Costs related to research, design and development of products are charged to research and development expense as incurred. These costs include direct salary and benefit costs for research and development employees including stock-based compensation, cost for materials used in research and development activities and costs for outside services. We expect our research and development expense to increase as we continue to expand our research and development activities, including the support of existing products and the research of potential future products.
A summary of our critical accounting policies is included in our Form 10-K, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” There have been no changes to those policies for the six months ended June 30, 2009.
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Selling, General and Administrative. Selling, general and administrative expense was $7.4 million for the three months ended June 30, 2009, compared to $5.1 million for the three months ended June 30, 2008. The increase of $2.3 million, or 45%, was primarily due to an increase in sales, marketing and operations costs associated with the production and commercialization of our products and an increase in general and administrative costs to support growth and costs associated with operating as a public company. Selling, general and administrative expense for the three months ended June 30, 2009 also included $860,000 of stock-based compensation expense compared with $484,000 for the three months ended June 30, 2008. The increase in stock-based compensation expense was primarily due to additional option and restricted stock grants made in 2009. We expect our selling, general and administrative expenses to continue to increase substantially due to our planned increase in the number of employees necessary to support the sales and marketing efforts associated with the growing commercialization of MAKOplasty, continued growth in operations and the costs associated with operating as a public company.
Research and Development. Research and development expense was $3.1 million for the three months ended June 30, 2009, compared to $2.5 million for the three months ended June 30, 2008. The increase of $605,000, or 24%, was primarily due to an increase in research and development activities associated with on-going development of our RIO system and our MAKO implant systems. We expect our research and development expense to increase as we continue to expand our research and development activities, including the support of existing products and the research of potential future products.
Depreciation and Amortization. Depreciation and amortization expense was $589,000 for the three months ended June 30, 2009, compared to $425,000 for the three months ended June 30, 2008. The increase of $164,000, or 39%, was primarily due to an increase in depreciation of property and equipment as a result of purchases made during 2009 and 2008.
Interest and Other Income. Interest and other income was $67,000 for the three months ended June 30, 2009, compared to $241,000 for the three months ended June 30, 2008. The decrease of $174,000, or 72%, was primarily due to lower yields realized on our cash, cash equivalents and investments for the three months ended June 30, 2009 compared with the same period of 2008.
Income Taxes. No income taxes were recognized for the three months ended June 30, 2009 and 2008, due to net operating losses in each period. In addition, no current or deferred income taxes were recorded for the three months ended June 30, 2009 and 2008, as all income tax benefits were fully offset by a valuation allowance against our net deferred income tax assets.
Comparison of the Six Months Ended June 30, 2009 to the Six Months Ended June 30, 2008
Revenue. Revenue was $18.6 million for the six months ended June 30, 2009, compared to $1.2 million for the six months ended June 30, 2008. The increase in revenue of $17.4 million was primarily due to the recognition of approximately $11.3 million of revenue from seventeen previously deferred unit sales of our TGS and $4.3 million of revenue from six unit sales of our RIO system. In accordance with our revenue recognition policy, recognition of revenue on unit sales of our TGS was deferred until delivery of the RIO system, which we commercially released in the first quarter of 2009. Prior to 2009, recognized revenue was primarily generated from the sale of implants and disposable products utilized in knee MAKOplasty procedures. Total revenue was also positively impacted by a $1.8 million increase in product revenue attributable to an increase in knee MAKOplasty procedures performed during the six months ended June 30, 2009 as compared with the six months ended June 30, 2008. There were 623 knee MAKOplasty procedures performed during the six months ended June 30, 2009 compared to 242 knee MAKOplasty procedures performed during six months ended June 30, 2008.
Cost of Revenue. Cost of revenue was $13.4 million for the six months ended June 30, 2009, compared to $851,000 for the six months ended June 30, 2008. The increase in cost of revenue of $12.5 million was primarily due to the recognition of the direct cost of revenue from seventeen previously deferred unit sales of our TGS, including the cost of providing the RIO system upgrades, as described in the “Factors Which May Influence Future Results of Operations” section above, to the cost of revenue from six unit sales of our RIO system and to an increase in knee MAKOplasty procedures performed.
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Selling, General and Administrative. Selling, general and administrative expense was $14.2 million for the six months ended June 30, 2009, compared to $9.8 million for the six months ended June 30, 2008. The increase of $4.4 million, or 45%, was primarily due to an increase in sales, marketing and operations costs associated with the production and commercialization of our products and an increase in general and administrative costs to support growth and costs associated with operating as a public company. Selling, general and administrative expense for the six months ended June 30, 2009 also included $1.5 million of stock-based compensation expense compared with $908,000 for the six months ended June 30, 2008. The increase in stock-based compensation expense was primarily due to additional option and restricted stock grants made in 2009.
Research and Development. Research and development expense was $5.6 million for the six months ended June 30, 2009, compared to $6.1 million for the six months ended June 30, 2008. The decrease of $491,000, or 8%, was primarily due to a nonrecurring charge of $949,000 incurred in the first quarter of 2008 associated with the vesting in full, upon completion of our IPO in February 2008, of restricted common stock issued pursuant to business consultation agreements entered into in December 2004. This was partially offset by an increase in research and development activities associated with on-going development of our RIO system and our MAKO implant systems for the six months ended June 30, 2009 compared with the same period of 2008.
Depreciation and Amortization. Depreciation and amortization expense was $1.1 million for the six months ended June 30, 2009, compared to $847,000 for the six months ended June 30, 2008. The increase of $220,000, or 26%, was primarily due to an increase in depreciation of property and equipment as a result of purchases made during 2009 and 2008.
Interest and Other Income. Interest and other income was $289,000 for the six months ended June 30, 2009, compared to $401,000 for the six months ended June 30, 2008. The decrease of $112,000, or 28%, was primarily due to lower yields realized on our cash, cash equivalents and investments for the six months ended June 30, 2009 compared with the same period of 2008.
Interest and Other Expense. Interest and other expense was $0 for the six months ended June 30, 2009, compared to $109,000 for the six months ended June 30, 2008. Through February 2008, interest and other expense consisted primarily of the amortization of a $590,000 discount associated with a deferred payment to IBM of $4.0 million which had been fully amortized and paid upon the completion of our IPO in February 2008.
Income Taxes. No income taxes were recognized for the six months ended June 30, 2009 and 2008, due to net operating losses in each period. In addition, no current or deferred income taxes were recorded for the six months ended June 30, 2009 and 2008, as all income tax benefits were fully offset by a valuation allowance against our net deferred income tax assets.
Liquidity and Capital Resources
| | | | | | | |
(in thousands) | | Six Months Ended June 30, | |
| | 2009 | | 2008 | |
Cash used in operating activities | | $ | (26,962 | ) | $ | (14,485 | ) |
Cash used in investing activities | | | (14,431 | ) | | (3,542 | ) |
Net cash provided by (used in) financing activities | | | (164 | ) | | 46,487 | |
Net increase (decrease) in cash and cash equivalents | | $ | (41,557 | ) | $ | 28,460 | |
We have incurred net losses and negative cash flow from operating activities for each period since our inception in November 2004. As of June 30, 2009, we had an accumulated deficit of $95.5 million and have financed our operations principally through the sale of Series A, B and C redeemable convertible preferred stock, the sale of common stock in our IPO in February 2008, and our equity financing in October 2008. We received net proceeds of $52.2 million from the issuance of Series A, B and C redeemable convertible preferred stock. In February 2008, we completed our IPO of common stock, issuing a total of 5.1 million shares at an issue price of $10.00 per share, resulting in net proceeds to us, after expenses, of approximately $43.8 million. In conjunction with the closing of the IPO in February 2008, all of our outstanding Series A, Series B and Series C redeemable convertible preferred stock was converted into 10,945,080 shares of common stock, as adjusted for a one-for-3.03 reverse stock split, which has been retroactively reflected in the accompanying financial statements.
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In October 2008, we entered into a Securities Purchase Agreement for an equity financing of up to approximately $60 million, with initial gross proceeds of approximately $40.2 million, which we closed on October 31, 2008, and conditional access to an additional $20 million, which we refer to as the Second Closing. In connection with the financing, we issued and sold to the participating investors 6,451,613 shares of our common stock at a purchase price of $6.20 per share and issued warrants to the participating investors to purchase 1,290,323 shares of common stock at a purchase price of $0.125 per warrant and an exercise price of $7.44 per share. In addition, we issued warrants to purchase 322,581 shares of common stock at a purchase price of $0.125 per warrant and an exercise price of $6.20 per share to investors that agreed to purchase an additional $20 million of common stock in the Second Closing. The financing resulted in net proceeds of approximately $39.7 million, after expenses of approximately $525,000.
Although the Second Closing is conditioned upon our achievement of certain business-related milestones before December 31, 2009, we received the necessary stockholder approval in January 2009 for the potential future issuance of $20 million of common stock along with related warrants as contemplated by the Securities Purchase Agreement.
In May 2009, we filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission under which we may issue up to $50 million of equity, debt or other securities. As of July 30, 2009, no securities had been issued under this shelf registration statement.
As of June 30, 2009, we had approximately $35.7 million in cash, cash equivalents and investments. Our cash and investment balances are held in a variety of interest bearing instruments, including notes and bonds from U.S. government agencies and AAA rated U.S. corporate debt.
Net Cash Used in Operating Activities
Net cash used in operating activities primarily reflects the net loss for those periods, which was reduced in part by depreciation and amortization, stock-based compensation and inventory write-downs. Net cash used in operating activities was also affected by changes in operating assets and liabilities. Included in changes in operating assets and liabilities for the six months ended June 30, 2009 are approximately $11.4 million and $3.6 million of decreases to the deferred revenue balance and deferred cost of revenue balance, respectively, due to the recognition of seventeen previously deferred unit sales of our TGS, and $6.2 million of increases in inventory necessitated by the commercial release of the RIO system, the commercial release of the RESTORIS MCK implant system and increased sales of implants and disposable products. Included in changes in operating assets and liabilities for the six months ended June 30, 2008 are approximately $3.2 million and $1.2 million of increases to the deferred revenue balance and deferred cost of revenue balance, respectively, due primarily to unit sales of our TGS. In accordance with our revenue recognition policy, recognition of revenue and direct cost of revenue associated with the unit sales of our TGS was deferred until delivery of the RIO system, which we commercially released in the first quarter of 2009
Net Cash Used in Investing Activities
Net cash used in investing activities for the six months ended June 30, 2009 was primarily attributable to the purchase of investments of $14.7 million, which was partially offset by proceeds of $1.0 million from sales and maturities of investments. Net cash used in investing activities for the six months ended June 30, 2008 was primarily attributable to the payment of a $4.0 million deferred license fee due to IBM upon completion of our IPO and to $2.0 million of purchases of investments, which was partially offset by proceeds of $3.1 million from sales and maturities of investments.
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Net Cash Provided by Financing Activities
Net cash used by our financing activities for the six months ended June 30, 2009 was primarily attributable to the payment of $350,000 for payroll taxes associated with the taxable income from the vesting of restricted stock granted to the Company’s Chief Executive Officer, for which 40,211 shares of common stock were surrendered by the Chief Executive Officer to cover the payment of the payroll taxes. This was partially offset by proceeds received under our employee stock purchase plan. Net cash provided by our financing activities for the six months ended June 30, 2008 was primarily attributable to net proceeds received in connection with our IPO in February 2008.
Operating Capital and Capital Expenditure Requirements
To date, we have not achieved profitability. We anticipate that we will continue to incur substantial net losses for at least the next two or three years as we expand our sales and marketing capabilities in the orthopedic products market, commercialize our RIO system and RESTORIS implant systems, continue research and development of existing and future products and continue development of the corporate infrastructure required to sell and market our products and operate as a public company. We also expect to experience increased cash requirements for inventory and property and equipment in conjunction with the continued commercialization of our RIO system and RESTORIS implant systems.
In executing our current business plan, we believe our existing cash, cash equivalents and investment balances, and interest income we earn on these balances will be sufficient to meet our anticipated cash requirements through at least the first quarter of 2010. To the extent our available cash, cash equivalents and investment balances are insufficient to satisfy our operating requirements after that period, we will need to seek additional sources of funds, including selling additional equity, debt or other securities or entering into a credit facility, or modify our current business plan. The sale of additional equity and convertible debt securities may result in dilution to our current stockholders. If we raise additional funds through the issuance of debt securities, these securities may have rights senior to those of our common stock and could contain covenants that could restrict our operations and issuance of dividends. We may also require additional capital beyond our currently forecasted amounts. Any required additional capital, whether forecasted or not, may not be available on reasonable terms, or at all. In connection with the October 2008 equity financing with initial gross proceeds of approximately $40.2 million, we obtained a call right, subject to our satisfaction of certain business milestones, to an additional $20 million from certain investors in exchange for additional warrants to purchase shares of our common stock. There is no guarantee that we will satisfy the milestones, or, if we do satisfy them and choose to exercise our call right, the investors will be able to comply with their obligations. If we are unable to obtain additional financing, we may be required to reduce the scope of, delay or eliminate some or all of our planned research, development and commercialization activities, which could materially harm our business and results of operations.
Because of the numerous risks and uncertainties associated with the development of medical devices and the current economic situation, we are unable to estimate the exact amounts of capital outlays and operating expenditures necessary to complete the development of our products and successfully deliver commercial products to the market. Our future capital requirements will depend on many factors, including but not limited to the following:
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• | the revenue generated by sales of our current and future products; |
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• | the expenses we incur in selling and marketing our products; |
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• | the costs and timing of regulatory clearance or approvals for upgrades or changes to our products; |
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• | the rate of progress, cost and success of on-going development activities; |
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• | the emergence of competing or complementary technological developments; |
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• | the costs of filing, prosecuting, defending and enforcing any patent or license claims and other intellectual property rights, or participating in litigation related activities; |
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• | the acquisition of businesses, products and technologies, although we currently have no understandings, commitments or agreements relating to any material transaction of this type; and |
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• | the current downturn in general economic conditions and interest rates. |
Contractual Obligations
At June 30, 2009, we were committed to make future purchases for inventory related items under various purchase arrangements with fixed purchase provisions aggregating approximately $3.3 million.
In May 2009, we entered into a license agreement for patents relating to our robotic arm system, which we refer to as the robotic arm license. The robotic arm license requires minimum running royalties on sales our robotic arm systems. The minimum running royalties are estimated to be approximately $200,000 for year ended December 31, 2009, and increase annually thereafter through 2013. The minimum running royalties for the year ended December 31, 2013 and for each subsequent year through the term of the agreement are estimated to be approximately $1.0 million annually.
In June 2009, we entered into a Research and Development License and Supply Agreement, or the R&D Agreement, associated with a potential future product for RIO enabled hip procedures. The R&D Agreement requires an up-front payment of $450,000, and requires future milestone payments based on development progress. The aggregate future milestone payments under the R&D Agreement are $1.6 million assuming the achievement of all development milestones. As of June 30, 2009, we had paid the $450,000 up-front payment. No milestone payments were paid or have become due as of June 30, 2009. The aggregate up-front payment and milestone payments of $2.0 million we are required to pay under the R&D Agreement will be recognized as research and development expense on a straight-line basis over the period development services are performed based on our current expectation that all development milestones will be achieved.
Other than as described above and scheduled payments through June 30, 2009, there have been no significant changes in our contractual obligations during the six months ended June 30, 2009 as compared to the contractual obligations described in our Form 10-K for the year ended December 31, 2008.
Recent Accounting Pronouncements
Adopted Accounting Pronouncements
Effective January 1, 2009, we adopted Emerging Issues Task Force (“EITF”) Issue No. 07-05,Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF 07-05”). EITF 07-05 addresses the determination of whether an instrument (or an embedded feature) is indexed to an entity’s own stock, if an instrument (or an embedded feature) that has the characteristics of a derivative instrument is indexed to an entity’s own stock, it is still necessary to evaluate whether it is classified in stockholders’ equity (or would be classified in stockholders’ equity if it were a freestanding instrument). In addition, for some instruments that are potentially subject to the guidance in EITF Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, but do not have all the characteristics of a derivative instrument under paragraphs 6 through 9, it is still necessary to evaluate whether it is classified in stockholders’ equity. The adoption of EITF 07-05 did not have a material impact on our results of operations and financial position.
Effective January 1, 2009, we adopted SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”). SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations. SFAS 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination, establishes the acquisition date as the date that the acquirer achieves control and requires the acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest at their fair values as of the acquisition date. SFAS 141(R) also requires that acquisition related costs be recognized separately from the acquisition. The adoption of SFAS 141(R) did not have a material impact on our results of operations and financial position.
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Effective January 1, 2009, we adopted SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The adoption of SFAS 160 did not have a material impact on our results of operations and financial position.
In April 2009, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP 157-4”), which provides additional guidance for estimating fair value in accordance with FASB Statement No. 157,Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. This pronouncement is effective for periods ending after June 15, 2009. The adoption of FSP 157-4 did not have a material impact on our results of operations and financial position.
In April 2009, the FASB issued Staff Position No. FAS 115-2 and FAS 124-2,Recognition and Presentation of Other-Than-Temporary Impairments(“FSP 115-2 and FAS 124-2”), to amend the other-than-temporary impairment guidance in debt securities to be based on intent to sell instead of ability to hold the security and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This pronouncement is effective for periods ending after June 15, 2009. The adoption of FSP 115-2 and FAS 124-2 did not have a material impact on our results of operations and financial position.
In May 2009, the FASB issued SFAS No. 165,Subsequent Events (“SFAS 165”), which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date, but before the financial statements are issued or available to be issued (“subsequent events”). SFAS 165 is effective for interim or annual periods ending after June 15, 2009. In accordance with SFAS No. 165, we have evaluated subsequent events through the time of filing this Form 10-Q with the SEC on August 5, 2009. No material subsequent events have occurred since June 30, 2009 that required recognition or disclosure in this Form 10-Q.
Recent Accounting Pronouncements
In June 2009, the FASB issued SFAS No. 168,The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with generally accepted accounting principles. SFAS 168 explicitly recognizes rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. The adoption of SFAS 168 will not have a material impact on our results of operations and financial position.
Other than as described above, there have been no significant changes in Recent Accounting Pronouncements during the six months ended June 30, 2009 as compared to the Recent Accounting Pronouncements described in our Form 10-K for the year ended December 31, 2008.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our exposure to market risk is confined to our cash, cash equivalents and investments. The goals of our cash investment policy are the security of the principal invested and fulfillment of liquidity needs, with the need to maximize value being an important consideration. To achieve our goals, we maintain a portfolio of cash equivalents and investments in a variety of securities including notes and bonds from U.S. government agencies and AAA rated U.S. corporate debt. The securities in our investment portfolio are not leveraged and are classified as available for sale. We currently do not hedge interest rate exposure. We do not believe that a variation in market rates of interest would significantly impact the value of our investment portfolio.
ITEM 4T. CONTROLS AND PROCEDURES.
In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934, or the Exchange Act, our management evaluated, with the participation of our chief executive officer and chief financial officer, or the Certifying Officers, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of June 30, 2009. Based upon their evaluation of these disclosure controls and procedures, our Certifying Officers concluded that the disclosure controls and procedures were effective as of June 30, 2009 to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC rules and forms, and to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.
We believe that a controls system, no matter how well designed and operated, is based in part upon certain assumptions about the likelihood of future events, and therefore can only provide reasonable, not absolute, assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
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PART II
OTHER INFORMATION
ITEM 1A. RISK FACTORS.
The following risk factors and other information related to our business and operations should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently treat as immaterial also may impair our business operations. If any of the following risks occur, our business, financial condition, operating results and cash flows could be materially adversely affected.
Risks Related to Our Business
Adverse changes in economic conditions and reduced spending on innovative medical technology may adversely impact our business.
The purchase of a robotic arm system is discretionary and requires our customers to make significant initial commitments of capital and other resources. In addition, purchase of a robotic arm system requires a commitment to purchase exclusively from us other products and services, including our proprietary RESTORIS family of knee implant systems. Continuing weak economic conditions, or a reduction in healthcare technology spending even if economic conditions improve, could adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and services and reduced unit sales.
Current credit and financial market conditions could delay or prevent our customers from obtaining financing to purchase a robotic arm system, which would adversely affect our business, financial condition and results of operations.
Due to the tightening of credit markets in the past year and concerns regarding the availability of credit, particularly in the United States, our customers may be delayed in obtaining, or may not be able to obtain, necessary financing for their purchases of the robotic arm system. These delays may in some instances lead to our customers postponing the shipment and installation of previously ordered systems, cancelling their system orders, postponing their system installation or cancelling their agreements with us. An increase in delays and order cancellations of this nature could adversely affect our product sales and revenues and, therefore, harm our business and results of operations.
Negative worldwide economic conditions and the long lead times required by certain suppliers could prevent us from accurately forecasting demand for our products, which could adversely affect our operating results.
The current negative worldwide economic conditions and market instability makes it increasingly difficult for us, our customers and our suppliers to accurately forecast future product demand trends, which could cause us to order and/or produce excess products that can increase our inventory carrying costs and result in obsolete inventory. Alternatively, this forecasting difficulty could cause a shortage of products, or materials used in our products, that could result in an inability to satisfy demand for our products and a resulting material loss of revenue.
In addition, certain of our suppliers may require extensive advance notice of our requirements in order to produce products in the quantities we desire. This long lead time may require us to place orders far in advance of the time when certain products will be offered for sale, thereby also making it difficult for us to accurately forecast demand for our products, exposing us to risks relating to shifts in consumer demand and trends and adversely affecting our operating results.
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We may not have sufficient funding to complete the development and commercialization of our existing products and the weak worldwide economic conditions may hamper our efforts to raise additional capital to run our business.
To date, we have not achieved profitability. We anticipate that we will continue to incur substantial net losses for at least the next two or three years as we expand our sales and marketing capabilities in the orthopedic products market, continued commercialization of the RIO system and the RESTORIS MCK multicompartmental knee implant system and continue to develop the corporate infrastructure required to sell and market our products and operate as a public company. We also expect to experience increased cash requirements for inventory and property and equipment in conjunction with the current commercial launch of the RIO system and the RESTORIS MCK multicompartmental knee implant system. Given the current weak economic conditions, we may be unable to obtain additional financing. As a result, we may be required to reduce the scope of, delay or eliminate some or all of our planned research, development and commercialization activities. We also may have to reduce marketing, customer support or other resources devoted to our products. Any of these factors could materially harm our business and results of operations.
We believe our existing cash, cash equivalents, short-term investment balances, and interest income we earn on these balances, if any, will be sufficient to meet our anticipated cash requirements through at least the first quarter of 2010. To the extent our available cash, cash equivalents and short-term investment balances are insufficient to satisfy our operating requirements after that period, we will need to seek additional sources of funds, including selling additional equity or debt securities or entering into a credit facility, or modify our current business plan. In connection with the October 2008 equity financing , we obtained a call right, subject to our satisfaction of certain business milestones, to an additional $20 million from certain investors in exchange for additional warrants to purchase shares of our common stock. There is no guarantee that we will satisfy the milestones or, if we do satisfy them and choose to exercise our call right with respect to the $20 million, the investors will be able to comply with their obligations. For more information regarding the equity financing, see Part I, Financial Statements, Note 6 to the Financial Statements above. The sale of additional equity and debt securities may result in dilution to our current stockholders or may require us to grant a security interest in our assets. If we raise additional funds through the issuance of debt securities, these securities may have rights senior to those of our common stock and could contain covenants that could restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, or at all.
Because of the numerous risks and uncertainties associated with the development of medical devices, such as future versions of the RIO system and the RESTORIS family of knee systems, we are unable to estimate the exact amounts of capital outlays and operating expenditures necessary to complete the development of the products and successfully deliver commercial products to the market. Our future capital requirements will depend on many factors, including but not limited to the following:
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| • | the revenue generated by sales of our current and future products; |
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| • | the expenses we incur in selling and marketing our products; |
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| • | the costs and timing of regulatory clearance or approvals for upgrades or changes to our products; |
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| • | the rate of progress, cost, and success or failure of on-going development activities; |
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| • | the emergence of competing or complementary technological developments; |
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| • | the costs of filing, prosecuting, defending and enforcing any patent or license claims and other intellectual property rights, or participating in litigation related activities; |
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| • | the terms and timing of any collaborative, licensing, or other arrangements that we may establish; |
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| • | the acquisition of businesses, products and technologies, although we currently have no understandings, commitments or agreements relating to any material transaction of this type; and |
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| • | general economic conditions and interest rates, including the current downturn. |
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Our reliance on third-party suppliers, including single source suppliers, for our implants and nearly all components of our robotic arm systems could harm our ability to meet demand for our products in a timely and cost effective manner.
We rely on third-party suppliers to manufacture and supply our implants and nearly all components used in our robotic arm systems, other than software. We currently rely on a number of single source suppliers, such as The Anspach Effort, Inc., for our bone cutting instrument, Northern Digital Inc., or NDI, for the stereo tracking camera used in MAKOplasty and Millstone Medical Outsourcing, LLC, for sterile packaging of our RESTORIS family of knee implant systems. We currently do not have long-term contracts with any of our suppliers. As a result, our suppliers generally are not required to provide us with any guaranteed minimum production levels, and we cannot assure you that we will be able to obtain sufficient quantities of key components in the future. In addition, our reliance on third-party suppliers involves a number of risks, including, among other things:
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| • | Our suppliers may encounter financial hardships as a result of unfavorable economic and market conditions unrelated to our demand for components, which could inhibit their ability to fulfill our orders and meet our requirements. |
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| • | Suppliers may fail to comply with regulatory requirements, be subject to lengthy compliance, validation or qualification periods, or make errors in manufacturing components that could negatively affect the efficacy or safety of our products or cause delays in supplying of our products to our customers; |
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| • | Newly identified suppliers may not qualify under the stringent regulatory standards to which our business is subject; |
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| • | We or our suppliers may not be able to respond to unanticipated changes in customer orders, and if orders do not match forecasts, we or our suppliers may have excess or inadequate inventory of materials and components; |
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| • | We may be subject to price fluctuations due to a lack of long-term supply arrangements for key components; |
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| • | We may experience delays in delivery by our suppliers due to changes in demand from us or their other customers; |
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| • | We or our suppliers may lose access to critical services and components, resulting in an interruption in the manufacture, assembly and shipment of our systems; |
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| • | Our suppliers may be subject to allegations by third parties of misappropriation of proprietary information in connection with their supply of products to us, which could inhibit their ability to fulfill our orders and meet our requirements |
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| • | Fluctuations in demand for products that our suppliers manufacture for others may affect their ability or willingness to deliver components to us in a timely manner; |
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| • | Our suppliers may wish to discontinue supplying components or services to us for risk management reasons; and |
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| • | We may not be able to find new or alternative components or reconfigure our system and manufacturing processes in a timely manner if the necessary components become unavailable; |
If any of these risks materialize, it could significantly increase our costs and impact our ability to meet demand for our products. If we are unable to satisfy commercial demand for the RIO system or the RESTORIS family of knee systems in a timely manner, our ability to generate revenue would be impaired, market acceptance of our products could be adversely affected, and customers may instead purchase or use our competitors’ products. In addition, we could be forced to secure new or alternative components through a replacement supplier. Securing a replacement supplier could be difficult, especially for complex components such as motors, encoders, brakes and certain robotic arm system components that are manufactured in accordance with our custom specifications. The introduction of new or alternative components may require design changes to our system that are subject to FDA and other regulatory clearances or approvals. We may also be required to assess the new manufacturer’s compliance with all applicable regulations and guidelines, which could further impede our ability to manufacture our products in a timely manner. As a result, we could incur increased production costs, experience delays in deliveries of our products, suffer damage to our reputation and experience an adverse effect on our business and financial results.
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We are an early-stage medical device company with a limited operating history and our business may not become profitable.
We are an early-stage medical device company with a limited operating history. Our current or planned products with 510(k) marketing clearance from the FDA are versions 1.0, 1.2 and 1.3 of our Tactile Guidance System, or TGS, the first version of our RIO Robotic Arm Interactive Orthopedic system, or RIO system, and inlay and onlay implant systems for use in unicompartmental and bicompartmental knee resurfacing procedures. The future success of our business depends on our ability to continue to develop and obtain regulatory clearances or approvals for innovative and commercially successful products in our field, which we may be unable to do in a timely manner, or at all. Our success and ability to generate revenue or be profitable also depends on our ability to establish our sales and marketing force, generate product sales and control costs, all of which we may be unable to do. We have a limited history of operations upon which you can evaluate our business and our operating expenses are increasing. Our lack of any significant operating history also limits your ability to make a comparative evaluation of us, our products and our prospects.
We have incurred significant losses since our inception and anticipate that we will continue to incur significant losses for at least the next two or three years.
We have sustained net losses in every fiscal year since our inception in 2004, including a net loss attributable to common stockholders of $6.4 million for the quarter ended June 30, 2009. As of June 30, 2009, we had total stockholders’ equity of $52.9 million. We expect to continue to incur significant operating losses as we increase our sales and marketing activities and otherwise continue to invest capital in the development of our products and our business generally. We also expect that our general and administrative expenses will increase due to additional operational and regulatory burdens associated with operating as a public company. Our losses have had and will continue to have an adverse effect on our stockholders’ equity and working capital. Any failure to achieve and maintain profitability would continue to have an adverse effect on our stockholders’ equity and working capital and could result in a decline in our stock price or cause us to cease operations.
We rely heavily on intellectual property that we license from others, and if we are unable to maintain these licenses or obtain additional licenses that we may need, our ability to compete will be harmed.
We rely heavily on intellectual property that we license or sublicense from others, including patented technology that is integral to our RIO system and RESTORIS family of knee systems. As of July 30, 2009, we had licensed rights to 126 U.S. and 51 foreign third-party granted patents, and we had licensed rights to 22 U.S. and 29 foreign third-party pending patent applications. The majority of these patents and applications are either used in our current products or relate to core technologies used in our products, such as computer assisted surgery, or CAS, robotics, haptics and implants. Three of the licensed U.S. patents will expire by the end of 2009, one of which relates to robotic technology. This patent is considered material to our intellectual property portfolio because it potentially enables us to exclude others from practicing the claimed technology. Our portfolio also includes 36 wholly owned pending U.S. patent applications, 56 pending foreign applications and other intellectual property that is wholly owned by us. We are particularly dependent on our licensing arrangements with Z-Kat, Inc., or Z-Kat, from whom we license or sublicense, among other things, core technologies in CAS, and haptics and robotics. Third parties may terminate a license in the event that we fail to make required payments or for other causes. In the event a third party terminates a license agreement, we cannot assure you that we could acquire another license to adequately replace the product, technology or method covered by the terminated license. If we fail to maintain our current licenses, our ability to compete in the knee implant market will be harmed.
In addition, as we enhance our current product offerings and develop new ones, including the RIO system and the RESTORIS family of knee implant systems, we may find it advisable or necessary to seek additional licenses from third parties who hold patents covering technology or methods used in these products. If we cannot obtain these additional licenses, we could be forced to design around those patents at additional cost or abandon the product altogether. As a result, our ability to grow our business and compete in the knee implant market may be harmed.
We are currently required by the FDA to refrain from using certain terms to label and market our products, which could harm our ability to market and commercialize our current or future products.
On September 28, 2007, we submitted a Special 510(k) application to the FDA for version 1.2 of our TGS which the FDA converted to a Traditional 510(k) application. On November 1, 2007, the FDA provided us with a letter requesting additional information in which the FDA, among other things, asked us to justify our proposed use of the terms “haptic” and “robot” in the labeling of version 1.2 of our TGS. Through subsequent correspondence and communications, the FDA indicated that we needed to use the term “tactile” in lieu of “haptic” and the term “robotic arm” in lieu of “robotic,” as appropriate, when these terms are used to market our products. The FDA granted 510(k) clearance in January 2008 for version 1.2 of our TGS with those terms. Because the FDA currently requires us to use the terms “tactile” or “robotic arm,” we revised the promotional and labeling materials for our existing products, including the RIO system, for which we received 510(k) clearance from the FDA in the fourth quarter of 2008, and may need to consider the use of modified language for our future products. As a result, our ability to market and commercialize our products and our growth may be harmed.
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Modifications to our currently FDA cleared products or the introduction of new products may require new regulatory clearances or approvals or require us to recall or cease marketing our current products until clearances or approvals are obtained.
In November 2005, we obtained 510(k) marketing clearance from the FDA for version 1.0 of our TGS for use with our FDA cleared tibial knee inlay implant system. We were not required to obtain premarket approval, or PMA. We were also not required to conduct any clinical trials in support of our application for 510(k) marketing clearance. Modifications to our products, however, may require new regulatory approvals or clearances or require us to recall or cease marketing the modified products until these clearances or approvals are obtained. Any modification to one of our 510(k) cleared products that would constitute a major change in its intended use, or any change that could significantly affect the safety or effectiveness of the device would require us to obtain a new 510(k) clearance and may even, in some circumstances, require the submission of a PMA, if the change raises complex or novel scientific issues or the product has a new intended use. The FDA requires every manufacturer to make the determination regarding the need for a new 510(k) submission in the first instance, but the FDA may review any manufacturer’s decision. Since obtaining 510(k) marketing clearance for version 1.0 of our TGS, we developed and commercially introduced several upgrades to our TGS that we believe did not require additional clearances or approvals. Our Special 510(k) application for version 1.2, which the FDA converted to a Traditional 510(k) application and cleared in January 2008, incorporated these upgrades. Since this 510(k) marketing clearance, we have made additional upgrades to the system (namely, version 1.3) that we believe were cleared under our most recent 510(k) clearance and therefore did not require additional filings for clearance or approval. In the fourth quarter of 2008 we received 510(k) marketing clearance from the FDA for the RIO system and for the RESTORIS MCK multicompartmental knee implant system, which the RIO system is designed to support. We may continue to make additional modifications in the future to the RIO system without seeking additional clearances or approvals if we believe such clearances or approvals are not necessary. If the FDA disagrees and requires new clearances or approvals for the modifications, we may be required to recall and stop marketing our products as modified, which could cause us to redesign our products, conduct clinical trials to support any modifications, and pay significant regulatory fines or penalties. Any of these actions would harm our operating results.
Obtaining clearances and approvals can be a difficult and time consuming process, and we may not be able to obtain any of these or other clearances or approvals in a timely manner, or at all. In addition, the FDA may not approve or clear these products for the indications that are necessary or desirable for successful commercialization or could require clinical trials to support any modifications. Any delay or failure in obtaining required clearances or approvals would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our future growth.
Moreover, clearances and approvals are subject to continual review, and the later discovery of previously unknown problems can result in product labeling restrictions or withdrawal of the product from the market. The loss of previously received approvals or clearances, or the failure to comply with existing or future regulatory requirements could reduce our sales, profitability and future growth prospects.
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We depend on the success of a single line of products for our revenue, which could impair our ability to achieve profitability.
We expect to derive most of our revenue from capital sales of our RIO system, recurring sales of implants and disposable products required for each knee MAKOplasty procedure, and service plans that are sold with the RIO system. Currently, the only line of products that has been commercially introduced and received 510(k) marketing clearance is versions 1.0 and 1.2 of our TGS, the off-the-shelf inlay and onlay knee implant systems for use in unicompartmental knee resurfacing procedures, the RIO system and our RESTORIS family of knee implant systems. Our future growth and success is dependent on the successful commercialization of the RIO system and the RESTORIS family of knee implant systems. If we are unable to achieve commercial acceptance of MAKOplasty for bicompartmental knee resurfacing procedures or obtain regulatory clearances or approvals for future products, including products to treat other joints of the human body besides the knee, our revenue would be adversely affected and we would not become profitable.
If our knee MAKOplasty solution does not gain market acceptance, we will not be able to generate the revenue necessary to develop a sustainable, profitable business.
Achieving patient, surgeon and hospital acceptance of MAKOplasty as the preferred method of treating early to mid-stage osteoarthritis of the knee is crucial to our success. We believe MAKOplasty represents a fundamentally new way of performing arthroplasty of the knee, employing computer assisted robotic arm technology and a patient specific visualization system to resurface only the diseased areas of the knee joint. The orthopedic market has been traditionally slow to adopt new products and treatment practices. We believe that if surgeons and hospitals do not broadly adopt the concept of computer assisted robotics enabled technology and do not perceive such technology as having significant advantages over conventional arthroplasty procedures, patients will be less likely to accept or be offered knee MAKOplasty and we will fail to meet our business objectives. Surgeons’ and hospitals’ perceptions of such technology having significant advantages are likely to be based on a determination that, among other factors, our products are safe, reliable, cost-effective and represent acceptable methods of treatment. Even if we can prove the clinical value of MAKOplasty through clinical use, surgeons may elect not to use our products for any number of other reasons. For example, surgeons may continue to recommend total knee replacement surgery simply because such surgery is already widely accepted. In addition, surgeons may be slow to adopt our products because of the perceived liability risks arising from the use of new products. Hospitals may not accept MAKOplasty because the RIO system is a piece of capital equipment, representing a significant portion of a hospital’s budget. The RIO system may not be cost-efficient if hospitals are not able to perform a significant volume of knee MAKOplasty procedures. If MAKOplasty fails to achieve market acceptance for any of these or other reasons, we will not be able to generate the revenue necessary to develop a sustainable, profitable business.
We have only limited clinical data to support the value of knee MAKOplasty, which may make patients, surgeons and hospitals reluctant to purchase our products.
We believe that patients, surgeons and hospitals will only accept MAKOplasty or purchase our products if they believe that MAKOplasty is a safe and effective procedure with advantages over competing products and conventional knee arthroplasty procedures. To date, we have collected only limited, short-term clinical data with which to assess MAKOplasty’s clinical value. As of June 30, 2009, 1,405 MAKOplasty procedures had been performed since commercial introduction in 2006. As of July 30, 2009, pursuant to the FDA guidelines on medical device reporting, or MDRs, we have filed thirty-six incident reports with the FDA. See “Risks Related to Regulatory Compliance.” We have not collected, and are not aware that others have collected, any long-term clinical data regarding the clinical value of knee MAKOplasty. The results of short-term studies, such as our post-market studies, do not necessarily predict long-term clinical results. As of July 30, 2009, we have two published MAKOplasty surgical technique book chapters, thirteen peer-reviewed manuscripts, thirty-four peer-reviewed abstracts at conferences, and eight completed whitepapers. We also have twenty-nine studies either recently completed or in progress, which range from cadaveric biomechanics studies to retrospective chart and radiographic reviews to prospective functional comparison slides to basic science histology studies. If longer-term or more extensive clinical studies that may be performed by us or others indicate that MAKOplasty is a less safe or less effective procedure than our current data suggest, patients may choose not to undergo, and surgeons may choose not to perform, knee MAKOplasty. Furthermore, unsatisfactory patient outcomes or patient injury could cause negative publicity for our products, particularly in the early phases of product introduction. The FDA could also rescind our marketing clearances if future results and experience indicate that our products cause unexpected or serious complications or other unforeseen negative effects. See “Risks Related to Regulatory Compliance.” Surgeons may be slow to adopt our products if they perceive liability risks arising from the use of these new products. As a result, patients, surgeons and hospitals may not accept knee MAKOplasty or our products and we may fail to become profitable and may be subject to significant legal liability.
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We have limited sales and marketing experience and capabilities, which could impair our ability to achieve profitability.
We have limited experience as a company in the sales and marketing of our products. We may not be successful in marketing and selling our products in the U.S. through our direct sales force with assistance from independent orthopedic product agents and distributors. Our sales and marketing organization is supported by clinical and technical representatives who provide training, clinical and technical support and other services to our customers before and during the surgery. As of July 30, 2009, we have forty-two employees in our sales and marketing organization, which includes all clinical and technical representatives. To reach our revenue targets, we need to expand and strengthen our U.S. direct sales force. Developing a sales and marketing organization is expensive and time consuming and an inability to develop such an organization in a timely manner could delay the successful adoption of our products. Additionally, any sales and marketing organization that we develop may be competing against the experienced and well funded sales and marketing organizations of some of our competitors. We will face significant challenges and risks in developing our sales and marketing organization, including, among others:
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| • | our ability to recruit, train and retain adequate numbers of qualified sales and marketing personnel; |
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| • | the ability of sales personnel to obtain access to leading surgeons and persuade adequate numbers of hospitals to purchase our products; |
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| • | costs associated with hiring, maintaining and expanding a sales and marketing organization; and |
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| • | government scrutiny with respect to promotional activities in the healthcare industry. |
If we are unable to develop and maintain these sales and marketing capabilities, we may be unable to generate revenue and may not become profitable.
Surgeons, hospitals and orthopedic product agents and distributors may have existing relationships with other medical device companies that make it difficult for us to establish new relationships with them, and as a result, we may not be able to sell and market our products effectively.
We believe that to sell and market our products effectively, we must establish relationships with key surgeons and hospitals in the field of orthopedic knee surgery. Many of these key surgeons and hospitals already have long-standing relationships with large, better known companies that dominate the medical devices industry through collaborative research programs and other relationships. Because of these existing relationships, some of which may be contractually enforced, surgeons and hospitals may be reluctant to adopt knee MAKOplasty, particularly if MAKOplasty competes with or has the potential to compete with products supported through their own collaborative research program or by these existing relationships. Even if these surgeons and hospitals purchase our RIO system, they may be unwilling to enter into collaborative relationships with us to promote joint marketing programs such as the MAKOplasty Center of Excellence or to provide us with clinical and financial data.
In addition to our direct sales force, we work with distributors that primarily generate sales leads for us. If these distributors believe that their relationship with us is less beneficial than other relationships they may have with more established or well known medical device companies, they may be unwilling to continue their relationships with us, making it more difficult for us to sell and market our products effectively.
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Because the markets for our products are highly competitive, customers may choose to purchase our competitors’ products, resulting in reduced revenue and harm to our financial results.
MAKOplasty requires the use of new robotics technology, and we face competition from large, well known companies, principally Zimmer Holdings, Inc., DePuy Orthopedics, Inc., a Johnson & Johnson company, Stryker Corporation, and Biomet, Inc., that dominate the market for orthopedic products. Each of these companies, as well as other companies like Smith & Nephew, Inc., which introduced the Journey Deuce Bi-Compartmental Knee System in July 2007, offers conventional instruments and implants for use in conventional total and partial knee replacement surgeries as well as unicompartmental resurfacing procedures, which may compete with our MAKOplasty solution and negatively impact sales of our robotic arm technology. A number of these and other companies also offer CAS systems for use in arthroplasty procedures that provide a minimally invasive means of viewing the anatomical site. In addition, Biomet has a license from Z-Kat to intellectual property rights in CAS intellectual property for use in the field of orthopedics. The license is non-exclusive with respect to use of CAS intellectual property in combination with robotics technology and exclusive with respect to all other uses within the field of orthopedics, which could enable them to compete with us.
Currently, we are not aware of any well known orthopedic company that broadly offers robotics technology in combination with CAS. All of these companies, however, have the ability to acquire and develop robotics technology that may compete with our products. We are aware of certain early stage companies developing CAS and robotic applications in orthopedics and others commercializing customized implants and instruments for early and mid-stage arthroplasty solutions. For example, CUREXO Technology Corporation has engaged in marketing in the United States of its ROBODOC® Surgical System, which received 510(k) clearance from the FDA in August 2008 for total hip arthroplasty procedures.
We also may face competition from other medical device companies that may seek to extend robotics technology and minimally invasive approaches and products that they have developed for use in other parts of the human anatomy to minimally invasive arthroplasty of the knee. Even if these other companies currently do not have an established presence in the field of minimally invasive surgery for the knee, they may attempt to apply their robotics technology to the field of knee replacement and resurfacing procedures to compete directly with us. Many of these medical device competitors enjoy competitive advantages over us, including:
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| • | significantly greater name recognition; |
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| • | longer operating histories; |
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| • | established exclusive relations with healthcare professionals, customers and third-party payors; |
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| • | established distribution networks; |
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| • | additional lines of products and the ability to offer rebates or bundle products to offer higher discounts or incentives to gain a competitive advantage; |
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| • | greater experience in conducting research and development, manufacturing, clinical trials, obtaining regulatory clearance for products and marketing approved products; and |
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| • | greater financial and human resources for product development, sales and marketing and patent litigation. |
Moreover, our competitors in the medical device industry make significant investments in research and development, and innovation is rapid and continuous. If new products or technologies emerge that provide the same or superior benefits as our products at equal or lesser cost, they could render our products obsolete or unmarketable. Because our products can have long development and regulatory clearance or approval cycles, we must anticipate changes in the marketplace and the direction of technological innovation and customer demands. In addition, we face increasing competition from well financed orthopedic companies in our attempts to acquire such new technologies, products and businesses. As a result, we cannot be certain that surgeons will use our products to replace or supplement established surgical procedures or that our products will be competitive with current or future products and technologies resulting in reduced revenue and harm to our financial results.
If we do not timely achieve our development goals for new products, the commercialization of these products will be delayed and our business and financial results may be adversely affected.
The success of our business is dependent on our ability to develop new products, to introduce enhancements to our existing products and to develop these new products and enhancements within targeted time frames and budgets. The actual timing of these product releases can vary dramatically compared to our estimates for reasons that may or may not be within our control, including clearance or approval by the FDA to market future products. Customers may forego purchases of our existing products and purchase our competitors’ products as a result of delays in the introduction of our new products and enhancements or failure by us to offer innovative products or enhancements at competitive prices and in a timely manner. Announcements of new products by us or by competitors may also result in a delay in or cancellation of purchasing decisions in anticipation of such new products. Any such losses of new customers would harm our business and financial results.
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We have limited experience in assembling and testing our products and may encounter problems or delays in the assembly of our products or fail to meet certain regulatory requirements that could result in a material adverse effect on our business and financial results.
We have limited experience in assembling and testing our products, including the RIO system, and no experience in doing so on a large commercial scale. The current and intended future versions of our robotic arm systems are complex and require the integration of a number of separate components and processes. To become profitable, we must assemble and test the RIO system in commercial quantities in compliance with regulatory requirements and at an acceptable cost. Increasing our capacity to assemble and test our products on a commercial scale will require us to improve internal efficiencies. We may encounter a number of difficulties in increasing our assembly and testing capacity, including:
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| • | managing production yields; |
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| • | maintaining quality control and assurance; |
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| • | providing component and service availability; |
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| • | maintaining adequate control policies and procedures; |
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| • | hiring and retaining qualified personnel; and |
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| • | complying with state, federal and foreign regulations. |
If we are unable to satisfy commercial demand for our RIO system due to our inability to assemble and test the system, our business and financial results, including our ability to generate revenue, would be impaired, market acceptance of our products could be materially adversely affected and customers may instead purchase or use, our competitors’ products.
Any failure in our efforts to train surgeons or hospital staff could result in lower than expected product sales and potential liabilities.
A critical component of our sales and marketing efforts is the training of a sufficient number of surgeons and hospital staff to properly use the knee MAKOplasty system. As of June 30, 2009, we had trained seventy-eight surgeons on the MAKOplasty system. We rely on surgeons and hospital staff to devote adequate time to learn to use our products. Convincing surgeons and hospital staff to dedicate the time and energy necessary for adequate training in the use of our system is challenging, and we cannot assure you we will be successful in these efforts. If surgeons or hospital staff are not properly trained, they may misuse or ineffectively use our products. If nurses or other members of the hospital staff are not adequately trained to assist in using our robotic arm systems, surgeons may be unable to use our products. Insufficient training may result in reduced system use, unsatisfactory patient outcomes, patient injury and related liability or negative publicity, which could have an adverse effect on our product sales or create substantial potential liabilities.
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We will likely continue to experience extended and variable sales cycles, which together with the unit price of the RIO system, could cause significant variability in our results of operations for any given quarter.
Our robotic arm system has a lengthy sales cycle because it involves a major piece of capital equipment, the purchase of which will generally require the approval of senior management at hospitals, inclusion in the hospitals’ budget process for capital expenditures and, in some instances, a certificate of need from the state or other regulatory clearance. As a result, a relatively small number of units are installed each quarter. Based on our limited experience, we estimate that the sales cycle of the RIO system will continue to take between seven and eighteen months from the point of initial identification and contact with a qualified surgeon until closing of the purchase with the hospital. Certain sales of RIO systems may also be subject to a customer acceptance period, during which the customer may return the RIO system to us subject to a penalty. Although we believe that training can be accomplished in a relatively short period of time, there may be situations where training of physicians and staff may last an additional month or more after installation. In addition, the introduction of new products could adversely impact our sales cycle as customers take additional time to assess the capital products. Because of the lengthy sales cycle, the unit price of the RIO system and the relatively small number of systems installed each quarter, each installation of a RIO system can represent a significant component of our revenue for a particular quarter, particularly in the near term and during any other periods in which our sales volume is relatively low.
Certain factors that may contribute to variability in our operating results may include:
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| • | timing and level of expenditures associated with new product development activities; |
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| • | delays in shipment due, for example, to cancellations by customers, natural disasters or labor disturbances; |
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| • | delays or unexpected difficulties in the manufacturing processes of our suppliers or in our assembly process; |
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| • | timing of the announcement, introduction and delivery of new products or product upgrades by us and by our competitors; |
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| • | timing and level of expenditures associated with expansion of sales and marketing activities and our overall operations; |
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| • | disruptions in the supply or changes in the costs of raw materials, labor, product components or transportation services; and |
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| • | changes in third-party coverage and reimbursement, changes in government regulation, or a change in a customer’s financial condition or ability to obtain financing. |
These factors are difficult to forecast and may contribute to substantial fluctuations in our quarterly revenue and substantial variation from our projections, particularly during the periods in which our sales volume is low. Moreover, many of our expenses, such as office leases and certain personnel costs, are relatively fixed. We may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall. Accordingly, any shortfall in revenue may cause significant variation in operating results in any quarter. Based on the above factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. These and other potential fluctuations also mean that you will not be able to rely upon our operating results in any particular period as an indication of future performance.
If we receive a significant number of warranty claims or our robotic arm system units require significant amounts of service after sale, our costs will increase and our business and financial results will be adversely affected.
We currently warrant each robotic arm system against defects in materials and workmanship for a period of approximately 12 months from the installation of the initial system at a customer’s facility. We also provide technical and other services to customers beyond the warranty period pursuant to a supplemental service plan sold with each system. We have a limited history of commercial placements from which to judge our rate of warranty claims. If product returns or warranty claims are significant or exceed our expectations, we could incur unanticipated reductions in sales or additional expenditures for parts and service. In addition, our reputation could be damaged and our products may not achieve market acceptance. While we have established accruals for liability associated with product warranties, unforeseen warranty exposure in excess of those accruals could negatively impact our business and financial results.
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We could become subject to product liability claims, product actions, including product recalls, and other field or regulatory actions that could be expensive, divert management’s attention and harm our business.
Our business exposes us to potential liability risks, product actions and other field or regulatory actions that are inherent in the manufacturing, marketing and sale of medical device products. We may be held liable if our TGS or the RIO system or implants cause injury or death or is found otherwise unsuitable or defective during usage. These robotic arm systems incorporate mechanical, electrical and optical parts, complex computer software and other sophisticated components, any of which can contain errors or failures. Complex computer software is particularly vulnerable to errors and failures, especially when first introduced. In addition, new products or enhancements to our existing products may contain undetected errors or performance problems that, despite testing, are discovered only after installation.
We may, from time to time, elect to initiate a product action concerning one or more of our products for the purpose of improving device performance. If any of our products are defective, whether due to design or manufacturing defects, improper use of the product or other reasons, we may voluntarily or involuntarily undertake a product action to remove, repair, or replace the product at our expense and, in some circumstances, to notify regulatory authorities of such product action pursuant to a product recall. Through July 30, 2009, we had initiated nine voluntary product actions, two of which were a product recall reportable to the FDA pursuant to the correction / removal guidelines. We are required to submit an MDR report to the FDA for any incident in which our product may have caused or contributed to a death or serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury. Through July 30, 2009, pursuant to the FDA guidelines on MDRs, we had filed thirty-six incident reports with the FDA.
In the future, we may experience additional events that may require reporting to the FDA pursuant to the MDR regulations. See “Risks Related to Regulatory Compliance.” A required notification to a regulatory authority could result in an investigation by regulatory authorities of our products, which could in turn result in product actions, restrictions on the sale of the products, civil or criminal penalties and other field corrective action. In addition, because our products are designed to be used to perform complex surgical procedures, defects could result in a number of complications, some of which could be serious and could harm or kill patients. The adverse publicity resulting from any of these events could cause surgeons or hospitals to review and potentially terminate their relationships with us. Regulatory investigations or product actions could also result in our incurring substantial costs, losing revenue, and implementing a change in the design, manufacturing process or the indications for which our products may be used, each of which would harm our business. It is also possible that defects in the design, manufacture or labeling of our products could result in a product liability claim. The medical device industry has historically been subject to extensive litigation over product liability claims. A product liability claim, regardless of its merit or eventual outcome, could result in significant legal defense costs. Although we maintain product liability insurance, the coverage is subject to deductibles and limitations, and may not be adequate to cover future claims. Additionally, we may be unable to maintain our existing product liability insurance in the future at satisfactory rates or adequate amounts. A product liability claim, regardless of its merit or eventual outcome could result in:
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| • | decreased demand for our products; |
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| • | injury to our reputation; |
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| • | diversion of management’s attention; |
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| • | significant costs of related litigation; |
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| • | payment of substantial monetary awards by us; |
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| • | product actions; |
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| • | a change in the design, manufacturing process or the indications for which our products may be used; |
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| • | loss of revenue; and |
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| • | an inability to commercialize our products under development. |
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If hospitals, surgeons and other healthcare providers are unable to obtain coverage or reimbursement from third-party payors for MAKOplasty procedures, hospitals may not purchase the RIO system and surgeons may not perform knee MAKOplasty, which would harm our business and financial results.
Our ability to successfully commercialize MAKOplasty depends significantly on the availability of coverage and reimbursement from third-party payors, including governmental programs such as Medicare and Medicaid as well as private insurance and private health plans. Reimbursement is a significant factor considered by hospitals in determining whether to acquire new capital equipment such as our technology. Although our customers have been successful in obtaining coverage and reimbursement, we cannot assure you that procedures using our technology will be covered or reimbursed by third-party payors in the future or that such reimbursements will not be reduced to the extent that they will adversely affect capital allocations for purchase of our robotic arm systems. We anticipate that in the U.S. our products will be purchased primarily by hospitals, which bill various third-party payors, including governmental healthcare programs, such as Medicare, and private insurance plans for procedures using our technology. Ensuring adequate Medicare reimbursement can be a lengthy and expensive endeavor and we cannot provide assurance that we will be successful. In addition, the U.S. Congress may pass legislation impacting coverage and reimbursement for healthcare services, including Medicare reimbursement to physicians and hospitals. Many private payors look to Medicare’s coverage and reimbursement policies in setting their coverage policies and reimbursement amounts. If the Centers for Medicare and Medicaid Services, or CMS, the federal agency that administers the Medicare program, or Medicare contractors limit payments to hospitals or surgeons for knee MAKOplasty procedures, private payors may similarly limit payments. In addition, state legislatures may enact laws limiting or otherwise affecting the level of Medicaid reimbursements. As a result, hospitals may not purchase the RIO system and surgeons may choose not to perform knee MAKOplasty, and, as a result, our business and financial results would be adversely affected.
Medicare pays acute care hospitals a prospectively determined amount for inpatient operating costs under the Medicare hospital inpatient prospective payment system, or PPS. Under the Medicare hospital inpatient PPS, the prospective payment for a patient’s stay in an acute care hospital is determined by the patient’s condition and other patient data and procedures performed during the inpatient stay using a classification system known as diagnosis related groups, or DRGs. As of October 1, 2007, CMS, implemented a revised version of the DRG system that uses 745 Medicare Severity DRGs, or MS-DRGs, instead of the approximately 540 DRGs Medicare previously used. The MS-DRGs are intended to account more accurately for the patient’s severity of illness when assigning each patient’s stay to a payment classification. Medicare pays a fixed amount to the hospital based on the MS-DRG into which the patient’s stay is assigned, regardless of the actual cost to the hospital of furnishing the procedures, items and services provided. Accordingly, acute care hospitals generally do not receive direct Medicare reimbursement under PPS for the specific costs incurred in purchasing medical devices. Rather, reimbursement for these costs is deemed to be included within the MS-DRG based payments made to hospitals for the services furnished to Medicare eligible inpatients in which the devices are utilized. Accordingly, a hospital must absorb the cost of our products as part of the payment it receives for the procedure in which the device is used. In addition, physicians that perform procedures in hospitals are paid a set amount by Medicare for performing such services under the Medicare physician fee schedule. Medicare payment rates for both systems are established annually.
At this time, we do not know the extent to which hospitals and physicians would consider third-party reimbursement levels adequate to cover the cost of our products. Failure by hospitals and surgeons to receive an amount that they consider to be adequate reimbursement for procedures in which our products are used could deter them from purchasing or using our products and limit our sales growth. In addition, pre-determined MS-DRG payments or Medicare physician fee schedule payments may decline over time, which could deter hospitals from purchasing our products or physicians from using them. If hospitals are unable to justify the costs of our products or physicians are not adequately compensated for procedures in which our products are utilized, they may refuse to purchase or use them, which would significantly harm our business.
Notwithstanding current or future FDA clearances, if granted, third-party payors may deny reimbursement if the payor determines that a therapeutic medical device is unnecessary, inappropriate, not cost-effective or experimental, or is used for a non-approved indication. Although we are not aware of any potential customer that has declined to purchase our robotic arm system based upon third-party payors’ reimbursement policies, cost control measures adopted by third-party payors may have a significant effect on surgeries performed using MAKOplasty or as to the levels of reimbursement. All third-party payors, whether governmental or private, whether inside the U.S. or outside, are developing increasingly sophisticated methods of controlling healthcare costs. These cost control methods include prospective payment systems, capitated rates, benefit redesigns, pre-authorization or second opinion requirements prior to major surgery, an emphasis on wellness and healthier lifestyle interventions and an exploration of other cost-effective methods of delivering healthcare. These cost control methods also potentially limit the amount which healthcare providers may be willing to pay for medical technology which could, as a result, adversely affect our business and financial results. In addition, in the U.S., no uniform policy of coverage and reimbursement for medical technology exists among all these payors. Therefore, coverage and reimbursement for medical technology can differ significantly from payor to payor.
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There also can be no assurance that current levels of reimbursement will not be decreased or eliminated in the future, or that future legislation, regulation, or reimbursement policies of third-party payors will not otherwise adversely affect the demand for our products or our ability to sell products on a profitable basis. Our customers are currently using existing reimbursement codes for knee arthroplasty. Knee arthroplasty performed in the hospital inpatient setting is currently assigned to MS-DRG 469 (“Major Joint Replacement or Reattachment of Lower Extremity with Major Complication or Comorbidity”) and MS-DRG 470 (“Major Joint Replacement or Reattachment of Lower Extremity without Major Complication of Comorbidity”), and surgeons currently bill Current Procedural Terminology, or CPT, code 27446 (“Arthroplasty, knee, condyle and plateau; medial OR lateral compartment”) for services performed in connection with procedures using our technology. Our customers also have available CPT codes 27446 and 73700 (“CT lower extremity without contrast”) for out-patient procedures and procedures performed in an ambulatory surgery center. If unicompartmental and bicompartmental knee resurfacing procedures gain market acceptance and the number of such procedures increases, CMS and other payors may establish billing codes for unicompartmental and bicompartmental knee resurfacing procedures that provide for a smaller reimbursement amount than knee arthroplasty, which could adversely affect our financial results and business.
In international markets, market acceptance of our products will likely depend in large part on the availability of reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country, and by region in some countries, and include both government sponsored healthcare and private insurance. We may not obtain international reimbursement approvals in a timely manner, if at all. In addition, even if we do obtain international reimbursement approvals, the level of reimbursement may not be enough to commercially justify expansion of our business into the approving jurisdiction. To the extent we or our customers are unable to obtain coverage or reimbursement for procedures using our technology in major international markets in which we seek to market and sell our technology, our international revenue growth would be harmed, and our business and results of operations would be adversely affected.
Healthcare reforms, changes in healthcare policies and changes to third-party coverage and reimbursements may affect demand for our systems and products.
The U. S. government, state and local governments, and a number of foreign governments, are currently considering or may in the future consider healthcare policies and proposals intended to curb rising healthcare costs, including those that could significantly affect both coverage and reimbursement for healthcare services. Future significant changes in the healthcare systems in the United States or elsewhere, and current uncertainty about whether and how changes may be implemented, could have a negative impact on the demand for our products and services and our business. These changes may include basing coverage and reimbursement policies and rates on clinical outcomes, the comparative effectiveness and costs of different treatment technologies and modalities; imposing price controls on medical products and services providers; reducing reimbursement rates; and other measures. It is unclear which, if any, of the various U.S. healthcare reforms currently being discussed and/or proposed might be enacted by the U.S. Congress and signed into law by the President of the United States. We are unable to predict what healthcare reform legislation or regulations, if any, will be enacted in the United States or elsewhere; whether other healthcare legislation or regulations affecting our business may be proposed or enacted in the future; what effect any legislation or regulation would have on our business; or the effect ongoing uncertainty about these matters will have on the purchasing decisions of our customers.
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We may attempt to acquire new products or technologies, and if we are unable to successfully complete these acquisitions or to integrate acquired businesses, products, technologies or employees, we may fail to realize expected benefits or harm our existing business.
Our success will depend, in part, on our ability to expand our product offerings and grow our business in response to changing technologies, customer demands and competitive pressures. In some circumstances, we may determine to do so through the acquisition of complementary businesses, products or technologies rather than through internal development. The identification of suitable acquisition candidates can be difficult, time consuming and costly, and we may not be able to successfully complete identified acquisitions. Furthermore, even if we successfully complete an acquisition, we may not be able to successfully integrate newly acquired organizations, products or technologies into our operations, and the process of integration could be expensive, time consuming and may strain our resources. Consequently, we may not achieve anticipated benefits of the acquisitions, which could harm our existing business. In addition, future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or expenses, or other charges such as in-process research and development, any of which could harm our business and materially adversely affect our financial results or cause a reduction in the price of our common stock.
We depend on key employees, and if we fail to attract and retain employees with the expertise required for our business, we cannot grow or achieve profitability.
We are highly dependent on members of our senior management, in particular Maurice R. Ferré, M.D., our President, Chief Executive Officer and Chairman of the Board. Our future success will depend in part on our ability to retain these key employees and to identify, hire and retain additional qualified personnel with expertise in research and development and sales and marketing. Competition for qualified personnel in the medical device industry is intense, and finding and retaining qualified personnel with experience in our industry is very difficult. We believe that there are only a limited number of individuals with the requisite skills to serve in many of our key positions, and we compete for key personnel with other medical equipment and software manufacturers and technology companies, as well as universities and research institutions. It is often difficult to hire and retain these persons, and we may be unable to replace key persons if they leave or fill new positions requiring key persons with appropriate experience. A significant portion of our compensation to our key employees is in the form of stock option grants. A prolonged depression in our stock price could make it difficult for us to retain our employees and recruit additional qualified personnel.
We do not maintain, and do not currently intend to obtain, key employee life insurance on any of our personnel other than Dr. Ferré. Although we have obtained key man insurance covering Dr. Ferré in the amount of $2,000,000, this would not fully compensate us for the loss of Dr. Ferré’s services. Dr Ferré may terminate his employment at will at any time with 30 days notice. Each of our other officers and key employees may terminate his or her employment at will at any time with 60 days’ notice. The loss of key employees, the failure of any key employee to perform or our inability to attract and retain skilled employees, as needed, could harm our business.
If we do not effectively manage our growth, we may be unable to successfully develop, market and sell our products.
Our future revenue and operating results will depend on our ability to manage the anticipated growth of our business. We have experienced significant growth in the scope of our operations and the number of our employees since our inception. This growth has placed significant demands on our management, as well as our financial and operations resources. In order to achieve our business objectives, we must continue to grow. However, continued growth presents numerous challenges, including:
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| • | implementing appropriate operational and financial systems and controls; |
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| • | expanding manufacturing and assembly capacity and increasing production; |
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| • | developing our sales and marketing infrastructure and capabilities; |
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| • | improving our information systems; |
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| • | identifying, attracting and retaining qualified personnel in our areas of activity; and |
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| • | hiring, training, managing and supervising our personnel. |
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We cannot be certain that our systems, controls, infrastructure and personnel will be adequate to support our future operations. Any failure to effectively manage our growth could impede our ability to successfully develop, market and sell our products and our business will be harmed.
If we are successful in our efforts to market and sell knee MAKOplasty internationally, we will be subject to various risks relating to our international activities, which could adversely affect our business and financial results.
We have begun to pursue international markets for the sale of our products and we anticipate being exposed to risks separate and distinct from those we face in our U.S. operations. Our international business may be adversely affected by changing economic conditions in foreign countries. In addition, because international sales would most likely be denominated in the functional currency of the country where the product is being shipped, increases or decreases in the value of the U.S. dollar relative to foreign currencies could affect our results of operations. Engaging in international business inherently involves a number of other difficulties and risks, including:
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| • | approval of product submissions with healthcare systems outside the United States; |
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| • | gathering the clinical data that may be required for product submissions with healthcare systems outside the United States; |
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| • | export restrictions and controls and other government regulation relating to technology; |
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| • | the availability and level of reimbursement within prevailing foreign healthcare payment systems; |
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| • | pricing pressures that we may experience internationally; |
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| • | compliance with existing and changing foreign regulatory laws and requirements; |
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| • | foreign laws and business practices favoring local companies; |
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| • | longer payment cycles; |
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| • | shipping delays; |
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| • | difficulties in enforcing agreements and collecting receivables through certain foreign legal systems; |
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| • | political and economic instability; |
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| • | potentially adverse tax consequences, tariffs and other trade barriers; |
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| • | international terrorism and anti-American sentiment; |
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| • | difficulties and costs of staffing and managing foreign operations; and |
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| • | difficulties in enforcing intellectual property rights. |
Our exposure to each of these risks may increase our costs, impair our ability to market and sell our products and require significant management attention, resulting in harm to our business and financial results.
Our operations are currently conducted primarily at a single location in Florida, which may be at risk from hurricanes, storm, fire, terrorist attacks or other disasters.
We currently conduct all of our management activities, most of our research and development activities and assemble all of our products at a single location in Fort Lauderdale, Florida. We have taken various precautions to safeguard our facilities, such as obtaining insurance, establishing health and safety protocols and securing off-site storage of computer data. However, a casualty due to a hurricane, storm or other natural disasters, a fire, terrorist attack, or other unanticipated problems at this location could cause substantial delays in our operations, delay or prevent assembly of our RIO systems and shipment of our implants, damage or destroy our equipment and inventory, and cause us to incur substantial expenses. Our insurance does not cover losses caused by certain events such as floods or other activities and may not be adequate to cover our losses in any particular case. Any damage, loss or delay could seriously harm our business and have an adverse affect on our financial results.
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Certain of our directors, executive officers and key employees have an interest in Z-Kat that could pose potential conflicts of interest, which could harm our business.
We believe that certain of our directors, executive officers and key employees hold equity interests in Z-Kat, Inc., or Z-Kat. We are dependent on intellectual property that we license or sublicense from Z-Kat and have entered into various licensing and related arrangements with Z-Kat. Each of these individuals may face potential conflicts of interest regarding these licensing transactions as a result of their interests in Z-Kat. Dr. Ferré may face additional conflicts of interest regarding these licensing and related arrangements if he serves on the board of directors of Z-Kat. To address these potential conflicts of interest, we have adopted a Related Person Transaction Policy. In addition, the audit committee of our board of directors, under the terms of its charter, must review and approve all related person transactions. We cannot, however, assure you that any conflicts will be resolved in our favor, and as a result, our business could be harmed.
Risks Related to Our Intellectual Property
If we, or the third parties from whom we license intellectual property, are unable to secure and maintain patent or other intellectual property protection for the intellectual property contained in our products, our ability to compete will be harmed.
Our commercial success depends, in part, on obtaining patent and other intellectual property protection for the technologies contained in our products. The patent positions of medical device companies, including ours, can be highly uncertain and involve complex and evolving legal and factual questions. Our patent position is uncertain and complex, in part, because of our dependence on intellectual property that we license from others. If we, or the third parties from whom we license intellectual property, fail to obtain adequate patent or other intellectual property protection for intellectual property contained in our products, or if any protection is reduced or eliminated, others could use the intellectual property contained in our products, resulting in harm to our competitive business position. In addition, patent and other intellectual property protection may not provide us with a competitive advantage against competitors that devise ways of making competitive products without infringing any patents that we own or have rights to.
U.S. patents and patent applications may be subject to interference proceedings and U.S. patents may be subject to reexamination proceedings in the U.S. Patent and Trademark Office. Foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent offices. Any of these proceedings could result in either loss of the patent or denial of the patent application, or loss or reduction in the scope of one or more of the claims of the patent or patent application. Changes in either patent laws or in interpretations of patent laws may also diminish the value of our intellectual property or narrow the scope of our protection. Interference, reexamination and opposition proceedings may be costly and time consuming, and we, or the third parties from whom we license intellectual property, may be unsuccessful in defending against such proceedings. Thus, any patents that we own or license may provide limited or no protection against competitors. In addition, our pending patent applications and those we may file in the future may have claims narrowed during prosecution or may not result in patents being issued. Even if any of our pending or future applications are issued, they may not provide us with adequate protection or any competitive advantages. Our ability to develop additional patentable technology is also uncertain.
Non-payment or delay in payment of patent fees or annuities, whether intentional or unintentional, may also result in the loss of patents or patent rights important to our business. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties. In addition, many countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as do the laws of the U.S., particularly in the field of medical products and procedures.
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If we are unable to prevent unauthorized use or disclosure of our proprietary trade secrets and unpatented know-how, our ability to compete will be harmed.
Proprietary trade secrets, copyrights, trademarks and unpatented know-how are also very important to our business. We rely on a combination of trade secrets, copyrights, trademarks, confidentiality agreements and other contractual provisions and technical security measures to protect certain aspects of our technology, especially where we do not believe that patent protection is appropriate or obtainable. We require our employees and consultants to execute confidentiality agreements in connection with their employment or consulting relationships with us. We also require our employees and consultants to disclose and assign to us all inventions conceived during the term of their employment or engagement while using our property or which relate to our business. We also have taken precautions to initiate reasonable safeguards to protect our information technology systems. However, these measures may not be adequate to safeguard our proprietary intellectual property and conflicts may, nonetheless, arise regarding ownership of inventions. Such conflicts may lead to the loss or impairment of our intellectual property or to expensive litigation to defend our rights against competitors who may be better funded and have superior resources. Our employees, consultants, contractors, outside clinical collaborators and other advisors may unintentionally or willfully disclose our confidential information to competitors. In addition, confidentiality agreements may be unenforceable or may not provide an adequate remedy in the event of unauthorized disclosure. Enforcing a claim that a third party illegally obtained and is using our trade secrets is expensive and time consuming, and the outcome is unpredictable. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how. Unauthorized parties may also attempt to copy or reverse engineer certain aspects of our products that we consider proprietary. As a result, third parties may be able to use our proprietary technology or information, and our ability to compete in the market would be harmed.
We could become subject to patent and other intellectual property litigation that could be costly, result in the diversion of management’s attention, require us to pay damages and force us to discontinue selling our products.
The medical device industry is characterized by competing intellectual property and a substantial amount of litigation over patent and other intellectual property rights. In particular, the fields of orthopedic implants, CAS, haptics and robotics are well established and crowded with the intellectual property of competitors and others. A number of companies in our market, as well as universities and research institutions, have issued patents and have filed patent applications which relate to the use of CAS.
Determining whether a product infringes a patent involves complex legal and factual issues, and the outcome of a patent litigation action is often uncertain. We have not conducted an extensive search of patents issued to third parties, and no assurance can be given that third-party patents containing claims covering our products, parts of our products, technology or methods do not exist, have not been filed or could not be filed or issued. Because of the number of patents issued and patent applications filed in our technical areas, our competitors or other third parties, including third parties from whom we license intellectual property, may assert that our products and the methods we employ in the use of our products are covered by U.S. or foreign patents held by them. In addition, because patent applications can take many years to issue and because publication schedules for pending applications vary by jurisdiction, there may be applications now pending of which we are unaware and which may result in issued patents which our current or future products infringe. Also, because the claims of published patent applications can change between publication and patent grant, there may be published patent applications that may ultimately issue with claims that we infringe. There could also be existing patents that one or more of our products or parts may infringe and of which we are unaware. As the number of competitors in the market for CAS and robotics assisted knee implant systems grows, and as the number of patents issued in this area grows, the possibility of patent infringement claims against us increases. In certain situations, we or third parties, such as Z-Kat from whom we license intellectual property, may determine that it is in our best interests or their best interests to voluntarily challenge a third party’s products or patents in litigation or other proceedings, including patent interferences or reexaminations. Pursuant to our licensing arrangement with Z-Kat, we have the right to prosecute, control and maintain all Z-Kat patents and intellectual property rights that are licensed to us within the field of orthopedic surgery. Z-Kat retains the right to prosecute, control and maintain its patent and intellectual property rights outside the field of orthopedic surgery, subject to certain conditions. For example, Z-Kat must notify us prior to taking any action to enforce their patent or intellectual property rights. To help ensure that Z-Kat has the resources necessary for proper prosecution and defense of any litigation arising from such enforcement action, our agreement with Z-Kat also requires that it enter into an engagement letter with competent counsel and deposit funds into an escrow account, for use by us to take over the litigation or action in the event Z-Kat is unable or unwilling to conduct proper prosecution and defense of such litigation or action. Despite these arrangements, we may have no control over Z-Kat’s decisions regarding enforcement actions outside the field of orthopedic surgery. As a result, we may become involved in unwanted litigation that could be costly, result in diversion of management’s attention, require us to pay damages and force us to discontinue selling our products.
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Infringement actions and other intellectual property claims and proceedings, whether with or without merit, may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management from our business and harm our reputation. Some of our competitors may be able to sustain the costs of complex patent or intellectual property litigation more effectively than we can because they have substantially greater resources.
We cannot be certain that we will successfully defend against allegations of infringement of third-party patents and intellectual property rights. In the event that we become subject to a patent infringement or other intellectual property lawsuit and if the other party’s patents or other intellectual property were upheld as valid and enforceable and we were found to infringe the other party’s patents or violate the terms of a license to which we are a party, we could be required to pay damages. We could also be prevented from selling our products unless we could obtain a license to use technology or processes covered by such patents or were able to redesign the product to avoid infringement. A license may not be available at all or on commercially reasonable terms or we may not be able to redesign our products to avoid infringement. Modification of our products or development of new products could require us to conduct clinical trials and to revise our filings with the FDA and other regulatory bodies, which would be time consuming and expensive. In these circumstances, we may be unable to sell our products at competitive prices or at all, our business and operating results could be harmed and our stock price may decline. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise the funds necessary to continue our operations.
We may be subject to damages resulting from claims that our employees, our consultants or we have wrongfully used or disclosed alleged trade secrets of their former employers.
Many of our employees and consultants were previously employed at universities or other medical device companies, including our competitors or potential competitors. We could in the future be subject to claims that these employees or consultants, or we, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. If we fail in defending against such claims, a court could order us to pay substantial damages and prohibit us from using technologies or features that are essential to our products and processes, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. In addition, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, such litigation could result in substantial costs and be a distraction to management.
Risks Related to Regulatory Compliance
If we fail to comply with the extensive government regulations relating to our business, we may be subject to fines, injunctions and other penalties that could harm our business.
Our medical device products and operations are subject to extensive regulation by the FDA, pursuant to the Federal Food, Drug, and Cosmetic Act, or FDCA, and various other federal, state and foreign governmental authorities. Government regulations and foreign requirements specific to medical devices are wide ranging and govern, among other things:
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| • | design, development and manufacturing; |
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| • | testing, labeling and storage; |
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| • | clinical trials; |
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| • | product safety; |
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| • | marketing, sales and distribution; |
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| • | premarket clearance or approval; |
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| • | record keeping procedures; |
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| • | advertising and promotions; |
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| • | recalls and field corrective actions; |
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| • | post-market surveillance, including reporting of deaths or serious injuries and malfunctions that, if they were to recur, could lead to death or serious injury; and |
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| • | product export. |
In the U.S., before we can market a new medical device, or a new use of, or claim for, or significant modification to, an existing product, we must first receive either premarket clearance under Section 510(k) of the FDCA, or approval of a PMA from the FDA, unless an exemption applies. In the 510(k) clearance process, the FDA must determine that a proposed device is “substantially equivalent” to a device legally on the market, known as a “predicate” device, with respect to intended use, technology and safety and effectiveness, in order to clear the proposed device for marketing. Clinical data is sometimes required to support substantial equivalence. The PMA approval pathway requires an applicant to demonstrate the safety and effectiveness of the device based, in part, on data obtained in clinical trials. Both of these processes can be expensive and lengthy and entail significant user fees, unless exempt. The FDA’s 510(k) clearance process usually takes from three to 12 months, but it can last longer. The process of obtaining PMA approval is much more costly and uncertain than the 510(k) clearance process. It generally takes from one to three years, or even longer, from the time the PMA application is submitted to the FDA until an approval is obtained. There is no assurance that we will be able to obtain FDA clearance or approval for any of our new products on a timely basis, or at all.
The FDA, state, foreign and other governmental authorities have broad enforcement powers. Our failure to comply with applicable regulatory requirements could result in governmental agencies or a court taking action, including any of the following sanctions:
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| • | untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties; |
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| • | customer notifications or repair, replacement, refunds, detention or seizure of our products; |
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| • | operating restrictions or partial suspension or total shutdown of production; |
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| • | refusing or delaying requests for 510(k) clearance or PMA approvals of new products or modified products; |
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| • | withdrawing 510(k) clearances or PMA approvals that have already been granted; |
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| • | refusing to provide Certificates for Foreign Government (CFG); |
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| • | refusing to grant export approval for our products; or |
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| • | pursuing criminal prosecution. |
Failure to obtain regulatory approval in additional foreign jurisdictions will prevent us from expanding the commercialization of our products abroad.
To be able to market and sell our products in other countries, we must obtain regulatory approvals and comply with the regulations of those countries. These regulations, including the requirements for approvals and the time required for regulatory review, vary from country to country. Obtaining and maintaining foreign regulatory approvals are expensive, and we cannot be certain that we will receive regulatory approvals in any foreign country in which we plan to market our products. If we fail to obtain or maintain regulatory approval in any foreign country in which we plan to market our products, our ability to generate revenue will be harmed.
As we modify existing products or develop new products in the future, including new instruments, we apply for permission to affix a European Union CE mark, which is a legal requirement for medical devices intended for sale in Europe, to such products. In addition, we will be subject to annual regulatory audits in order to maintain those CE mark permissions. We do not know whether we will be able to obtain permission to affix the CE mark for new or modified products or that we will continue to meet the quality and safety standards required to maintain the permissions we have already received. If we are unable to maintain permission to affix the CE mark to our products, we will no longer be able to sell our products in member countries of the European Union or other areas of the world that require CE approval of medical devices.
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If we or our third-party manufacturers or suppliers fail to comply with the FDA’s Quality System Regulation, our manufacturing operations could be interrupted and our product sales and operating results could suffer.
We and some of our third-party manufacturers and suppliers are required to comply with the FDA’s Quality System Regulation, or QSR, which covers the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our products. We and our manufacturers and suppliers are also subject to the regulations of foreign jurisdictions regarding the manufacturing process if we market our products overseas. The FDA enforces the QSR through periodic and unannounced inspections of manufacturing facilities. In January 2009, the FDA conducted its first audit of our facility, during which we received certain inspectional observations. We are addressing the observations and intend to submit responses to them to the FDA on a voluntary basis. The FDA inspection report relating to the audit has not yet been issued. To date, our facilities have not been inspected by any other regulatory authorities. In November 2008, BSi, an independent global certification body, conducted an annual assessment of our quality management system, which concluded that our quality management system complied with the requirements of ISO13485:2003 in all material respects. We have completed the necessary audits in order to update our ISO certifications to include class III devices, such as orthopedic implants. In connection with achieving CE marking, which is a legal requirement for medical devices intended for sale in Europe, we have also submitted design dossiers to BSi for the purpose of review and approval. BSi will continue to conduct annual audits to assess our compliance with BSi certification standards. We anticipate that we and certain of our third-party manufacturers and suppliers will be subject to inspections by regulatory authorities in the future. If our facilities or those of our manufacturers or suppliers fail to take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take enforcement action, including any of the following sanctions:
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| • | untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties; |
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| • | customer notifications or repair, replacement, refunds, detention or seizure of our products; |
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| • | operating restrictions or partial suspension or total shutdown of production; |
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| • | refusing or delaying requests for 510(k) clearance or PMA approvals of new products or modified products; |
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| • | withdrawing 510(k) clearances or PMA approvals that have already been granted; |
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| • | refusing to provide Certificates for Foreign Government (CFG) |
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| • | refusing to grant export approval for our products; or |
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| • | pursuing criminal prosecution. |
Any of these sanctions could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers’ demands. We may also be required to bear other costs or take other actions that may have a negative impact on our future sales and our ability to generate profits.
Our products may in the future be subject to product actions that could harm our reputation, business operations and financial results.
Manufacturers may, on their own initiative, initiate a product action, including a non-reportable market withdrawal or a reportable product recall, for the purpose of correcting a material deficiency, improving device performance, or other reasons. Additionally, the FDA and similar foreign governmental authorities have the authority to require an involuntary recall of commercialized products in the event of material deficiencies or defects in design, or manufacture or labeling. In the case of the FDA, the authority to require a recall must be based on an FDA finding that there is a reasonable probability that the device would cause serious injury or death. In addition, foreign governmental bodies have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. Product actions involving any of our products would divert managerial and financial resources and have an adverse effect on our financial condition and results of operations. Through July 30, 2009, we had initiated nine product actions, two of which were reportable to the FDA pursuant to the correction / removal guidelines. The first reportable recall was associated with two tracking array instruments for the patient specific visualization of the TGS and was communicated to the FDA in May 2008. We internally closed the action in January 2009 and requested that the FDA do the same. The second reportable recall was associated with a fiber optic cable used in communication between components of the RIO system. The action is currently ongoing, all RIO sites have been notified of the action, and we anticipate internal closure in the third quarter of 2009. The FDA has been notified of this reportable action.
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Companies are required to maintain certain records of product actions, even if they are not reportable to the FDA. If we determine that certain of those product actions do not require notification of the FDA, the FDA may disagree with our determinations and require us to report those actions as recalls. A future recall announcement could harm our reputation with customers and negatively affect our sales. In addition, the FDA could take enforcement action, including any of the following sanctions for failing to report the recalls when they were conducted:
| | |
| • | untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties; |
| | |
| • | customer notifications or repair, replacement, refunds, recall, detention or seizure of our products; |
| | |
| • | operating restrictions or partial suspension or total shutdown of production; |
| | |
| • | refusing or delaying our requests for 510(k) clearance or PMA approvals of new products or modified products; |
| | |
| • | withdrawing 510(k) clearances or PMA approvals that have already been granted; |
| | |
| • | refusing to provide Certificates for Foreign Government (CFG); |
| | |
| • | refusing to grant export approval for our products; or |
| | |
| • | pursuing criminal prosecution. |
Any of these sanctions could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers’ demands. We may also be required to bear other costs or take other actions that may have a negative impact on our future sales and our ability to generate profits.
If our products, or malfunction of our products, cause or contribute to a death or a serious injury, we will be subject to medical device reporting regulations, which can result in voluntary corrective actions or agency enforcement actions.
Under the FDA MDR regulations, we are required to report to the FDA any incident in which our product may have caused or contributed to a death or serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury. In addition, all manufacturers placing medical devices in European Union markets are legally bound to report any serious or potentially serious incidents involving devices they produce or sell to the relevant authority in whose jurisdiction the incident occurred. Through July 30, 2009, pursuant to the FDA guidelines on MDRs, we had filed thirty-six incident reports with the FDA. In the future, we may experience additional events that may require reporting to the FDA pursuant to the MDR regulations. Any adverse event involving our products could result in future voluntary corrective actions, such as product actions or customer notifications, or agency action, such as inspection, mandatory recall or other enforcement action. Through July 30, 2009, we had initiated nine product actions, two of which were reportable to the FDA pursuant to the correction / removal guidelines. Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and financial results. In addition, failure to report such adverse events to appropriate government authorities on a timely basis, or at all, could result in an enforcement action against us.
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We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products for unapproved or “off-label” uses, resulting in damage to our reputation and business.
Our promotional materials and training methods must comply with FDA and other applicable laws and regulations, including the prohibition of the promotion of a medical device for a use that has not been cleared or approved by FDA. Use of a device outside its cleared or approved indications is known as “off-label” use. We believe that the specific surgical procedures for which our products are marketed fall within the scope of the surgical applications that have been cleared by the FDA. However, physicians may use our products off-label, as the FDA does not restrict or regulate a physician’s choice of treatment within the practice of medicine. However, if the FDA determines that our promotional materials or training constitutes promotion of an off-label use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine and criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement. In that event, our reputation could be damaged and adoption of the products would be impaired. Although our policy is to refrain from statements that could be considered off-label promotion of our products, the FDA or another regulatory agency could disagree and conclude that we have engaged in off-label promotion. In addition, the off-label use of our products may increase the risk of injury to patients, and, in turn, the risk of product liability claims. Product liability claims are expensive to defend and could divert our management’s attention and result in substantial damage awards against us.
Federal regulatory reforms may adversely affect our ability to sell our products profitably.
From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the clearance or approval, manufacture and marketing of a medical device. In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products. It is impossible to predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be.
Without limiting the generality of the foregoing, Congress has recently enacted, and the President has signed into law, the Food and Drug Administration Amendments Act of 2007, or the Amendments. This law requires, among other things, that the FDA propose, and ultimately implement, regulations that will require manufacturers to label medical devices with unique identifiers unless a waiver is received from the FDA. Once implemented, compliance with those regulations may require us to take additional steps in the manufacture of our products and labeling. These steps may require additional resources and could be costly. In addition, the Amendments will require us to, among other things, pay annual establishment registration fees to the FDA for each of our FDA registered facilities.
We may be subject, directly or indirectly, to federal and state healthcare fraud and abuse laws and regulations and could face substantial penalties if we are unable to fully comply with such laws.
While we do not control referrals of healthcare services or bill directly to Medicare, Medicaid or other third-party payors, many healthcare laws and regulations apply to our business. For example, we could be subject to healthcare fraud and abuse and patient privacy regulation and enforcement by both the federal government and the states in which we conduct our business. The healthcare laws and regulations that may affect our ability to operate include:
| | |
| • | the federal healthcare programs’ Anti-Kickback Statute, which prohibits, among other things, persons or entities from soliciting, receiving, offering or providing remuneration, directly or indirectly, in return for or to induce either the referral of an individual for, or the purchase order or recommendation of, any item or service for which payment may be made under a federal healthcare program such as the Medicare and Medicaid programs; |
| | |
| • | federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, or are for items or services not provided as claimed, and which may apply to entities like us to the extent that our interactions with customers may affect their billing or coding practices; |
| | |
| • | the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which established new federal crimes for knowingly and willfully executing a scheme to defraud any healthcare benefit program or making false statements in connection with the delivery of or payment for healthcare benefits, items or services, as well as leading to regulations imposing certain requirements relating to the privacy, security and transmission of individually identifiable health information; and |
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| | |
| • | state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts. |
The orthopedic medical device industry is, and in recent years has been, under heightened scrutiny as the subject of government investigations and enforcement actions involving manufacturers who allegedly offered unlawful inducements to potential or existing customers in an attempt to procure their business, specifically including arrangements with physician consultants. We have arrangements with surgeons, hospitals and other entities which may be subject to scrutiny. For example, we have consulting agreements with orthopedic surgeons using or considering the use of our present and future robotic arm systems and MAKOplasty implants and disposable products, for assistance in product development, and professional training and education, among other things. Payment for some of these consulting services has been in the form of stock options or royalties rather than per hour or per diem amounts that would require verification of time worked. We may continue in the future to make payment for these consulting services in the form of royalties or also possibly in the form of part time employment. In addition, we sometimes allow hospitals a period of evaluation of our products at no charge. If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations. Any penalties, damages, fines, exclusions, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of these laws are broad and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. If the surgeons or other providers or entities with whom we do business are found to be non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on our business.
Risks Related to Ownership of our Common Stock
We expect that the price of our common stock will fluctuate substantially, which could lead to losses for stockholders, possibly resulting in class action securities litigation.
Prior to our IPO in February 2008, there was no public market for shares of our common stock. Since the IPO, our common stock has experienced significant price fluctuations and low trading volumes. An active public trading market may not develop or, if developed, may not be sustained. The market price for our common stock will be affected by a number of factors, including:
| | |
| • | the receipt, denial or timing of regulatory clearances or approvals of our products or competing products; |
| | |
| • | changes in policies affecting third-party coverage and reimbursement in the U.S. and other countries; |
| | |
| • | ability of our products, if they receive regulatory clearance, to achieve market success; |
| | |
| • | the performance of third-party contract manufacturers and component suppliers; |
| | |
| • | our ability to develop sales and marketing capabilities; |
| | |
| • | our ability to manufacture our products to commercial standards; |
| | |
| • | the success of any collaborations we may undertake with other companies; |
| | |
| • | our ability to develop, introduce and market new or enhanced versions of our products on a timely basis; |
| | |
| • | actual or anticipated variations in our results of operations or those of our competitors; |
| | |
| • | announcements of new products, technological innovations or product advancements by us or our competitors; |
| | |
| • | developments with respect to patents and other intellectual property rights; |
| | |
| • | sales of common stock or other securities by us or our stockholders in the future; |
| | |
| • | additions or departures of key scientific or management personnel; |
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| • | disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our technologies; |
| | |
| • | trading volume of our common stock; |
| | |
| • | changes in earnings estimates or recommendations by securities analysts, failure to obtain analyst coverage of our common stock or our failure to achieve analyst earnings estimates; |
| | |
| • | developments in our industry; and |
| | |
| • | general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors. |
In addition, the stock prices of many companies in the medical device industry have experienced wide fluctuations that have often been unrelated to the operating performance of these companies. We expect our stock price to be similarly volatile. These broad market fluctuations may continue and could harm our stock price. Following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Class action securities litigation, if instituted against us, could result in substantial costs and a diversion of our management resources, which could significantly harm our business.
Securities analysts may issue negative reports or cease to cover our common stock, which may have a negative impact on the market price of our common stock.
The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about us or our business. As a result of our smaller market capitalization, it may be difficult for our company to continue to attract securities analysts that will cover our common stock. If one or more of the analysts who elects to cover us downgrades our stock, our stock price would likely decline rapidly. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline. This could have a negative effect on the market price of our stock.
Our principal stockholders, directors and executive officers own a large percentage of our voting stock, which allows them to exercise significant influence over matters subject to stockholder approval.
As of July 30, 2009, our executive officers, directors and principal stockholders holding 5% or more of our outstanding common stock beneficially owned or controlled approximately 60% of the outstanding shares of our common stock. Accordingly, these executive officers, directors and principal stockholders, acting as a group, have substantial influence over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transaction. These stockholders may also delay or prevent a change of control or otherwise discourage a potential acquirer from attempting to obtain control of us, even if such a change of control would benefit our other stockholders. This significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise.
We have not paid dividends in the past and do not expect to pay dividends in the foreseeable future.
We have never declared or paid cash dividends on our capital stock. We currently intend to retain all future earnings for the operation and expansion of our business and, therefore, do not anticipate declaring or paying cash dividends in the foreseeable future. The payment of dividends will be at the discretion of our board of directors and will depend on our results of operations, capital requirements, financial condition, prospects, contractual arrangements, any limitations on payments of dividends present in any of our future debt agreements, and other factors our board of directors may deem relevant. If we do not pay dividends, a return on your investment will only occur if our stock price appreciates.
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Sales of a substantial number of shares of our common stock in the public market, or the perception that they may occur, may depress the market price of our common stock.
We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of such shares upon the effectiveness of a registration statement, or upon the expiration of any holding period under Rule 144, will have on the market price prevailing from time to time. The effectiveness of our registration statement on Form S-3, declared effective by the SEC on May 7, 2009, under which we registered for resale approximately 13.0 million shares of our common stock sold in the October 2008 equity financing, issued upon conversion of our previously outstanding convertible preferred stock, or that may be acquired upon exercise of warrants sold in the equity financing, and the expiration of the holding periods under Rule 144 create a circumstance commonly referred to as an “overhang” and could depress the market price of our common stock. We also have filed with the SEC a shelf registration statement on Form S-3, declared effective by the SEC on May 26, 2009, under which we may offer and sell at any time or from time to time common stock, preferred stock, debt securities and other securities at any time in an amount not to exceed $50 million. The effectiveness of this shelf registration statement also may create an overhang. The existence of an overhang, whether or not sales have occurred or are occurring, also could make more difficult our ability to raise additional financing through the sale of equity or equity related securities in the future at a time and price that we deem reasonable or appropriate.
Approximately all of the 25.1 million shares of our common stock currently outstanding are freely tradable without registration pursuant to Rule 144 under the Securities Act or have been registered for resale with the U.S. Securities and Exchange Commission, or SEC, and the sale of such shares could have a negative impact on the price of our common stock.
Our recent capital raising transaction, and our need to raise additional capital in the future, could have a negative effect on your investment.
We will need to raise additional capital in the future in order for us to continue to operate our business as currently contemplated. In October 2008, we raised approximately $40.2 million in gross proceeds through the sale in a private placement of our common stock and warrants to purchase shares of our common stock. Under the terms of the private placement, we granted the investors in the private placement additional warrants to purchase 322,581 shares of our common stock at an exercise price of $6.20 per share in exchange for a right to require, under certain circumstances, the investors to purchase an additional $20 million in shares of our common stock and warrants to purchase shares of our common stock. We may, in the future, also raise additional capital through the public or private sale of common stock or securities convertible into or exercisable for our common stock. We also have filed with the SEC a shelf registration statement under which we may offer and sell common stock, preferred stock, debt securities and other securities at any time or from time to time in an amount not to exceed $50 million. Such sales could be consummated at a significant discount to the trading price of our stock.
If we sell additional shares of our common stock, such sales will further dilute the percentage of our equity that our existing stockholders own. In addition, private placement financings could involve the issuance of securities at a price per share that represents a discount to the trading prices of our common stock. Further, debt and equity financings may involve the issuance of dilutive warrants. No assurance can be given that previous or future investors, finders or placement agents will not claim that they are entitled to additional anti-dilution adjustments or dispute the calculation of any such adjustments. Any such claim or dispute could require us to incur material costs and expenses regardless of the resolution and, if resolved unfavorably to us, to effect dilutive securities issuances or adjustment to previously issued securities.
The private placement in October 2008 included, and future financings may include, provisions requiring us to make additional payments to the investors if we fail to obtain or maintain the effectiveness of SEC registration statements by specified dates or take other specified action. Our ability to meet these requirements may depend on actions by regulators and other third parties, over which we will have no control. These provisions may require us to make payments or could lead to costly and disruptive disputes. In addition, these provisions could require us to record additional non-cash expenses. Such provisions in future financings could also require us to issue additional dilutive securities, although the provisions of the private placement in October 2008 include no such requirement.
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We are obligated to develop and maintain proper and effective internal control over financial reporting, and we may not complete our analysis of our internal control over financial reporting in a timely manner or this internal control may not be determined to be effective, which may adversely affect investor confidence in our company and, as a result, the value of our common stock.
We are required, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting beginning in our annual reports on Form 10-K. For our annual report on Form 10-K for our year ended December 31, 2008, this assessment concluded that no material weaknesses in our internal control over financial reporting have been identified by our management as of December 31, 2008. If our auditors are unable to express an opinion on the effectiveness of our internal control over financial reporting, which, in accordance with SEC rules will be required as of December 31, 2009, we could lose investor confidence in the accuracy and completeness of our financial reports, which would have a material adverse effect on the price of our common stock. Future failure to comply with the rules might make it more difficult for us to obtain certain types of insurance, including director and officer liability insurance, and we might be forced to accept reduced policy limits and coverage and/or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on committees of our board of directors, or as executive officers.
In addition, as a public company, we incur significant additional legal, accounting and other expenses that we did not incur as a private company, and our administrative staff is required to perform additional tasks. For example, we have increased the size of our accounting staff, updated our accounting systems and procedures, revised the roles and duties of our board committees, retained a transfer agent, adopted an insider trading policy and disclosure controls and procedures and are bearing all of the internal and external costs of preparing and distributing periodic public reports in compliance with our obligations under the securities laws. Changing laws, regulations and standards relating to corporate governance and public disclosure, and related regulations implemented by the SEC and The NASDAQ Global Market, are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We are investing resources to comply with evolving laws, regulations and standards, and this investment will result in increased general and administrative expenses and a diversion of management’s time and attention from revenue generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
| |
(a) | Sales of Unregistered Securities |
| |
| Not applicable. |
| |
(b) | Use of Proceeds from Registered Securities |
Our IPO was effected through a registration statement on Form S-1 (File No. 333-146162) that was declared effective by the SEC on February 14, 2008. We registered 5,100,000 shares of our common stock with an aggregate offering price of $51 million, all of which shares we sold. The offering was completed after the sale of all 5,100,000 shares. J.P. Morgan Securities Inc. and Morgan Stanley & Co. Incorporated were the joint book-running managing underwriters of our IPO and Cowen and Company and Wachovia Securities acted as co-managers. The underwriters elected not to exercise their over-allotment option. We paid $3.6 million of the proceeds in underwriting discounts and commissions, and we incurred an additional $3.6 million of expenses. None of the expenses were paid, directly or indirectly, to directors, officers or persons owning 10% or more of our common stock, or to our affiliates.
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As of June 30, 2009, all of the aggregate net proceeds of the initial public offering had been used. The use of the proceeds consisted of approximately $14.3 million of the IPO proceeds for sales and marketing activities, $12.7 million for research and development activities, $12.8 million for working capital and general corporate purposes and $4.0 million for a deferred license fee payment due to IBM upon completion of IPO.
| |
(c) | Issuer Purchases of Equity Securities |
The following table summarizes the surrenders of the Company’s common stock during the three month period ended June 30, 2009:
| | | | | | | | | | | | | |
| | | | | | | | | |
| | Total
Number of
Shares
Purchased(1) | | Average
Price Paid
per Share(1) | | Total Number
of Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs | | Maximum
Dollar Value of
Shares that May
Yet be
Purchased
Under the Plans
or Programs | |
| | | | | | | | | | | | | |
Period | | | | | | | | | | | | | |
April 1 to 30, 2009 | | | — | | $ | — | | | — | | $ | — | |
May 1 to 31, 2009 | | | 40,211 | | | 8.70 | | | — | | | — | |
June 1 to 30, 2009 | | | — | | | — | | | — | | | — | |
| | | 40,211 | | $ | 8.70 | | | — | | $ | — | |
| |
(1) | Represents the surrender of shares of common stock of the Company to satisfy the tax withholding obligations associated with the vesting of restricted stock. |
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We held our 2009 annual meeting of stockholders on June 11, 2009 at our headquarters in Fort Lauderdale, Florida. We submitted the following matters to a vote of our stockholders, with the results of voting as follows:
Proposal 1 – Election of three Class II directors, each to serve until the 2012 Annual Meeting of Stockholders and until his successor is duly elected and qualified:
| | | | |
NOMINEE | | FOR | | WITHHELD |
Charles W. Federico | | 17,755,804 | | 328,384 |
Maurice R. Ferré, M.D. | | 18,071,840 | | 12,348 |
Fredric H. Moll, M.D. | | 15,545,747 | | 2,538,441 |
Our other directors who were in office prior to the 2009 Annual Meeting of Stockholders and with terms of office that continue after the meeting are S. Morry Blumenfeld, Ph.D., Marcelo G. Chao, Christopher C. Dewey, John G. Freund, M.D., William D. Pruitt, and John J. Savarese, M.D.
Proposal 2 – Ratification of the appointment of Ernst & Young LLP as our independent registered public accounting firm for 2009:
| | | | |
FOR | | AGAINST | | ABSTAIN |
18,065,566 | | 14,394 | | 4,228 |
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ITEM 6. EXHIBITS.
| | | | |
Exhibit
No. | | Description | |
| | | |
| 31.1 | | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act |
| 31.2 | | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act |
| 32.1 | | Certification of Chief Executive Officer pursuant to18 U.S.C. §1350 |
| 32.2 | | Certification of Chief Financial Officer pursuant to18 U.S.C. §1350 |
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.
| | | | |
| | MAKO Surgical Corp. |
| | | |
Date: August 5, 2009 | | By: | /s/ Fritz L. LaPorte | |
| | | Fritz L. LaPorte
Senior Vice President of Finance and
Administration, Chief Financial Officer and
Treasurer |
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EXHIBIT INDEX
| | | | |
Exhibit
No. | | Description | |
| | | |
| 31.1 | | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act |
| 31.2 | | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act |
| 32.1 | | Certification of Chief Executive Officer pursuant to18 U.S.C. §1350 |
| 32.2 | | Certification of Chief Financial Officer pursuant to18 U.S.C. §1350 |
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