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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-Q
/X/ Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the quarterly period ended July 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 (I.R.S. Employer
of 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 August 5, 1998, there were 13,933,716 shares of the Registrant's
Common Stock outstanding.
==============================================================================
1
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CARDIOTHORACIC SYSTEMS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1. Financial Statements
Consolidated Condensed Balance Sheets as of
July 3, 1998 and January 2, 1998 3
Consolidated Condensed Statements of
Operations for the three and six months
ended July 3, 1998 and June 27, 1997 4
Consolidated Condensed Statements of Cash
Flows for the six months ended July 3, 1998
and June 27, 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 18
SIGNATURES 20
2 /Page
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED BALANCE SHEET
July 3, January 2,
1998 1998
----------- ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 9,098,000 $ 4,681,000
Available-for-sale securities 30,067,000 52,105,000
Trade accounts receivables, net 1,993,000 1,369,000
Notes receivable from officers 87,000 87,000
Inventories, net 771,000 641,000
Interest receivable 639,000 1,158,000
Prepaid expenses and other current assets 449,000 449,000
------------ ------------
Total current assets 43,104,000 60,490,000
Property and equipment, net 3,640,000 3,613,000
Available-for-sale securities 11,032,000 4,048,000
Notes receivable from officers 1,119,000 1,073,000
Other assets 74,000 52,000
------------ ------------
Total assets $ 58,969,000 $ 69,276,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Equipment note, current portion $ 472,000 $ 410,000
Accounts payable 1,320,000 779,000
Accrued liabilities 4,155,000 4,430,000
------------ ------------
Total current liabilities 5,947,000 5,619,000
Bank borrowings 1,557,000 1,557,000
Equipment note, less current portion 1,686,000 1,966,000
------------ ------------
Total liabilities 9,190,000 9,142,000
------------ ------------
Stockholders' equity:
Common stock, par value $0.001 14,000 14,000
Additional paid-in capital 103,361,000 103,156,000
Deferred compensation, net (2,589,000) (3,614,000)
Unrealized gain on available-for-sale
securities 12,000 17,000
Accumulated deficit (51,019,000) (39,439,000)
------------ ------------
Total stockholders' equity 49,779,000 60,134,000
------------ ------------
Total liabilities and stockholders' equity $ 58,969,000 $ 69,276,000
============ ============
See accompanying notes. 3 /Page
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS
(unaudited)
Three Months Ended Six Months Ended
July 3, 1998 June 27, 1997 July 3, 1998 June 27, 1997
------------ ------------- ------------- -------------
Net sales $ 3,817,000 $ 2,836,000 $ 6,779,000 $ 4,948,000
Cost of sales 1,699,000 1,744,000 3,302,000 3,216,000
------------ ------------- ------------- ------------
Gross profit 2,118,000 1,092,000 3,477,000 1,732,000
Operating Expenses:
Research & Devel. 2,675,000 2,396,000 5,352,000 4,447,000
Sales, marketing,
administration 5,867,000 4,497,000 10,997,000 8,806,000
------------ ------------- ------------- ------------
Total operating
expenses 8,542,000 6,893,000 16,349,000 13,253,000
------------ ------------- ------------- ------------
Loss from operations (6,424,000) (5,801,000) (12,872,000) (11,521,000)
Interest income,net 594,000 986,000 1,292,000 2,002,000
------------ ------------- ------------- ------------
Net loss $(5,830,000) $(4,815,000) $(11,580,000) $(9,519,000)
============ ============= ============= ============
Net loss per common
share and per common
share-assuming
dilution $ (0.42) $ (0.36) $ (0.84) $ (0.71)
============ ============ ============= ============
Shares used in computing
net loss per common share
and per common share
-assuming dilution 13,890,000 13,480,000 13,829,000 13,419,000
============= ============= ============= ============
See accompanying notes.
4 /Page
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
(unaudited)
Six Months Ended Six Months Ended
July 3, 1998 June 27, 1997
------------------ ----------------
OPERATING ACTIVITIES
Net loss $ (11,580,000) $ (9,519,000)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation & amortization 940,000 460,000
Amortization of notes receivable from officers 34,000 56,000
Amortization of deferred compensation 958,000 1,135,000
Allowance for bad debts and product returns 62,000 80,000
Changes in operating assets & liabilities:
Notes receivable from officers (80,000) -
Trade accounts receivable (686,000) (1,790,000)
Inventory (130,000) (910,000)
Interest receivable 519,000 34,000
Prepaid expenses and other current assets - (363,000)
Other assets (22,000) (7,000)
Accounts payable 541,000 190,000
Accrued liabilities (275,000) 411,000
-------------- -------------
Net cash used in operating activities (9,719,000) (10,223,000)
-------------- ------------
INVESTING ACTIVITIES
Purchases of property and equipment (967,000) (822,000)
Purchase of available-for-sale securities (29,312,000) (37,193,000)
Proceeds from maturities of available-for-
sale securities 44,361,000 46,102,000
-------------- -------------
Net cash provided by investing activities 14,082,000 8,087,000
-------------- -------------
FINANCING ACTIVITIES
Proceeds from equipment note - 850,000
Bank borrowings - 1,200,000
Repayment of equipment note (218,000) (216,000)
Proceeds from issuance of common stock 272,000 610,000
-------------- -------------
Net cash provided by financing activities 54,000 2,444,000
-------------- -------------
Net increase in cash & cash equivalents 4,417,000 308,000
Cash and cash equivalents at beginning of period 4,681,000 5,184,000
-------------- -------------
Cash and cash equivalents at end of period $ 9,098,000 $ 5,492,000
============== =============
See accompanying notes.
5 /Page
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
July 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.
6 /Page
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(continued)
July 3, 1998
(Unaudited)
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.
At July 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 $ 1,805,000 $ 1,000 $ -- $ 1,806,000
Gov't agency notes and bonds 12,912,000 6,000 (5,000) 12,913,000
Corporate notes and bonds 26,370,000 12,000 (2,000) 26,380,000
----------- ----------- ----------- -----------
$41,087,000 $ 19,000 $ (7,000) $41,099,000
============ =========== =========== ===========
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 July 3, 1998 are
shown below:
Amortized Estimated
Cost Fair Value
------------ ------------
Less than one year $ 30,057,000 $ 30,067,000
Due in one to two years 11,030,000 11,032,000
------------ ------------
$ 41,087,000 $ 41,099,000
============ ============
7 /Page
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
July 3, 1998
(Unaudited)
Note 4. Inventories
Inventories, net consist of the following:
July 3, January 2,
1998 1998
--------- ----------
Raw materials $ 268,000 $ 188,000
Work-in-process 249,000 203,000
Finished goods 254,000 250,000
---------- ----------
$ 771,000 $ 641,000
========== ==========
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 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 Plans
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.
In May 1998, the shareholders approved an increase of 600,000 shares in the
number of shares reserved for issuance under the Company's Incentive Stock
Plan, bringing the total number of shares issuable under the Incentive
Stock Plan to 2,800,000.
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 /Page
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 family of products ("Company's
products" or "Company's current products"). The Company has experienced
operating losses since its inception, and, as of July 3, 1998, the Company
had an accumulated deficit of approximately $51,019,000. The Company expects
its operating losses to continue at least through 1999 as it expends sub-
stantial resources to continue development of the Company's products, obtain
additional regulatory clearances or approvals, continue to market, sell, and
manufacture its products, support its finance and administrative organ-
izations and conduct further research and development. There can be no
assurance that the Company's products will gain enough commercial acceptance
that will allow the Company to generate the revenues necessary 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. 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 pro-
9 /Page
cedures, 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 MICS as compared to other currently available treat-
ments. 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 14,600 systems in the six
quarters ended July 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.
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 current products and 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.
10 /Page
In order for the Company to market its products 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 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 and six months ended July 3, 1998 compared to the three and six
months ended June 27, 1997.
Net sales increased 35% to $3.8 million and 37% to $6.8 million in
the three and six months ended July 3, 1998, respectively when compared to
the same periods in fiscal year 1997. The increase in net sales was due
primarily to a 94% and 103% increase in unit shipments of the CTS MIDCAB
System and OPCAB family of products for the three and six months ended July
3, 1998, respectively over the three and six months ended June 27, 1997,
respectively. These increases in unit shipments were offset by a 24% and 28%
drop in the average selling price per procedural unit for the three and six
months ended July 3, 1998, respectively.
11 /Page
Gross profit increased to $2.1 million (55% of net sales) in the three
months ended July 3, 1998 compared to $1.1 million (39% of net sales) in the
same period last year. For the six months ended July 3, 1998 gross profit
increased to $3.5 million (51% of net sales) compared to $1.7 million (35%
of net sales) for the six months ended June 27, 1997. The improvement in
gross profit as a percent of net sales 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 and six months ended July
3, 1998 were $2.7 million and $5.4 million, respectively compared to $2.4
million and $4.4 million in the three and six months ended June 27, 1997,
respectively. 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
family of products, 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 may
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. Milestone payments totaling
$115,000 were expensed in the three and six months ended July 3, 1998.
No milestone payments were made in the same periods last year.
Sales, marketing, general and administrative expenses increased to $5.9
million and $11.0 million in the three and six months ended July 3, 1998,
respectively compared to $4.5 million and $8.8 million in the same periods
last year, respectively. This increase was due primarily to additional sales
and marketing personnel, the costs associated with the support of a larger
field sales organization and higher surgeon training costs. 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 exer-
cise 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 for the deemed fair value of the Company's Common Stock
for options granted to non-employees since inception. The deferred compen-
sation 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 and six months ended July 3, 1998 totaled $475,000 and $958,000,
respectively compared to $573,000 and $1.1 million for the same periods
last year, respectively.
12 /Page
Net interest income decreased to $594,000 and $1.3 million in the three
and six months ended July 3, 1998, respectively compared to $1.0 million and
$2.0 million in the same periods last year, respectively. 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 July 3, 1998, the Company had raised
approximately $90.6 million (net of stock issuance costs) from the sale of
equity securities. As of July 3, 1998, cash, cash equivalents and available-
for-sale securities totaled $50.2 million. The Company's cash used in
operations was $9.7 million for the six months ended July 3, 1998, reflecting
expenditures made primarily to continue research and development and
sales and marketing activities, and to support its administrative infra-
structure. The Company also spent $967,000 for the purchases of property
and equipment in the six months ended July 3, 1998.
The Company plans to finance its operations principally from existing
cash, cash equivalents and available-for-sale securities and interest there-
on, 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 July 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 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 July 3, 1998, the Company had approximately $36.7 million in federal
and $31.8 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.
13 /Page
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 treat-
ments, 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, manu-
facturing 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. Medtronic, Inc., Genzyme
Surgical Products Corp., Johnson & Johnson, Guidant Corporation, Baxter
International, Inc., Heartport, 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
14 Page/>
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 seven
issued United States patents. 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 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 electro-
surgical 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-four pending U.S. patent appli-
cations 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 inter-
ference proceeding to which the Company may become a party, including any
15 /Page
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.
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 un-
approved 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 undergone inspection with a notified body in connection with the
receipt of ISO 9001 certification and with the California Department of Health
Services in obtaining a California Device Manufacturing license. 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.
16 /Page
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.
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 manu-
facturing 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.
17 /Page
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 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 govern-
ment 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 inter-
national 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.
18 /Page
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 July 3, 1998.
Use of Proceeds Amount
--------------- -------
Construction of plant, building and facilities 0
Purchase and installation of machinery and equipment 5,727,000
Purchase of real estate 0
Acquisition of other businesses 0
Repayment of indebtedness 0
Working capital 3,088,000
Cost of operations 28,346,000
Temporary Investment
--------------------
Cash 5,855,000
Commercial paper, notes and bonds $41,099,000
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 $816,000
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of shareholders was held on May 19, 1998.
(b) The matters voted upon at the meeting and results of the
voting with respect to those matters were as follows:
19 /Page
(1) Election of two Class I directors:
For Withheld
------------ ----------
Thomas J. Fogarty, M.D. 12,313,498 137,992
Charles S. Taylor 12,313,498 137,992
(2) Approve amendment to the Incentive Stock Plan to increase
the number of shares of Common Stock reserved for issuance
thereunder by 600,000 shares to a new total of 2,800,000 shares.
For: 11,468,187 Against: 958,793 Abstain: 24,510
(3) To consider a stockholder proposal by the State of
Wisconsin Investment Board to amend the Company's Bylaws to
prohibit the repricing of stock options without stockholder
approval.
For: 2,402,939 Against: 6,331,525 Abstain: 48,767
(4) Confirm appointment of Coopers & Lybrand L.L.P. as the
independent auditors of the Company for the fiscal year ending
January 1, 1999.
For: 12,425,728 Against: 9,897 Abstain: 15,865
The foregoing matters are described in detail in the Company's
definitive proxy statement dated April 9, 1998 for the Annual
Meeting of Shareholders held May 19, 1998.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8 - K.
a) Exhibits
Exhibit
No. Description
-------- ------------------------------------
27.1 Financial Data Schedule
b) Reports on Form 8-K
None
20
/Page
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: August 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)
21 /Page