to or greater than $25.00 per share. The price offered for each eligible stock option was at a discount to its fair value as determined using the Black-Scholes option pricing model.
 
The following table illustrates how equity-based compensation, including the expense related to the tender offer that expired on March 19, 2010, was allocated to the condensed consolidated statements of operations (in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Cost of revenue
$
60
 
 
$
137
 
Sales and marketing
120
 
 
430
 
Research and development
179
 
 
414
 
General and administrative
260
 
 
506
 
Total equity-based compensation expense
$
619
 
 
$
1,487
 
 
As of March 31, 2011, $4.5 million of unrecognized compensation expense related to stock options was expected to be recognized over a weighted-average period of 2.6 years. As of March 31, 2011, $176,000 of unrecognized compensation expense related to restricted stock awards was expected to be recognized over a weighted-average period of 2.0 years.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model. The Black-Scholes option valuation model requires the development of assumptions that are input into the model. These assumptions include the expected stock volatility, the risk-free interest rate, the option's expected life and the dividend yield on the underlying stock.
For purposes of calculating the fair value of options under applicable accounting standards, the weighted-average fair value of options granted was $5.22 and $5.84 for the three months ended March 31, 2011 and 2010, respectively. The weighted-average fair values for the options were based on the fair values on the dates of grant. The fair values for the options were calculated using the Black-Scholes option-pricing model, with the following weighted-average assumptions and expense adjusted using the following expected forfeiture rate assumptions:
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Expected option life
3.75 years
 
 
3.73 years
 
Expected volatility factor
44
%
 
46
%
Expected dividend yield
%
 
%
Risk-free interest rate
1.67
%
 
1.98
%
Expected forfeiture rate
2
%
 
2
%
 

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The following table summarizes stock option activity for the three months ended March 31, 2011:
 
Shares Underlying Options
Total outstanding as of December 31, 2010
2,221,251
 
Options granted
323,400
 
Options exercised
(39,874
)
Options cancelled
(45,825
)
Total outstanding as of March 31, 2011
2,458,952
 
 
Options granted during the three months ended March 31, 2011 consisted primarily of the Company's annual grant to employees.
The following table summarizes restricted shares activity for the three months ended March 31, 2011:
 
Restricted Shares
Total outstanding as of December 31, 2010
18,937
 
Shares vested
(187
)
Total outstanding as of March 31, 2011
18,750
 
 
6.    Per share data
Basic earnings per share is computed using net income (loss) and the weighted average number of common shares outstanding. Diluted earnings per share reflect the weighted average number of common shares outstanding plus any potentially dilutive shares outstanding during the period. Potentially dilutive shares consist of shares issuable upon the exercise of stock options and warrants, as well as unvested restricted stock. All common share equivalents are anti-dilutive in periods in which the Company generates a net loss.
 
The computations for basic and diluted net income (loss) per share are as follows (in thousands, except per share amounts):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Numerator:
 
 
 
Net income (loss)
$
43
 
 
$
(1,092
)
 
 
 
 
Denominator:
 
 
 
Denominator for weighted average common shares outstanding
- basic
14,021
 
 
14,332
 
Dilution associated with the Company’s equity-based
compensation plans
99
 
 
 
Denominator for weighted average common shares outstanding
– diluted
14,120
 
 
14,332
 
 
 
 
 
Net income (loss) per share — basic
$
0.00
 
 
$
(0.08
)
Net income (loss) per share — diluted
$
0.00
 
 
$
(0.08
)
 
 
 
 
Antidilutive stock options and restricted stock awards excluded
2,039
 
 
2,352
 
 
7.    Comprehensive income (loss)
Comprehensive income (loss) includes net income (loss) and items defined as other comprehensive income (loss). The applicable accounting guidance requires that items defined as other comprehensive income (loss), such as unrealized gains and losses on certain marketable securities, be separately classified in the financial statements. Such items are reported in the consolidated statements of stockholders’ equity as comprehensive income (loss).
 

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The components of comprehensive income (loss) were as follows (in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Net income (loss)
$
43
 
 
$
(1,092
)
Other comprehensive income (loss):
 
 
 
Net change in unrealized gain or loss on available-for-sale investments, net of tax
(26
)
 
14
 
Comprehensive income (loss)
$
17
 
 
$
(1,078
)
 
8.     Fair value measurements
The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of March 31, 2011 and December 31, 2010 (in thousands):
 
 
 
Fair Value Measurements at March 31, 2011 Using
 
Total Carrying Value at
 
Quoted price in active markets
 
Significant other observable inputs
 
Significant unobservable inputs
 
March 31, 2011
 
(Level 1)
 
(Level 2)
 
(Level 3)
Cash equivalents:
 
 
 
 
 
 
 
Money market
$
58,494
 
 
$
 
 
$
58,494
 
 
$
 
Corporate debt
1,500
 
 
1,500
 
 
 
 
 
Total cash equivalents
59,994
 
 
1,500
 
 
58,494
 
 
 
 
 
 
 
 
 
 
 
Marketable securities:
 
 
 
 
 
 
 
Corporate debt
23,548
 
 
23,548
 
 
 
 
 
Government debt
48,748
 
 
48,748
 
 
 
 
 
Total marketable securities
72,296
 
 
72,296
 
 
 
 
 
Total cash equivalents and marketable
     securities
$
132,290
 
 
$
73,796
 
 
$
58,494
 
 
$
 
 
 
 
Fair Value Measurements at December 31, 2010 Using
 
Total Carrying Value at
 
Quoted price in active markets
 
Significant other observable inputs
 
Significant unobservable inputs
 
December 31, 2010
 
(Level 1)
 
(Level 2)
 
(Level 3)
Cash equivalents:
 
 
 
 
 
 
 
Money market
$
79,904
 
 
$
 
 
$
79,904
 
 
$
 
 
 
 
 
 
 
 
 
Marketable securities:
 
 
 
 
 
 
 
Corporate debt
26,836
 
 
26,836
 
 
 
 
 
Government debt
25,368
 
 
25,368
 
 
 
 
 
Total marketable securities
52,204
 
 
52,204
 
 
 
 
 
Total cash equivalents and marketable
     securities
$
132,108
 
 
$
52,204
 
 
$
79,904
 
 
$
 
Marketable securities, as well as corporate debt securities included in cash equivalents, measured at fair value using quoted market prices are classified within Level 1 of the valuation hierarchy. Money market instruments included in cash equivalents are valued at net asset value, which generally approximates the current fair value, but since the value is not obtained from a quoted price in an active market, such securities are reflected as Level 2. The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.
 
As of March 31, 2011 and December 31, 2010, the Company’s marketable securities were as follows (in thousands):
 
March 31, 2011
 
December 31, 2010
 
Adjusted Cost
Basis
 
Aggregate Fair
Value
 
Net Unrealized
Gains
 
Adjusted
Cost Basis
 
Aggregate Fair
Value
 
Net Unrealized
Gains
Corporate debt
$
23,486
 
 
$
23,548
 
 
$
62
 
 
$
26,761
 
 
$
26,836
 
 
$
75
 
Government debt
48,703
 
 
48,748
 
 
45
 
 
25,310
 
 
25,368
 
 
58
 
 
$
72,189
 
 
$
72,296
 
 
$
107
 
 
$
52,071
 
 
$
52,204
 
 
$
133
 
 

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As of March 31, 2011 and December 31, 2010, the Company’s gross unrealized gains and losses were as follows (in thousands):
 
March 31, 2011
 
December 31, 2010
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Net Unrealized
Gains
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Net Unrealized
Gains
Corporate debt
$
62
 
 
$
 
 
$
62
 
 
$
81
 
 
$
(6
)
 
$
75
 
Government debt
47
 
 
(2
)
 
45
 
 
58
 
 
 
 
58
 
 
$
109
 
 
$
(2
)
 
$
107
 
 
$
139
 
 
$
(6
)
 
$
133
 
 
The carrying values of available-for-sale securities are at fair value. There were no material realized gains or losses on any investments for the three months ended March 31, 2011 or 2010.
 
Expected maturities of marketable securities as of March 31, 2011 were as follows (in thousands):
Expected Maturity
Fair Value
Due in one year or less
$
50,257
 
Due in one to two years
22,039
 
Total marketable securities
$
72,296
 
 
9.    Deferred revenue
The components of deferred revenue were as follows:
 
March 31,
2011
 
December 31,
2010
Maintenance and support
$
13,722
 
 
$
13,535
 
Customer education
2,537
 
 
2,626
 
Professional services
671
 
 
693
 
Software
231
 
 
209
 
Hardware and other
384
 
 
431
 
Total deferred revenue
17,545
 
 
17,494
 
Less current portion
(16,554
)
 
(16,409
)
Long-term portion of deferred revenue
$
991
 
 
$
1,085
 
 
10.    Income taxes
The Company recognized a provision for income taxes of $24,000 for each of the three-month periods ended March 31, 2011 and 2010, relating entirely to foreign income taxes.
 
As of March 31, 2011 and December 31, 2010, the Company's accrued liabilities included an accrual of $264,000 related to taxes payable for its international operations pending the resolution of certain prior year filings, which the Company considers to be an uncertain tax position. The Company anticipates changes to its uncertain tax position upon resolution of such filings.
Currently, the Company is not able to reasonably estimate the amount by which the liability for unrecognized tax benefits will increase or decrease during the next 12 months as a result of the ongoing income tax authority examinations.
The Company did not have any material unrecognized tax benefits as of March 31, 2011 and December 31, 2010. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision. The Company recorded no interest and penalties during the three months ended March 31, 2011 and 2010 and had no accrued interest and penalties as of March 31, 2011 and December 31, 2010. The Company is no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2007. The Company is open to state tax audits until the applicable statute of limitations expires.
 
11.    Commitments and contingencies
Under general contract terms, the Company often includes provisions in its software license agreements under which the Company agrees to indemnify its customers against liability and damages arising from claims of patent, copyright, trademark

11

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or trade secret infringement by the Company's software. The Company has not incurred any material costs as a result of this type of indemnification clause, and the Company does not maintain a product warranty liability reserve related to such indemnification clauses.
The Company has entered into various employment agreements with certain executives of the Company, which include provisions for severance payments subject to certain conditions and events.
The Company is involved in various claims and legal actions in the normal course of business. The outcome of such legal actions, even if unfavorable, will not have a significant adverse effect on the Company's financial position, results of operations or cash flows.
 
12.     Share repurchase program
During 2008, the Company's Board of Directors approved a share repurchase program, which authorized repurchases of shares on the open market of up to $40.0 million, including fees and expenses, of the Company's common stock, which program was completed in February 2009. On March 3, 2009, the Company announced a second share repurchase program, which provided for repurchases on the open market of up to 1.0 million shares of its common stock and was completed in March 2011. On August 4, 2010, the Company announced the Company's current share repurchase program, authorizing repurchases of shares on the open market of up to $20.0 million.
 
The programs authorize the repurchase of shares from time to time, depending on market conditions. During the three months ended March 31, 2011, the Company completed the second repurchase plan, repurchasing 77,000 shares for $1.0 million, inclusive of fees and expenses, and commenced activity under the current repurchase plan, repurchasing 3,000 shares for $41,000, inclusive of fees and expenses. Since the inception of its first share repurchase program in 2008 and through March 31, 2011, the Company has purchased an aggregate 3.9 million shares of its common stock for $51.9 million through open market transactions. As of March 31, 2011, under the current program, there remained $20.0 million authorized for share repurchases on the open market. Subsequent to March 31, 2011, the Company repurchased 34,000 shares for $450,000. The Company terminated the share repurchase program on April 27, 2011, in conjunction with its execution of a definitive agreement pursuant to which a subsidiary of Toshiba will acquire all of the Company's outstanding shares of common stock for $18.75 per share, or approximately $273 million in the aggregate, through a cash tender offer followed by a merger.
 
13.    Subsequent event
On April 27, 2011, Toshiba Medical Systems Corporation ("Toshiba") and the Company announced that they have entered into a definitive agreement pursuant to which a subsidiary of Toshiba ("Merger Sub") will acquire all of the outstanding shares of common stock of the Company for $18.75 per share, or approximately $273 million in the aggregate, through a cash tender offer followed by a merger.
Under the terms of the agreement, it is anticipated that Merger Sub will commence a tender offer for all of the outstanding shares of the Company by May 11, 2011.
The closing of the tender offer is conditioned on, among other things, the tender of at least a majority of the outstanding shares of the Company's common stock on a fully diluted basis, required regulatory approvals, including those of the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and other customary closing conditions. It is expected that the transaction will close in the second or third quarter of 2011.
 

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Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Executive summary
On April 27, 2011, Vital Images, Inc. (also referred to as “we”, “us” and “our”) executed a definitive agreement pursuant to which a subsidiary of Toshiba will acquire all of our outstanding shares of common stock for $18.75 per share, or approximately $273 million in the aggregate, through a cash tender offer followed by a merger.
 
Our financial results improved during 2010 and into the first quarter of 2011, reflecting a slightly improved economic environment. However, contracted capital spending by U.S. hospitals, continued weakness in the high-end computed tomography ("CT") and picture archiving and communication systems ("PACS") markets, and increased competitive pressure in the advanced visualization market have pressured our results in 2011 as they did in past years. We have mitigated the impact of these negative factors by making strategic investments to expand the range of our market opportunities and through cost-control measures.
 
Vital Images, Inc. summary results for the three months ended March 31, 2011, were as follows:
Revenue increased 1% to $14.9 million, compared to $14.8 million for the first quarter of 2010.
Gross margin was 71.1%, compared to 74.9% for the first quarter of 2010.
Income before income taxes was $67,000, compared to loss before income taxes of $1.1 million for the first quarter of 2010.
Net income was $43,000, or $0.00 per diluted share, compared to net loss of $1.1 million, or ($0.08) per diluted share, for the first quarter of 2010.
 
Total cash, cash equivalents and marketable securities were $140.5 million as of March 31, 2011, compared to $139.9 million as of December 31, 2010. Working capital (defined as current assets less current liabilities) was $111.4 million as of March 31, 2011, a decrease from $127.2 million as of December 31, 2010. The decrease in working capital during the three months ended March 31, 2011 was primarily due to cash used for purchases of noncurrent marketable securities and repurchases of our common stock during the period.
Critical accounting policies and estimates
Our discussion and analysis of financial condition and results of operations are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. We have adopted various accounting policies to prepare the Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America. The most significant accounting policies are disclosed in Note 2 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2010. The preparation of these financial statements requires us 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 periods. Actual results could differ from those estimates. We continually evaluate our critical accounting policies and estimates. We discuss our critical accounting estimates in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. We did not have any significant changes in our critical accounting policies or estimates since December 31, 2010.
 

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Results of Operations
The following table sets forth information from our condensed consolidated statements of operations, expressed as a percentage of total revenue.
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
Revenue:
 
 
 
License fees
36.6
 %
 
37.4
 %
Maintenance and services
58.7
 
 
59.7
 
Hardware
4.7
 
 
2.9
 
Total revenue
100.0
 
 
100.0
 
 
 
 
 
Cost of revenue:
 
 
 
License fees
5.7
 
 
6.2
 
Maintenance and services
19.5
 
 
15.9
 
Hardware
3.7
 
 
3.0
 
Total cost of revenue
28.9
 
 
25.1
 
 
 
 
 
Gross profit
71.1
 
 
74.9
 
 
 
 
 
Operating expenses:
 
 
 
Sales and marketing
31.6
 
 
37.1
 
Research and development
22.5
 
 
27.3
 
General and administrative
17.4
 
 
18.4
 
Total operating expenses
71.5
 
 
82.8
 
 
 
 
 
Operating loss
(0.4
)
 
(7.9
)
 
 
 
 
Interest income
0.9
 
 
0.7
 
Income (loss) before income taxes
0.5
 
 
(7.2
)
 
 
 
 
Provision for income taxes
0.2
 
 
0.2
 
 
 
 
 
Net income (loss)
0.3
 %
 
(7.4
)%
 
Revenue
A comparison of revenue by category is as follows (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
Revenue:
 
 
 
 
 
 
License fees
$
5,440
 
 
$
5,521
 
 
$
(81
)
(1
)%
Maintenance and services
8,715
 
 
8,804
 
 
(89
)
(1
)%
Hardware
697
 
 
434
 
 
263
 
61
 %
Total revenue
$
14,852
 
 
$
14,759
 
 
$
93
 
1
 %

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License fee revenue        
The following table sets forth information on license fee revenue by source (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
License fee revenue:
 
 
 
 
 
 
Direct and other distributors
$
2,144
 
 
$
1,000
 
 
$
1,144
 
114
 %
Toshiba
3,296
 
 
4,521
 
 
(1,225
)
(27
)%
Total license fee revenue
$
5,440
 
 
$
5,521
 
 
$
(81
)
(1
)%
 
 
 
 
 
 
 
Percent of license fee revenue:
 
 
 
 
 
 
Direct and other distributors
39
%
 
18
%
 
 
 
Toshiba
61
%
 
82
%
 
 
 
Total license fee revenue
100
%
 
100
%
 
 
 
The decrease in license fee revenue during the three months ended March 31, 2011, compared to the same period in 2010, was driven primarily by decreased Toshiba license fee revenue, reflecting weakness in the U.S. and international markets for high-end CT equipment. This was offset by increased license fee revenue in the U.S. through our direct channel and other distributors due to increased sales of Vitrea Enterprise Suite.
Maintenance and services revenue (dollars in thousands)
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
Maintenance and services revenue:
 
 
 
 
 
 
Maintenance and support
$
7,309
 
 
$
7,849
 
 
$
(540
)
(7
)%
Customer education
971
 
 
573
 
 
398
 
69
 %
Professional services
435
 
 
382
 
 
53
 
14
 %
Total maintenance and services revenue
$
8,715
 
 
$
8,804
 
 
$
(89
)
(1
)%
Maintenance and support revenue decreased for the three months ended March 31, 2011, compared to the same period in 2010, due significantly to a $348,000 decrease in Toshiba billing adjustments relating to historic periods.
Recognition of education revenue is impacted by the amount of license sales in preceding quarters and the timing of education sessions provided to customers. The increase in customer education revenue for the three months ended March 31, 2011, compared to the same period in 2010, was due to the effect of increased U.S. license sales in 2010 compared to 2009, for which education sessions are generally provided up to a year after the sale, as well as the general timing of training sessions provided.
Professional services revenue increased for the three months ended March 31, 2011, compared to the same period in 2010, due to the timing of professional services provided.

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The following table sets forth information on maintenance and services revenue by source (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
Maintenance and services revenue:
 
 
 
 
 
 
Direct and other distributors
$
5,540
 
 
$
5,144
 
 
$
396
 
8
 %
Toshiba
3,175
 
 
3,660
 
 
(485
)
(13
)%
Total maintenance and services revenue
$
8,715
 
 
$
8,804
 
 
$
(89
)
(1
)%
 
 
 
 
 
 
 
Percent of maintenance and services revenue:
 
 
 
 
 
 
Direct and other distributors
64
%
 
58
%
 
 
 
Toshiba
36
%
 
42
%
 
 
 
Total maintenance and services revenue
100
%
 
100
%
 
 
 
The increase in maintenance and services revenue from direct and other distributors for the three months ended March 31, 2011, compared to the same period in 2010, was primarily due to an increasing customer base and was driven by increased direct and other distributors license sales in the U.S.
The decrease in maintenance and services revenue from Toshiba for the three months ended March 31, 2011, compared to the same period in 2010, was driven by a $348,000 decrease in Toshiba billing adjustments relating to historic periods and lower software license sales through Toshiba in the U.S. and internationally.
Hardware revenue
Hardware revenue increased 61% to $697,000 for the first quarter of 2011, compared to $434,000 for the first quarter of 2010. Although the hardware we sell is commercially available, the increase in our hardware revenue was also driven by the fact that more hardware is purchased from us in connection with sales of Vitrea Enterprise Suite than in conjunction with sales of Vitrea, which were primarily on a workstation basis. We offer to sell hardware to our customers in conjunction with license sales, and fluctuations are driven by individual customer purchasing preferences. Sales of hardware systems are not core to our strategy, although many customers purchasing our software on an enterprise basis are choosing to also purchase the hardware for their enterprise from us. We expect hardware sales to fluctuate from period to period depending upon the needs and preferences of our customers.
 
Cost of revenue and gross profit
A comparison of gross profit and gross margin by revenue category is as follows (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
Gross profit:
 
 
 
 
 
 
License fees
$
4,587
 
 
$
4,604
 
 
$
(17
)
 %
Maintenance and services
5,824
 
 
6,457
 
 
(633
)
(10
)%
Hardware
144
 
 
(6
)
 
150
 
n/m
 
Total gross profit
$
10,555
 
 
$
11,055
 
 
$
(500
)
(5
)%
 
 
 
 
 
 
 
Gross margin:
 
 
 
 
 
 
License fees
84.3
%
 
83.4
 %
 
 
 
Maintenance and services
66.8
%
 
73.3
 %
 
 
 
Hardware
20.7
%
 
(1.4
)%
 
 
 
Total gross margin
71.1
%
 
74.9
 %
 
 
 
Fluctuations in license fee gross margin are generally a result of changes in the product and customer mix. Additionally, the mix between domestic and international sales may impact license fee gross margins. License gross margin increased for the three months ended March 31, 2011, compared to the same period in 2010, due primarily to a decrease in fixed amortization expense. This increase was offset in part by the impact of the overall product mix, including increased sales of third party software, which sales generally have lower margins.
Maintenance and services gross margin decreased for the three months ended March 31, 2011, compared to the same period in 2010, due to an increase in services personnel to 65 employees as of March 31, 2011 from 50 as of March 31, 2010. We

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continue to invest in our maintenance and services capability, which we believe increases customer satisfaction and drives additional sales of our products, but can temporarily lower maintenance and service gross margins. Maintenance and support revenue included Toshiba billing adjustments relating to historic periods of $90,000 and $438,000 for the three months ended March 31, 2011 and 2010, respectively, for which there were no incremental costs.
Hardware gross margins increased for the three months ended March 31, 2011, compared to the same period in 2010, due to variability in pricing during the periods. Variances in gross margin for hardware are expected, as hardware sales are not a substantial part of the sales strategy.
 
Operating expenses
The following is a comparison of operating expenses as a percent of revenue, as well as the percent change in total expense:
 
Percent of Revenue for the Three Months Ended
 
Percent Change in Expense for the Three Months Ended
 
March 31,
 
March 31,
 
2011
 
2010
 
2010 to 2011
Operating expenses:
 
 
 
 
 
Sales and marketing
31.6
%
 
37.1
%
 
(14
)%
Research and development
22.5
 
 
27.3
 
 
(17
)%
General and administrative
17.4
 
 
18.4
 
 
(5
)%
Total operating expenses
71.5
%
 
82.8
%
 
(13
)%
Sales and marketing
Sales and marketing expenses were as follows (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
Salaries, benefits and bonuses
$
2,143
 
 
$
2,132
 
 
$
11
 
1
 %
Commissions
597
 
 
517
 
 
80
 
15
 %
Travel, meals and entertainment
531
 
 
657
 
 
(126
)
(19
)%
Overhead and other expenses
519
 
 
584
 
 
(65
)
(11
)%
Trade shows and advertising
513
 
 
607
 
 
(94
)
(15
)%
Depreciation
161
 
 
332
 
 
(171
)
(52
)%
Equity-based compensation
120
 
 
430
 
 
(310
)
(72
)%
Outside services and consulting
111
 
 
220
 
 
(109
)
(50
)%
Total
$
4,695
 
 
$
5,479
 
 
$
(784
)
(14
)%
Sales and marketing expense decreased for the three months ended March 31, 2011, compared to the same period in 2010. Equity-based compensation decreased due to the reduction in options outstanding subsequent to the tender offer for certain employee stock options in March 2010, described in the “Tender offer for certain employee stock options” section below. Depreciation expense decreased as certain assets became fully depreciated. Additionally, we decreased our utilization of consultants for the three months ended March 31, 2011, compared to the same period in 2010. Travel, meals and entertainment and overhead and other expenses decreased for the three months ended March 31, 2011, due to a general reduction in travel, as well as lower headcount, which consisted of 62 sales and marketing personnel as of March 31, 2011, compared to 66 at March 31, 2010. These decreases were partially offset by increased commissions expense due to increased direct and other distributor sales.
We will continue to manage our sales and marketing expenses based on market conditions and business opportunities.

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Research and development
Research and development expenses were as follows (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
Salaries, benefits and bonuses
$
2,427
 
 
$
2,720
 
 
$
(293
)
(11
)%
Overhead and other expenses
593
 
 
665
 
 
(72
)
(11
)%
Outside services and consulting
294
 
 
309
 
 
(15
)
(5
)%
Equity-based compensation
179
 
 
414
 
 
(235
)
(57
)%
Depreciation
106
 
 
163
 
 
(57
)
(35
)%
Development reimbursement
(263
)
 
(241
)
 
(22
)
9
 %
Total
$
3,336
 
 
$
4,030
 
 
$
(694
)
(17
)%
The decrease in research and development expenses for the three months ended March 31, 2011, compared to the same period in 2010, resulted primarily from lower headcount, which consisted of 72 research and development personnel as of March 31, 2011, compared to 87 at March 31, 2010. Equity-based compensation decreased due to the reduction in options outstanding subsequent to the tender offer for certain employee stock options in March 2010.
We will continue to devote resources to develop applications and solutions to improve the cost, quality and accessibility of health care.
General and administrative
General and administrative expenses were as follows (dollars in thousands):
 
For the Three Months Ended
 
March 31,
 
2011
 
2010
 
Change
Salaries, benefits and bonuses
$
1,170
 
 
$
1,127
 
 
$
43
 
4
 %
Overhead and other expenses
554
 
 
554
 
 
 
 %
Equity-based compensation
260
 
 
506
 
 
(246
)
(49
)%
Accounting, auditing and legal fees
422
 
 
389
 
 
33
 
8
 %
Consulting
179
 
 
146
 
 
33
 
23
 %
Total
$
2,585
 
 
$
2,722
 
 
$
(137
)
(5
)%
General and administrative expenses decreased during the three months ended March 31, 2011, compared to the same period in 2010, due primarily to decreased equity-based compensation expense as fewer options remained outstanding subsequent to the tender offer for certain employee stock options. We had 40 and 38 general and administrative personnel as of March 31, 2011 and 2010, respectively.
We will continue to manage our general and administrative expenses relative to changes in the business.
Tender offer for certain employee stock options
During the three months ended March 31, 2010, we initiated a cash tender offer for certain employee stock options in an effort to reduce the number of our stock options outstanding. The tender offer expired on March 19, 2010. Pursuant to the tender offer, employees tendered for purchase 360,000 options, and we accepted for purchase all such options. As a result, we paid an aggregate of $194,000 to the participating employees and incurred an equity-based compensation expense of $692,000 related to the remaining unamortized equity-based compensation expense associated with the options tendered in the offer. The tender offer applied to outstanding stock options held by employees with an exercise price equal to or greater than $25.00 per share. The price offered for each eligible stock option was at a discount to its fair value, as determined using the Black-Scholes option pricing model.
Interest income
We generated $128,000 of interest income in the first quarter of 2011, compared to $108,000 in the first quarter of 2010. The increase for the three months ended March 31, 2011, compared to the same period in 2010, was due to increased investment in corporate commercial paper.

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Income taxes
We recognized a provision for income taxes of $24,000 for each of the three-month periods ended March 31, 2011 and 2010, relating entirely to foreign income taxes.
 
Liquidity and capital resources
The following table sets forth certain relevant measures of our liquidity and capital resources (in thousands):
 
March 31,
2011
 
December 31,
2010
Cash and cash equivalents
$
68,225
 
 
$
87,697
 
Marketable securities - current
50,257
 
 
46,519
 
Marketable securities - noncurrent
22,039
 
 
5,685
 
Cash, cash equivalents and marketable securities
$
140,521
 
 
$
139,901
 
 
 
 
 
Working capital
$
111,427
 
 
$
127,222
 
 
 
 
 
Debt
$
 
 
$
 
The increase in our cash, cash equivalents and marketable securities as of March 31, 2011, compared to December 31, 2010, resulted from cash from operating activities, offset by cash used in repurchases of our common stock. The decrease in our working capital as of March 31, 2011, compared to December 31, 2010, was primarily due to cash used for purchases of noncurrent marketable securities. As of March 31, 2011, our marketable securities consist of U.S. government obligations and corporate commercial obligations.
We believe our existing cash and investments will satisfy our foreseeable working capital requirements for at least the next 12 months. Additionally, we believe our liquidity and balance sheet position enable us invest in our enterprise solution and marketing strategy while still remaining well positioned to pursue strategic acquisition opportunities if and when they emerge.
Summary of Cash Flows
A summary of cash flows is as follows (in thousands):
 
 For the Three Months Ended
 
March 31,
 
2011
 
2010
 Cash provided by (used in):
 
 
 
 Operating activities
$
1,512
 
 
$
(104
)
 Investing activities
(20,514
)
 
(230
)
 Financing activities
(470
)
 
1,138
 
 Net change in cash and cash equivalents
$
(19,472
)
 
$
804
 
Operating activities 
Net cash provided by operating activities increased $1.6 million for the three months ended March 31, 2011 to $1.5 million, compared to cash used in operating activities of $104,000 for the same period in 2010, due to a $1.1 million change in net income (loss) and a $1.7 million increase in cash provided by changes in operating assets and liabilities, offset by a $1.2 million decrease in cash used in non-cash operating items.
 
The increase of changes in operating assets and liabilities of $1.7 million for the three months ended March 31, 2011, compared to the same period in 2010, was primarily due to the timing of receipts and payments in the ordinary course of business. A $1.1 million source of cash resulted from the change in accounts receivable for the three months ended March 31, 2011, compared to a $938,000 use of cash for the same period in 2010. Changes in the accounts receivable balances each period resulted primarily from the amount and timing of sales within the quarter and the timing of receipts from large enterprise transactions and channel partners. Our days' sales outstanding (calculated by dividing ending net accounts receivable by revenue per day) was 80 days as of March 31, 2011, compared to 81 days as of March 31, 2010. A $1.4 million use of cash resulted from changes in accounts payable, accrued expenses and other liabilities for the three months ended March 31, 2011, compared to a $1.0 million use of cash for the same period in 2010. Changes in the accounts payable, accrued expenses and other liabilities balances each period are primarily affected by purchases in the last quarter of the respective reporting period and the timing of payments to vendors. A $51,000 source of cash resulted from the change in deferred revenue for the three months ended March 31, 2011, compared to a $318,000 source of cash for the same period in 2010. Changes in the deferred revenue balances each period are primarily

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affected by sales for the preceding four quarters and the timing of services provided.
 
Non-cash operating expenses decreased by $1.2 million to $1.3 million for the three months ended March 31, 2011, compared to the same period in 2010. The changes primarily resulted from an $868,000 decrease in equity-based compensation expense due to fewer options outstanding subsequent to the tender offer in March 2010, a $212,000 decrease in depreciation expense as certain assets became fully depreciated, and a $191,000 decrease in the provision for doubtful accounts resulting from changes in the estimated collectability of outstanding accounts receivable.
 
Investing activities 
Net cash used in investing activities was $20.5 million for the three months ended March 31, 2010, compared to cash used in investing activities of $230,000 for the same period in 2010.
 
We used $38.0 million to purchase investments in marketable securities during the three months ended March 31, 2011. We realized $17.7 million of proceeds from maturities and sales of marketable securities for the three months ended March 31, 2011. No marketable securities were purchased and none matured or was sold during the three months ended March 31, 2010. As of March 31, 2011, the marketable securities consisted of U.S. government obligations and corporate commercial obligations.
 
We used $264,000 and $230,000 for purchases of property and equipment for the three months ended March 31, 2011 and 2010, respectively. The purchases for both periods were principally to upgrade computer equipment. We anticipate that we will continue to purchase property and equipment in the normal course of business. The amount and timing of these purchases and the related cash outflows in future periods are difficult to predict and depend on a number of factors, including the hiring of employees and the rate of change of computer hardware.
 
Financing activities
Cash used in financing activities totaled $470,000 and cash provided by financing activities totaled $1.1 million for the three months ended March 31, 2011 and 2010, respectively. The primary use of cash for the three months ended March 31, 2011 was for the repurchase our common stock under our share repurchase programs. The primary source of cash for the three months ended March 31, 2010 was from the sale of common stock under our stock plans.
 
We have never paid or declared any dividends and do not intend to pay dividends in the foreseeable future.
Off-balance-sheet arrangements
We did not have any off-balance sheet arrangements as of March 31, 2011 or December 31, 2010.
Other purchase commitments
We had no significant outstanding purchase commitments as of March 31, 2011. We have entered into a number of technology licensing agreements that provide for the payment of royalties when we sell our software products; we are not obligated for any minimum payments under such agreements.
Foreign currency transactions
Our export sales are primarily negotiated, invoiced and paid in U.S. dollars, with a portion of sales transactions denominated in foreign currencies. As we expand our direct business internationally, we expect to enter into a higher percentage of sales transactions in foreign currencies and could be subject to greater gains or losses based on exchange rate fluctuations.
Cautionary Statement Regarding Forward-Looking Information
Vital Images desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”) and is filing this cautionary statement in connection with the Reform Act. This Quarterly Report on Form 10-Q and any other written or oral statements made by or on our behalf may include forward-looking statements that reflect our current views with respect to future events and future financial performance. Certain statements in this Quarterly Report on Form 10-Q are “forward-looking statements” within the meaning of Section 27(a) of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by our use of the words “believes,” “anticipates,” “forecasts,” “projects,” “could,” “plans,” “expects,” “may,” “will,” “would,” “intends,” “estimates” and similar expressions, whether in the negative or affirmative. We wish to caution you that any forward-looking statements made by us or on our behalf are subject to uncertainties and other factors that could cause such statements to be

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wrong. We cannot guarantee that we actually will achieve these plans, intentions or expectations. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These statements are only predictions and speak only of our views as of the date the statements were made. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, and/or performance of achievements. Except as required by law, we do not assume any obligation to update or revise any forward-looking statements that we make, whether as a result of new information, future events or otherwise.
Factors that may impact forward-looking statements include, among others, our abilities to maintain the technological competitiveness of our current products, develop new products, successfully market our products, respond to competitive developments, develop and maintain partnerships with providers of complementary technologies, identify and close mergers and acquisitions, manage our costs and the challenges that may come with growth of our business, and attract and retain qualified sales, technical and management employees. We are also affected by the growth and regulation of the medical technology industry, including the acceptance of advanced visualization by hospitals, clinics, and universities, product clearances and approvals by the United States Food and Drug Administration and similar regulatory bodies outside the United States, and reimbursement and regulatory practices by Medicare, Medicaid, and private third-party payer organizations. We are also affected by other factors identified in our filings with the Securities and Exchange Commission, some of which are set forth in the section entitled “Item 1A.Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010 and in the section entitled “Item 1A.Risk Factors” in this Quarterly Report on Form 10-Q (and many of which we have discussed in prior filings). Although we have attempted to list comprehensively these important factors, we also wish to caution investors that other factors may prove to be important in the future in affecting our operating results. New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact each factor or combination of factors may have on our business.
 
Item 3.     Quantitative and Qualitative Disclosures About Market Risk
For information regarding our exposure to certain market risks, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, which is hereby incorporated herein. There have been no material changes in the financial instruments or market risk exposures from the amounts and descriptions disclosed therein.
 
Item 4.     Controls and Procedures
Evaluation of disclosure controls and procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial disclosure.
Our management, under the supervision of and with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective at a reasonable assurance level.
Limitations on the effectiveness of controls
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with established policies or procedures may deteriorate.
Changes in internal control over financial reporting
There were no changes in internal control over financial reporting during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 

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Part II. Other Information
 
Item 1.    Legal Proceedings
None.
 
Item 1A.    Risk Factors
The discussion of our business and operations included in this Quarterly Report on Form 10-Q should be read together with the risk factors described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010. They describe various risks and uncertainties to which we are or may become subject. These risks and uncertainties, together with other factors described elsewhere in this report, have the potential to affect our business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner. There have been no material changes to the risk factors described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, except as described below. New risks may emerge at any time, and we cannot predict those risks or estimate the extent to which they may affect financial performance.
 
Pending Acquisition by Toshiba Medical Systems Corporation
On April 27, 2011, we entered into an Agreement and Plan Merger (the “Merger Agreement”) with Toshiba Medical Systems Corporation (“Toshiba”) and Magenta Corporation, a wholly owned subsidiary of Toshiba (“Merger Sub”), for the acquisition of the Company by Merger Sub. Pursuant to the terms of the Merger Agreement, Merger Sub could acquire all of the issued and outstanding shares of our common stock for $18.75 per share, or approximately $273 million in the aggregate, through a cash tender offer followed by a merger. The proposed transactions, whether or not consummated, may result in a diversion of management's attention from day-to-day operations, a loss of key personnel and a disruption of our operations. The proposed transaction may also affect our relationships with third parties, including customers and suppliers. The Merger Agreement imposes customary restrictions on the conduct of our business outside of the ordinary course prior to the closing of the transactions contemplated by the Merger Agreement or the termination of the Merger Agreement, which may also adversely affect our ability to manage our operations effectively in light of changes in economic or market conditions or to execute our business strategy. Additionally, litigation is common in connection with acquisitions of publicly traded companies like our company. As a result, we and our directors or officers may become parties to lawsuits relating to the proposed transactions, which, even if these suits are without merit, could be time consuming, expensive and divert the attention of our management from the operation of our business. If we experience the potential consequences of any of the foregoing risk factors, our results of operations, financial condition and prospects could be materially and adversely affected.
 
The proposed transactions are subject to customary closing conditions, including, among others, the tender of at least a majority of the outstanding shares of our common stock on a fully diluted basis in the tender offer and required regulatory approvals, including those of the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. The Merger Agreement contains certain termination rights of Toshiba and the Company and provides that, upon the termination of the Merger Agreement under specified circumstances, the Company will be required to pay Toshiba a termination fee of $8.2 million or, under different circumstances, a termination fee of one-half of such amount. If we are required to pay a termination fee pursuant to the Merger Agreement, including in the event that we do not complete an alternative change-in-control transaction, our results of operations and financial position could be materially and adversely affected.
 
We cannot predict whether or when the proposed transactions set forth in the Merger Agreement will be completed. Any delay in the consummation of the proposed transactions could exacerbate the impact of the risks associated with the proposed transactions, if they were to occur. If the proposed transactions are not completed or are delayed for any reason, the market price of our common stock may decline.
 
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
c)     The following table presents information with respect to purchases of Vital Images, Inc. common stock made during the quarter ended March 31, 2011 by us or our “affiliated purchaser,” as defined in Rule 10b-18(a)(3) under the Exchange Act.
    

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Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number and Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
January 1-31, 2011
 
7,515
 
$
13.18
 
 
7,515
 
69,937 shares and $20.0 million
February 1-28, 2011
 
1,103
 
$
13.24
 
 
1,103
 
68,834 shares and $20.0 million
March 1-31, 2011
 
71,896
 
$
12.93
 
 
71,896
 
$20.0 million
 
 
80,514
 
$
12.96
 
 
80,514
 
$20.0 million
 
During 2008, our Board of Directors approved a share repurchase program, which authorized repurchases of shares on the open market of up to $40.0 million, including fees and expenses, of our common stock, which program was completed in February 2009. On March 3, 2009, we announced a second share repurchase program, which provided for repurchases on the open market of up to 1.0 million shares of our common stock and was completed in March 2011. On August 4, 2010, we announced our current share repurchase program, authorizing repurchases of shares on the open market of up to $20.0 million.
 
The programs authorize the repurchase of shares from time to time, depending on market conditions. During the three months ended March 31, 2011, we completed the second repurchase plan, repurchasing 77,000 shares for $1.0 million, inclusive of fees and expenses, and commenced activity under the current repurchase plan, repurchasing 3,000 shares for $41,000, inclusive of fees and expenses. Since the inception of our first share repurchase program in 2008 through March 31, 2011, we have purchased an aggregate 3.9 million shares of our common stock for $51.9 million through open market transactions. As of March 31, 2011, under the current program, there remained $20.0 million authorized for share repurchases on the open market. Subsequent to March 31, 2011, we repurchased 34,000 shares for $450,000. We terminated the share repurchase program on April 27, 2011, in conjunction with our execution of a definitive agreement pursuant to which a subsidiary of Toshiba will acquire all of our outstanding shares of common stock for $18.75 per share, or approximately $273 million in the aggregate, through a cash tender offer followed by a merger.
 
Item 3.    Defaults Upon Senior Securities
None.
 
Item 4.    Reserved
 
Item 5.    Other Information
None.
 
Item 6.    Exhibits
The following exhibits are filed with this Quarterly Report on Form 10-Q:
31.1
Certification of Chief Executive Officer Pursuant to Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934 (filed herewith electronically).
 
31.2
Certification of Chief Financial Officer Pursuant to Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934 (filed herewith electronically).
 
32.1
Section 1350 Certification of Chief Executive Officer (filed herewith electronically).
 
32.2
Section 1350 Certification of Chief Financial Officer (filed herewith electronically).
 
 

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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
VITAL IMAGES, INC.
 
Date:
May 9, 2011
/s/ Peter J. Goepfrich
 
 
Peter J. Goepfrich
 
 
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
 

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