United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
__X__ Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the quarterly period ended April 3, 1998 or
_____ Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the transition period from ____________to ___________.
Commission File Number
0-27880
CardioThoracic Systems, Inc.
--------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 94-3228757
---------- ------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10600 N. Tantau Ave., Cupertino, CA 95014-0739
---------------------------------------------- --------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone, including area code: (408) 342-1700
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months(or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such requirements for the past 90 days.
Yes __X__ No _______
As of April 30, 1998, there were 13,865,519 shares of the Registrant's
Common Stock outstanding.
1
CARDIOTHORACIC SYSTEMS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------
Item 1. Financial Statements
Consolidated Condensed Balance Sheets as of
April 3, 1998 and January 2, 1998 3
Consolidated Condensed Statements of Operations
for the three months ended April 3, 1998 and
March 28, 1997 4
Consolidated Condensed Statements of Cash Flows
for the three months ended April 3, 1998 and
March 28, 1997 5
Notes to Consolidated Condensed Financial
Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II. OTHER INFORMATION 20
SIGNATURES 24
EXHIBIT INDEX 25
2
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
April 3, 1998 January 2, 1998
------------- --------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $4,279,000 $4,681,000
Available-for-sale securities 38,355,000 52,105,000
Trade accounts receivable, net 1,759,000 1,369,000
Notes receivable from officers 87,000 87,000
Inventories, net 557,000 641,000
Interest receivable 1,006,000 1,158,000
Prepaid expenses and other current assets 711,000 449,000
------------ ------------
Total current assets 46,754,000 60,490,000
Property and equipment, net 3,677,000 3,613,000
Available-for-sale securities 12,058,000 4,048,000
Notes receivable from officers 1,051,000 1,073,000
Other assets 73,000 52,000
------------ ------------
Total assets $63,613,000 $69,276,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Equipment note, current portion $ 460,000 $ 410,000
Accounts payable 1,120,000 779,000
Accrued liabilities 3,759,000 4,430,000
------------ ------------
Total current liabilities 5,339,000 5,619,000
Bank borrowings 1,557,000 1,557,000
Equipment note, less current portion 1,809,000 1,966,000
------------ ------------
Total liabilities 8,705,000 9,142,000
------------ ------------
Stockholders' equity:
Common stock, par value $0.001 14,000 14,000
Additional paid-in capital 103,147,000 103,156,000
Deferred compensation, net (3,078,000) (3,614,000)
Unrealized gain on available-for-sale
securities 14,000 17,000
Accumulated deficit (45,189,000) (39,439,000)
------------ ------------
Total stockholders' equity 54,908,000 60,134,000
------------ ------------
Total liabilities and stockholders' equity $63,613,000 $69,276,000
============ ============
3
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Three Months Ended
April 3, 1998 March 28, 1997
----------------- ----------------
Net sales $ 2,962,000 $ 2,112,000
Cost of sales 1,603,000 1,472,000
------------ -------------
Gross profit 1,359,000 640,000
------------ -------------
Operating expenses:
Research and development 2,677,000 2,051,000
Sales, marketing, general, and adm 5,130,000 4,309,000
------------ ------------
Total operating expenses 7,807,000 6,360,000
------------ ------------
Loss from operations (6,448,000) (5,720,000)
Interest income, net 698,000 1,016,000
------------ -------------
Net loss $(5,750,000) $(4,704,000)
============= =============
Net loss per common share and
per common share - assuming dilution $ (0.42) $ (0.35)
============= =============
Shares used in computing net
loss per common share and per
common share - assuming
dilution 13,767,000 13,358,000
============= =============
4
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended Three Months Ended
April 3, 1998 March 28, 1997
----------------- -----------------
Operating Activities
Net loss $(5,750,000) $(4,704,000)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 421,000 214,000
Amortization of notes receivable
from officers 22,000 28,000
Allowance for bad debts and product returns 30,000 45,000
Amortization of deferred compensation 483,000 562,000
Changes in operating assets and liabilities:
Trade accounts receivable (420,000) (1,362,000)
Inventory 84,000 (341,000)
Interest receivable 152,000 34,000
Prepaid expenses and other current
assets (262,000) (144,000)
Other assets (21,000) (8,000)
Accounts payable 341,000 967,000
Accrued liabilities (671,000) 369,000
------------- ------------
Net cash used in operating
activities (5,591,000) (4,340,000)
------------- ------------
Investing Activities
Purchases of property and equipment (485,000) (526,000)
Purchase of available-for-sale
securities (18,619,000) (18,873,000)
Proceeds from maturities of
available-for-sale securities 24,356,000 22,036,000
------------- ------------
Net cash provided by
investing activities 5,252,000 2,637,000
------------- ------------
Financing Activities
Bank borrowings - 1,200,000
Repayment of equipment note (107,000) (33,000)
Proceeds from issuance of common stock 44,000 410,000
------------- ------------
Net cash provided by (used in)
financing activies (63,000) 1,577,000
------------- ------------
Net decrease in cash and cash equivalents (402,000) (126,000)
Cash and cash equivalents at
beginning of period 4,681,000 5,184,000
-------------- ------------
Cash and cash equivalents at end of
period $ 4,279,000 $ 5,058,000
============== =============
5
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
April 3, 1998
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated condensed financial
statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and in
accordance with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included.
The operating results of the interim periods presented are not
necessarily indicative of the results for the year ending January 1,
1999 or for any other interim period. The accompanying financial
statements should be read in conjunction with the audited financial
statements and notes thereto for the year ended January 2, 1998
included in the Company's Form 10-K filed with the Securities and
Exchange Commission.
Note 2. Formation and Business of the Company
CardioThoracic Systems, Inc. (the Company) was incorporated on
June 15, 1995 to design, develop, manufacture and market surgical
products and systems for minimally invasive cardiac surgery.
Note 3. Available-for-Sale Securities
The Company has classified its investments as available-for-sale
securities. Available-for-sale securities are carried at fair value
with unrealized gains and losses, net of tax, reported as a separate
component of stockholders' equity. The amortized cost of available-
for-sale debt securities is adjusted for the amortization of premiums
and the accretion of discounts to maturity. Such amortization is
included in interest income. Realized gains and losses and declines
in value judged to be other than temporary on available-for-sale
securities are included in interest income. The cost of securities
sold is based on the specific identification method.
6
At April 3, 1998, available-for-sale securities consist of the following:
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- -----------
U.S. Gov't notes and bonds $ 1,997,000 $ - $ - $ 1,997,000
Gov't agency notes and bonds 14,922,000 4,000 (2,000) 14,924,000
Corporate notes and bonds 33,480,000 12,000 - 33,492,000
------------ --------- --------- -----------
$50,399,000 $ 16,000 $ (2,000) $50,413,000
=========== ========== ========== ===========
At January 2, 1998, available-for-sale securities consist of the following:
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
----------- ---------- ---------- -----------
Gov't agency notes and bonds 10,759,000 8,000 (1,000) 10,766,000
Corporate notes and bonds 45,377,000 12,000 (2,000) 45,387,000
----------- ----------- ---------- -----------
$ 56,136,000 $ 20,000 $ (3,000) $56,153,000
============ =========== =========== ===========
Available-for-sale securities by contractual maturity at April 3, 1998 are
shown below:
Amortized Estimated
Cost Fair Value
-------------- ---------------
Less than one year $38,345,000 $38,355,000
Due in one to two years 12,054,000 12,058,000
-------------- --------------
$50,399,000 $50,413,000
============== ==============
Note 4. Inventories
Inventories, net consist of the following:
April 3, 1998 January 2, 1998
-------------- ---------------
Raw materials $ 186,000 $ 188,000
Work-in-process 220,000 203,000
Finished goods 151,000 250,000
---------------- ---------------
$ 557,000 $ 641,000
================ ================
7
Note 5. Net Loss Per Share
The Company has adopted the Financial Accounting Standards Board
Statement No. 128 "Earnings Per Share" and the Securities and Exchange
Commission Staff Accounting Bulletin No. 98. Accordingly, net loss per
share for all prior periods have been restated. Net loss per common
share and per common share-assuming dilution, are computed using the
weighted average number of shares of common stock outstanding. Common
equivalent shares from stock options and preferred stock are excluded
from the computation of net loss per common share-assuming dilution as
their effect is antidilutive. No additional shares are considered to
be outstanding for either calculation under the provisions of Staff
Accounting Bulletin No. 98.
Note 6. Stock Option Plan
In January 1998, the Company approved the 1998 Nonstatutory Stock
Option Plan under which the officers of the Company are authorized to
enter into stock option agreements with selected individuals. The
Company has reserved 150,000 shares of common stock for issuance under
this plan.
Note 7. Recent Accounting Pronouncements
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income,"
effective January 3, 1998. This statement requires the disclosure of
comprehensive income and its components in a full set of general-
purpose financial statements. Comprehensive income is defined as net
income plus revenues, expenses, gains and losses that, under generally
accepted accounting principles, are excluded from net income. The
components of comprehensive income which are excluded from net income
are not significant, individually or in aggregate, and therefore, no
separate statement of comprehensive income has been presented.
8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion of the financial condition and results
of operations of CardioThoracic Systems, Inc. ("CTS" or the "Company")
should be read in conjunction with the Condensed Consolidated
Financial Statements and the related Notes thereto included herein.
This report contains forward looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The Company's future results
of operations could vary significantly from those anticipated by such
statements as a result of factors described in this Management's
Discussion and Analysis of Financial Condition and Results of
Operations and under "Factors Affecting Results of Operations".
Overview
The business of the Company was commenced in November 1993 as a
sole proprietorship, Informed Creation. In June 1995, the business
was incorporated and as part of the Company's initial financing in
September 1995, the Company acquired all intellectual property assets
of Informed Creation. The Company has a limited operating history upon
which evaluation of its prospects can be made. Such prospects must be
considered in light of the substantial risks, expenses and
difficulties encountered by entrants into the medical device industry,
which is characterized by an increasing number of participants,
intense competition and a high failure rate. The Company began
commercial sales of its products in December 1996 and has limited
experience in manufacturing, marketing and selling the CTS MIDCAB
System, Access MV System and the CTS OPCAB System ("Company's
products" or "Company's current products"). The Company has
experienced operating losses since its inception, and, as of April 3,
1998, the Company had an accumulated deficit of approximately
$45,189,000. The development and commercialization of the Company's
products will continue to require substantial development, regulatory,
sales and marketing, manufacturing and other expenditures. The Company
expects its operating losses to continue at least through 1999 as it
expends substantial resources to continue development of the Company's
products, obtain additional regulatory clearances or approvals, build
its marketing, sales, manufacturing and finance organizations and
conduct further research and development. There can be no assurance
that the Company's products will ever gain widespread commercial
acceptance or that the Company will ever generate enough revenues to
achieve profitability.
The Company's current products are designed to enable the majority of
cardiothoracic surgeons to perform minimally invasive cardiac surgery
("MICS") on a beating heart. Accordingly, the Company's success is
dependent upon acceptance of these procedures by the medical community
as a reliable, safe and cost effective alternative to existing
treatments for revascularizing blocked coronary arteries. To date,
MICS has been performed on a limited basis by several hundred highly
skilled cardiothoracic surgeons. Of the procedures performed to date,
the majority have been performed on a single artery, typically the
9
left anterior descending artery ("LAD") or, in fewer instances, the
right coronary artery ("RCA"), and a limited number have been
performed on the circumflex artery. Currently, a significant
percentage of conventional coronary artery bypass graft ("CABG")
procedures are performed on multiple vessels. To date, multiple vessel
MICS procedures have only been performed on a limited basis, and there
can be no assurance that MICS will be effectively utilized for
multiple bypasses on a more widespread or more frequent basis. The
Company is unable to predict how quickly, if at all, MICS will be
adopted by the medical community or, if it is adopted, the number of
MICS procedures that will be performed. The medical conditions that
can be treated with MICS can also be treated by widely accepted
surgical procedures such as CABG surgery and catheter-based
treatments, including balloon angioplasty, atherectomy and coronary
stenting. Although the Company believes that MICS has significant
advantages over competing procedures, broad-based clinical adoption of
MICS will not occur until physicians determine that the approach is an
attractive alternative to current treatments for coronary artery
disease. The Company believes that physician endorsements will be
essential for clinical adoption of MICS , and there can be no
assurance that any such endorsements will be obtained in a timely
manner, if at all. Clinical adoption will also depend upon the
Company's ability to facilitate training of cardiothoracic surgeons to
perform MICS, and the willingness of such surgeons to perform MICS
procedures. Patient acceptance of MICS will depend in part upon
physician recommendations as well as other factors, including the
degree of invasiveness, the effectiveness of the procedure and rate
and severity of complications associated with MICS as compared to
other treatments. Even if the clinical efficacy of MICS is
established, physicians may elect not to recommend the procedure
unless acceptable reimbursement from health care payors is available.
Health care payor acceptance may require evidence of the cost
effectiveness of the MICS as compared to other currently available
treatments. There can be no assurance that MICS will gain clinical
adoption. Failure of MICS to achieve significant clinical adoption
would have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company's current products are designed for beating heart
MICS and are expected to account for the great majority of the
Company's revenues in 1998. The Company's products are in the early
stage of commercialization. The Company manufactured and sold
approximately 11,000 systems in the five quarters ended April 3, 1998,
but there can be no assurance that demand for the Company's current
or future products will be sufficient to allow profitable operations.
Failure of the Company's current and future products to be
successfully commercialized at significantly higher volumes would have
a material adverse effect on the Company's business, financial
condition and results of operations.
10
Before the Company can market certain products under development
in the United States, the Company must obtain clearance or approval
from the FDA. The Company has filed or will be filing 510(k) premarket
notifications or premarket approval ("PMA") applications with the FDA
for clearance or approval to market certain products under
development. There can be no assurance that the FDA will act
favorably or quickly on the Company's submissions, or that significant
difficulties and costs will not be encountered by the Company in its
efforts to obtain FDA clearance or approval. Any such difficulties
could delay or preclude obtaining regulatory clearance or approval.
In addition, there can be no assurance that the FDA will not impose
strict labeling or other requirements as a condition of its 510(k)
clearance or PMA approval, any of which could limit the Company's
ability to market its products under development. Further, if the
Company wishes to modify a product after FDA clearance or approval,
including changes in indications or other modifications that could
affect safety and efficacy, additional clearances or approvals will be
required from the FDA. Failure to receive, or delays in receipt of,
FDA clearances or approvals, including delays resulting from an FDA
request for clinical trials or additional data as a prerequisite to
clearance or approval, or any FDA conditions that limit the ability of
the Company to market its products under development, could have a
material adverse effect on the Company's business, financial condition
and results of operations.
In order for the Company to market its products under development
in Europe and certain other international jurisdictions, the Company
and its distributors and agents will have to obtain required
regulatory registrations or approvals and otherwise comply with
extensive regulations regarding safety, efficacy and quality. These
regulations, including the requirements for registrations or approvals
and the time required for regulatory review, vary from country to
country. The Company has received ISO 9001 certification and the CE
Mark approval for sale of its current products. The CE Mark evidences
receipt of the regulatory approval necessary for commercialization in
European Union countries and eliminates the requirement to obtain
individual country approvals. There can be no assurance that the
Company will obtain future regulatory registrations or approvals in
other such countries or that it will not be required to incur
significant costs in obtaining or maintaining its foreign regulatory
registrations or approvals. Delays in receipt of these registrations
or approvals to market its products under development, failure to
receive these clearances or approvals, or future loss of previously
received registrations or approvals could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Impact of the Year 2000 Issue
The Year 2000 Issue is the result of computer programs written
using two digits rather than four to define the applicable year. Any
of the Company's computer programs that have date-sensitive software
11
may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations
causing disruptions of operations, including, among other things, a
temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
Based on a preliminary assessment, the Company believes that
there will be no material impact on the operations of the Company due
to the Year 2000 Issue. In late 1996 the Company acquired its
manufacturing, order entry, finance and network software from third
party vendors that have certified such software to be Year 2000
compliant. The Company has no custom software which requires
modification. Virtually all of the computer hardware currently owned
by the Company is Year 2000 compliant and in any event will most
likely be replaced before the year 2000 in the normal course of
business.
Results of Operations
Three months ended April 3, 1998 compared to the three months
ended March 28, 1997.
Net sales increased 40% to $3.0 million in the three months ended
April 3, 1998 compared to $2.1 million in the three months ended March
28, 1997. The increase in net sales was due primarily to a 130%
increase in unit shipments of the CTS MIDCAB System and Access MV
System offset by a 36% drop in the average selling price per unit.
Gross profit increased to $1.4 million (46% of net sales) in the
three months ended April 3, 1998 compared to $640,000 (30% of net
sales) in the same period last year. This improvement in gross profit
is primarily due to lower material costs per unit and higher
production volumes which resulted in increased manufacturing
efficiencies.
Research and development expenses in the three months ended April
3, 1998 were $2.7 million compared to $2.1 million in the three months
ended March 28, 1997. This increase was due to an increase in
research and development staff, facility costs, increased expenditures
related to the continuing development and prototyping of the
instruments associated with the OPCAB System, Modular MIDCAB System
and Ceres Saphenous Vein Harvesting System, cannulation systems and
valve attachment products. The Company expects that research and
development expenses will continue at higher levels in 1998 when
compared to 1997.
The Company has entered into development and licensing
agreements, and expects to enter into additional agreements in the
future, that require milestone payments which are tied to certain
events. The timing of these milestone payments is uncertain and could
have a material impact on the operating results in the quarter and
year in which they are expensed. No such milestone payments were
expensed in either the three months ended April 3, 1998 or March 28,
1997.
12
Sales, marketing, general and administrative expenses increased
to $5.1 million in the three months ended April 3, 1998 compared to
$4.3 million in the same period last year. This increase was due
primarily to additional sales and marketing personnel and the costs
associated with the support of a larger field sales organization. The
Company expects that sales and marketing and administrative expenses
will continue at higher levels in 1998 when compared to 1997.
The Company has recorded deferred compensation of $14.6 million,
less cancellations of $1.9 million, for the difference between the
option exercise price or restricted stock purchase price and the
deemed fair value of the Company's Common Stock for options granted
and restricted stock sold in 1995 and early 1996 and the deemed fair
value of the Company's Common Stock for options granted to non-
employees since inception. The deferred compensation is being
amortized to operating expenses over the related vesting period of the
shares (one to four years) and will, therefore, continue to have an
adverse effect on the Company's results of operations through 2000.
Amortization of deferred compensation charged to operating expenses in
the three months ended April 3, 1998 totaled $483,000 compared to
$562,000 for the same period last year.
Net interest income decreased to $698,000 in the three months
ended April 3, 1998 compared to $1.0 million in the same period last
year. This decrease was primarily due to lower average cash and
investment balances.
Liquidity and Capital Resources
Since inception, the Company has financed its operations
primarily from the sale of equity securities. As of April 3, 1998,
the Company had raised approximately $90.4 million (net of stock
issuance costs) from the sale of equity securities. As of April 3,
1998, cash, cash equivalents and available-for-sale securities totaled
$54.7 million. The Company's cash used in operations was $5.6 million
for the three months ended April 3, 1998, reflecting expenditures made
primarily to continue research and development and sales and marketing
activities, and to support its administrative infrastructure. The
Company also spent $485,000 for the purchases of property and
equipment in the three months ended April 3, 1998.
The Company plans to finance its operations principally from
existing cash, cash equivalents and available-for-sale securities and
interest thereon, product revenues and, to the extent available, lines
of credit. The Company currently has an agreement with a bank for a
$5.0 million line of credit, fully secured by cash, cash equivalents
and available-for-sale securities, of which $3.4 million is available
at April 3, 1998. The Company believes that its existing cash
balances and available-for-sale securities and interest thereon,
credit line and product revenues will be sufficient to fund its
operations through 1999. The Company's capital requirements, and the
availability of product revenues, depend on numerous factors,
including the progress of the Company's product development programs,
the receipt of and the time required to obtain regulatory clearances
13
or approvals, the resources the Company devotes to developing,
manufacturing and marketing its products, the extent to which the
Company's products receive market acceptance, and other factors. The
Company expects to devote substantial capital resources to research
and development, to support a direct sales force and marketing
operation in the United States and Germany and to continue to support
its manufacturing capacity and facilities. Consequently, the Company
may be required to raise additional funds through public or private
financing, collaborative relationships or other arrangements. There
can be no assurance that the Company will not require additional
funding or that such additional funding, if needed, will be available
on terms attractive to the Company, or at all, which could have a
material adverse effect on the Company's business, financial condition
and results of operations. Any additional equity financing may
be dilutive to stockholders, and debt financing, if available, may
involve restrictive convenants.
At April 3, 1998, the Company had approximately $31.6 million in
federal and $29.3 million in state net operating loss carryforwards,
which will expire in the years 2001 through 2018, if not utilized.
Utilization of federal income tax carryforwards is subject to certain
limitations under Section 382 of the Internal Revenue Code of 1986.
These annual limitations may result in expiration of net operating
loss carryforwards and research and development credits before they
can be fully utilized.
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income,"
effective January 3, 1998. This statement requires the disclosure of
comprehensive income and its components in a full set of general-
purpose financial statements. Comprehensive income is defined as net
income plus revenues, expenses, gains and losses that, under generally
accepted accounting principles, are excluded from net income. The
components of comprehensive income which are excluded from net income
are not significant, individually or in aggregate, and therefore, no
separate statement of comprehensive income has been presented.
Factors Affecting Results of Operations
Highly Competitive Market; Risk of Alternative Therapies; Risk of
Reuse. The medical device industry and the market for treatment of
cardiovascular disease, in particular, are characterized by rapidly
evolving technology and intense competition. A number of competitors,
including Johnson & Johnson, Boston Scientific Corporation, Guidant
Corporation and Medtronic, Inc., are currently marketing stents,
catheters, lasers, drugs and other less invasive means of treating
cardiovascular disease. Many of these less invasive treatments, as
well as CABG surgery, are widely accepted in the medical community and
have a long history of safe and effective use. Many of the Company's
competitors have substantially greater capital resources, name
recognition and expertise in and resources devoted to research and
development, manufacturing and marketing and obtaining regulatory
clearances or approvals. Furthermore, competition in the emerging
market for minimally invasive cardiac surgery is intense and is
expected to increase. Heartport, Inc., Medtronic, Inc., Johnson &
14
Johnson, Guidant Corporation, Baxter International, Inc. and United
States Surgical Corp. are marketing or have announced that they are
developing products to be used in MICS procedures. There can be no
assurance that MICS will replace any current treatments.
Additionally, even if MICS is widely adopted, there can be no
assurance that the Company's competitors will not succeed in
developing or marketing alternative procedures and technologies,
competing devices to perform the same procedure, or therapeutic drugs
that are more effective than the Company's products or that render the
Company's products or technologies obsolete or not competitive. In
addition, there can be no assurance that existing products for other
surgical uses will not be used in MICS procedures. Furthermore, sales
of the Company's products could be adversely affected by reuse,
notwithstanding the instructions in the Company's clinical protocols
and product labeling indicating that each of the components of the
Company's products is a single-use device. Such competition or reuse
could have a material adverse effect on the Company's business,
financial condition and results of operations.
Limited Sales, Marketing and Distribution Experience. The
Company currently has a small sales and marketing organization when
compared to most of its competitors. The Company sells its products
in the United States and in Germany through a direct sales force. In
certain other international markets, the Company sells its products
through distributors. There can be no assurance that the Company will
be able to build a larger direct sales force or marketing
organization, that maintaining a direct sales force or marketing
organization will be cost effective, or that the Company's sales and
marketing efforts will be successful. There can be no assurance that
the Company will be able to maintain agreements with distributors, or
that such distributors will devote adequate resources to selling the
Company's products. Since the Company has entered into distribution
agreements for the sale of its products in certain countries, it will
be dependent upon the efforts of these third parties, and there can be
no assurance that such efforts will be successful. Failure to maintain
or grow an effective direct sales and marketing organization or to
maintain effective distributors could have a material adverse effect
on the Company's business, financial condition and results of
operations.
Dependence on Licenses, Patents and Proprietary Technology. The
Company's ability to compete effectively will depend in part on its
ability to develop and maintain proprietary aspects of its technology.
The Company owns six issued United States patents. None of the issued
patents contains claims that protect the Company's current products.
In January 1998, the Company received a formal notice from the United
States Patent and Trademark Office ("USPTO") indicating that all
claims are allowable in its patent application covering the mechanical
stabilization aspects of the Company's products. However, the USPTO
also notified the Company that the prosecution of this application is
15
suspended for up to six months due to a potential interference
proceeding. The Company is the licensee of a United States patent for
a heart valve insertion and stapling device and a United States patent
application for bipolar electrosurgical scissors that are used in the
CTS Saphenous Vein Harvesting System. The Company also has an option
for a patent application covering methods for vessel harvesting. The
Company has forty pending U.S. patent applications and various foreign
patent applications pending. There can be no assurance that any issued
patents or any patents which may be issued as a result of the
Company's licensed patent applications or pending United States and
foreign patent applications will provide any competitive advantages
for the Company's products or that they will not be successfully
challenged, invalidated or designed around in the future. In addition,
there can be no assurance that competitors, many of which have
substantial resources and have made substantial investments in
competing technologies, will not seek to apply for and obtain patents
that will prevent, limit or interfere with the Company's ability to
make, use and sell its products either in the United States or in
international markets.
The medical device industry has been characterized by extensive
litigation regarding patents and other intellectual property rights,
and companies in the medical device industry have employed
intellectual property litigation to gain a competitive advantage.
There can be no assurance that the Company will not become subject to
patent infringement claims or litigation or interference proceedings
declared by the USPTO to determine the priority of inventions.
The defense and prosecution of intellectual property suits, USPTO
interference proceedings and related legal and administrative
proceedings are both costly and time-consuming. Litigation may be
necessary to enforce patents issued to the Company, to protect trade
secrets or know-how owned by the Company or to determine
the enforceability, scope and validity of the proprietary rights of
others. Any litigation or interference proceedings will result in
substantial expense to the Company and significant diversion of effort
by the Company's technical and management personnel. An adverse
determination in litigation or interference proceeding to which the
Company may become a party, including any litigation that may arise
against the Company as described in "Potential Litigation" below,
could subject the Company to significant liabilities to third parties
or require the Company to seek licenses from third parties or prevent
the Company from selling its products in certain markets, or at all.
Costs associated with settlements, licensing and similar arrangements,
may be substantial and could include ongoing royalties. Furthermore,
there can be no assurance that the necessary licenses would be
available to the Company on satisfactory terms, if at all. Adverse
determinations in a judicial or administrative proceeding or failure
to obtain necessary licenses could prevent the Company from
manufacturing and selling its products, which would have a material
adverse effect on the Company's business, financial condition and
results of operations.
16
Congress enacted legislation, which became effective October 1,
1996, that places certain restrictions on the ability of medical
device manufacturers to enforce certain patent claims, relating to
surgical and medical methods, against medical practitioners. Such
limitations on the enforceability of patent claims, relating to
medical and surgical methods, against medical practitioners could have
a material adverse effect on the Company's ability to protect its
proprietary methods and procedures against medical practitioners.
In addition to patents, the Company relies on trade secrets and
proprietary know-how, which it seeks to protect, in part, through
confidentiality and proprietary information agreements. There can be
no assurance that such confidentiality or proprietary information
agreements will not be breached, that the Company would have adequate
remedies for any breach, or that the Company's trade secrets will not
otherwise become known to or be independently developed by
competitors.
Continuing Government Regulation. Regulatory clearances or
approvals, if granted, may include significant limitations on the
indicated uses for which the Company's products may be marketed. FDA
enforcement policy strictly prohibits the marketing of FDA cleared or
approved medical devices for unapproved uses. In addition, the
Company's manufacturing processes will be required to comply with the
Good Manufacturing Practices ("GMP") regulations of the FDA. These
regulations include design, testing, production, control,
documentation and other requirements. Enforcement of GMP regulations
has increased significantly in the last several years, and the FDA has
publicly stated that compliance will be more strictly scrutinized. The
Company's facilities and manufacturing processes, as well as those of
any future third-party suppliers, will be subject to periodic
inspection by the FDA, the California Department of Health Services
and other agencies. To date, the Company has only undergone inspection
for ISO 9001 certification. Failure to comply with these and other
applicable regulatory requirements could result in, among other
things, warning letters, fines, injunctions, civil penalties, recall
or seizure of products, total or partial suspension of production,
refusal of the government to grant premarket clearance or premarket
approval for devices, withdrawal of clearances or approvals and
criminal prosecution, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
Potential Litigation. Heartport, Inc. (formerly Stanford
Surgical Technologies, Inc.), the former employer of the Company's
founder and Chief Technical Officer, Charles S. Taylor, has alleged in
certain correspondence in late 1995 and again in September 1997 that
Mr. Taylor and the Company may have misappropriated trade secrets of
the former employer and breached confidentiality obligations to the
former employer. The former employer has also claimed in such
correspondence an ownership interest in certain developments and
products of the Company. The Company has agreed to provide for the
defense of Mr. Taylor in the event that litigation is commenced.
17
Litigation is subject to inherent uncertainties, especially in cases
where complex technical issues are decided by a lay jury. Accordingly,
no assurance can be given that if a lawsuit is commenced it would not
be decided against the Company. Such an adverse determination could
have a material adverse effect upon the Company's business, financial
condition and results of operations.
Potential Component Shortages; Dependence on Sole Sources of
Supply. The Company contracts with third parties for the manufacture
of certain components or the performance of certain processes involved
in the manufacturing cycle. Some of these components and processes may
only be available from single-source vendors. Any prolonged supply
interruption or yield problems experienced by the Company due to a
single-source vendor could have a material adverse effect on the
Company's ability to manufacture its products until a new source of
supply is qualified. Many of the Company's components are molded parts
that require custom tooling which is manufactured and maintained by
third party vendors. Should such custom tooling be damaged it could
result in a supply interruption that could have a material adverse
effect on the Company's ability to manufacture its products until a
new tool is manufactured. Also, the Company's new product development
efforts and the timeliness of new product launches could be
significantly affected by the tooling vendor's ability to meet
completion and quality commitments on the manufacture of custom
tooling. As the Company increases production, it may from time to
time experience lower than anticipated yields or production
constraints, resulting in delayed product shipments, which could have
a material adverse effect on the Company's business, financial
condition and results of operation.
Limited Manufacturing Experience; Scale-up Risk. The Company has
no experience manufacturing its products in the volumes that would be
necessary for the Company to achieve profitable operations. There can
be no assurance that reliable, high-volume manufacturing can be
established or maintained at commercially reasonable costs. Companies
often encounter difficulties in scaling up production, including
problems involving production yield, quality control and assurance,
and shortages of qualified personnel. In addition, the Company's
manufacturing facilities will be subject to GMP regulations,
international quality standards and other regulatory requirements.
Difficulties encountered by the Company in manufacturing scale-up or
failure by the Company to implement and maintain its facilities in
accordance with GMP regulations, international quality standards or
other regulatory requirements could entail a delay or termination of
production, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
Uncertainty Relating to Third-Party Reimbursement. In the United
States, health care providers, such as hospitals and physicians, that
purchase medical devices, such as the Company's products, generally
rely on third-party payors, principally Medicare, Medicaid and private
health insurance plans, to reimburse all or part of the cost of the
procedure in which the medical device is being used. Reimbursement for
cardiovascular surgery, including CABG surgery, using devices that
18
have received FDA approval has generally been available in the United
States. In addition, certain health care providers are moving toward a
managed care system in which such providers contract to provide
comprehensive health care for a fixed cost per person. The Company is
unable to predict what changes, if any, may be made in the
reimbursement methods utilized by third-party health care payors. The
Company could be adversely affected by changes in reimbursement
policies of government or private health care payors, particularly to
the extent any such changes affect reimbursement for the procedures in
which the Company's products are intended to be used. Failure by
physicians, hospitals and other potential users of the Company's
products to obtain sufficient reimbursement from health care payors
for the procedures in which the Company's products are intended to be
used or adverse changes in government and private third-party payors'
policies toward reimbursement for such procedures could have a
material adverse effect on the Company's business, financial condition
and results of operations.
Market acceptance of the Company's products in international
markets is dependent, in part, upon the availability of reimbursement
within prevailing health care payment systems. Reimbursement and
health care payment systems in international markets vary
significantly by country, and include both government sponsored health
care and private insurance. The Company intends to seek international
reimbursement approvals, although there can be no assurance that any
such approvals will be obtained in a timely manner, if at all, and
failure to receive international reimbursement approvals could have a
material adverse effect on market acceptance of the Company's products
in the international markets in which such approvals are sought.
Product Liability Risk; Limited Insurance Coverage. The development,
manufacture and sale of medical products entail significant risk of
product liability claims and product recalls. The Company's current
product liability insurance coverage limits are $3,000,000 per
occurrence and $3,000,000 in the aggregate, and there can be no
assurance that such coverage limits are adequate to protect the
Company from any liabilities it might incur in connection with the
development, manufacture and sale of its products. In addition, the
Company may require increased product liability insurance coverage as
product sales increase. Product liability insurance is expensive and
in the future may not be available to the Company on acceptable terms,
if at all. A successful product liability claim or series of claims
brought against the Company in excess of its insurance coverage, or a
product recall, could have a material adverse effect on the Company's
business, financial condition and results of operations.
19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
The following information is provided as an amendment to the
initial report on Form SR, "Report of Sales and Securities and
Use of Proceeds Therefrom", regarding the use of proceeds from
the sale of securities under the Company's Registration Statement
Form S-1 (333-1840), which was declared effective on April 18,
1996 (CUSIP number 141907). The information provided is for the
period from April 18, 1996 through April 3, 1998.
Use of Proceeeds Amount
----------------- ---------
Construction of plant, building and facilities $ 0
Purchase and installation of machinery and
equipment 5,245,000
Purchase of real estate 0
Acquisition of other businesses 0
Repayment of indebtedness 0
Working capital 2,902,000
Cost of operation 24,710,000
Temporary Investment
--------------------
Cash 913,000
Commercial paper, notes and bonds $50,413,000
All amounts above represent estimates of direct or indirect
payments to third parties.
The amounts below were paid directly to officers of the Company.
Use of Proceeds Amount
--------------- ---------
Loans to officers $ 748,000
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
20
Item 6. Exhibits and Reports on Form 8 - K.
a) Exhibits
Exhibit
No. Description
------- ------------------------------------------
3.2(1) Restated Certificate of Incorporation.
3.3(7) Bylaws (as ammended).
3.4(4) Certificate of Designations of Rights,Preferences
and Privileges of Series A Participating Preferred
Stock.
3.5(4) Preferred Shares Rights Agreement, dated as of
February 14, 1997.
3.6(7) Certificate of Amendment to Restated Certificate
of Incorporation.
4.1(1) Specimen Common Stock Certificate.
10.1(1) Form of Indemnification Agreement between the
Company and each of its directors and officers
10.2(7) Incentive Stock Plan and forms of Agreements
thereunder (as amended).
10.3(1) Director Option Plan and form of Director Stock
Option Agreement thereunder.
10.4(1) Employee Stock Purchase Plan and forms of
agreements thereunder.
10.5(5) Nonstatutory Stock Option Plan and form of Non-
statutory Stock Option Agreement thereunder (as amended).
10.6(1) Form of Employment, Confidential Information and
Invention Assignment Agreement.
10.8(1) Consulting Agreement, dated June 30, 1995, between
the Company and Federico Benetti, M.D.
10.9(1) Assignment Agreement, dated June 30, 1995 (as
amended by Amendment Agreement dated August 31, 1995)
between the Company and Federico Benetti, M.D.
10.10(1) Employment Letter Agreement, dated September 5, 1995,
between the Company and Charles S. Taylor.
10.11(1) Assignment Agreement, dated September 7, 1995, between
the Company and Charles S. Taylor.
10.12(1) Shareholder Rights Agreement dated September 8,1995
(as amended January 3, 1996) between the Company and
certain holders of the Registrant's securities.
10.13(1) Letter Agreement regarding Heartport trade secret
allegations, dated October 11, 1995, between the
Company and Charles S. Taylor.
10.14(1) Assignment, Assumption of Lease and Consent, dated
November 9, 1995, between the Company and Cardio-
vascular Concepts, Inc. ("CVC") for the premises
located at 3260 Alpine Road, Portola Valley,
California 94028.
10.17(1) Consent to Assignment, dated December 22, 1995,
among the Company, Viking Partners, Inc. ("Viking"),
CVC and Fogarty Engineering, Inc. for the premises
located at 3260 Alpine Road, Portola Valley,
California 94028.
21
10.19(1) First Amendment to Assigment, Assumption of Lease
and Consent, dated December 22, 1995, between the
Company and CVC for the premises located at 3260
Alpine Road, Portola Valley, California 94028
10.21(1) Consulting Agreement, dated February 21, 1996,
between the Company and Thomas J. Fogarty, M.D.
10.22(1) Development and License Agreement, dated February
19, 1996, between the Company and Enable Medical
Corporation.
10.23(1) Employment Letter Agreement, dated March 15, 1996,
between the Company and Steve M. Van Dick.
10.24(1) Lease dated March 29, 1996, for space located at
10600 North Tantau Avenue, Cupertino, California
between the Company and Spieker Properties, L.P.
10.27(2) Employment Agreement, dated April 19, 1996, between
the Company and Steve Van Dick.
10.28(2) Promissory Note for $300,000 dated April 29, 1996,
between the Company and Thomas Afzal.
10.29(2) Promissory Note for $35,000 dated May 20, 1996,
between the Company and Michael Billig.
10.30(2) Promissory Note for $55,000 dated June 5, 1996,
between the Company and Thomas Afzal.
10.31(3) Promissory Note for $750,000 and Security
Agreement dated August 16, 1996, between the Company
and Richard Ferrari.
10.32(5) Promissory Note for $200,000 dated December 3, 1996,
between the Company and Steve Van Dick.
10.33(6) Employment Letter Agreement, dated February 25, 1997,
between the Company and Jeffrey Gold.
10.34(7) Employment Letter Agreement, dated July 17, 1997,
between the Company and Geoffrey Dillon.
10.35(7) Employment Letter Agreement, dated November 24,
1997, between the Company and Richard Lotti.
27.1 Financial Data Schedule
- ------------------
(1) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Registration Statement on
Form S-1 (Registration No. 333-1840).
(2) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-Q for the period
ended June 30, 1996.
(3) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-Q for the period
ended September 30, 1996.
(4) Incorporated herein by reference to the Company's Registration
Statement on Form 8-A, filed with the Securites and Exchange
Commission on February 28, 1997.
22
(5) Incorporate herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-K for the period
ended December 31, 1996.
(6) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-Q for the period
ended July 27, 1997.
(7) Incorporate herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-K for the period
ended January 2, 1998.
b) Reports on Form 8 - K
None
23
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.
Date: May 12, 1998 CARDIOTHORACIC SYSTEMS, INC.
/S/ Richard M. Ferrari
-----------------------------
Richard M. Ferrari
President and Chief Executive
Officer
/S/ Steve Van Dick
-----------------------------
Steve Van Dick
Vice President, Finance and Chief
Financial Officer (Principal
Financial and Accounting Officer)
24
EXHIBIT INDEX
Exhibit
Number Exhibit Description
- ---------- -----------------------------------
27.1 Financial Data Schedule
25