Vital Images (VTAL)

3.           Research and Development

In January 2009, the Company and Toshiba entered into a co-development and collaboration agreement in which the two companies will enter into a mutual license of intellectual property and will jointly invest to develop and deliver innovative technology advancements for Toshiba’s medical equipment and the Company’s advanced visualization software solutions. The Company accounts for the agreement under the provisions of Emerging Issues Task Force (“EITF”) Issue No. 07-1, “Accounting for Collaborative Arrangements” (“EITF 07-1”). The Company’s policy is to recognize payments received under the agreement as an offset to research and development expense in the period in which the related costs are incurred. During the first quarter of 2009, the Company received $569,000 and recognized a credit of $243,000 to its research and development expense for reimbursement from Toshiba for development costs the Company incurred under the agreement. The remaining unrecognized balance of $326,000 was included in other current liabilities as of March 31, 2009.

Research and development

Research and development expenses increased $744,000 to $4.3 million in the first quarter of 2008, compared to $3.5 million in the first quarter of 2007. The change in research and development expenses is as follows (dollars in thousands):

The increase in research and development expenses for the three months ended March 31, 2008 was primarily due to an increase in consulting expense and compensation costs as a result of additional consultants and personnel focused on product development. We had 116 and 99 research and development personnel as of March 31, 2008 and 2007, respectively.

We will continue to devote resources to develop applications focused on cardiovascular disease and oncology, PACS integration and Web-based solutions that help physicians across the hospital enterprise better serve their patients. For full year 2008, we expect research and development expenses will be approximately 24% to 26% of total revenue.

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Research and development

Research and development expenses increased $520,000 to $3.5 million in the first quarter of 2007 compared to $3.0 million in the first quarter of 2006. The change in research and development expense is as follows (in thousands):

The increase in expenses was primarily due to an increase in compensation costs as a result of additional personnel focused on product innovation and development. We had 99 and 73 research and development personnel as of March 31, 2007 and 2006, respectively. The increase in depreciation is due to the increase in headcount and significant capital additions during 2006. The decrease in equity-based compensation was primarily due to a $146,000 one-time charge related to the retirement of Vincent Argiro, our former Chief Technology Officer and founder, which was recorded in the first quarter of 2006. The decrease in consulting expenses is due to the fact that during the first quarter of 2006, we required a significant amount of temporary consulting services in completing

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certain research and development activities, specifically in the area of software testing and validation.  During 2006, we added a significant number of research and development personnel, which allowed us to rely less on outside consulting as a total percentage of research and development expense during the first quarter of 2007.

We expect research and development expenses to continue to increase in future periods primarily as a result of additional personnel to support the expansion of our product development activities so that we can maintain our status as an industry leader in advanced visualization. We expect research and development expenses to be between 17% and 18% of total revenue for the year ending December 31, 2007.

Research and development

Research and development expenses increased 57% to $3.4 million in the third quarter of 2006, compared to $2.2 million in the third quarter of 2005. Research and development expenses increased 61% to $9.5 million in the first nine months of 2006, compared to $5.9 million in the first nine months of 2005.

The increase in expenses during both periods was due to an increase in compensation costs as a result of additional personnel and higher equity-based compensation costs as a result of our implementation of SFAS 123(R) as of January 1, 2006.  Research and development expenses as a percentage of revenue were 19% and 16% for the quarters ended September 30, 2006 and 2005, respectively. Research and development expenses as a percentage of revenue were 19% and 16% for the nine months ended September 30, 2006 and 2005, respectively.

Salaries, benefits and bonus-related expenses increased $839,000 to $2.2 million in the third quarter of 2006, compared to $1.4 million in the third quarter of 2005, and increased $2.1 million to $6.0 million in the first nine months of 2006, compared to $3.9 million in the first nine months of 2005.  For both periods, the increase was driven primarily by additional personnel focused on product innovation and development. We had 93 and 65 research and development personnel as of September 30, 2006 and 2005, respectively.  The $2.1 million increase for

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the nine month period ended September 30, 2006 also included a $138,000 one-time charge related to the retirement of Vincent Argiro, our Chief Technology Officer and founder, which was recorded in the first quarter of 2006.

Equity-based compensation expense related to research and development increased $144,000 to $156,000 in the third quarter of 2006, which compares to $12,000 in the third quarter of 2005, and increased $612,000 to $639,000 in the first nine months of 2006, compared to $27,000 in the first nine months of 2005.  For both periods, the increase is a result of our implementation of SFAS 123(R) as of January 1, 2006.  The $612,000 increase equity-based compensation expense for the nine month period ended September 30, 2006 also included a $146,000 one-time charge related to the retirement of Vincent Argiro, which was recorded in the first quarter of 2006. In addition, contract and consulting costs increased $310,000 to $718,000 in the first nine months of 2006, compared to $408,000 in the first nine months of 2005.  The nine month increase was due to our requirement for additional temporary assistance in completing certain research and development activities, specifically in the area of software testing and validation.

We expect research and development expenses to continue to increase in future periods primarily as a result of additional personnel to support the expansion of our product development activities so that we can maintain our status as an industry leader in advanced visualization. Including the equity-based compensation, we expect research and development expenses to be approximately 19% of total revenue for the year ending December 31, 2006.

Research and development

Research and development expenses increased 57% to $3.1 million in the second quarter of 2006 compared to $2.0 million in the second quarter of 2005. Research and development expenses increased 63% to $6.1 million in the first six months of 2006 compared to $3.8 million in the first six months of 2005.

The increase in expenses during both periods was due to an increase in compensation costs as a result of additional personnel, higher equity-based compensation costs as a result of our implementation of SFAS 123(R) as of January 1, 2006 and higher contract and consulting costs.  Research and development expenses as a percentage of revenue were 19% and 17% for the quarters ended June 30, 2006 and 2005, respectively. Research and development expenses as a percentage of revenue were 19% and 16% for the six months ended June 30, 2006 and 2005, respectively.

Salaries, benefits and bonus-related expenses increased $727,000 to $2.0 million in the second quarter of 2006 compared to $1.3 million in the second quarter of 2005 and increased $1.3 million to $3.7 million in the first six months of 2006 compared to $2.4 million in the first six months of 2005.  For both periods, the increase was driven primarily by additional personnel focused on product innovation and development. We had 86 and 55 research and development personnel as of June 30, 2006 and 2005, respectively.  The $1.3 million increase for the six month period ended June 30, 2006 also included a $138,000 one-time charge related to the retirement of Vincent Argiro, our Chief Technology Officer and founder, which was recorded in the first quarter of 2006.

Equity-based compensation expense related to research and development increased $163,000 to $173,000 in the second quarter of 2006, which compares to $10,000 in the second quarter of 2005, and increased $468,000 to $483,000 in the first six months of 2006 compared to $15,000 in the first six months of 2005.  For both periods, the increase is a result of our implementation of SFAS 123(R) as of January 1, 2006.  The $468,000 increase for the six month period ended June 30, 2006 also included a $146,000 one-time charge related to the retirement of Vincent Argiro, which was recorded in the first quarter of 2006. In addition, contract and consulting costs increased $95,000 to $268,000 in the second quarter of 2006 compared to $173,000 in the second quarter of 2005 and increased $306,000 to $510,000 in the first six months of 2006 compared to $204,000 in the first six months of 2005.  For both periods, the increase was due to our requirement for additional temporary assistance in completing certain research and development activities, specifically in the area of software testing and validation.

We expect research and development expenses to continue to increase in future periods primarily as a result of additional personnel to support the expansion of our product development activities so that we can maintain our status as an industry leader in advanced visualization. Including the equity-based compensation, we expect research and development expenses to be approximately 19% of total revenue for the year ended December 31, 2006.

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Research and development

Research and development expenses increased 70% to $3.0 million in the first quarter of 2006 compared to $1.8 million in the first quarter of 2005. The increase in expenses was due to an increase in compensation costs as a result of additional personnel, higher equity-based compensation costs as a result of our implementation of SFAS 123(R) as of January 1, 2006, higher contract and consulting costs, and a one-time charge related to the retirement of Vincent Argiro, Chief Technology Officer and founder of the company. Research and development expenses as a percentage of revenue were 19% and 16% for the quarters ended March 31, 2006 and 2005, respectively.

Equity-based compensation expense related to research and development increased to $310,000 in the first quarter of 2006, of which $146,000 related to the retirement of Mr. Argiro, which compares to $5,000 in the first quarter of 2005. Salaries, benefits and bonus-related expenses increased $577,000 to $1.8 million in the first quarter of 2006, of which $138,000 related to the retirement of Mr. Argiro. This compares to $1.2 million in of salaries, benefits, and bonus-related expenses the first quarter of 2005, with the increase being driven primarily by additional personnel focused on product innovation and development. We had 73 and 51 research and development personnel as of March 31, 2006 and 2005, respectively. In addition, contract and consulting costs increased $217,000 to $242,000 in the first quarter of 2006 compared to $25,000 in the first quarter of 2005, as we continue to require additional temporary assistance in completing certain research and development activities, specifically in the area of software testing and validation.

We expect research and development expenses to continue to increase in future periods primarily as a result of additional personnel to support the expansion of our product development activities so that we can maintain our status as an industry leader in advanced visualization. Including the equity-based compensation, we expect research and development expenses to be between 20% and 21% of total revenue for the year ended December 31, 2006.

Research and development

Research and development expenses increased 29% to $8.1 million in 2005 compared to $6.3 million in 2004. Research and development expenses increased 22% to $6.3 million in 2004 compared to $5.2 million in 2003. Research and development expenses as a percentage of revenue were 16%, 18% and 19% in 2005, 2004 and 2003, respectively.

The increases in expenses for all periods were due in part to increases in compensation costs as a result of additional personnel. Salaries, benefits and bonus-related expenses increased $964,000 to $5.4 million in 2005 compared with $4.4 million in 2004, and increased $651,000 to $4.4 million in 2004 compared to $3.7 million in 2003. The increases were caused primarily by the costs of additional personnel to continue expanding our product development efforts. We had 62, 50 and 38 research and development personnel as of December 31, 2005, 2004 and 2003, respectively.  In addition, contract and consulting costs increased $442,000 to $646,000 in 2005 compared to $204,000 in 2004, and increased $162,000 to $204,000 in 2004 compared to $42,000 in 2003, as we continue to require additional temporary assistance in completing certain research and development activities, specifically in the area of software testing and validation.

We expect research and development expenses to continue to increase in future periods primarily as a result of additional personnel required to support the expansion of our product development activities so that we can maintain our status as an industry leader in advanced visualization.

Research and development

Research and development expenses increased 40% to $2.2 million from $1.5 million for the three months ended September 30, 2005 compared to the three months ended September 30, 2004.  Research and development expenses increased 26% to $5.9 million from $4.7 million for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004. 

The increases were due in part to an overall increase in research and development personnel to 65 as of September 30, 2005 from 52 as of September 30, 2004, resulting in an increase in salaries, benefits and bonus-related expenses of $276,000 and $646,000, respectively, for the three and nine months ended September 30, 2005 due to the increased number of personnel. In addition, consulting and temporary worker costs increased $138,000 and $260,000, respectively, for the three and nine months ended September 30, 2005 related to the continued expansion of product development efforts within the organization. 

The Company anticipates that research and development costs will increase in absolute dollars in near term future periods as a result of the hiring of additional research and development personnel as the Company develops software tools for applications with large potential markets such as cardiovascular disease, disease screening applications such as colon cancer, and surgical and therapy planning.  The Company is also making significant investments in future products in order to offer increased productivity, flexibility and efficiency for its customers.

Research and development

Research and development expenses increased 35% to $2.0 million from $1.5 million for the three months ended June 30, 2005 compared to the three months ended June 30, 2004.  Research and development expenses increased 19% to $3.8 million from $3.2 million for the six months ended June 30, 2005 compared to the six months ended June 30, 2004.

The increases were due in part to an increase in salaries, benefits and bonus-related expenses of $214,000 and $370,000, respectively, for the three and six months ended June 30, 2005 due to increased headcount. In addition, consulting and temporary worker costs increased $129,000 and $122,000, respectively, for the three and six months ended June 30, 2005 related to the continued expansion of product development efforts within the organization.

The Company anticipates that research and development costs will increase in absolute dollars but remain consistent as a percentage of total revenue in near term future periods as a result of the hiring of additional research and development personnel as the Company develops software tools for applications with large potential markets, such as cardiovascular disease, disease screening applications such as colon cancer, and surgical and therapy planning.  The Company is making significant investments in tools that offer increased productivity, flexibility and efficiency for its customers.

Research and development

Research and development expenses increased 6% to $1.8 million for the three months ended March 31, 2005, compared with $1.7 million for the same period last year.  The increase in expenses was primarily due to increased salaries and benefits expense from the addition of personnel, which increased $97,000 to $1.2 million from $1.1 million for the period ended March 31, 2004.  Research and development expenses for the three months ended March 31, 2004 also include $192,000 of costs related to severance for the Company’s former vice-president of engineering and two other employees.

The Company anticipates that research and development costs will increase in future periods as the Company develops software tools for applications with large potential markets, such as cardiovascular disease, disease screening applications such as colon cancer, and surgical and therapy planning.  The Company is making significant investments in tools that offer increased productivity, flexibility and efficiency for its customers.

Research and development

Research and development expenses were $6.3 million, $5.2 million and $4.1 million in 2004, 2003 and 2002, respectively.  Of the $1.2 million expense increase from 2003 to 2004, $677,000 was due to increased compensation costs resulting from additional personnel supporting software and product development and additional employees related to the Company’s acquisition of HInnovation, Inc.  Total research and development personnel increased from 38 at December 31, 2003 to 50 at December 31, 2004.

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