=============================================================================
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 October 2, 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 November 3, 1998, there were 14,209,428 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
October 2, 1998 and January 2, 1998 3
Consolidated Condensed Statements of Operations
for the three and nine months ended October 2,
1998 and September 26, 1997 4
Consolidated Condensed Statements of Cash Flows
for the nine months ended October 2, 1998 and
September 26, 1997 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION 21
SIGNATURES 23
2
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
October 2, 1998 January 2, 1998
--------------- ---------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 4,162,000 $ 4,681,000
Available-for-sale securities 28,922,000 52,105,000
Trade accounts receivable,net 2,256,000 1,369,000
Notes receivable from officers 87,000 87,000
Inventories, net 875,000 641,000
Interest receivable 508,000 1,158,000
Prepaid expenses and other current assets 636,000 449,000
-------------- --------------
Total current assets 37,446,000 60,490,000
Property and equipment, net 3,507,000 3,613,000
Available-for-sale securities 11,143,000 4,048,000
Notes receivable from officers 1,102,000 1,073,000
Other assets 79,000 52,000
-------------- --------------
Total assets $ 53,277,000 $ 69,276,000
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Equipment note, current portion $ 486,000 $ 410,000
Accounts payable 1,437,000 779,000
Accrued liabilities 4,298,000 4,430,000
-------------- --------------
Total current liabilities 6,221,000 5,619,000
Bank borrowings - 1,557,000
Equipment note, less current portion 1,540,000 1,966,000
-------------- --------------
Total liabilities 7,761,000 9,142,000
-------------- --------------
Stockholders' equity:
Common stock, par value $0.001 14,000 14,000
Additional paid-in capital 103,107,000 103,156,000
Deferred compensation, net (1,878,000) (3,614,000)
Unrealized gain on available-for-sale
securities 200,000 17,000
Accumulated deficit (55,927,000) (39,439,000)
-------------- --------------
Total stockholders' equity 45,516,000 60,134,000
-------------- --------------
Total liabilities and stockholders'
equity $ 53,277,000 $ 69,276,000
============== ==============
See accompanying notes.
3
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Nine Months Ended
October 2, September 26, October 2, September 26,
1998 1997 1998 1997
------------ ------------ ------------ -------------
Net sales $ 4,365,000 $ 1,629,000 $11,144,000 $ 6,577,000
Cost of sales 1,897,000 1,115,000 5,199,000 4,331,000
------------ ------------ ------------ -------------
Gross profit 2,468,000 514,000 5,945,000 2,246,000
------------ ------------ ------------ -------------
Operating expenses:
Research and
development 2,712,000 2,832,000 8,064,000 7,279,000
Sales, marketing,
gen'l & admin. 5,249,000 4,499,000 16,246,000 13,305,000
------------ ------------ ------------ -------------
Total operating
expenses 7,961,000 7,331,000 24,310,000 20,584,000
------------ ------------ ------------ -------------
Loss from operations (5,493,000) (6,817,000) (18,365,000) (18,338,000)
Interest income, net 585,000 920,000 1,877,000 2,922,000
------------ ------------ ------------ -------------
Net loss $(4,908,000) $(5,897,000) $(16,488,000) $(15,416,000)
============ ============ ============ =============
Net loss per common
share and per common share
assuming dilution $ (0.35) $ (0.44) $ (1.19) $ (1.15)
============ ============ ============= =============
Shares used in computing
net loss per common share and
per common share -
assuming dilution 14,018,000 13,528,000 13,892,000 13,456,000
============ ============ ============= ============
See accompanying notes.
4
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended Nine Months Ended
October 2, 1998 September 26, 1997
----------------- ------------------
Operating Activities
Net loss $ (16,488,000) $ (15,416,000)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 1,410,000 761,000
Amortization of notes receivable
from officers 51,000 84,000
Amortization of deferred compensation 1,411,000 1,695,000
Allowance for bad debts and product returns 101,000 170,000
Changes in operating assets and
liabilities:
Trade accounts receivable (988,000) (1,128,000)
Inventory (234,000) (964,000)
Interest receivable 650,000 (21,000)
Prepaid expenses and other current assets (187,000) (499,000)
Other assets (27,000) (7,000)
Accounts payable 658,000 290,000
Accrued liabilities (132,000) 678,000
------------- -------------
Net cash used in operating activities (13,775,000) (14,357,000)
------------- -------------
Investing Activities
Purchases of property and equipment (1,304,000) (1,726,000)
Notes receivable from officers (80,000) -
Purchase of available-for-sale securities (46,923,000) (50,679,000)
Proceeds from maturities of
available-for-sale securities 63,194,000 63,912,000
------------- -------------
Net cash provided by investing
activities 14,887,000 11,507,000
------------- -------------
Financing Activities
Proceeds from equipment note - 1,083,000
Bank borrowings - 1,200,000
Repayment of equipment note (350,000) (425,000)
Repayment of bank borrowings (1,557,000) -
Proceeds from issuance of common stock 276,000 614,000
------------- -------------
Net cash provided by (used in)
financing activiites (1,631,000) 2,472,000
------------- -------------
Net decrease in cash and cash equivalents (519,000) (378,000)
Cash and cash equivalents at
beginning of period 4,681,000 5,184,000
------------- -------------
Cash and cash equivalents at end
of period $ 4,162,000 $ 4,806,000
============= =============
See accompanying notes. 5
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
October 2, 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
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
October 2, 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 October 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 $10,767,000 $ 109,000 - $10,876,000
Corporate notes and bonds 29,098,000 91,000 - 29,189,000
----------- ---------- ----------- -----------
$39,865,000 $ 200,000 - $40,065,000
=========== ========== =========== ===========
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 October 2, 1998 are
shown below:
Amortized Estimated
Cost Fair Value
----------- -----------
Less than one year $28,860,000 $28,922,000
Due in one to two years 11,005,000 11,143,000
----------- -----------
$39,865,000 $40,065,000
=========== ===========
7
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
October 2, 1998
(Unaudited)
Note 4. Inventories
Inventories, net consist of the following:
October 2, January 2,
1998 1998
-------------- --------------
Raw materials $ 329,000 $ 188,000
Work-in-process 355,000 203,000
Finished goods 191,000 250,000
-------------- --------------
$ 875,000 $ 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 stockholders 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.
In October 1998, the stockholders approved the adoption of the 1998
Employee Stock Purchase Plan and the reservation of 250,000 shares of common
stock for sale thereunder.
8
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
October 2, 1998
(Unaudited)
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 (loss) plus revenues, expenses,
gains and losses that, under generally accepted accounting principles, are ex-
cluded from net income (loss). The components of comprehensive income which
are excluded from net income (loss) are not significant, individually or in
aggregate, and therefore, no separate statement of comprehensive income has
been presented.
In June 1997, the Financial Accounting Standards Board issued Statement
No.131 (FASB 131) "Disclosures about Segments of an Enterprise and Related
Information". SFAS No. 131 requires publicly-held companies to report finan-
cial and other information about key revenue-producing segments of the entity
for which such information is available and is utilized by the chief operating
decision maker. Specific information to be reported for individual segments
includes profit or loss, certain revenue and expense items and total assets.
A reconciliation of segment financial information to amounts reported in the
financial statements is also required. SFAS No. 131 is effective for the
Company in fiscal 1998 and the impact of adoption has not been determined.
9
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 October 2, 1998, the Company had an accumulated deficit of approx-
imately $55,927,000. The Company expects its operating losses to continue at
least through 1999 as it expends substantial resources to continue develop-
ment of the Company's products, obtain additional regulatory clearances or
approvals, continue to market, sell, and manufacture its products, support
its finance and administrative organizations 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 procedures, broad-based
10
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 the
remainder of 1998 and 1999. The Company manufactured and sold approximately
18,700 systems in the seven quarters ended October 2, 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 United
States Food and Drug Administration ("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 marke its products under development, could
11
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 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.
The Company is in the process of performing an inventory of all soft-
ware utilized by the Company and determining whether or not the software is
year 2000 compliant. 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 believes it
has no custom software in its manufacturing or development processes which
requires modification. The Company expects to complete this evaluation of
software by early 1999. The Company is not anticipating finding any sig-
nificant non-compliant software. If any such software is found it would most
likely be replaced by commercially available software that was year 2000
compliant.
The Company is also surveying its major suppliers to determine their
year 2000 readiness. It is expected that the survey will be completed in
early 1999. The Company currently has no plans to contact its customers
concerning their year 2000 readiness. The Company has sold its products to
over 500 hospitals and distributors worldwide and no one customer represents
more than 10% of the Company's revenue.
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.
12
Based on a prelimanary assessment, the Company believes that there will be
no material impact on the operations of the Company due to the year 2000 issue.
The costs incurred to date to determine the impact of the year 2000 issue
are immaterial and no significant future costs are anticipated.
Results of Operations
Three and nine months ended October 2, 1998 compared to the three and
nine months ended September 26, 1997.
Net sales increased 175% to $4.4 million and 68% to $11.1 million in the
three and nine months ended October 2, 1998, respectively when compared to the
same periods in fiscal 1997. The increase in net sales was due primarly to
a 193% and 130% increase in unit shipments of the CTS MIDCAB System and OPCAB
family of products for the three and nine months ended October 2, 1998,
respectively over the same periods in 1997. These increases in unit shipments
were offset by a 11% and 23% drop in the average selling price per procedural
unit for the three and nine months ended October 2, 1998, respectively.
Gross profit increased to $2.5 million (57% of net sales) in the three
months ended October 2, 1998 compared to $514,000 (32% of net sales) in the
same period last year. For the nine months ended October 2, 1998 gross profit
increased to $5.9 million (53% of net sales) compared to $2.2 million (34% of
net sales) for the nine months ended September 26, 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 man-
ufacturing efficiencies.
Research and development expenses in the three and nine months ended
October 2, 1998 were $2.7 million and $8.1 million, respectively compared to
$2.8 million and $7.3 million in the three and nine months ended September 26,
1997, repectively. This increase in the year-to-date research and development
expenses was due to an increase in reasearch 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, offset somewhat by lower development
and licensing agreement milestone payments. 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
$60,000 and $175,000 were expensed in the three and nine months ended October
2, 1998, respectively, compared to $650,000 in the three and nine months ended
September 26, 1997.
13
Sales, marketing, general and administrative expenses increased to $5.2
million and $16.2 million in the three and nine months ended October 2, 1998,
respectively compared to $4.5 million and $13.3 million in the same periods
last year, respectively. This increase was due primarily to the addition of
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 $2.1 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 for 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 2001. Amortization of
deferred compensation charged to operating expenses in the three and nine
months ended October 2, 1998 totaled $452,000 and $1.4 million, respectively
compared to $560,000 and $1.7 million for the same periods in 1997, respec-
tively.
Net interest income decreased to $585,000 and $1.9 million in the three
and nine months ended October 2, 1998, respectively compared to $920,000 and
$2.9 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 October 2, 1998, the Company had raised
approximately $90.9 million (net of stock issuance costs) from the sale of
equity securities. As of October 2, 1998, cash, cash equivalents and avail-
able-for-sale securities totaled $44.2 million. The Company's cash used in
operations was $13.9 million for the nine months ended October 2, 1998, re-
flecting expenditures made primarily to continue research and development and
sales and marketing activities, and to support its administrative infra-
structure. The Company also spent $1.3 million for the purchases of property
and equipment in the nine months ended October 2, 1998.
The Company plans to finance its operations principally from existing cash,
cash equivalents and available-for-sale securities and interest thereon, and
product revenues. The Company believes that its existing cash balances and
available-for-sale securities and interest thereon, 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
14
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 operations 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 covenants.
At October 2, 1998, the Company had approximately $43.3 million in federal
and $32.9 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.
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 compon-
ents in a full set of general-purpose financial statements. Comprehensive
income is defined as net income (loss) plus revenues, expenses, gains and losses
that, under generally accepted accounting principles, are excluded from net
income (loss). The components of comprehensive income which are excluded from
net income (loss) are not significant, individually or in aggregate, and there-
fore, no separate statement of comprehensive income has been presented.
In June 1997, the Financial Accounting Standards Board issued Statement
No. 131 (FASB 131) "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 131 requires publicly-held companies to report financial
and other information about key revenue-producing segments of the entity for
which such information is available and is utilized by the chief operating
decision maker. Specific information to be reported for individual segments
includes profit or loss, certain revenue and expense items and total assets.
A reconciliation of segment financial information to amounts reported in the
financial statements is also required. SFAS No. 131 is effective for the
Company in fiscal 1998 and the impact of adoption has not been determined.
15
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. Medtronic, Inc., Genzyme
Surgical Products Corp., Johnson & Johnson, Guidant Corporation, Baxter
International, Inc., Heartport, Inc. and Unites 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 product 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 large 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.
16
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 nine
issued United States patents. The Company is the licensee of a United States
patent for a heart valve insertion and stapling device and a U.S. patent and
two U.S. patent applications for bipolar electrosurgical scissors for use in
minimally invasive cardiothoracic surgery. The Company also has an option for
a U.S. patent application covering methods for vessel harvesting. The Company
has forty-seven 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 Unites 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 pro-
ducts 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 determiniation in litigation
or interference proceedings 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 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.
17
Congress enacted ligislation, 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 pro-
hibits 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 signi-
ficantly 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. The Company has received its ISO 9001
certification and obtained its 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, re-
fusal of the government of clearances or approvals and criminal prosecution,
which could have a material 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
18
for the defense of Mr. Taylor in the event that litigation is commenced. Liti-
gation is subject to inherent uncertainties, expecially 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 manu-
facture 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 ex-
perience 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 maintian 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.
19
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 re-
imburse 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 receive 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 util-
ized by third-party health care payors. The Company could be adversely affected
by change in reimbursement policies of government or private health care payors,
particularly to the extent any such changes affect reimbursement for the pro-
cedures 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 intened 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 internationl
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 coverage is expensive and in the future
may not be available to the Company on acceptable terms, if at all. A success-
ful 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 or results of
operations.
20
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
October 2, 1998.
Use of Proceeds Amount
--------------- ----------
Construction of plant, building and facilities $ 0
Purchase and installation of machinery and equipment 6,064,000
Purchase of real estate 0
Acquisition of other businesses 0
Repayment of indebtedness 0
Working capital 3,642,000
Cost of operations 31,739,000
Temporary Investment
---------------------
Cash 2,622,000
Commercial paper, notes and bonds $40,065,000
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 $ 799,000
Item 3. Defaults upon Senior Securites
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
21
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
22
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: November 12, 1998 CARDIOTHORACIC SYSTEMS, INC.
/S/ Richard M. Ferrari
----------------------------------
Richard M. Ferrari
President and Chief Executive Officer
/S/ Steve Van Dick
----------------------------------
Vice President, Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer)
23