As filed with the Securities and Exchange Commission on August 16, 1999
Registration No. 333-82511
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
ORATEC INTERVENTIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)
--------------
Delaware 3845 94-3180773
(State or Other (Primary Standard (I.R.S. Employer
Jurisdiction of Industrial Identification Number)
Incorporation or Classification Code
Organization) Number)
3700 Haven Court
Menlo Park, California 94025
(650) 369-9904
(Address, Including Zip Code, and Telephone Number, Including Area
Code, of Registrant's Principal Executive Offices)
--------------
Kenneth W. Anstey
Chief Executive Officer
ORATEC Interventions, Inc.
3700 Haven Court
Menlo Park, California 94025
(650) 369-9904
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
--------------
Copies to:
Mark B. Weeks Patrick T. Seaver
Laurel Finch Charles R. Ruck
Brooke Campbell Shayne Kennedy
VENTURE LAW GROUP LATHAM & WATKINS
A Professional Corporation 650 Town Center Drive
2800 Sand Hill Road Costa Mesa, CA 92626
Menlo Park, California 94025
--------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration
Statement.
--------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
Proposed Maximum Proposed Maximum
Title of Each Class of Amount to be Offering Price Aggregate Amount of
Securities to be Registered Registered (1) Per Share (2) Offering Price (2) Registration Fee
- --------------------------------------------------------------------------------------------------------
Common stock, par value $0.001 per
share.............................. 2,875,000 $17.00 $48,875,000 $13,588 (3)
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
(1) Includes 375,000 shares of Common Stock issuable upon the exercise of the
underwriters' over-allotment option.
(2) Estimated solely for the purpose of computing the amount of the
registration fee pursuant to Rule 457(a) and Rule 457(o) under the
Securities Act.
(3) Previously paid.
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this
registration statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until this registration
statement shall become effective on such date as the Commission, acting
pursuant to said Section 8(a), may determine.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This preliminary prospectus +
+is not an offer to sell these securities and is not soliciting an offer to +
+buy these securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion
Preliminary Prospectus dated August 16, 1999
PROSPECTUS
- -----------
2,500,000 Shares
[ORATEC LOGO APPEARS HERE]
Common Stock
------------
This is ORATEC's initial public offering of common stock. All the shares of
common stock are being sold by ORATEC.
We expect the initial public offering price to be between $15.00 and $17.00.
Currently, no public market exists for the shares. We have applied to list our
common stock on the Nasdaq National Market under the symbol "OTEC."
Investing in our common stock involves risks which are described in the "Risk
Factors" section beginning on page 5 of this Prospectus.
------------
Per Share Total
--------- -----
Public offering price.................................. $ $
Underwriting discount and commissions.................. $ $
Proceeds, before expenses, to ORATEC................... $ $
The underwriters may also purchase up to an additional 375,000 shares of
common stock from us at the public offering price, less the underwriting
discount, within 30 days from the date of this prospectus to cover over-
allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares of common stock will be ready for delivery in New York, New York
on or about , 1999.
------------
Merrill Lynch & Co.
J.P. Morgan & Co.
U.S. Bancorp Piper Jaffray
------------
The date of this prospectus is , 1999.
TABLE OF CONTENTS
Page
----
Summary of the Prospectus................................................ 3
Risk Factors............................................................. 5
Special Note Regarding Forward-Looking Statements........................ 12
Use of Proceeds.......................................................... 13
Our Policy Regarding Dividends........................................... 13
Capitalization........................................................... 14
Dilution................................................................. 15
Selected Financial Data.................................................. 16
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 17
Business................................................................. 24
Management............................................................... 39
Transactions with Affiliates............................................. 48
Principal Stockholders................................................... 50
Description of Capital Stock............................................. 52
Shares Eligible for Future Sale.......................................... 55
Underwriting............................................................. 57
Legal Matters............................................................ 59
Experts.................................................................. 59
Where You Can Find More Information...................................... 60
Index to Financial Statements............................................ F-1
----------------
You should rely only on the information contained in this prospectus. We have
not and the underwriters have not authorized any other person to provide you
with information different from that contained in this prospectus. We are
offering to sell, and seeking offers to buy, shares of common stock only in
jurisdictions where offers and sales are permitted. The information contained
in this prospectus is accurate only as of the date of this prospectus,
regardless of the time of delivery of this prospectus or of any sale of the
common stock.
Until , 1999 (25 days after the date of this prospectus), all dealers that
effect transactions in these securities, whether or not participating in this
offering, may be required to deliver a prospectus. This is in addition to the
dealers' obligation to deliver a prospectus when acting as underwriters and
with respect to their unsold allotments or subscriptions.
----------------
We own or have rights to trademarks or tradenames that we use in conjunction
with the sale of our products. The term "ORATEC" and our logo are registered
trademarks owned by us. We have also filed for trademark protection for the use
of the terms SpineCATH, IDET and ElectroThermal, which are used in conjunction
with the sale of our products. This prospectus also makes reference to
trademarks of other companies.
Our principal offices are located at 3700 Haven Court, Menlo Park, CA 94025
and our telephone number is (650) 369-9904. We were incorporated in May 1993 as
Dorsamed Incorporated, and we changed our name to ORATEC Interventions, Inc. in
October 1995.
i
SUMMARY OF THE PROSPECTUS
This summary highlights information contained elsewhere in this prospectus.
You should read this entire prospectus carefully, including the "Risk Factors"
section and the financial statements and the notes to those statements.
ORATEC Interventions, Inc.
ORATEC Interventions is a leader in the development of medical devices that
use controlled thermal energy to treat spine and joint disorders. We currently
market two minimally invasive systems, the SpineCATH IntraDiscal ElectroThermal
Therapy, or IDET, system and the ElectroThermal Arthroscopy System. Our
proprietary systems use heat to shrink and repair damaged or stretched soft
tissue. We market our products to orthopedic surgeons, neurosurgeons,
anesthesiologists, radiologists and physiatrists.
Our SpineCATH IDET system offers a minimally invasive outpatient alternative
to patients suffering from chronic low back pain caused by degenerative disc
disease. The IDET system enables physicians to navigate to the location of
damaged tissue within a spinal disc using a self-guiding single use catheter.
Physicians can then apply heat directly to the disc wall, causing the tissue to
contract and thicken. We believe that the application of heat desensitizes
nerve fibers and results in a stiffening of the disc wall. Following the IDET
procedure, many patients experience significant pain reduction and improved
overall quality of life, and reduce or eliminate pain medication. In addition,
the procedure does not require general anesthesia or extended hospitalization
and does not subject the patient to the post-operative complications often
associated with spine surgery. The IDET system was formally launched in October
1998, and we estimate that, as of June 30, 1999, over 250 physicians had
performed the IDET procedure on approximately 4,000 patients.
The treatment of back pain costs the U.S. health care system as much as $100
billion annually and represents the second most common reason for doctor
visits. Conditions related to back pain account for more hospitalizations
annually than any other orthopedic condition. Specifically, it is estimated
that, at any given time, five million individuals in the U.S. suffer from low
back pain. Many of these cases are resolved within three months using non-
operative therapies ranging from physical therapy to spinal injections.
However, it is estimated that there are approximately 1.4 million people who
have failed to improve with non-operative therapies. Spine surgery is not
recommended for these individuals because the level of disc degeneration does
not yet warrant a spinal fusion. We believe these individuals are candidates
for our IDET procedure.
In addition to our spine products, we offer a proprietary ElectroThermal
Arthroscopy System, which treats joint disorders through the application of
controlled heat by shrinking soft tissue. The system provides a minimally
invasive outpatient treatment option for patients who suffer from joint
instability caused by loose or stretched ligaments and whose most viable option
is often open surgery. In addition, we believe our system can improve on
existing arthroscopic procedures, which may require tissue shrinkage in
combination with tissue anchoring, cutting and tissue removal, or ablation. The
ElectroThermal Arthroscopy System was launched in March 1997, and we estimate
that, as of June 30, 1999, over 1,500 physicians had used our arthroscopy
products in approximately 45,000 procedures.
Approximately 2.2 million arthroscopic procedures were performed in the U.S.
in 1998. However, many joint injuries and disorders are still treated using
open surgery because, for many of these conditions, arthroscopic techniques are
not available, not effective or are difficult to perform. Our products expand
arthroscopic treatment options for surgeons treating joint disorders.
We have a focused sales and marketing team for each of the spine and
arthroscopy markets in order to address the different physician groups in these
high growth areas. Our sales organizations include direct sales employees
complemented by select sales agencies. We have recently entered into an
exclusive distribution agreement with DePuy AcroMed, a division of Johnson &
Johnson, for the international marketing and sales of our spine products. The
marketing platform for both spine and arthroscopy is built on scientific and
clinical data and extensive surgeon training programs. The products we
currently market have received 510(k) premarket clearance from the FDA, and as
of June 30, 1999 we had six issued patents, eight notices of allowance and 40
U.S. and foreign patent applications pending.
3
The Offering
Common stock offered by ORATEC....... 2,500,000 shares
Common stock to be outstanding after
the offering........................ 12,245,546 shares
Use of proceeds...................... Expanded sales and marketing activities,
future product development, repayment of
debt and general corporate purposes. See
"Use of Proceeds."
Proposed Nasdaq National Market sym-
bol................................. "OTEC"
This table is based on shares outstanding as of June 30, 1999 and excludes:
(a) 1,881,607 shares that were subject to outstanding options at a weighted
average exercise price of $3.39 as of June 30, 1999; (b) 127,745 shares that
were issuable upon exercise of outstanding warrants at a weighted average
exercise price of $5.48 per share as of June 30, 1999; and (c) an aggregate of
123,768 shares that were available for future issuance under our 1995 stock
plan as of June 30, 1999.
Summary Financial Data
(in thousands, except per share data)
Six Months Ended
Years Ended December 31, June 30,
-------------------------- ------------------
1996 1997 1998 1998 1999
------- ------- -------- -------- --------
(unaudited)
Statement of Operations Data:
Sales........................ $ -- $ 2,600 $ 11,129 $ 4,106 $ 12,899
Gross profit................. -- 859 4,563 1,752 6,638
Total operating expenses..... 2,384 7,857 15,748 6,676 11,583
Net loss..................... (2,302) (6,832) (11,342) (4,800) (5,284)
Net loss per common share,
basic and diluted........... $ (1.00) $ (2.91) $ (4.72) $ (2.01) $ (2.16)
Shares used in computing net
loss per common share, basic
and diluted................. 2,304 2,347 2,403 2,393 2,447
Pro forma net loss per share,
basic and diluted
(unaudited)................. $ (1.51) $ (0.55)
Shares used in computing pro
forma net loss per share,
basic and diluted
(unaudited)................. 7,525 9,688
June 30, 1999
---------------------
Actual As Adjusted
-------- -----------
(unaudited)
Balance Sheet Data:
Cash, cash equivalents and short term investments...... $ 13,179 $49,279
Total assets........................................... 25,020 61,120
Long term obligations, net of current portion.......... 5,951 5,951
Redeemable convertible preferred stock................. 35,816 --
Common stock, additional paid-in capital, deferred
stock compensation and accumulated deficit............ (25,642) 46,274
The as adjusted numbers in the table above are adjusted to give effect to
receipt of the net proceeds from the sale of shares of common stock offered by
us at an assumed offering price of $16.00 per share, after deducting the
estimated underwriting discount and commissions and estimated offering expenses
payable by us. See also "Use of Proceeds," "Capitalization" and "Underwriting."
Except as otherwise indicated, all information in this prospectus is based on
the following assumptions: (a) the completion of our three for five reverse
stock split prior to the completion of this offering, (b) the conversion of
each outstanding share of redeemable preferred stock into one share of common
stock immediately before the completion of this offering, (c) no exercise of
the underwriters' overallotment option, (d) our reincorporation in Delaware
before the effectiveness of this offering and (e) the filing of our amended and
restated certificate of incorporation immediately prior to the closing of the
offering.
4
RISK FACTORS
If you purchase our common stock and become an ORATEC stockholder, you will
be subject to risks inherent in our business. Our stock price will fluctuate
for many reasons, including how our business performs relative to, among other
things, competition, market conditions and general economic and industry
conditions. You should carefully consider the following risk factors as well as
other information in this prospectus before purchasing our common stock. The
risks and uncertainties described below are intended to be the ones that are
specific to us but are not the only ones that we face. Additional material
risks and uncertainties that are specific to our industry or to companies going
public may also impair our business.
Because we are a new company operating largely in markets that we are creating,
we may fail to gain market acceptance for our products and our business could
suffer.
We have developed products for spine and joint disorders that we believe are
not effectively addressed by existing medical devices. Because no established
market exists for our products, we face the challenge of establishing the
viability of this market, as well as gaining widespread acceptance of our
products. If we fail at either task, we may not achieve expected revenues and
may never become profitable.
If we fail to achieve significant sales growth of our SpineCATH IDET system, we
may never become profitable.
Because the market for our spine products is new and evolving, we cannot
accurately predict either the future growth rate, if any, or the ultimate size
of the spine market. Physicians will not use our spine products unless they
determine, based on experience, clinical data and recommendations from
prominent physicians and mentors, that the SpineCATH IDET system is an
effective means of treating spine disorders. In addition, physicians tend to be
slow to change their medical treatment practices because of perceived liability
risks arising from the use of new spine products and the uncertainty of third
party reimbursement for the SpineCATH IDET system.
If physicians and payors do not support the use of our products, we may not
achieve future sales growth.
Our product sales have mainly been to a group of early adopting physicians
who are receptive to minimally invasive techniques. Further sales may require
us to convince physicians who currently favor existing techniques to switch to
our minimally invasive procedures. Many physicians will not purchase our
products until there is sufficient, long term clinical evidence to convince
them to alter their existing treatment methods. In addition, some payors
require the publication of peer reviewed clinical data before authorizing
payment. There has been no published clinical data for our spine products. We
have been collecting clinical data on patients for only two years for our spine
products and three years for our arthroscopy products. Thus, continued
publication of positive clinical data and longer term patient follow-up are
necessary for us to achieve significant sales growth.
Because we have a history of losses, we may never become profitable.
Our sales may not continue to grow, and we may not be able to achieve or
maintain profitability in the future. We have incurred net losses each year
since inception. In particular, we incurred losses of $11.3 million in 1998 and
$5.3 million in the six months ended June 30, 1999. As of June 30, 1999, we had
an accumulated deficit of approximately $26.3 million. We anticipate that our
operating expenses will increase substantially in absolute dollars for the
foreseeable future as we expand our sales and marketing, manufacturing, product
development and administrative staff.
5
You may have a difficult time evaluating an investment in our stock because we
have a limited operating history.
You can only evaluate our business based on a limited operating history
because we began selling arthroscopy products in 1997 and spine products in
1998. This short history may not be adequate to enable you to fully assess our
ability to successfully develop our products, achieve market acceptance of our
products and respond to competition.
Because we lack sufficient long term data regarding the efficacy of our
products, we could find that our long term data does not support our current
clinical results.
Because our spine products are supported by only two years of patient follow
up and our arthroscopy products are supported by only three years of patient
follow up, some physicians may not purchase our products until longer term data
is available. If longer term patient studies indicate that treatments with our
products do not provide patients with sustained benefits, our sales could
decline. If longer term patient studies indicate that our procedures cause
tissue damage or other negative effects, we could be subject to significant
liability. Further, because our data has been produced in studies that are not
randomized and involve small patient groups our data may not be reproduced in
wider patient populations. In addition, we are aware of studies related to our
arthroscopy products that have produced bench data that is inconsistent with
our scientific findings. If we are unable to produce clinical data that is
supported by the independent efforts of other clinicians, our business could
suffer.
Because we face significant competition from companies with greater resources
than we have, we may be unable to compete effectively.
The market for our products is intensely competitive, subject to rapid change
and significantly affected by new product introductions and other market
activities of industry participants. We compete with many larger companies that
enjoy several competitive advantages, including:
. established distribution networks;
. established relationships with health care providers and payors; and
. greater resources for product development, sales and marketing and
patent litigation.
Competition in the Arthroscopy Market
Several larger companies sell products that compete directly with our
ElectroThermal Arthroscopy System. For example, ArthroCare Corporation and
Mitek, an Ethicon division of Johnson & Johnson, both offer tissue shrinkage
products. We also compete in the cutting and tissue removal, or ablation,
product market with ArthroCare, Mitek and CONMED Corporation.
Competition in the Spine Market
There are numerous treatments for low back pain, including physical therapy,
medication and spinal injections. Our IDET procedure is sometimes offered to a
patient as an alternative to spinal fusion, and thus spine implant companies,
such as Sofamor Danek, a division of Medtronic, Sulzer Spine-Tech, Surgical
Dynamics, a U.S. Surgical division of Tyco International, DePuy AcroMed, a
division of Johnson & Johnson, and SYNTHES-STRATEC may be viewed as
competitors. We are also aware that Radionics, a privately held medical device
company, offers a radiofrequency, or RF, probe which is designed for lesioning
in the spine. See "Business--Competition."
These and other large companies may decide to dedicate substantial resources
to develop more directly competitive products.
6
Because of the importance of our patent portfolio to our business, we may lose
market share to our competitors if we fail to protect our intellectual property
rights.
Protection of our patent portfolio is key to our future success, particularly
because we compete in the medical device industry. We rely on patent
protection, as well as a combination of copyright, trade secret and trademark
laws, and nondisclosure and confidentiality agreements and other contractual
restrictions to protect our proprietary technology. However, these legal means
afford only limited protection and may not adequately protect our rights or
permit us to gain or keep any competitive advantage. For example, our patents
may be challenged, invalidated or circumvented by third parties. While we have
received notices of allowance with respect to some patent claims for our spine
products, none of these patents has issued. Our patent applications and the
notices of allowance we have received may not issue as patents in a form that
will be advantageous to us. Our patents and applications cover particular
aspects of our products and technology. There may be more effective
technologies, designs or methods. If the most effective treatment method is not
covered by our products or applications, it could have an adverse effect on our
sales. If we lose any key personnel, we may not be able to prevent the
unauthorized disclosure or use of our technical knowledge or other trade
secrets by those former employees. Furthermore, the laws of foreign countries
may not protect our intellectual property rights to the same extent as the laws
of the U.S. Finally, even if our intellectual property rights are adequately
protected, litigation may be necessary to enforce our intellectual property
rights, which could result in substantial costs to us and result in a
substantial diversion of management attention. If our intellectual property is
not adequately protected, our competitors could use the intellectual property
that we have developed to enhance their products and compete more directly with
us, which could result in a decrease in our market share.
Because the medical device industry is litigious, we are particularly
susceptible to an intellectual property suit.
There is a substantial amount of litigation over patent and other
intellectual property rights in the medical device industry generally and in
the spine and arthroscopy market segments particularly. Infringement and other
intellectual property claims, with or without merit, can be expensive and time-
consuming to litigate and divert management's attention from our core business.
While we attempt to ensure that our products do not infringe other parties'
patents and proprietary rights, our products may infringe. Whether a product
infringes a patent involves complex legal and factual issues, the determination
of which is, in many cases, not certain. In addition, because patent
applications can take many years to issue, there may be applications now
pending of which we are unaware, which may later result in issued patents which
our products may infringe. There could also be existing patents that one or
more of our products may inadvertently be infringing of which we are unaware.
As the number of competitors in the markets for minimally invasive treatment of
spine and joint disorders grows, the possibility of a patent infringement claim
against us increases.
Our spine and arthroscopy products and the methods they employ may be covered
by U.S. patents held by our competitors. We have made a careful analysis in
consultation with our experts and, based on such analysis, we believe that
either such patents or claims are invalid or if valid that we do not infringe.
If the holder of patents brought an infringement action against us, the cost
of litigating the claim could be substantial. In addition, if the relevant
patent claims were upheld as valid and enforceable and our products were found
to infringe the patent, we could be prevented from selling the relevant product
unless we could obtain a license from the owner of the patent or were able to
redesign our product to avoid infringement. A license may not be available or
if available may be on terms unacceptable to us, or we may not be successful in
any attempt to redesign our products to avoid any infringement. Modification of
our products or development of new products may require us to conduct
additional clinical trials for these new or modified products and to revise our
filings with the FDA, which is time consuming and expensive. If we were not
successful in obtaining a license or redesigning our product, our business
could suffer.
7
If health care providers cannot get reimbursed for the procedures using our
products, our sales may decline.
Physicians, hospitals and other health care providers are unlikely to
purchase our products if they do not receive reimbursement from third party
payors for the cost of the procedures using our products. Some payors have
refused to reimburse for the cost of procedures using our products until peer
reviewed clinical data has been published. In addition, even upon the
publication of peer reviewed data, a payor still may not reimburse for the
procedure. The advent of contracted rates per procedure has also made it
difficult to receive reimbursement for disposable products, even if the use of
these products improves clinical outcomes. See "Business--Third-Party
Reimbursement."
If we are sued in a product liability action, we could be forced to pay
substantial penalties.
We manufacture medical devices that are used on patients in surgery, and we
may be subject to a product liability lawsuit. In particular, the market for
spine products has a history of product liability litigation. We have reported
to the FDA a few instances in which the tip of our SpineCATH catheter broke
off in the patient's body as the catheter was being removed after the
procedure. We believe that these instances did not result in any negative
health effect and were not the result of a product malfunction.
Any product liability claim brought against us, with or without merit, could
result in the increase of our product liability insurance rates or the
inability to secure coverage in the future. In addition, we would have to pay
any amount awarded by a court in excess of policy limits. Our insurance
policies have various exclusions, and thus we may be subject to a product
liability claim for which we have no insurance coverage, in which case we may
have to pay the entire amount of any award. Even in the absence of a claim,
our insurance rates may rise in the future to a point where we decide not to
carry this insurance. Finally, even a meritless or unsuccessful product
liability claim would be time-consuming and expensive to defend and could
result in the diversion of management's attention from our core business. See
"--Complying with FDA and other regulations is an expensive and time-consuming
process, and any failure to comply could result in substantial penalties."
Any failure to build and manage our sales organization may negatively affect
our market share and revenues.
We currently have two separate sales forces, one for each of our spine and
arthroscopy product lines, and we rely on a combination of direct sales
employees and sales agents to sell each product line in the U.S. We need to
expand the spine sales team substantially over the next twelve months to
achieve our market share and revenue growth goals. There are significant risks
involved in building and managing our spine and arthroscopy sales forces,
including:
. failure to manage the development and growth of two distinct sales
forces;
. failure to adequately train both our employees and our outside sales
agents in the use and benefits of our products; and
. dependence on outside agencies, over which we have limited or no control.
See "--If we fail to support our anticipated growth in operations, our
business could suffer." See also "Business--Sales and Marketing."
Any failure in our physician training efforts could significantly reduce
product sales.
It is critical to the success of our sales effort to train a sufficient
number of physicians and to provide them adequate instruction in the use of
our products. We rely on physicians to spend their time and money to attend
our training sessions. If physicians are not properly trained they may misuse
or ineffectively use our products. This may result in unsatisfactory patient
outcomes, patient injury, negative publicity or lawsuits against us, any of
which could have an adverse effect on our product sales.
8
If we fail to support our anticipated growth in operations, our business could
suffer.
To succeed in the implementation of our business strategy, our management
team must rapidly execute our sales strategy and further develop products,
while managing anticipated growth by implementing effective planning and
operating processes. To manage anticipated growth in operations, we must
increase our manufacturing and quality assurance staff, expand our sales teams
and expand our manufacturing facility. Our systems, procedures and controls may
not be adequate to support our expected growth in operations.
We have a sole supplier of generators, and any disruption in supply could
result in decreased sales.
All of the generators we sell are currently manufactured according to our
specifications by a sole source third party supplier. We believe there are no
other third-party contractors who could readily assume this manufacturing
function. Any delay in production of generators could result in our failure to
meet customer demand.
If we fail to successfully transition the manufacture of our generators to
internal operations, we may experience a decrease in sales.
We intend to begin manufacturing generators internally in the second half of
1999, but have no experience in manufacturing generators. Any failure to
manufacture a sufficient number of generators to keep pace with demand, or any
failure to make generators of sufficient quality or at a commercially
reasonable cost, will lead to lower than expected generator placements and a
corresponding decrease in the sale of disposable products.
Because we have limited control over third-party distributors, we may be unable
to sell our products in international markets.
We intend to rely on third-party distributors, over whom we have limited
control, to sell our products in international markets. We have entered into an
exclusive agreement with, and are dependent upon, DePuy AcroMed for the
marketing and sales of our spine products internationally. We also have
exclusive distributor relationships for the sale of our arthroscopy products in
some foreign countries.
Because we compete with DePuy in the arthroscopy market, a conflict with them
could negatively affect our international spine sales effort.
Because our exclusive international spine product distributor is also a
competitor in the arthroscopy market, they may devote insufficient resources to
sales of our products or a conflict may arise which could disrupt international
sales. If DePuy fails to devote adequate resources to our products, we could
fail to achieve expected international sales. If a conflict arises which we
could not readily resolve, there could be a period of declining international
sales as we search for an alternative means of international product
distribution. See "Business--Competition."
Complying with FDA and other regulations is an expensive and time-consuming
process, and any failure to comply could result in substantial penalties.
We are subject to a host of federal, state, local and international
regulations regarding the manufacture and marketing of our products. In
particular, our failure to comply with FDA regulations could result in, among
other things, recalls of our products, substantial fines and/or criminal
charges against us and our employees. We received returns of approximately 500
TAC probes as a result of a March 1999 product recall, due to a faulty part
supplied to us by an outside vendor. No patient complaints or claims were
received by us. We informed the FDA about this recall, and the FDA determined
that it was not a reportable event as defined under FDA regulations. These
regulations require us to report any incident in which our products may have
contributed to a
9
death or serious injury, or in which our products malfunctioned in a way that
would be likely to contribute to a death or serious injury. See "Business--
Government Regulation."
Product introductions or modifications may be delayed or canceled as a result
of the FDA regulatory process, which could cause our sales to decline.
Before we can sell a new medical device in the U.S., we must obtain FDA
approval, which can be a lengthy and time-consuming process. To date, all of
our products have either received clearances from the FDA through premarket
notification under Section 510(k) of the Federal Food, Drug and Cosmetic Act or
are exempt from the 510(k) clearance process. We have modified some of our
products, but we do not believe these modifications require us to submit new
510(k) applications. However, if the FDA disagrees with us and requires us to
submit a new 510(k) application for modifications to our existing products, or
if the FDA requires us to go through a lengthier, more rigorous examination
than we had expected, our product introductions or modifications could be
delayed or canceled, which could cause our sales to decline. In addition, the
FDA may determine that future products will require the more costly, lengthy
and uncertain premarket approval, or PMA, process. See "Business--Government
Regulation."
Off label use of our products could result in substantial penalties.
510(k) clearance only permits us to market our products for the uses
indicated on their labels. We may request additional label indications for our
current products, and the FDA may either deny those requests outright, require
additional expensive clinical data to support any additional indications or
impose limitations on the intended use of any cleared product as a condition of
clearance. We received a warning letter from the FDA in April 1999 regarding
information on our website which the FDA believed was broadening our label
indications. We removed some information from our website and responded that
the remaining information was not intended to expand label indications. In
addition, our disposable probes have been approved by the FDA for single use,
but we are aware that from time to time physicians reuse our disposable
products. We have strongly advised physicians against reuse of our products.
See "Business--Government Regulation."
Our stock price, like that of many early stage medical technology companies,
may be volatile.
If our future quarterly operating results are below the expectations of
securities analysts or investors, the price of our common stock would likely
decline. Stock price fluctuations may be exaggerated if the trading volume of
our common stock is low.
In the past, securities class action litigation has often been brought
against a company after a period of volatility in the market price of its
stock. Any securities litigation claims brought against us could result in
substantial expense and the diversion of management's attention from our core
business. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Quarterly Results of Operations."
We may need to raise additional capital in the future and may be unable to do
so on acceptable terms.
We may need to raise additional funds for operations and to execute our
business strategy. The sale of additional equity or convertible debt securities
could result in additional dilution to our stockholders. If additional funds
are raised through the issuance of debt securities, these securities could have
some rights senior to holders of common stock, and could contain covenants that
would restrict our operations. Any additional financing may not be available in
amounts or on terms acceptable to us, if at all.
Any year 2000 problems that our customers experience in their internal systems
could result in a delay in product orders or decrease in sales.
Any year 2000 problems that hospitals or other providers encounter in their
ordering and payment systems could result in the delay or cancellation of
purchase orders for our products or the delay in payment for our products, any
of which could result in a decline in our anticipated sales or cash flow. Any
slowdowns in
10
processing insurance claims or pre-certifications for our products or
procedures by Medicare or other payors could result in a delay or cancellation
of orders or a delay in our collection of accounts receivable.
Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval after this offering.
Immediately after this offering, our executive officers and directors, and
their respective affiliates, will continue to own approximately 27.1% of our
outstanding common stock. Accordingly, these stockholders may, as a practical
matter, be able to exert significant influence over matters requiring approval
by our stockholders, including the election of directors and the approval of
mergers or other business combinations. This concentration could have the
effect of delaying or preventing a change in control.
Our certificate of incorporation, our bylaws and Delaware law contain
provisions that could discourage a takeover.
Provisions of our certificate of incorporation, bylaws and Delaware law may
discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable. See "Management--Board Composition" and "Description of
Capital Stock--Delaware Anti-Takeover Law and Provisions of our Certificate of
Incorporation and Bylaws."
11
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus are forward-looking
statements, such as "may," "plans," "expects" or "continue" and other similar
words. These statements relate to future events or our future financial
performance, and involve known and unknown risks, uncertainties and other
factors that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any
future results, levels of activity, performance or achievements expressed or
implied by these forward-looking statements. Such factors include those listed
under "Risk Factors" in this prospectus.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We are under no duty to update any of
the forward-looking statements after the date of this prospectus to conform
such statements to actual results.
12
USE OF PROCEEDS
Our net proceeds from the sale of the 2,500,000 shares of common stock we are
offering are estimated to be $36,100,000 ($41,680,000 if the underwriters'
over-allotment option is exercised in full), assuming an offering price of
$16.00 per share, after deducting the estimated underwriting discount and
commissions and the estimated offering expenses.
We currently intend to use the net proceeds from this offering for expansion
of sales and marketing activities, future development of our product lines,
repayment of approximately $6.0 million of debt and general corporate purposes.
The debt being repaid was used primarily for purchasing generators and funding
the increased costs of operations as ORATEC's sales activities increased. We
may use a portion of the net proceeds to fund, acquire or invest in
complementary businesses or technologies, although we have no present
commitments with respect to any acquisition or investment. The amount of cash
that we actually expend for any of the described purposes will vary
significantly depending on a number of factors, including future sales growth,
if any, and the amount of cash we generate from operations. Thus, management
will have significant discretion in applying the net proceeds of this offering.
Pending the uses described above, we will invest the net proceeds in short
term, investment grade, interest bearing securities.
OUR POLICY REGARDING DIVIDENDS
We have never paid dividends on our common stock or preferred stock. We
currently intend to retain any future earnings to fund the development of our
business. In addition, there is a covenant in one of our loan agreements
restricting our ability to pay dividends. Therefore, we do not currently
anticipate paying any cash dividends in the foreseeable future.
13
CAPITALIZATION
The following table sets forth the following information:
. the actual capitalization of ORATEC as of June 30, 1999;
. the pro forma capitalization of ORATEC, after giving effect to the
automatic conversion of all outstanding shares of preferred stock
into 7,247,923 shares of common stock; and
. the as adjusted capitalization, after giving effect to the sale of
shares of common stock at an assumed initial public offering price of
$16.00 per share in this offering, after deducting the estimated
underwriting discount and commissions and estimated offering expenses
that ORATEC expects to pay in connection with this offering.
This table should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Financial
Statements and Notes to the Financial Statements included elsewhere in this
prospectus.
June 30, 1999
-------------------------------------------
Actual Pro Forma As Adjusted
------------ ------------ --------------
(in thousands, except per share data)
(unaudited)
Current portion of long term
obligations........................ $ 1,609 $ 1,609 $ 1,609
============ ============ ============
Long term obligations............... $ 5,951 $ 5,951 $ 5,951
Redeemable convertible preferred
stock, par value $0.001 per share;
7,440,000 shares authorized,
actual, 7,247,923 shares issued and
outstanding, actual; 5,000,000
shares authorized, none issued or
outstanding, pro forma and as
adjusted........................... 35,816 -- --
Common stock, par value $0.001 per
share, 11,940,000 shares authorized
actual, 2,497,623 shares issued and
outstanding, actual; 75,000,000
shares authorized, pro forma,
9,745,546 issued and outstanding,
pro forma; 75,000,000 shares
authorized, as adjusted, 12,245,546
shares issued and outstanding, as
adjusted........................... 2 10 12
Additional paid-in capital.......... 966 36,774 72,872
Deferred stock compensation......... (310) (310) (310)
Accumulated deficit................. (26,300) (26,300) (26,300)
------------ ------------ ------------
Total capitalization................ $ 16,125 $ 16,125 $52,225
============ ============ ============
- --------
This table excludes the following shares (in thousands, except per share data):
. 1,881,607 shares that were issuable upon exercise of outstanding options
at a weighted average exercise price of $3.39 per share as of June 30,
1999,
. 127,745 shares that were issuable upon exercise of outstanding warrants
at a weighted average exercise price of $5.48 per share as of June 30,
1999, and
. an aggregate of 123,768 shares that were available for future issuance
under our 1995 Stock Plan as of June 30, 1999. See "Management--Stock
Plans" and Note 11 of Notes to Financial Statements.
14
DILUTION
The pro forma net tangible book value of our common stock on June 30, 1999
was $10,174,000, or $1.04 per share. Pro forma net tangible book value per
share represents the amount of our total tangible assets less total
liabilities, divided by the number of shares of common stock outstanding,
assuming the conversion of all outstanding shares of preferred stock into
shares of common stock. Dilution in net tangible book value per share
represents the difference between the amount per share paid by purchasers of
shares of our common stock in this offering and the net tangible book value per
share of our common stock immediately following this offering. After giving
effect to our sale of shares of common stock in this offering and after
deducting the estimated underwriting discount and commissions and our estimated
offering expenses, our pro forma net tangible book value as of June 30, 1999
would have been $46,274,000 or $3.78 per share of common stock. This represents
an immediate increase in net tangible book value of $2.74 per share to existing
stockholders and an immediate dilution of $12.22 per share to new investors.
The following table illustrates this per share dilution:
Assumed initial public offering price per share................... $16.00
Pro forma net tangible book value per share as of June 30,
1999........................................................... $1.04
Increase per share attributable to new investors................ 2.74
-----
Pro forma net tangible book value per share after the offering.. 3.78
------
Dilution per share to new investors............................. $12.22
======
The following table summarizes, on a pro forma basis, as of June 30, 1999,
the differences between the existing stockholders and new investors with
respect to the number of shares of stock purchased from us, the total
consideration paid to us, and the average price per share paid.
Shares
Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
Existing stockholders...... 9,745,546 79.6% $36,766,000 47.9% $ 3.77
New investors.............. 2,500,000 20.4 40,000,000 52.1 16.00
---------- ----- ----------- -----
Total.................... 12,245,546 100.0% $76,766,000 100.0%
========== ===== =========== =====
This table excludes the following shares:
. 1,881,607 shares issuable upon exercise of outstanding options at a
weighted average exercise price of $3.39 per share as of June 30,
1999,
. 127,745 shares issuable upon exercise of outstanding warrants at a
weighted average exercise price of $5.48 per share as of June 30,
1999, and
. an aggregate of 123,768 shares available for future issuance under
our 1995 Stock Plan as of June 30, 1999. See "Management--Stock
Plans" and Note 11 of Notes to Financial Statements.
If the underwriters' over-allotment option is exercised in full, the
following will occur:
. the number of shares of common stock held by existing stockholders
will decrease to approximately 77.2% of the total number of shares of
our common stock outstanding after this offering; and
. the number of shares held by new investors will be increased to
2,875,000 or approximately 22.8% of the total number of shares of our
common stock outstanding after this offering.
15
SELECTED FINANCIAL DATA
(In thousands, except per share data)
The following selected financial data should be read in conjunction with the
Financial Statements and Notes and with "Management's Discussion and Analysis
of Financial Condition and Results of Operations," which are included elsewhere
in this prospectus. The statement of operations data for the years ended
December 31, 1996, 1997 and 1998, and the balance sheet data at December 31,
1997 and 1998, are derived from audited financial statements included elsewhere
in this prospectus. The statement of operations data for the years ended
December 31, 1994 and 1995, and the balance sheet data as of December 31, 1994,
1995 and 1996, are derived from audited financial statements not included in
this prospectus. The statement of operations data for the six months ended June
30, 1998 and 1999 and balance sheet data as of June 30, 1999 are derived from
unaudited financial statements included elsewhere in this prospectus.
Six Months Ended
Years Ended December 31, June 30,
------------------------------------------ ------------------
1994 1995 1996 1997 1998 1998 1999
------ ------ ------- ------- -------- -------- --------
(unaudited)
Statement of Operations
Data:
Sales................... $ -- $ -- $ -- $ 2,600 $ 11,129 $ 4,106 $ 12,899
Cost of sales........... -- -- -- 1,741 6,566 2,354 6,261
------ ------ ------- ------- -------- -------- --------
Gross profit............ -- -- -- 859 4,563 1,752 6,638
Operating expenses:
Research and
development.......... 90 156 878 2,514 4,706 2,094 2,624
Sales and marketing... -- -- 561 2,622 8,318 3,390 7,494
General and
administrative....... 110 187 945 2,721 2,724 1,192 1,465
------ ------ ------- ------- -------- -------- --------
Total operating
expenses........... 200 343 2,384 7,857 15,748 6,676 11,583
------ ------ ------- ------- -------- -------- --------
Loss from operations.... (200) (343) (2,384) (6,998) (11,185) (4,924) (4,945)
Interest income
(expense), net......... -- 3 82 166 (157) 124 (339)
------ ------ ------- ------- -------- -------- --------
Net loss................ $ (200) $ (340) $(2,302) $(6,832) $(11,342) $ (4,800) $ (5,284)
====== ====== ======= ======= ======== ======== ========
Net loss per common
share, basic and
diluted................ $(0.20) $(0.17) $ (1.00) $ (2.91) $ (4.72) $ (2.01) $ (2.16)
====== ====== ======= ======= ======== ======== ========
Shares used in computing
net loss per common
share, basic and
diluted................ 1,015 1,947 2,304 2,347 2,403 2,393 2,447
Pro forma net loss per
share, basic and
diluted................ $ (1.51) $ (0.55)
======== ========
Shares used in computing
pro forma net loss per
share, basic and
diluted................ 7,525 9,688
December 31,
---------------------------------------- June 30,
1994 1995 1996 1997 1998 1999
----- ----- ------- ------- -------- -----------
(unaudited)
Balance Sheet Data:
Cash, cash equivalents
and short term
investments............. $ 1 $ 64 $ 1,778 $ 9,185 $ 15,581 $13,179
Working capital.......... (78) (97) 1,545 8,717 13,997 12,852
Total assets............. 1 97 2,593 13,418 24,195 25,020
Long term obligations,
net of current portion.. -- 35 221 404 2,702 5,951
Redeemable convertible
preferred stock......... 120 474 4,792 20,324 35,816 35,816
Common stock, additional
paid-in capital,
deferred stock
compensation and
accumulated deficit..... (198) (536) (2,838) (9,646) (20,746) (25,642)
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
ORATEC Interventions is a leader in the development of medical devices that
use controlled thermal energy to treat spine and joint disorders. From
inception in 1993 until February 1997, our operations consisted primarily of
various start-up activities, including development of technologies central to
our business, recruiting personnel and raising capital. In December 1995 we
gained FDA clearance for our first product, our TAC probe for the treatment of
joint disorders. In March 1997, after 18 months of funding scientific and
clinical studies, we formally launched this product at the American Academy of
Orthopedic Surgeons convention. We received FDA clearance for our SpineCATH
product in March 1998 and formally launched this product at the North American
Spine Society, or NASS, conference in October 1998.
All of our revenues are generated from the sales of our spine and arthroscopy
products. For the six months ended June 30, 1999, 90% of our total sales were
derived from our disposable spine catheters and arthroscopy probes and 10% were
derived from sales of generators and accessories. We incurred net losses of
approximately $11.3 million in 1998 and $5.3 million during the six months
ended June 30, 1999. As of June 30, 1999, we had an accumulated deficit of
$26.3 million.
For the six months ended June 30, 1999, approximately 65% of our U.S. sales
was generated by our direct sales employees and the remainder of our revenues
was generated by independent sales agencies. These sales agencies do not
purchase our products, but are paid a commission at the time they generate a
product sale. We intend to continue building our direct sales force, and expect
that in the future an increasing percentage of U.S. sales will be generated by
our direct sales employees.
In the six months ended June 30, 1999, only 3% of our revenues was derived
from sales of products in markets outside the U.S., and we do not expect
international sales to increase significantly in the near future. In
international markets, we expect to rely exclusively on third-party
distributors. Our gross margins on sales through international third-party
distributors are less than our gross margins on U.S. sales as a result of price
discounts. In addition, we have limited or no control over the sales efforts of
these third-party distributors.
We recognize revenue upon shipment of products to customers, and in some
cases when inventory provided to customers has been used at their facilities as
evidenced by receipt of a purchase order. Our return policy allows customers to
return unopened products up to 90 days after a sale. To date, returns have been
insignificant. As is common in the arthroscopy market, we have retained title
to the majority of arthroscopy generators, which we have placed with customers
for their use with our disposable arthroscopy probes. In connection with the
market launch of our spine products, we have been placing spine generators with
customers for a demonstration period, after which we intend to convert these
placements to sales. We have limited experience in selling the spine generators
and may not be able to achieve spine generator sales for all placements.
We currently rely upon a single supplier of generators. We expect to begin
production of generators at our manufacturing facility prior to the end of 1999
to lower the risk related to our dependance on a sole supplier. If we are
unable to successfully transition the manufacture of generators to our in-house
operations or if there is a shortage of generators from our sole-source
manufacturer, we could experience a disruption in supply and decreased sales.
Our early product sales have mainly been to a group of early adopting
physicians who are receptive to minimally invasive techniques. As we gain
market share, our opportunity for further market penetration may slow and
require additional sales efforts, longer term supporting clinical data and
further training, in order to convince physicians who currently favor open
surgery or other treatment alternatives to switch to our minimally invasive
procedures.
17
The medical device market is litigious and we may become a party to product
liability or patent proceedings. The costs of such lawsuits may be material and
could affect our earnings and financial position. If we were to lose a patent
lawsuit we may be forced to stop sales of affected products or to pay royalties
which could have a negative effect on our results of operations.
Our future growth depends on expanding our current markets and finding new
high growth markets in which we can leverage our core technologies of applying
thermal energy to treat soft tissue disorders. To the extent any current or
additional markets do not materialize in accordance with our expectations, our
revenues could be lower than expected.
Results of Operations
Six Months Ended June 30, 1999 and 1998
Sales
Overall sales increased 214% to $12.9 million for the six months ended June
30, 1999 from $4.1 million for the six months ended June 30, 1998, as a result
of the commercial launch of our spine products and increased sales of our
arthroscopy products.
Sales of spine products were $5.6 million for the six months ended June 30,
1999. These sales followed the commercial launch of our SpineCATH product in
October 1998 and the training of additional spine specialists in the use of the
product.
Sales of our arthroscopy products increased 83% to $7.3 million for the six
months ended June 30, 1999 from $4.0 million for the six months ended June 30,
1998. This increase in revenues was due primarily to higher unit sales of our
TAC probes due to an increase in the number of physicians trained, as well as
the enhancement of our product line through modifications to the probe tips and
sizes of our existing products.
Cost of sales
Cost of sales increased by 166%, to $6.3 million for the six months ended
June 30, 1999 from $2.4 million for the six months ended June 30, 1998. Cost of
sales consists of material, labor and overhead costs, as well as depreciation
on generators placed with customers for their use with our disposable probes.
The growth in cost of sales was attributable primarily to the significant
expansion of our manufacturing function, increased costs associated with
additional product shipments, and depreciation charges on a larger number of
generators placed with customers. For the six months ended June 30 , 1999,
gross margins expanded to 51% from 43% for the six months ended June 30, 1998
due to the increased leverage of higher sales over our manufacturing and
depreciation costs.
Research and development expenses
Research and development expenses increased 25% to $2.6 million for the six
months ended June 30, 1999 from $2.1 million for the six months ended June 30,
1998. This increase was attributable to increased headcount, new product
development, the expansion of our intellectual property rights and additional
clinical studies. Research and development expenses consist of costs related to
our research and development, regulatory, quality assurance and patent
functions, as well as costs associated with scientific and clinical studies. We
expect to continue to make substantial investments in research and development
and anticipate that research expenses will continue to increase in absolute
dollars.
Sales and marketing expenses
Sales and marketing expenses increased 121% to $7.5 million for the six
months ended June 30, 1999 from $3.4 million for the six months ended June 30,
1998. This increase reflected significantly increased
18
personnel in both the spine and arthroscopy direct sales forces and the
reimbursement group, as well as higher total commission expenses from increased
unit sales. Sales and marketing expenses consist primarily of costs for sales,
marketing and reimbursement staff, sales commissions, medical conference
participation and physician training programs. We anticipate that sales and
marketing expenses will increase in absolute dollars as we continue to develop
our sales forces and expand our physician training programs.
General and administrative expenses
General and administrative expenses increased 23% to $1.5 million for the six
months ended June 30, 1999 from $1.2 million for the six months ended June 30,
1998. This increase was due primarily to the addition of finance personnel and
reserves for accounts receivable related to higher sales levels. General and
administrative expenses consist primarily of personnel costs, professional
service fees and general corporate expenses. We expect general and
administrative expenses to increase in absolute dollars as we add personnel and
incur additional expenses related to our operation as a public company.
Interest and other income (expense), net
Net interest and other expense was $339,000 for the six months ended June 30,
1999 and net interest and other income was $124,000 for the six months ended
June 30, 1998. The increase in overall interest expense was primarily
attributable to significantly increased debt balances outstanding as we
obtained equipment and other loans to fund operations during 1998. Net interest
and other income (expense) is comprised primarily of interest earned on short
term investments, offset by interest expense on equipment and debt obligations.
Quarterly Results of Operations
The following table sets forth our operating results for each of the six
quarters in the period ended June 30, 1999. This data has been derived from
unaudited financial statements that, in the opinion of our management, include
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of such information when read in conjunction with our
annual audited financial statements and notes thereto appearing elsewhere in
this prospectus. These operating results are not necessarily indicative of
results for any future period.
Quarter Ended
----------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, Jun. 30,
1998 1998 1998 1998 1999 1999
-------- -------- --------- -------- -------- --------
(in thousands, unaudited)
Sales................... $ 1,572 $ 2,535 $ 2,782 $ 4,240 $ 5,197 $ 7,702
Cost of sales........... 987 1,368 1,867 2,344 2,829 3,432
------- ------- ------- ------- ------- -------
Gross profit............ 585 1,167 915 1,896 2,368 4,270
Gross margin............ 37% 46% 33% 45% 46% 55%
Operating expenses:
Research and
development.......... 980 1,113 1,227 1,386 1,231 1,393
Sales and marketing... 1,512 1,879 2,284 2,643 3,254 4,240
General and
administrative....... 498 694 832 700 810 655
------- ------- ------- ------- ------- -------
Total operating
expenses........... 2,990 3,686 4,343 4,729 5,295 6,288
------- ------- ------- ------- ------- -------
Loss from operations.... (2,405) (2,519) (3,428) (2,833) (2,927) (2,018)
Interest and other
income (expense), net.. 56 68 (43) (238) (106) (233)
------- ------- ------- ------- ------- -------
Net loss................ $(2,349) $(2,451) $(3,471) $(3,071) $(3,033) $(2,251)
======= ======= ======= ======= ======= =======
We have historically experienced seasonal fluctuations in our sales of
arthroscopy products. Sales of our arthroscopy products tend to flatten or
decrease during the summer months when people often defer elective
19
surgeries until the fall. In addition, sales of arthroscopy products tend to
increase in the last quarter of the year as individuals seek to use health plan
coverage before the end of the insurance year.
For the quarter ended December 31, 1998, our revenues increased 52% to $4.2
million from $2.8 million for the quarter ended September 30, 1998 as a result
of the commercial launch of our spine products and the seasonal strength of
arthroscopy sales in the fourth quarter. This growth continued during the next
two quarters, with an increase of 23% in revenues during the quarter ended
March 31, 1999 and a further increase of 48% during the quarter ended June 30,
1999 as a result of increased sales of our spine products. We expect spine
sales to continue to account for a growing percentage of total sales for the
foreseeable future.
Gross margin percentage tended to increase over the six quarter period ending
June 30, 1999 as a result of the formal launch of our products and the
leveraging of these sales over our manufacturing cost base. We expect gross
margin to flatten or decline along with any leveling or decline in sales
growth. There was a decline in gross margin percentage in the quarter ended
September 30, 1998 due to a major investment in manufacturing infrastructure
and personnel to accommodate an expected increase in product demand.
The total number of our employees grew from 59 at December 31, 1997 to 162 at
June 30, 1999. As a result of the growth in the number of employees in our
sales and marketing, manufacturing, research and development, and general and
administrative organizations, all of the related operational expenses have
generally tended to increase on a quarter-to-quarter basis. Additionally, the
increased product sales on a quarter-to-quarter basis have caused commission
expenses paid to both employees and sales agents to increase. We have also
increased spending on clinical studies, physician training, medical conferences
and outside development costs during this six quarter period.
We believe that period-to-period comparisons of our operating results are not
necessarily meaningful. You should not rely on them to predict future
performance. The amount and timing of our operating expenses may fluctuate
significantly in the future as a result of a variety of factors. We face a
number of risks and uncertainties encountered by early stage companies,
particularly those in rapidly evolving markets such as the medical device
industry. In addition, although we have experienced revenue growth recently,
such revenue growth may not continue, and we may not achieve or maintain
profitability in the future.
Our quarterly revenues and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter due to a number of factors,
some of which are outside of our control. These factors include, but are not
limited to:
. the timing of training physicians in the use of our products;
. the timing of publication of supporting clinical data;
. delays in obtaining pre-certification for insurance reimbursement from
payors;
. the introduction of new products by us or our competitors;
. possible intellectual property litigation;
. changes in our pricing policies or those of our competitors or customers;
. delays in introducing new products;
. timing of regulatory approvals or other FDA action; and
. delays in product orders or payment as a result of our customers' or
payors' year 2000 problems.
Most of our expenses, such as employee compensation and lease payments for
facilities and equipment, are relatively fixed. In addition, our expense levels
are based, in part, on our expectations regarding future sales. As a result,
any shortfall in sales relative to our expectations could cause significant
changes in our operating results from quarter-to-quarter.
20
Years Ended December 31, 1998, 1997 and 1996
Sales
Sales increased by 328% to $11.1 million in 1998 from $2.6 million in 1997.
We formally launched our spine products during the fourth quarter of 1998, and
sales of these products were $1.2 million in 1998. Sales of our arthroscopy
products increased 280% to $9.9 million in 1998 from $2.6 million in 1997. This
increase in arthroscopy sales was due primarily to increased unit shipments to
an increased number of physicians who were trained in the use of our products
and the higher level of staffing and overall effectiveness of the direct sales
force in 1998. There were no sales of any products in 1996.
Cost of sales
Cost of sales increased by 277% to $6.6 million in 1998 from $1.7 million in
1997. The growth in cost of sales was attributable primarily to higher
material, labor and overhead costs on increased unit shipments, higher
depreciation costs for generators placed with customers and additional
manufacturing and other support personnel.
Research and development expenses
Research and development expenses increased 87% to $4.7 million in 1998 from
$2.5 million in 1997, and increased 186% in 1997 from $878,000 in 1996. These
increases were attributable primarily to increased headcount in all functional
areas of research and development, including product development and regulatory
compliance, as well as increased numbers of clinical studies and payments to
outside contractors for the development of generators.
Sales and marketing expenses
Sales and marketing expenses increased 217% to $8.3 million in 1998 from $2.6
million in 1997, and increased 367% in 1997 from $561,000 in 1996. This
increase reflected increased headcount expenses as we developed a direct field
sales force in each of the spine and arthroscopy markets, as well as greater
spending for physician training, medical conferences and higher commission
expenses on an increased number of product shipments.
General and administrative expenses
General and administrative expenses remained constant at $2.7 million in 1998
compared with 1997, but increased 188% in 1997 from $945,000 in 1996. The
increase from 1996 to 1997 was due primarily to hiring and relocating executive
officers.
Interest and other income (expense), net
Net interest and other expense was $157,000 in 1998. Net interest and other
income was $166,000 in 1997 and $82,000 in 1996. The year-to-year changes
resulted from earnings on short term investment balances, which varied as a
result of the timing of our private placement financings, and increased
interest expense as a result of our drawdown of debt.
Income Taxes
As of December 31, 1998, we had net operating loss carryforwards of
approximately $20.0 million for federal and $6.4 million for California income
tax purposes. We also had research and development credit carryforwards of
$200,000 for federal income tax purposes. The net operating loss and credit
carryforwards will expire at various dates beginning in 2009 through 2018, if
not utilized. Utilization of the net operating losses and credits may be
subject to a substantial annual limitation due to the ownership change
limitations of the
21
Internal Revenue Service Code of 1986. The annual limitation may result in the
expiration of the net operating losses before utilization. See Note 12 of Notes
to Financial Statements.
Liquidity and Capital Resources
From inception through June 30, 1999, we financed our operations primarily
through private sales, net of expenses, of $35.8 million of redeemable
convertible preferred stock. To a lesser extent, we also financed our
operations through equipment financing and other loans, which totaled $8.7
million in principal outstanding at June 30, 1999. As of June 30 1999, we had
$10.2 million of cash and cash equivalents, $3.0 million of short term
investments and $12.9 million of working capital.
Net cash used for operating activities was $5.5 million in the six months
ended June 30, 1999, $9.3 million in 1998, $6.2 million in 1997 and $2.3
million in 1996. Cash used for operating activities was attributable primarily
to net losses after adjustment for non-cash depreciation and amortization
charges and increases in accounts receivable and inventories, resulting from
higher revenues on increasing unit shipments in all periods. There was also a
$754,000 increase in prepaid and other current assets related to ORATEC's
increasing operating activities during this period. This increase in use of
cash for operating activities was offset in part by increases in accounts
payable, accrued compensation and other accrued liabilities also resulting from
the upward trend in business activities in all periods.
Net cash used in investing activities was $347,000 in the six months ended
June 30, 1999, compared to $4.0 million in 1998, $5.3 million in 1997 and $1.2
million in 1996. For each of these periods, cash used in investing activities
reflected purchases of property and equipment and net purchases or sales of
short term investments.
Net cash provided by financing activities was $4.4 million in the six months
ended June 30, 1999, $19.4 million in 1998, $15.8 million in 1997 and $4.7
million in 1996. Cash provided during these periods was attributable to
proceeds from the issuance of stock and debt obligations.
As of June 30, 1999, our principal debt and other commitments consisted of
$3.6 million outstanding under our equipment loans, $1.2 million under our
accounts receivable credit line, $4.0 million under our subordinated debt
facility and amounts payable under various operating leases. As of June 30,
1999, we had a commitment to purchase generators in the amount of $2.4 million
from a third party supplier. We expect to increase capital expenditures
consistent with our anticipated growth in manufacturing, infrastructure and
personnel. We also may increase our capital expenditures as we expand our
product lines or invest to address new markets.
As of June 30, 1999, we had available debt facilities totaling $1.3 million
under our asset-based line of credit. Some of our loan agreements require the
lenders' consent before we can incur additional debt. One of our loan
agreements contains financial covenants including a maximum debt to tangible
net worth ratio of 2:1. We received a waiver from the lender for our failure to
comply with all of these financial covenants during the third quarter of 1998.
From December 1998 to the present, we have been in compliance with all
financial covenants.
We believe that the net proceeds from this offering, together with our
current cash and investment balances and cash generated from operations, will
be sufficient to meet our anticipated cash needs for working capital and
capital expenditures for at least the next 18 months. If existing cash and cash
generated from operations is insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity or debt securities or
obtain an additional credit facility. The sale of additional equity or
convertible debt securities could result in dilution to our stockholders. If
additional funds are raised through the issuance of debt securities, these
securities could have some rights senior to holders of common stock, and could
contain covenants that would restrict our operations. Any additional financing
may not be available in amounts or on terms acceptable to us, if at all. If we
are unable to obtain this additional financing, we may be required to reduce
the scope of our planned product development and marketing efforts, which could
harm our results of operations and financial condition.
22
Year 2000 Readiness
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
distinguish between twentieth and twenty-first century dates. This may result
in software failures or the creation of erroneous results.
Our products are not date-sensitive, and therefore they are not affected by
year 2000 issues. We are in the process of testing all of our significant
internal systems for year 2000 compliance and anticipate completing this
process in the third quarter of 1999. We have purchased almost all of our
internal systems within the last three years, and we have not discovered, and
do not expect, material year 2000 problems.
We have contacted all of our major suppliers, and service and system
providers. They have assured us that their products and operations are year
2000 compliant or will be compliant by 2000. Despite our testing and assurances
from developers of software used in our operations, our business may be
disrupted by year 2000 problems.
We do not have any information concerning the year 2000 compliance status of
hospitals or other providers or the payors who reimburse those providers for
our procedures and products. Any year 2000 compliance problems that providers
or payors encounter in their internal systems could result in the delay or
cancellation of purchase orders for our products or the delay in payment for
our products. These delays could cause significant declines in sales in 2000
and longer accounts receivable collection cycles.
To date, expenses related to year 2000 compliance have not been and are not
expected to be material. We have not yet fully developed a contingency plan to
address situations that may result if we are unable to achieve year 2000
readiness of our critical operations, but we intend to have a contingency plan
in place in the fourth quarter of 1999. Finally, we are also subject to
external forces that might generally affect industry and commerce, such as year
2000 compliance failures by utility or transportation companies and related
service interruptions.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to interest rate risk at December 31, 1998 related to our
investment portfolio and our borrowings. Fixed rate investments and borrowings
may have their fair market value adversely impacted from changes in interest
rates. Floating rate investments may produce less income than expected if
interest rates fall, and floating rate borrowings will lead to additional
interest expense if interest rates increase. Due in part to these factors, our
future investment income may fall short of expectations, and our interest
expense may be above our expectations due to changes in U.S. interest rates.
Further, we may suffer losses in investment principal if we are forced to sell
securities which have declined in market value due to changes in interest
rates.
We invest our excess cash in debt instruments of the U.S. government and its
agencies, and in high quality corporate issuers. The average contractual
duration of all of our investments in 1998 was approximately two months. Due to
the short term nature of these investments, we have assessed that there is no
material exposure to interest rate risk arising from our investments.
We enter into loan arrangements with banks and financial institutions when
available on favorable terms. At December 31, 1998, we had bank borrowings of
$1.2 million outstanding, which bear interest at 1% above the prime rate. This
bank facility is being extended from its initial expiration date of June 30,
1999. We have determined that there is no material exposure to interest rate
risk arising from these borrowings.
23
BUSINESS
Overview
ORATEC Interventions is a leader in the development of medical devices that
use controlled thermal energy to treat spine and joint disorders. We currently
market two minimally invasive systems, the SpineCATH IntraDiscal ElectroThermal
Therapy, or IDET, system and the ElectroThermal Arthroscopy System. These
proprietary systems deliver heat to shrink and repair damaged or stretched
tissue.
Our SpineCATH IDET system is a minimally invasive treatment for low back pain
caused by degenerative disc disease. The SpineCATH IDET system enables
physicians to navigate a self-guiding catheter within a spinal disc to the
location of damaged tissue and apply heat to tighten and stiffen the disc wall.
We believe IDET is a new and effective solution for many patients facing few
options to treat their chronic discogenic pain.
Our ElectroThermal Arthroscopy System is a minimally invasive treatment for
joint disorders. Our proprietary tissue temperature control technology enables
physicians to treat damaged tissue in joints by shrinking tissue. We believe
that this minimally invasive treatment not only complements existing
arthroscopic procedures, but is a viable alternative to many open surgical
procedures.
All of the products we currently market have received 510(k) clearance from
the FDA, and as of June 30, 1999 we had six issued patents, eight notices of
allowance and 40 U.S. and foreign patent applications.
For the remainder of 1999 and the first six months of 2000, we plan to
continue to devote substantial resources to physician training programs, to our
sales and marketing efforts, to the continued establishment of clinical and
scientific support of our products and to our research and development efforts.
Our goal is to establish and maintain technology leadership by meeting the
needs of the spine and arthroscopy markets, two of the fastest growing segments
of the medical device industry.
Spine Market Opportunity
The treatment of back pain costs the U.S. health care system as much as $100
billion annually and represents the second most common reason for doctor
visits. Conditions related to back pain account for more hospitalizations
annually than any other orthopedic condition. It is estimated that at any given
time, five million individuals in the U.S. suffer from pain in the lumbar
region, commonly known as low back pain. The prescribed treatment for low back
pain depends on the severity and duration of the pain and the success or
failure of non-operative therapies. Non-operative therapies include bed rest,
medication, lifestyle modification, exercise, physical therapy, chiropractic
care and steroid injections. It has been estimated that physicians are able to
effectively treat most low back pain cases within three months using non-
operative therapies. However, it is estimated that there are approximately 1.4
million people in the U.S. for whom non-operative therapies have not been
successful and for whom spine surgery is not recommended because the level of
disc degeneration does not yet warrant a spiral fusion. We believe these
individuals are candidates for our IDET procedure.
Spinal Anatomy and Back Pain
The spinal column is segmented into 24 separate bones called vertebrae that
are connected together to permit a normal range of motion, including forward,
backward, lateral and twisting movement. The spinal cord, the body's central
nerve column, is enclosed within the spinal column.
Between each vertebra of the spine is a disc which allows for flexible
movement between the vertebra. Discs act as shock absorbers that protect the
spinal column during normal activities. Each disc consists of a "jelly-like"
internal mass, known as the nucleus. The layered fibrous wall, known as the
annulus, which surrounds the nucleus is composed primarily of collagen. In a
healthy spine, the nucleus is elastic and is surrounded by a strong disc wall
which allows the vertebra to be well supported and move normally.
24
Everyday motion of our backs causes repeated stress on the spine. Over time,
and after repeated stress, the wall of the disc may weaken and develop cracks
and fissures. This condition is known as degenerative disc disease. The cracks
and fissures may allow the nucleus to seep into the disc wall, which can
sensitize nerve fibers and cause severe back pain. In addition, small blood
vessels and tiny nerve fibers grow into the fissures, causing ongoing pain. The
weakened disc wall may also bulge or rupture under the pressure of the seeping
nucleus, resulting in a disc herniation. This bulging or rupturing of the disc
can injure the spinal nerve roots causing leg and hip pain, also known as
sciatica.
Existing Surgical Alternatives
Spine surgery is highly invasive and complex due to the proximity of major
muscle groups, nerves, blood vessels and organs. The spinal cord, branching
nerves and major muscle groups surround the rear portion of the spine, while
blood vessels, nerves and organs surround the front portion of the spine.
Discectomies, which involve the removal of a portion of the affected disc
tissue, are the most commonly performed surgical treatment to treat severe leg
pain caused by disc herniation. However, for patients suffering from chronic
back pain caused by degenerative disc disease, spinal fusion is the most viable
surgical treatment option.
Spinal fusion involves the fusing together of adjoining vertebrae in cases
where the patient has advanced disc degeneration or spine instability. This
invasive procedure involves a surgical incision in the patient's back or
abdomen. Fusions frequently require the removal of the affected disc material
and the surgical attachment of a metal implant or a spinal fusion cage to join
the two surrounding vertebrae. In addition, this procedure often involves a
second incision to remove bone from the patient's hip for implantation as a
bone graft for insertion into the disc space.
The operating time for low back spinal fusion surgeries utilizing metal
implants and spine cages averages over three hours with a post-operative
hospital stay for the patient which averages over four days. The patient also
generally requires significant post-operative pain medication. While the cost
of these procedures varies widely, we estimate that the total cost of most
spinal fusion surgeries is approximately $45,000.
We estimate that approximately 170,000 low back pain sufferers in the U.S.
undergo spinal fusion surgery annually. Only a small percentage of patients
with chronic low back pain actually undergo spinal fusion because it is
permanent, highly invasive and generally limited to the treatment of severe
conditions which could not be treated with a minimally invasive procedure. In
addition, clinical data has indicated that spinal fusion often causes further
deterioration of the discs on either side of the fusion site and only reduces
pain in approximately 60% of patients treated. Further, there are spine
disorders for which spinal fusion is not the medically indicated treatment. We
believe that the overall invasiveness of available therapies, as well as the
uncertainty of the alleviation of pain, leads many patients to defer surgery
until surgery is their only option, and continue to live with their chronic
pain.
The ORATEC Catheter-Based Spine Solution
Our SpineCATH IntraDiscal ElectroThermal Therapy, or IDET, system offers a
minimally invasive outpatient alternative to patients suffering from chronic
low back pain caused by degenerative disc disease.
The Procedure
The SpineCATH IDET system uses thermal energy technology to treat the
degenerated disc wall in a minimally invasive manner. The procedure begins with
the insertion of our proprietary single use SpineCATH catheter through an
introducer needle into the center of the disc. As the surgeon inserts the
catheter into the spine, the catheter guides itself along the disc wall. The
position of the catheter is confirmed by the physician using real time X-rays.
The physician begins to treat the disc by applying controlled levels of heat to
the disc wall. In response to the application of heat, the collagen in the disc
shrinks, causing the wall to contract and thicken. We believe that the
application of heat during the procedure desensitizes nerve fibers and that
25
following the procedure the contracted collagen acts as a scaffold which
supports the growth of new collagen, stiffening and repairing the disc wall. In
contrast to spine surgery, our procedure does not remove or destroy disc
tissue.
IDET is performed in an outpatient setting using local anesthesia and mild
sedation. The patient is responsive during the procedure to enable the
physician to closely monitor his or her condition. Depending on the condition
of the disc, the procedure may require the insertion of more than one catheter
for more complete treatment of the affected area of the disc wall. Multiple
discs may be treated in a single IDET procedure. Once the therapy is completed,
the catheter and needle are removed and an antibiotic is injected into the disc
to prevent infection. The patient is sent home with a bandaid over the needle
insertion site. The procedure costs approximately $8,000.
During the three to four month healing period following the procedure,
patients must exercise caution in the amount of stress the treated disc
endures. Patients are often advised by the physician to wear back support for
the first six weeks and to adhere to activity and physical rehabilitation
guidelines. Because we only have two years of patient follow-up data for our
spine products, we do not have sufficient data to determine if the pain relief
provided by the IDET procedure is permanent, but the procedure can be repeated
if longer-term patient follow up indicates that patients experience a
recurrence in pain.
Benefits of IDET
Clinical and scientific experience to date has indicated that IDET has the
following benefits:
. Minimally invasive treatment option: With the IDET procedure, patients
suffering from chronic low back pain have a new, minimally invasive
alternative if non-operative therapies have failed. IDET treats the
affected area of a specific disc in the lower back without the removal or
destruction of tissue or the permanent alteration of spinal anatomy
associated with conventional surgical treatments. Our procedure can be
repeated and does not preclude physicians from subsequently prescribing
more invasive surgical alternatives in the future.
. IDET may be reparative: Clinical results indicate that the IDET enables
physicians to apply controlled levels of heat to the disc wall causing
the collagen in the disc wall to contract and thicken. We believe the
contracted collagen, heated during the IDET procedure, acts as a scaffold
for the growth of new collagen, stiffening and repairing the disc wall.
Scientific studies are currently underway to investigate the healing
process following the IDET therapy.
. Significant reduction in reported patient pain levels and improvement in
overall quality of life: Clinical data has indicated that 60%-85% of
patients treated with IDET report a significant reduction in pain and a
significant improvement in physical function, as measured by the Visual
Analog Scale, or VAS, pain score system and the SF-36 patient outcomes
questionnaire. IDET benefits also include increased sitting tolerance and
ability to return to work. Over 70% of patients report that they reduced
or eliminated their intake of pain medication following the IDET
procedure.
. Significant decrease in overall time and cost: IDET takes approximately
one hour to perform in an outpatient setting under local anesthesia. In
contrast, spinal fusions are inpatient procedures performed under general
anesthesia, cost significantly more than the IDET procedure, require a
prolonged hospital stay and may result in post-operative complications.
Arthroscopy Market Opportunity
Arthroscopy is the minimally invasive treatment of joint tissue assisted with
a miniaturized camera, or arthroscope. Approximately 2.2 million arthroscopic
procedures were performed in the U.S. in 1998. We
26
believe the number of arthroscopic procedures is growing due to technological
advancements, physician and patient demand for less invasive procedures, the
increasing incidence of joint injuries caused by a greater emphasis on physical
fitness, and an aging population.
While we believe that shoulder arthroscopy is the fastest-growing portion of
the market, with 450,000 procedures performed last year, knee arthroscopy
continues to represent the greatest number of arthroscopic procedures,
accounting for approximately 1.5 million of arthroscopic procedures performed
in 1998. In addition, there were approximately 250,000 elbow, ankle, wrist and
hip joint arthroscopic procedures performed last year.
Joint Anatomy and Soft Tissue Disorders
Human joints are formed at the juncture of two or more bones and permit
motion of the otherwise rigid human skeleton. The bones of the joints are
joined by ligaments and separated by cartilage. The cartilage in the joints
acts as a cushion and the ligaments work to stabilize the joints when they are
stressed. As a result of injury or repetitive motion, soft tissue of the
ligaments and cartilage can be damaged, become worn and begin to stretch,
loosen or tear. This tissue damage can result in a wide range of joint
disorders from joint instability to severe ligament tears.
Existing Surgical Alternatives
Many joint injuries and disorders, including loose shoulder ligaments, severe
ankle sprains and torn and stretched knee ligaments, are treated using open
surgery. Open surgery involves large incisions, a prolonged hospital stay,
extensive rehabilitation over an extended recovery period and high overall
costs. Many of these conditions are not treated arthroscopically either because
arthroscopic techniques are not available, not effective, or are too difficult
to perform.
Arthroscopic surgery allows surgeons direct access to and a magnified view of
most areas of the joint through several small incisions. Using existing
electrosurgical tools, surgeons are able to cut and ablate damaged tissue.
However, research indicates that for some conditions which involve stretched or
loose tissue, the ability to shrink tissue could produce better patient
outcomes. Existing electrosurgical tools are capable of cutting and ablating
soft tissue because feedback on tissue temperature is not required for these
procedures. We believe that for tissue shrinkage physicians must be able to
monitor tissue temperature within an optimal temperature range. The
invasiveness of open surgery and the lack of effective arthroscopic procedures
to shrink tissue has led many patients to elect to live with their condition
until pain or loss of motion becomes unmanageable.
The ORATEC Temperature Control Arthroscopy Solution
Our ElectroThermal Arthroscopy System for tissue shrinkage offers a minimally
invasive solution to patients whose alternatives are open surgery or a less
effective arthroscopic procedure.
The Procedure
Our ElectroThermal Arthroscopy System utilizes the TAC probe, a single use
device which applies heat to soft tissue in the joints utilizing our
proprietary temperature control system. The procedure begins with the insertion
of several small tubes into the joint. An irrigant is then flushed through the
joint to permit clear visualization through the arthroscope and expand the
space in the joint for the surgical procedure. The surgeon inserts the TAC
probe into the joint and begins to paint the surface of the tissue with the tip
of the probe, controlling the energy level and monitoring tissue temperature.
In response to the application of heat, the collagen in the tissue of the
joints shrinks and tightens.
Our procedure is usually performed under general anesthesia, and the patient
is sent home the same day with the joint immobilized by a brace or a sling. The
post-operative healing period can extend to four months.
27
Benefits of the ElectroThermal Arthroscopy System
Clinical and scientific experience to date has indicated that our
ElectroThermal Arthroscopy System has the following benefits:
. Superior treatment option: Existing arthroscopic procedures do not allow
physicians to effectively monitor the temperature of the treated tissue.
Our proprietary temperature control feature allows physicians to
effectively shrink tissue by heating it to an optimal temperature range.
. Minimally invasive solution: The ElectroThermal Arthroscopy System
offers physicians a minimally invasive alternative for patients who might
otherwise avoid or delay open surgery. Compared to patients who undergo
open procedures, clinical data indicates that patients treated with our
products require significantly less post-operative pain medication,
experience a decreased risk of post-operative recovery complications and
require less extensive rehabilitation. Open surgical treatments require
large incisions and often result in a loss of range of motion and reduced
athletic function.
. Improvement of existing arthroscopic procedures: By combining our
shrinkage technology with other arthroscopic tools, physicians can more
completely treat certain joint disorders. For example, in connection with
the arthroscopic repair of a torn ligament, the application of our
shrinkage technology can improve patient outcomes by tightening the joint
tissue after the tear is repaired.
. Significant decrease in overall cost and time: For physicians, our
products offer less technically demanding procedures that significantly
reduce operating times. For patients, our procedures cost significantly
less than comparable open surgical procedures and allow them to leave the
hospital within two hours of the procedure as compared to open surgery
which requires hospitalization.
Business Strategy
Our strategy is to be the leading provider of minimally invasive devices for
the treatment of chronic back pain and joint injuries and disorders. The key
elements of our strategy include:
Target Large and Growing Markets. We target the spine and arthroscopy
markets, two of the fastest growing segments of the medical device industry. In
1998, these segments represented U.S. product sales in excess of $1 billion.
Provide Proprietary Minimally Invasive Techniques to Meet Unmet Medical
Needs. We focus on providing proprietary minimally invasive products to
overcome the limitations of existing treatment options, which can be highly
invasive and expensive and can result in sub-optimal patient outcomes.
Maintain Technology Leadership in Target Markets. We have an aggressive
product development program designed to enhance our current products and
develop new products for our target markets. Our ongoing focus will be to
design products that improve patient outcomes, simplify techniques, shorten
procedure and rehabilitation time and reduce costs.
Expand Clinical Leadership to Promote Use of Our Products. We will continue
to make substantial investments in the development of scientific and clinical
research to support market acceptance of our innovative minimally invasive
therapies. We have established strong relationships with leading physicians and
have developed an extensive physician training and education program.
Establish Sales Leadership. We are investing in, and marketing our products
through, separate spine and arthroscopy sales forces. In the U.S. market, we
have direct sales employees in most major markets and sales agents elsewhere.
We also provide reimbursement support for our customers. Internationally, we
use distributors to market our arthroscopy products and have an exclusive
distribution agreement with DePuy Acromed for the sale of our spine products.
28
Technology
Our proprietary SpineCATH IDET system and ElectroThermal Arthroscopy System
apply temperature-controlled thermal energy to achieve controlled contraction
of soft tissue. Collagen, the fibrous tissue that composes all human ligaments,
tendons and connective tissue, reacts to heat by shrinking. At optimal
temperatures, collagen fibers shrink, yet the mechanical and structural
integrity of the collagen is preserved so that it grows back in a reparative
way, as opposed to charring or forming scar tissue. Heating the tissue above
this range damages the collagen, making it weak and preventing optimal growth
of new collagen. Our SpineCATH IDET system utilizes our proprietary technology
to control the temperature of the catheter. The ElectroThermal Arthroscopy
System includes the only products in the market that monitor tissue
temperature. We believe our systems result in safer and more effective
treatments than competing technologies.
Technology--SpineCATH IDET
Our IDET system is based on the application of resistive heat, which is
thermal energy generated by an electric heating coil. This resistive heat is
delivered through a proprietary self-guiding spine catheter to achieve
controlled contraction of collagen in the affected areas of the spinal disc.
The thermal delivery system is a five-centimeter heating tip at the end of the
catheter. The tip of the catheter contains a thermal monitoring mechanism,
which continually measures and relays catheter temperature back to the energy
source, the generator. Our research indicates that the optimal heating protocol
for many procedures requires a 149(degrees)F initial catheter temperature,
which then rises by 2(degrees)F every 30 seconds for 17 minutes until the
temperature of the catheter reaches 194(degrees)F, where it remains for four
additional minutes. Our temperature feedback mechanism enables the generator to
continually adjust heat to achieve catheter temperatures consistent with these
predetermined heating protocols.
Technology--ElectroThermal Arthoscopy System
Physicians use our patented electrothermal arthroscopy products to apply
controlled radiofrequency energy to joint tissue. Radiofrequency, or RF, energy
is a portion of the electromagnetic spectrum, in which the alternating current
flow produces molecular friction and thus heat in soft tissue. All
electrosurgical systems contain two electrodes for directing energy: an active
electrode and a return electrode. In monopolar electrosurgery, the active
electrode is located at the tip of a hand-held probe and the return electrode
is a dispersive pad, which rests on the patient's body. In bipolar
electrosurgery, both active and return electrodes are located at the tip of the
probe. Consequently, in bipolar systems, the current travels through only a
shallow portion of target tissue before traveling back through the probe. We
have based our arthroscopic system for tissue shrinkage on monopolar technology
because we believe that monopolar technology allows for more effective and
consistent temperature control as well as deeper penetration of target tissue,
allowing more complete shrinkage of soft tissue. Scientific and clinical
studies indicate that heating the tissue to a range of 149(degrees)F to
167(degrees)F produces optimal shrinkage in the arthroscopic setting. The tip
of our probe contains a thermostat which records tissue temperature and relays
it back to the generator, enabling the generator to adjust energy output 50
times per second to maintain optimal tissue temperatures.
Products
We currently manufacture and sell the SpineCATH IntraDiscal ElectroThermal
Therapy system for the treatment of spine disorders and the ElectroThermal
Arthroscopy System for the treatment of joint injuries and disorders. Each of
these systems utilizes controlled thermal energy to enable physicians to
perform minimally invasive treatments of these disorders. In addition, we
market the ORAflex ElectroThermal Spine Probe for the treatment of spine
disorders.
SpineCATH IDET System
Our SpineCATH IDET system provides a non-surgical alternative for patients
suffering from degenerative disc disease in the lower back. Our SpineCATH IDET
system received 510(k) premarket clearance from the
29
FDA in March 1998 and was formally launched in October 1998. Our SpineCATH IDET
system consists of the following products:
. the SpineCATH IntraDiscal Catheter;
. the ORA-50 S ElectroThermal Generator; and
. an introducer needle and needle bender.
Our SpineCATH IntraDiscal disposable spine catheter is a 1.0 mm flexible,
self-guiding catheter designed to deliver resistive thermal energy to affected
disc walls in the lower back. Our proprietary SpineCATH product has the
following features:
. a broad five centimeter heating section for the delivery of thermal heat;
. a temperature sensing and control system;
. a pre-curved navigation tip, designed to automatically follow the
curvature of the human disc;
. an ergonomic handle, which controls catheter direction; and
. radiopaque indicators, which enable physicians to verify optimal catheter
placement through the use of real time X-rays.
The list price of this product is $795 per catheter. We estimate that
approximately 1.5 catheters are used per procedure.
Our ORA-50 S ElectroThermal Generator is the source of the resistive heat,
which the SpineCATH catheter delivers to the affected disc. Our spine generator
has the following features:
. software that enables the physician to program optimal treatment
temperatures, so that the catheter temperature is automatically elevated
according to the pre-determined heating protocols;
. a proprietary temperature feedback and control system, which monitors
temperature in the tip of the catheter; and
. an easy-to-read graphic display, which enables the physician to monitor
catheter temperatures, delivered power and total treatment time.
The list price of this product is $12,995.
ORAflex ElectroThermal Spine Probe
Our ORAflex electrothermal disposable spine probe is used for treating disc
herniations by shrinking the nucleus using RF energy. The ORAflex is used with
an endoscope and has the following main features:
. a deflectable tip, which improves access to affected disc tissue; and
. a thermostat, which provides direct temperature feedback during
treatment.
The list price of the ORAflex probe is $595.
ElectroThermal Arthroscopy System
Our ElectroThermal Arthroscopy System provides a minimally invasive
alternative for patients suffering from joint injuries. Our first TAC probe and
generator received 510(k) premarket clearance from the FDA in December 1995,
and this system was formally launched in March 1997. We received 510(k)
premarket clearance from the FDA for our ligament chisels in February 1997, and
began marketing these products in September 1997. Our arthroscopy system
consists of the following products:
. the Temperature Control, or TAC, family of probes, which includes the
MiniTAC-S probe and MicroTAC-S probe.
30
. the Ligament Chisel family of electrosurgical cutting probes, which
includes the MicroLigament Chisel, angled and MicroLigament Chisel,
curved; and
. the ORA-50 ElectroThermal Generator.
Our disposable temperature control probes have been designed to treat a
variety of joint disorders through low energy, soft tissue shrinkage. The main
features of our TAC probes are:
. a malleable tip, which can be bent up to 90 degrees for improved access
and maneuverability in difficult-to-reach areas;
. a thermostat in the tip of the probe, which measures and monitors actual
tissue temperature; and
. a variety of probe shapes and sizes for optimal tissue access.
The list price for each disposable TAC probe is $295.
Our line of disposable Ligament Chisel electrosurgical cutting probes is
designed to treat a variety of joint pathologies that require treatment of
small shallow tissue areas. The Ligament Chisel cutting probes cut and ablate
soft tissue while simultaneously cauterizing bleeding vessels. Our disposable
cutting probes allow physicians to use higher voltage energy and have the
following features:
. a malleable tip for improved access and maneuverability in difficult-to-
reach joint areas;
. four different tip designs to allow precise matching of energy delivery
to specific anatomy and procedures; and
. a tip design that enhances tactile feedback for optimal control and
access.
Our cutting probes can be used with all irrigation fluids. The list price for
each disposable Ligament Chisel is $95. We also sell a line of Micro Chisels
for use in small joints at a list price of $110.
Our ORA-50 ElectroThermal Generator is a dual mode generator, that provides
the electromagnetic RF energy source and control mechanism required for
temperature-controlled arthroscopic procedures. These two modes enable
physicians to either precisely shrink affected tissue or to rapidly cut and
ablate tissue with concurrent cauterization. The ORA-50 arthroscopy generator
has the following features:
. a proprietary temperature feedback and control mode, which automatically
adjusts the power 50 times per second for precise, consistent temperature
control of the target tissue;
. a power mode, which provides a constant power source for high temperature
tissue cutting and ablation with concurrent cauterization; and
. an easy-to-read numeric display, which enables physicians to monitor
actual tissue temperatures, total treatment time and delivered energy
during treatment.
The list price of ORA-50 generator is $8,995.
We believe that our current product liability insurance coverage provides us
with adequate protection against the risks associated with product liability
claims.
Sales and Marketing
We market our products in the U.S. directly to physicians who perform spine
and arthroscopic procedures. For our spine products, these physicians include
orthopedic spine surgeons, neurosurgeons, pain management specialists,
anesthesiologists, interventional radiologists and physiatrists. For our
arthroscopy products, these physicians are orthopedic surgeons, including
sports medicine specialists. We estimate that there are approximately 8,500
spine specialists in the U.S. and 7,000 orthopedic surgeons who consider
arthroscopy to be their major practice area.
31
We have focused sales and marketing teams for each of the spine and
arthroscopy markets in order to address the different physician groups in each
of these two areas. Each of these two sales organizations includes sales
employees covering most major markets, complemented by select sales agencies.
We believe that a direct sales force is better able to attain in-depth
expertise on the clinical benefits of our products. Sales agents typically
support the direct sales strategy by covering more rural areas. Agents
representing our product lines concurrently handle other related products and
have been selected based on their stature and performance in their respective
markets.
The marketing platform for both spine and arthroscopy is built on scientific
and clinical data and extensive surgeon training programs. To date, we have
trained over 500 physicians in the use of the IDET procedure and plan to
increase that number to over one thousand by the end of 1999. We expect to
provide spine and arthroscopy product-related training for approximately 1,500
physicians during 1999. Course faculty is comprised of physicians with
extensive procedure experience using our products. We expect to have scientific
data presented at over 30 specialty meetings during 1999.
Our spine products are marketed domestically by 12 direct sales employees,
one national director, three regional sales managers and 14 independent sales
agencies. We plan to significantly increase our sales force by the end of 1999.
Our arthroscopy products are marketed domestically by 21 direct sales
employees, one national director, four regional managers, one national training
manager and 23 sales agencies.
We have focused our resources on the rapid development of the U.S. market for
our products. International sales have not been significant to date. Our
arthroscopy products are distributed in select countries by exclusive
distributors in those countries. With the market introduction of the SpineCATH
product, we have entered into an exclusive distribution agreement with DePuy
AcroMed for the marketing and sales of our spine products internationally. The
initial term of the agreement is five years and is automatically renewable
subject to termination in some circumstances. We have the right to terminate
the agreement if DePuy fails to meet negotiated minimum purchase requirements
commencing in the year 2000.
Third-Party Reimbursement
Establishing reimbursement for any new technology is a challenge in the
current environment of cost containment and managed care. The cost reduction
orientation of the payor community makes it exceedingly difficult for new
medical technologies and surgical techniques to be covered for reimbursement.
We have a dedicated reimbursement group which:
. assists physicians and surgery centers with obtaining pre-determination
of procedures;
. screens each case to determine that the procedure is appropriate for the
patient's condition; and
. assists physicians and providers in claim collections.
We have been working with various medical associations responsible for
determining reimbursement coding to develop our coding and reimbursement
strategy. The codes define reimbursement levels and are used for billing
purposes by health care providers. We have also introduced a new service for
physicians. Based on physician authorization, we obtain payment pre-
determination for the IDET procedure by contacting payors on behalf of the
physician practice. The service is free to physicians and outpatient facilities
and has proven to be effective. Our reimbursement staff of eight individuals
educates the payor community on the IDET procedure from the local case managers
to the national policy makers. To date, over 85% of pre-determination requests
have been approved by the payors, however several large insurance plans have
yet to approve payment for the procedure. It is our belief that published
clinical data in peer reviewed journals will facilitate further acceptance by
payors.
Arthroscopy procedure costs, including the cost of our products, have been
covered under the customary payment policies of most payors. Reimbursement for
the incremental cost of our temperature control probes has
32
been an issue for ambulatory surgical centers. We have assisted these
facilities in understanding how to receive reimbursement for the incremental
cost.
Competition
The medical device industry is subject to intense competition. Accordingly,
our future success will depend on our ability to meet the clinical needs of
physicians, improve patient outcomes, and remain cost-effective for payors.
There are a number of medical treatments for low back pain ranging from
medication and physical therapy to spinal injections and interbody spine
fusion. Our IDET procedure is typically offered to a patient after medications,
injections and physical therapy have failed, usually after six months of
unresolved symptoms.
The spinal fusion market is highly competitive. Spinal fusion is not
considered directly competitive with our product because it treats severe disc
degeneration, which the IDET procedure is not designed to treat. However, spine
implant companies including Sofamor Danek, Sulzer Spine-Tech, Surgical
Dynamics, DePuy AcroMed and SYNTHES-STRATEC may consider us to be a competitor
because our IDET system may, if used preemptively, delay or eliminate the need
for a spinal fusion for some patients. We are also aware that Radionics offers
a probe which is designed for lesioning, or destroying tissue cells, in the
spine, not for tissue shrinkage.
Several larger companies sell competitive products to our ElectroThermal
Arthroscopy System. These competitors, ArthroCare, Mitek and CONMED, are
focused on the tissue ablation market and offer directly competitive cutting
and ablating products. ArthroCare and Mitek also have low energy tissue
coagulation products which compete directly with our shrinkage products and, we
believe based on current estimates, currently control 10% of the tissue
shrinkage market.
We believe that the principal competitive factors in the markets for the
treatment of spine and joint disorders include:
.improved patient outcomes;
.the publication of peer reviewed clinical studies;
.acceptance by leading physicians;
.ease of use for physicians;
.sales and marketing capability;
.timing and acceptance of product innovation;
.patent protection;
.product quality; and
.cost effectiveness.
The cost of our IDET procedure is approximately $8,000 compared to spinal
fusion, which costs approximately $45,000.
Patents and Proprietary Technology
We believe that in order to have a competitive advantage we must develop and
maintain the proprietary aspects of our technologies. To this end, we file
patent applications to protect technology, inventions and improvements that we
believe are significant to the growth of our business. As of June 30, 1999, we
had five issued U.S. patents, one issued foreign patent, eight notices of
allowance, 20 pending U.S. patent applications and 20 pending foreign patent
applications. None of our issued patents is spine specific. The issued and
allowed patents cover, among other things, method and apparatus claims for
directing energy to and sealing
33
fissures in the spinal discs, including navigation within a disc and devices
with a functional element at the tip, and the controlled contraction of tissue
in all joints and spinal discs. Our patents also cover our temperature feedback
system, probe tip technology, ligament shrinkage and controlled depth ablation.
We require our employees, consultants and advisors to execute confidentiality
agreements in connection with their employment, consulting or advisory
relationships with us. We also require our employees, consultants and some
advisors to agree to disclose and assign to us all inventions conceived during
the ORATEC work day, using our property or which relate to our business.
Despite any measures taken to protect our intellectual property, unauthorized
parties may attempt to copy aspects of our products or to obtain and use
information that we regard as proprietary. Finally, our competitors may
independently develop similar technologies. See "Risk Factors--Because of the
importance of our patent portfolio to our business, we may lose market share to
our competitors if we fail to protect our intellectual property rights."
The medical device industry is characterized by the existence of a large
number of patents and frequent litigation based on allegations of patent
infringement. As the number of entrants into our market increases, the
possibility of an infringement claim against us grows. Our spine and
arthroscopy products and the methods they employ may be covered by U.S. patents
held by our competitors. We have made a careful analysis in consultation with
our experts and, based on such analysis, we believe that either such patents or
claims are invalid or if valid we do not infringe. See "Risk Factors--Because
the medical device industry is litigious, we are particularly susceptible to an
intellectual property suit."
Research and Development
We have an aggressive product development program to develop and enhance
products for the spine and arthroscopy markets. The ongoing focus of our
research and development group is to design products that improve patient
outcomes, simplify techniques, shorten procedure and rehabilitation time and
reduce costs. As of June 30, 1999, we employed 29 people in our research and
development organization. Our probe and generator development group consisted
of 18 people. We also had two people focused on the management of intellectual
property, four responsible for clinical and regulatory affairs and five in
quality assurance.
New Product Development
We are committed to leveraging our existing technologies into new orthopedic
applications and responding to the clinical needs of physicians and patients in
cost effective ways. We have a number of new projects and product enhancements
under development by the research and development group. Product line
extensions include:
. the development of a spine catheter for the upper spine;
. a line of probes designed for use in arthroscopic hip procedures;
. variations of existing probes for improved access in the arthroscopic
environment;
. enhanced software and firmware elements for our electrothermal generators
to provide improved temperature control functions; and
. a new generation of electrothermal generators with enhanced capabilities.
Clinical Research
The clinical research department supports our development efforts by
conducting in-house cadaveric and bench testing for the development and
evaluation of products and managing the numerous scientific and clinical
studies conducted by investigators and institutions studying the effects of our
technologies. To date, there are seven clinical studies involving 651 patients
using our spine products and 13 clinical studies involving 925 patients using
our arthroscopy products. Some of these studies are still underway, and their
outcomes are not yet determined. In addition to administrative support and
funding, the department assists investigators in writing protocols and
collecting data, when necessary, as well as by providing site monitoring and
research support.
To date there have been eight published reports in peer reviewed journals
discussing the effects of our technologies. An additional seven manuscripts are
pending publication, and 35 abstracts have been presented at
34
medical conferences by both physicians affiliated with us as clinical and
scientific advisors and unaffiliated physicians.
Manufacturing
Our manufacturing operations are focused primarily on the manufacture of
disposable products. The manufacturing process includes the inspection,
assembly, testing, packaging and sterilization of components that have been
manufactured by us or to our specifications by outside contractors. We inspect
each lot of components and finished products to determine compliance with our
specifications.
We have established quality assurance systems in conformance with the Quality
System Regulation, or QSR, as mandated by the FDA. Our Menlo Park, California
facility received ISO 9001/EN 46001 certification in March 1998 and is in
conformance with the Medical Device Directive, or MDD, for sale of products in
Europe. We inspect incoming components, and inspect and test products both
during and after the manufacturing process. We also inspect packaged products
and test the sterilization process to produce quality products.
We subcontract the manufacture of the electrothermal generators to a single
source supplier. The generators are tested by both the contract manufacturer
and us before shipment to customers. We are currently preparing for in-house
assembly of the generators in order to reduce the risk of a single source
supplier, to control the quality and availability of the product and to
leverage fixed costs. See "Risk Factors--We have a sole supplier of generators,
and any disruption in supply could result in decreased sales" and "Risk
Factors--If we fail to successfully transition the manufacture of our
generators to internal operations, we may experience a decrease in sales."
Most purchased components and services are available from more than one
supplier. For some components and services, there are relatively few alternate
sources of supply and establishment of additional or replacement suppliers for
such components and services could not be accomplished quickly. As of June 30,
1999, we had a purchase order for $2.4 million in generators. Except for this
purchase order, there are no contractual obligations by suppliers to continue
to supply to us nor are we contractually obligated to purchase from a
particular supplier.
We utilize a gas plasma sterilization system that has been used extensively
in hospital settings but only recently for industrial applications. The system
received 510(k) clearance from the FDA in 1993. A contract sterilizer provides
gas plasma sterilization services as a backup to our system. We also utilize a
contract sterilizer that provides gamma sterilization services for those
products that cannot be sterilized with gas plasma. Sterilization indicators
for all products sterilized at our facilities are processed at an outside
certified laboratory to verify the effectiveness of the sterilization process
prior to the release of the product for distribution.
Government Regulation
Our products are regulated in the U.S. as medical devices by the FDA under
the Federal Food, Drug, and Cosmetic Act and require clearance of a premarket
notification under Section 510(k) of the FDC Act or approval of a PMA under
Section 515 of the FDC Act by the FDA prior to commercialization. Material
changes or modifications to medical devices are also subject to FDA review and
clearance or approval. The FDA regulates the research, clinical testing,
manufacturing, safety, labeling, storage, record keeping, advertising,
distribution, sale and promotion of medical devices in the U.S. Non-compliance
with applicable requirements can result in, among other actions, warning
letters, fines, injunctions, civil and criminal penalties against us, our
officers, and our employees, recall or seizure of products, total or partial
suspension of production, failure of the government to grant premarket
clearance or premarket approval for devices, withdrawal of marketing approvals,
and recommendation that we not be permitted to enter into government contracts.
To date, all of our products have received 510(k) clearances or are exempt
from the 510(k) clearance process. It generally takes three to 12 months from
the date of the submission to obtain clearance of a 510(k) submission, but may
take longer. Recently, the FDA has begun requiring a more rigorous
demonstration of substantial equivalence, including clinical trials for some
devices. While we have been successful to date in
35
obtaining regulatory clearance of our products through the 510(k) notification
process, our future products may not meet the requirements for 510(k)
clearance. If the FDA concludes that any product does not meet the requirements
for 510(k) clearance, then a PMA would be required and the time required for
obtaining regulatory approval would be significantly lengthened.
Once 510(k) clearance has been received, any products that we manufacture or
distribute are subject to extensive and continuing regulation by the FDA.
Modifications to devices cleared via the 510(k) process may require a new
510(k) submission. We have made modifications to some of our devices which we
believe do not require the submission of new 510(k) notifications. If the FDA
requires us to submit a new 510(k) notification for any device modification, we
may be prohibited from marketing the modified device until the 510(k) is
cleared by the FDA.
We have been an FDA registered medical device facility since 1996 and
obtained our manufacturing license from the California Department of Health
Services, or CDHS, in 1997. We are inspected by both the FDA and CDHS for
compliance with GMP, QSR and other applicable regulations. Our manufacturing
processes are required to comply with GMP and QSR regulations, which cover the
methods and documentation of the design, testing, production, control, quality
assurance, labeling, packaging and shipping of our products.
We are also required to comply with Medical Device Reporting regulations that
require us to report to the FDA any incident in which our product may have
caused or contributed to a death or serious injury, or in which our product
malfunctioned and, if the malfunction were to recur, it would be likely to
cause or contribute to a death or serious injury. To date, we have filed two
Medical Device Reports, or MDRs, with the FDA for burns caused by improperly
applied patient grounding pads, and six MDRs relating to breakage of the
SpineCATH IntraDiscal catheter upon its removal after the completion of the
procedure. In addition, 456 TAC probes were returned to us as a result of a
March 1999 voluntary recall for a faulty part supplied to us by an outside
vendor, however no patient complaints or claims were received. We informed the
FDA about this recall, and the FDA determined that it was not a reportable
event under FDA regulations. In addition, we received a warning letter from the
FDA in April 1999 regarding information on our website which the FDA believed
was broadening our label indications, which means it interpreted some
statements on our website to inform readers that our products could be used for
indications that are not FDA approved. We removed some information from our
website and responded that the remaining information was not intended to expand
label indications.
We are also subject to regulations and product registration requirements in
many of the foreign countries in which we sell our products, in the areas of
product standards, packaging requirements, labeling requirements, import
restrictions, tariff regulations, duties and tax requirements. The time
required to obtain clearance required by foreign countries may be longer or
shorter than that required for FDA clearance, and requirements for licensing a
product in a foreign country may differ significantly from FDA requirements.
Either we or our distributors have received registrations and approvals to
market the ORA-50 ElectroThermal Generator and arthroscopy probes and
accessories in Canada, the United Kingdom, Belgium, Italy, Spain, Australia and
Taiwan. Registration for market approval for our spine products is in process
in several international markets. We are seeking or intend to seek regulatory
approvals in other international markets. We may not obtain these foreign
approvals on a timely basis, or at all.
The European Union has promulgated rules, under the MDD 93/42/EEC, which
require medical devices to bear the "CE mark" by June, 1998. The CE mark is an
international symbol of adherence to quality assurance standards. Our
ISO9001/EN46001 registration and conformance with the MDD have allowed us to
affix the CE mark to our devices and export our devices to any EC-member
country.
Employees
As of June 30, 1999, we had 162 full-time employees, including 29 in research
and development, 56 in manufacturing, 62 in sales and marketing and 15 in
general and administrative functions. From time to time, we also employ
independent contractors to support our engineering, marketing, sales and
support and administrative organizations.
36
Facilities
We are headquartered in Menlo Park, California, where we lease two buildings
with approximately 25,000 square feet of office, research and development and
manufacturing space under leases expiring between September 2000 and July 2003.
Beginning in the third quarter of fiscal 1999 we will lease an additional 5,000
square feet of manufacturing space. We also maintain an office for our
reimbursement function in Dallas, Texas. We believe that our existing
facilities are adequate to meet our current and foreseeable requirements for
the next 12 months or that suitable additional or substitute space will be
available as needed.
Legal Proceedings
From time to time we are a party to various legal proceedings arising in the
ordinary course of our business. We are not currently subject to any material
legal proceedings.
Scientific and Clinical Advisory Boards
Our scientific and clinical advisory boards work collaboratively with ORATEC
to provide advice, assistance and consultation in the spine and arthroscopy
fields. We consider our advisory board members to be opinion leaders in their
fields, and they offer us advice regarding the applicability of our products to
procedures and feedback on both existing products and products under
development.
The following individuals sit on our advisory boards for spine.
Scientific Advisory Board
Name Position and Affiliation
---- ------------------------
Howard An, M.D. ............ Professor of Orthopedic Surgery, Rush
Presbyterian St. Luke's Medical Center, Chicago,
IL
Gunnar Anderson, M.D. ...... Orthopedic Spine Surgeon, Rush Presbyterian St.
Luke's Medical Center, Chicago, IL
Charles Aprill, M.D. ....... Radiologist and Medical Director, Magnolia
Diagnostics, New Orleans, LA
David Casper, M.D. ......... Clinician of Orthopedic and Spine Surgery,
Oklahoma Sports Science and Orthopedics, Oklahoma
City, OK
Richard Derby, M.D. ........ Medical Director, Spinal Diagnostics & Treatment
Center, Daly City, CA
Neil Kahanovitz, M.D. ...... Orthopedic Surgeon, Anderson Orthopedic Clinic,
Arlington, VA
Jeffrey Saal, M.D. ......... Associate Clinical Professor, Stanford University
School of Medicine, Palo Alto, CA
Joel Saal, M.D. ............ Assistant Clinical Professor, Stanford University
School of Medicine, Palo Alto, CA
Robert Watkins, M.D. ....... Orthopedic Spine Surgeon, Center for Orthopedic
Spinal Surgery, Los Angeles, CA
Hansen Yuan, M.D. .......... Professor of Orthopedic and Neurological Surgery,
State University of New York, Syracuse, NY
Clinical Advisory Board
Name Position and Affiliation
---- ------------------------
Arnold Criscitiello, M.D. .. Assistant Professor, University Hospital Health
Science Center, Syracuse, NY
Steve Garfin, M.D. ......... Orthopedic Surgeon, Spine; Professor and Chair in
the Department of Orthopedics, University of
California, San Diego, CA
Steve Hochschuler, M.D. .... Chairman, Texas Back Institute, Plano, TX
Dennis Karasek, M.D. ....... Physician, Northwest Spine Group, Eugene, OR
Michael Karasek, M.D. ...... President, Northwest Spine Group, Eugene, OR
Casey Lee, M.D. ............ Clinical Professor, Department of Orthopedics,
New Jersey Medical School, Newark, NJ
John Peloza, M.D............ Clinical Assistant Professor, University of
Texas, Southwestern Medical School, Department of
Orthopaedic Surgery, Dallas, TX; Spine Surgeon,
Center for Spine Care, Dallas, TX
Ralph Rashbaum, M.D. ....... Clinical Medical Director, Texas Back Institute,
Plano, TX
John Regan, M.D. ........... Associate, Texas Back Institute, Plano, TX
Kerry Thompson, M.D. ....... Neuroradiologist, Anne Arundel General Hospital,
Annapolis, MD
Todd Wetzel, M.D. .......... Associate Professor of Surgery, Section of
Orthopedic Surgery and Rehabilitation, University
of Chicago, Chicago, IL
37
The following individuals sit on our advisory boards for arthroscopy.
Scientific Advisory Board
Name Position and Affiliation
---- ------------------------
David Drez, M.D .......... Clinical Professor of Orthopedics, Louisiana State University School of Medicine,
Lake Charles, LA
Lawrence Lemak, M.D. ..... Orthopedic Surgeon, Alabama Sports Medicine Orthopedic Center, Birmingham, AL
Mark Markel, M.D. ........ Chair, Department of Medical Sciences, University of Wisconsin, Madison, WI
Gary Poehling, M.D. ...... Chairman of Orthopedics, Wake Forest School of Medicine, Winston-Salem, NC
Felix Savoie, M.D. ....... Director, Upper Extreme Service, Mississippi Sports Medicine, Jackson, MS
James Tibone, M.D. ....... Orthopedic Surgeon, Kerlan-Jobe Orthopedic Clinic, Inglewood, CA
Russell Warren, M.D. ..... Surgeon in Chief, Hospital for Special Surgery, New York, NY
Clinical Advisory Board
Name Position and Affiliation
---- ------------------------
Jeffrey Abrams, M.D. ..... Associate Medical Director, Princeton Orthopedic and Rehabilitation Associates,
Princeton, NJ
James Andrews, M.D. ...... Medical Director, American Sports Medicine Institute, Birmingham, AL
James Bradley, M.D. ...... Director, Pittsburgh Center for Sports Medicine, Shadyside Hospital, Pittsburgh, PA
Brian Cole, M.D. ......... Assistant Professor of Orthopedics, Sports Medicine, Rush Presbyterian St. Luke's
Medical Center, Chicago, IL
Michael Dillingham, M.D... Partner, Sports Orthopedic and Rehabilitation, or S.O.A.R., Medicine Associates,
Menlo Park, CA
Robert Eppley, M.D. ...... Orthopedic Consultant, University of California, Berkeley, CA
Gary Gartsman, M.D........ Orthopedic Surgeon, Fondren Orthopedic Group, Houston, TX
Jeffrey Halbrecht, M.D. .. Medical Director, Women's Professional Ski Tour; California Pacific Medical Center,
San Francisco, CA
Richard Hawkins, M.D. .... Orthopedic Surgeon, Steadman Hawkins Clinic, Vail, CO
Darryl Kan, M.D. ......... Orthopedic Team Physician, University of Hawaii, Honolulu, HI
Michael Krinsky, M.D. .... Chief of Staff, Health Surgery Center of Castro Valley, CA
Craig Levitz, M.D. ....... Attending Physician, Long Island Jewish Hospital; Director, OCOA Cartilage Repair
and Sports Medicine Center, Long Island, NY
Walter Lowe, M.D. ........ Associate Clinical Professor, Baylor College of Medicine, Department of Orthopaedic
Surgery, Houston, TX
Bruce Moseley, M.D. ...... Clinical Associate Professor, Baylor College of Medicine, Houston, TX
Lawrence Oloff, D.P.M. ... D.P.M. Surgeon, S.O.A.R., Menlo Park, CA
Jeffrey Schubiner, M.D. .. Orthopedic Surgeon, Consultant, San Bruno, CA
Pierce Scranton, M.D. .... Orthopedic Surgeon, Orthopedics International LTD P.S., Seattle, WA
Eric Stahl, M.D. ......... Orthopedic Surgeon, Lakewood Orthopedic Clinic, Lakewood, CO
George Thabit, M.D. ...... Orthopedic Surgeon, S.O.A.R., Menlo Park, CA
Eric Verploeg, M.D. ...... Orthopaedics Surgeon, Orthopaedics of Steamboat Springs, CO
Kenneth Zaslov, M.D. ..... Clinical Assistant Professor of Orthopaedic Surgery, Virginia Commonwealth University;
Director of Sports Medicine, Advanced Orthopaedic Centers, Richmond, VA
38
MANAGEMENT
Executive Officers and Directors
The following table sets forth specific information regarding our executive
officers and directors as of June 30, 1999:
Name Age Position
---- --- --------
Kenneth W. Anstey....... 53 President, Chief Executive Officer and Director
Hugh R. Sharkey......... 49 Executive Vice President, Chief Technical Officer and Director
Nancy V. Westcott....... 46 Chief Financial Officer and Vice President, Administration
Roger H. Lipton......... 41 Vice President, Sales and Marketing
Calvin K. Lee........... 45 Vice President, Operations
Richard M. Ferrari
(1)(2)................. 45 Chairman of the Board
Stephen Brackett (1).... 36 Director
Gary S. Fanton, M.D.
(2).................... 47 Director
Patrick F. Latterell
(1).................... 41 Director
Jeffrey A. Saal, M.D.
(2).................... 49 Director
- --------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Kenneth W. Anstey joined ORATEC in April 1996 as a director and has served as
President and Chief Executive Officer of ORATEC since July 1997. From December
1995 to March 1997, Mr. Anstey was the Chief Executive Officer of Biofield
Corporation, a cancer diagnostic company. From August 1991 to December 1995, he
served as President and Chief Executive Officer of Mitek Surgical Products, an
orthopedic implant company, which was subsequently acquired by Johnson &
Johnson. He currently serves as a director of Vision Sciences, a medical device
company. Mr. Anstey holds a B.A. degree in Advertising and an M.B.A. degree
from Michigan State University.
Hugh R. Sharkey co-founded ORATEC and has served as a director since
inception. From July 1995 until July 1997, he served as Chief Executive
Officer, President and Chief Financial Officer, and in June 1997 he became
Executive Vice President and Chief Technical Officer. In March 1994, Mr.
Sharkey co-founded ZoMed International (now RITA Medical Systems), a
radiofrequency ablation company. In 1992, Mr. Sharkey co-founded VIDAMed, a
urology company, and in 1987, he co-founded Danforth Biomedical, a medical
device company. From May 1988 to May 1989, he served as Vice President and
General Manager of EP Technologies, a cardiac electrode company, which was
acquired by Boston Scientific, a minimally invasive medical device company. Mr.
Sharkey is listed as an inventor on over 53 patents for medical devices. He
holds an A.A. degree in Nursing and a B.S. degree in Business Administration
from the University of Phoenix.
Nancy V. Westcott joined ORATEC as its Chief Financial Officer and Vice
President, Administration in November 1997. From November 1992, she served as
Vice President of Corporate Communications for Caremark International, a health
care services company, until its acquisition in September 1996. From June 1978
to November 1992, she held a number of management positions with Baxter
International in pension management and international and domestic treasury.
Ms. Westcott holds a B.A. degree in German from the University of Idaho and a
Masters of International Management degree from the American Graduate School of
International Management (Thunderbird). She earned her Professional Accounting
Certificate at the J.L. Kellogg Graduate School of Management at Northwestern
University.
Roger H. Lipton joined ORATEC in January 1996 as Vice President, Sales and
Marketing. From January 1989 to November 1995, Mr. Lipton held management
positions in marketing and business development at AME Orthofix, an orthopedic
and spine implant company. Prior to working at AME Orthofix, he served as a
principal of Martek, a marketing consulting firm, and as Director of Sales and
Marketing of Medmax, a start-up cardiovascular company. Mr. Lipton holds a B.S.
degree in Business Administration from the University of Hartford.
39
Calvin K. Lee joined ORATEC as Vice President, Manufacturing in October 1996,
and was promoted to Vice President, Operations in June 1999. From November 1987
to September 1996, Mr. Lee worked at Cardiometrics, a manufacturer of blood-
flow monitors, most recently as Vice President of Manufacturing. Prior to
working at Cardiometrics, Mr. Lee held several manufacturing management
positions with Advanced Cardiovascular Systems, a cardiovascular device
company. Mr. Lee holds a B.S. degree in Business Administration from California
State University at San Jose.
Richard M. Ferrari has served as a director of ORATEC since May 1996 and was
elected Chairman of the Board in January 1997. Since June 1995, Mr. Ferrari has
served as Chief Executive Officer of CardioThoracic Systems, a minimally
invasive coronary bypass company. From January 1991 to September 1995, Mr.
Ferrari was President and Chief Executive Officer of CVIS, a cardiovascular
medical device company, which was recently acquired by Boston Scientific. From
April 1990 to January 1991, he served as President and Acting Chief Executive
Officer of Medstone International, a shockwave therapy company, and from
January 1986 to April 1990, he was an Executive Vice President with ADAC
Laboratories, a nuclear medical imaging and healthcare information systems
company. Mr. Ferrari also serves as a director and advisor for several start-up
companies in the medical device industry. Mr. Ferrari holds a B.S. degree in
Health and Education from Ashland University and an M.B.A. from the University
of South Florida.
Stephen Brackett has served as a director of ORATEC since December 1998. Mr.
Brackett founded MF Private Capital, Inc., a merchant bank and registered
broker-dealer, in 1998 and currently serves as a managing director. From
February 1995 to December 1997, Mr. Brackett managed the Corporate Advisory and
Investment Banking services for The Bank of Tokyo-Mitsubishi Capital
Corporation. From March 1994 to February 1995 Mr. Brackett was President and
Chief Operating Officer of State Street Business Group, an investment banking
firm. Mr. Brackett also serves on the board of directors of several private
companies. Mr. Brackett holds a B.A. degree in Political Science from Bates
College.
Gary S. Fanton, M.D. is a co-founder of ORATEC and has served as a director
since August 1995. Since, 1983, Dr. Fanton has been conducting his medical
practice with Sports Orthopedic and Rehabilitation, or S.O.A.R., Medicine
Associates. In addition, Dr. Fanton has been an Assistant Clinical Professor at
Stanford University since 1983, the head orthopedic surgeon for the Stanford
University football team since 1992 and the associate team physician for the
San Francisco 49ers since 1984. Dr. Fanton founded the International
Musculoskeletal Laser Society and has done extensive research on the effects of
thermal energy on soft tissue. He is a member of the Orthopedic Research
Society and the American Orthopedic Society for Sports Medicine. Dr. Fanton
holds a B.S. degree in Zoology from the University of Michigan and an M.D.
degree from the Medical College of Wisconsin, and completed his orthopedic
residency training at the Cleveland Clinic and his fellowship training in
sports medicine at the Kerlan-Jobe Orthopedic Clinic. Dr. Fanton is board
certified in Orthopedic Surgery.
Patrick F. Latterell has served as a director of ORATEC since October 1997,
and previously served as a director and Chairman of the Board from August 1996
to January 1997. Mr. Latterell has been a general partner at Venrock
Associates, a venture capital firm, since April 1989. Mr. Latterell also serves
as a director of Vical, a gene-based pharmaceutical company, as well as several
private companies. He holds S.B. degrees in both Biology and Economics from the
Massachusetts Institute of Technology and an M.B.A degree from the Stanford
University Graduate School of Business.
Jeffrey A. Saal, M.D. is a co-founder of ORATEC and has been a director since
August 1995. Since 1981, Dr. Saal has been conducting his medical practice with
the S.O.A.R. Physiatry Medical Group. Since 1992, he has been an Associate
Clinical Professor at Stanford University, and since 1981 he has served as team
physician to various college sports teams. Dr. Saal is on the editorial boards
of several peer review journals, including Spine. Dr. Saal holds several
positions with professional societies, including Founding Chairman of PASSOR,
the Physiatric Association of Spine Sports and Occupational Rehabilitation. He
was also a former President of the North American Spine Society, or NASS. Dr.
Saal holds a B.A. degree in Biology from the
40
State University of New York, Oneonta and an M.D. degree from Tulane Medical
School. He completed his residency training at the Boston VA Hospital and
Stanford University. Dr. Saal is board certified in Physical Medicine, Internal
Medicine and Electrodiagnostic Medicine.
Board Composition
Our bylaws currently provide for a board of directors consisting of seven
members. Following the offering and beginning at the first annual meeting of
stockholders after the date on which we shall have had at least 800
stockholders, the board of directors will be divided into three classes, each
serving staggered three year terms: Class I, which is anticipated to consist of
directors Fanton and Ferrari, whose term will expire at the first annual
meeting of stockholders after the date on which we have 800 stockholders; Class
II, which is anticipated to consist of directors Latteral, Saal and Sharkey,
whose term will expire at the second annual meeting of stockholders after the
date on which we have 800 stockholders; and Class III, which is anticipated to
consist of directors Anstey and Brackett, whose term will expire at the third
annual meeting of stockholders after the date on which we have 800
stockholders. As a result, only one class of directors will be elected at each
annual meeting of stockholders of ORATEC, with the other classes continuing for
the remainder of their terms. Messrs. Latterell and Brackett were elected to
the board of directors pursuant to voting agreements between us and certain
principal stockholders. These voting agreements will terminate upon completion
of this offering. Our officers are appointed by the board of directors and
serve at the discretion of the board of directors.
Board of Directors Compensation
Our directors do not currently receive compensation for their services as
members of the board of directors. Employee directors are eligible to
participate in our 1995 Stock Plan and will be eligible to participate in our
1999 Employee Stock Purchase Plan. Nonemployee directors are eligible to
participate in our 1995 Stock Plan and will be eligible to participate in our
1999 Directors' Stock Option Plan. See "--Stock Plans."
Board Committees
The compensation committee currently consists of Gary Fanton, M.D., Richard
Ferrari and Jeffrey Saal, M.D. The compensation committee:
. reviews and approves the compensation and benefits for our executive
officers and grants stock options under our stock option plan; and
. makes recommendations to the board of directors regarding such matters.
The audit committee consists of Stephen Brackett, Richard Ferrari and Patrick
Latterell. The audit committee:
. makes recommendations to the board of directors regarding the selection
of independent auditors;
. reviews the results and scope of the audit and other services provided by
our independent auditors; and
. reviews and evaluates our audit and control functions.
Compensation Committee Interlocks and Insider Participation
The members of the compensation committee of the board of directors are
currently Gary Fanton, M.D., Richard Ferrari and Jeffrey Saal, M.D., none of
whom has ever been an officer or employee of ORATEC.
41
Executive Compensation
Summary Compensation. The following table sets forth the compensation
received for services rendered to us during the fiscal year ended December 31,
1998 by our Chief Executive Officer and the four other most highly compensated
executive officers who earned more than $100,000 during the fiscal year ended
December 31, 1998.
Summary Compensation Table
Annual Compensation Long Term Compensation
--------------------------------- ------------------------
All Other Restricted Securities
Compensation Stock Underlying
Name and Principal Position Salary ($) Bonus ($) ($) Awards ($) Options (#)
- --------------------------- ---------- --------- ------------ ---------- -----------
Kenneth W. Anstey,......
President and Chief
Executive Officer $200,000 $38,000 $101,629(1) $40,001(4) --
Hugh R. Sharkey,........
Executive Vice
President and Chief
Technical Officer $150,000 $37,500 $ 6,000(2) -- --
Nancy V. Westcott,......
Chief Financial Officer
and Vice President,
Administration $150,000 $50,000 $103,738(3) -- --
Roger H. Lipton,........
Vice President, Sales
and Marketing $150,000 $45,000 $ 3,600(2) -- 3,000
Calvin K. Lee,..........
Vice President,
Operations $135,000 $10,000 -- -- 6,000
- --------
(1) Consists of $95,629 in payments for moving and relocation costs and $6,000
car allowance.
(2) Consists of car allowance.
(3) Consists of $63,366 in payments for moving and relocation costs and $40,372
in tax reimbursement in connection with relocation.
(4) Represents 5,647 shares of common stock valued at the December 31, 1998
fair market value of $7.08. These shares were fully vested on the date of
grant. No dividends will be paid on these shares.
Option Grants. The following table shows information regarding stock options
granted to our executive officers during the year ended December 31, 1998. No
stock appreciation rights were granted to these individuals during the year.
Option Grants in Last Fiscal Year
Potential
Realizable
Value at Assumed
Annual Rates
Number of of Stock Price
Shares Percentage of Appreciation for
Underlying Total Options Option Term(2)
Options Granted to Exercise Price Expiration -----------------
Name Granted(1) Employees per Share Date 5% 10%
---- ---------- ------------- -------------- ---------- -------- --------
Roger H. Lipton......... 3,000 0.7% $2.92 1/18/08 $ 69,420 $115,740
Calvin K. Lee........... 6,000 1.4% $2.92 1/18/08 $138,840 $231,480
- --------
(1) These stock options, which were granted under our 1995 plan, become
exercisable at the rate of 1/48th of the total number of shares on the
monthly anniversary of the date of grant, as long as the optionee remains
an employee with, consultant to, or director of ORATEC.
(2) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the Securities and Exchange Commission and are based on the
assumption that the assumed initial public offering price of $16.00 was the
fair market value of the common stock on the date of grant. There is no
assurance provided to any executive officer or any other holder of our
securities that the actual stock price appreciation over the 10-year option
term will be at the assumed 5% and 10% levels or at any other defined
level. Unless the market price of the common stock appreciates over the
option term, no value will be realized from the option grants made to the
executive officers.
42
Aggregate Option Exercises and Holdings. The following table provides summary
information concerning the shares of common stock represented by outstanding
stock options held by each of our executive officers as of December 31, 1998.
Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Number of Options at at December 31, 1998
Shares Value December 31, 1998 (#) ($)(2)
Acquired on Realized ------------------------- -------------------------
Name Exercise (#) ($)(1) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ -------- ----------- ------------- ----------- -------------
Kenneth W. Anstey....... -- -- 137,250 162,750 $2,076,436 $2,400,563
Hugh R. Sharkey......... -- -- 24,000 -- $ 379,999 --
Nancy V. Westcott....... -- -- 24,375 65,625 $ 329,063 $ 885,938
Roger H. Lipton......... -- -- 46,187 27,313 $ 729,745 $ 427,411
Calvin K. Lee........... -- -- 33,875 32,125 $ 497,360 $ 466,120
- --------
(1) The amount set forth represents the difference between the fair market
value of the shares on the date of exercise as determined by the Board of
Directors and the exercise price of the option.
(2) The amount set forth represents the difference between the fair market
value of the underlying common stock at December 31, 1998, using an assumed
initial public offering price of $16.00 per share as the fair market value,
and the exercise price of the option.
Employment Agreements. We have entered into employment agreements with some
of our executive officers, which provide for the payment of severance or the
acceleration of unvested stock, options and warrants in some circumstances.
Mr. Anstey's agreement provides that if he is involuntarily terminated
without cause, including his constructive termination, he will receive a
severance payment, paid in two installments, equal to 12 months of his base
salary and target bonus earned, as well as acceleration of vesting on 50% of
his unvested options. If, as a result of a change of control of ORATEC, Mr.
Anstey is involuntarily terminated other than for cause, all of his unvested
options and stock shall vest immediately.
Mr. Sharkey's agreement provides that if we terminate him without cause, he
will receive continued payment of his base salary and a pro rata amount of his
prior year's annual bonus for a period of six months after his termination
date. In addition, upon a change of control of ORATEC, his unvested stock and
options shall immediately vest.
Ms. Westcott's agreement provides that if we terminate her without cause, she
will receive continued payment of base salary on a monthly basis for (a) 12
months, if the termination occurs on or before October 30, 1999, (b) six
months, if the termination occurs after October 30, 1999, or (c) 12 months, if
she is involuntarily terminated, including her constructive termination, in
connection with a change of control. In addition, if Ms. Westcott is
involuntarily terminated, including her constructive termination, within 12
months after a change of control of ORATEC, 100% of her unvested options will
vest immediately.
Mr. Lipton's agreement provides that, upon a change of control of ORATEC,
100% of his unvested options will vest immediately.
Stock Plans
1995 Stock Plan. Our 1995 plan provides for the grant of incentive stock
options to employees, including employee directors, and of nonstatutory stock
options and stock purchase rights to employees, directors, including employee
and non-employee directors, and consultants. The purposes of the 1995 plan are
to attract and retain the best available personnel, to provide additional
incentives to our employees and
43
consultants and to promote the success of our business. The 1995 plan was
originally adopted by our board of directors in July 1995 and approved by our
stockholders in September 1995. Our board of directors approved amendments to
the 1995 plan to increase the number of shares reserved under the 1995 plan in
April 1996, July 1997 and November 1998, and our stockholders approved these
amendments to the 1995 plan in May 1996, July 1997 and November 1998. As of
June 30, 1999, an aggregate of 2,250,000 shares was reserved for issuance under
the 1995 plan. The 1995 plan was amended by our board of directors on July 1,
1999 to increase the total number of shares reserved for issuance by 750,000
shares, and to incorporate some other changes, after which a total of 3,000,000
shares of common stock was reserved for issuance under the 1995 plan. In
addition, the 1995 plan was amended to provide for an automatic annual increase
on the first day of each of our fiscal years beginning in 2000, 2001 and 2002
equal to the lesser of 750,000 shares, 4% of our outstanding common stock on
the last day of the immediately preceding fiscal year, or such lesser number of
shares as the board of directors determines. This amendment to the 1995 plan
will be submitted to our stockholders for approval prior to the completion of
this offering. Unless terminated earlier by the board of directors, the 1995
plan will terminate in July 2005.
As of June 30, 1999, options to purchase 1,881,607 shares of common stock
were outstanding under the 1995 plan at a weighted average exercise price of
$3.39 per share, 244,625 shares had been issued upon exercise of outstanding
options or pursuant to restricted stock purchase agreements and 123,768 shares
remained available for future grant.
The 1995 plan may be administered by the board of directors or a committee of
the board, each known as the administrator. The administrator determines the
terms of options and stock purchase rights granted under the 1995 plan,
including the number of shares subject to the award, the exercise or purchase
price, and the vesting and/or exercisability of the award and any other
conditions to which the award is subject. In no event, however, may an employee
receive awards for more than 1,000,000 shares under the 1995 plan in any fiscal
year. Incentive stock options granted under the 1995 plan must have an exercise
price of at least 100% of the fair market value of the common stock on the date
of grant, and not less than 110% of the fair market value in the case of
incentive stock options granted to an employee who holds more than 10% of the
total voting power of all classes of our stock or any parent or subsidiary's
stock. Prior to this offering, nonstatutory stock options and stock purchase
rights granted under the 1995 plan were required to have an exercise or
purchase price of at least 85% of the fair market value of the common stock on
the date of grant, and grants vested at the rate of at least 20% per year.
After the date of this offering, the exercise price of nonstatutory stock
options and the purchase price of stock purchase rights will no longer be
subject to these restrictions, although nonstatutory stock options and stock
purchase rights granted to our Chief Executive Officer and our four other most
highly compensated officers will generally equal at least 100% of the fair
market value on the grant date if we intend that awards to those individuals
will qualify as performance-based compensation under applicable tax law.
Payment of the exercise or purchase price may be made in cash or other
consideration as determined by the administrator.
With respect to options granted under the 1995 plan, the administrator
determines the term of options, which may not exceed 10 years, or five years in
the case of an incentive stock option granted to an employee who holds more
than 10% of the total voting power of all classes of our stock or a parent or
subsidiary's stock. Generally, an option granted under the 1995 plan is
nontransferable other than by will or the laws of descent and distribution, and
may be exercised during the lifetime of the optionee only by such optionee.
However, the administrator may in its discretion provide for the limited
transferability of nonstatutory stock options granted under the 1995 plan under
some circumstances. Stock issued pursuant to stock purchase rights granted
under the 1995 plan is generally subject to a repurchase right at the
purchaser's original purchase price exercisable by ORATEC upon the termination
of the holder's employment or consulting relationship with us for any reason,
including death or disability. This repurchase right will lapse in accordance
with the terms of the stock purchase right determined by the administrator at
the time of grant.
If we sell all or substantially all of our assets or if we are acquired by
another corporation, each outstanding option and stock purchase right may be
assumed or an equivalent award substituted by the acquiror
44
or purchaser. However, if the acquirer does not agree to this assumption or
substitution, then outstanding options will terminate. Upon the closing of the
transaction, outstanding repurchase rights will terminate unless assigned to
the acquiror or purchaser. The administrator has the authority to amend or
terminate the 1995 plan, but no action may be taken that impairs the rights of
any holder of an outstanding option or stock purchase right without the
holder's consent. In addition, we must obtain stockholder approval of
amendments to the plan as required by applicable law.
1999 Employee Stock Purchase Plan. Our 1999 employee stock purchase plan was
adopted by the board of directors in July 1999 and will be submitted for
approval by our stockholders prior to completion of this offering. A total of
250,000 shares of common stock has been reserved for issuance under the 1999
purchase plan, none of which have been issued as of the date of this offering.
The number of shares reserved for issuance under the 1999 purchase plan will be
subject to an automatic annual increase on the first day of each of our fiscal
years beginning in 2001, 2002 and 2003 equal to the lesser of 250,000 shares,
2% of our outstanding common stock on the last day of the immediately preceding
fiscal year, or such lesser number of shares as the board of directors
determines. The 1999 purchase plan becomes effective upon the date of this
offering. Unless terminated earlier by the board of directors, the 1999
purchase plan shall terminate in 2009.
The 1999 purchase plan, which is intended to qualify under Section 423 of the
Internal Revenue Code, will be implemented by a series of offering periods of
approximately six months' duration, with new offering periods, other than the
first offering period, commencing generally on May 1 and November 1 of each
year. At the end of each offering period an automatic purchase will be made for
participants. The initial offering period is expected to commence on the date
of this offering and end on April 30, 2000. The 1999 purchase plan will be
administered by the board of directors or by a committee appointed by the
board. Employees, including officers and employee directors of ORATEC or of any
majority-owned subsidiary designated by the board, are eligible to participate
in the 1999 purchase plan if they are employed by us or any subsidiary for at
least 20 hours per week and more than five months per year. The 1999 purchase
plan permits eligible employees to purchase common stock through payroll
deductions, which in any event may not exceed 15% of an employee's base salary.
The purchase price is equal to the lower of 85% of the fair market value of the
common stock at the beginning of each offering period or at the end of each
offering period. Employees may end their participation in the 1999 purchase
plan at any time during an offering period, and participation ends
automatically on termination of employment.
An employee cannot be granted an option under the 1999 purchase plan if
immediately after the grant the employee would own stock and/or hold
outstanding options to purchase stock equaling 5% or more of the total voting
power or value of all classes of our stock or stock of our subsidiaries, or if
the option would permit an employee's rights to purchase stock under the 1999
purchase plan to accrue at a rate that exceeds $25,000 of the fair market value
of the stock for each year in which the option is outstanding. In addition, no
employee may purchase more than 2,000 shares of common stock under the 1999
purchase plan in any one offering period.
If we merge or consolidate with or into another corporation or sell all or
substantially all of our assets, each right to purchase stock under the 1999
purchase plan will be assumed or an equivalent right substituted by the
successor corporation. However, the board of directors will shorten any ongoing
offering period so that employees' rights to purchase stock under the 1999
purchase plan are able to be exercised prior to the transaction if the
successor corporation refuses to assume each purchase right or to substitute an
equivalent right. The board of directors has the power to amend or terminate
the 1999 purchase plan and to change or terminate an offering period as long as
this action does not adversely affect any outstanding rights to purchase stock.
However, the board of directors may amend or terminate the 1999 purchase plan
or an offering period even if it would adversely affect outstanding options in
order to avoid our incurring adverse accounting charges.
1999 Directors' Stock Option Plan. The 1999 directors' stock option plan was
adopted by the board of directors in July 1999 and will be submitted to our
stockholders for approval prior to completion of this offering. It will become
effective upon the date of this offering. A total of 200,000 shares of common
stock has been reserved for issuance under the 1999 directors' plan, all of
which remain available for future grants. The directors' plan provides for the
grant of nonstatutory stock options to our nonemployee directors. The
directors'
45
plan is designed to work automatically without administration; however, to the
extent administration is necessary, it will be performed by the board of
directors. To the extent a conflict of interest arises, it will be addressed by
abstention of any interested director from both deliberations and voting
regarding matters in which the director has a personal interest. Unless
terminated earlier, the directors' plan will terminate in July 2009.
The directors' plan provides that each person who becomes a nonemployee
director after the completion of this offering will be granted a nonstatutory
stock option to purchase 20,000 shares of common stock on the date on which the
individual first becomes a member of our board of directors. Thereafter, on the
date of each annual shareholder meeting, each nonemployee director will be
granted a nonstatutory stock option to purchase 5,000 shares of common stock,
if on the date of that meeting, the nonemployee director has been a member of
the board of directors for at least six months.
All options granted under the directors' plan will have a term of 10 years
and an exercise price equal to the fair market value of the common stock on the
date of grant and will generally be nontransferable. All options granted under
the directors' plan shall be vested and exercisable in full immediately upon
grant of such option. If a nonemployee director ceases to serve as a director
for any reason other than death or disability, he or she may, but only within
60 days after the date he or she ceases to be a director, exercise options
granted under the directors' plan. If he or she does not exercise the option
within this 60-day period, the option shall terminate. If a director's service
terminates as a result of his or her disability or death, or if a director dies
within three months following termination for any reason, the director or his
or her estate will have 12 months after the date of termination or death, as
applicable, to exercise options that were vested as of the date of termination.
If we are acquired by another corporation, each option outstanding under the
directors' plan will be assumed by the acquiror or equivalent options
substituted, unless our acquiror does not agree to such assumption or
substitution, in which case the options will terminate upon consummation of the
acquisition to the extent not previously exercised. Our board of directors may
amend or terminate the directors' plan as long as such action does not
adversely affect any outstanding option and we obtain stockholder approval for
any amendment to the extent required by applicable law.
Limitation of Liability and Indemnification Matters
Our certificate of incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for:
. any breach of their duty of loyalty to the corporation or its
stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
. any transaction from which the director derives an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission. Our certificate of
incorporation and bylaws provide that we shall indemnify our directors and
executive officers and may indemnify our other officers and employees and other
agents to the fullest extent permitted by law. We believe that indemnification
under our bylaws covers at least negligence and gross negligence on the part of
indemnified parties. Our bylaws also permit us to secure insurance on behalf of
any officer, director, employee or other agent for any liability arising out of
his or her actions in this capacity, regardless of whether the bylaws would
permit indemnification.
We have entered into agreements to indemnify our directors and executive
officers in addition to indemnification provided for in our bylaws. These
agreements provide, among other things, for indemnification
46
of our directors and executive officers for expenses specified in the
agreements, including attorneys' fees, judgments, fines and settlement amounts
incurred by any director or officer in any action or proceeding arising out of
his or her services as a director or executive officer of ORATEC, any
subsidiary of ORATEC or any other entity to which the person provides services
at our request. In addition, we maintain directors' and officers' insurance. We
believe that these provisions and agreements are necessary to attract and
retain qualified persons as directors and executive officers.
At present, we are not aware of any pending or threatened litigation or
proceeding involving a director, officer, employee or agent in which
indemnification would be required or permitted. We are not aware of any
threatened litigation or proceeding that might result in a claim for such
indemnification.
47
TRANSACTIONS WITH AFFILIATES
From October 1, 1995 through June 30, 1999, we issued shares of preferred
stock in private placement transactions as follows:
. an aggregate of 2,034,356 shares of Series B preferred stock at $2.25 per
share in October 1995, February 1996, April 1996 and February 1999;
. an aggregate of 865,511 shares of Series C preferred stock at $5.00 per
share in March 1997 through December 1997;
. an aggregate of 1,937,133 shares of Series D preferred stock at $5.83 per
share in November 1997 and December 1997; and
. an aggregate of 2,254,678 shares of Series E preferred stock at $7.08 per
share in December 1998.
The following table summarizes the shares of preferred stock purchased since
October 1, 1995 and held as of June 30, 1999 by our executive officers,
directors, holders of more than 5% of our outstanding stock and their
affiliates:
Series B Series C Series D Series E
Name Preferred Preferred Preferred Preferred
---- --------- --------- --------- ---------
Entities affiliated with Venrock Associates(1).......... 555,554 342,857 105,881
Entities affiliated with Delphi Ventures................ 555,555 257,142
Entities affiliated with Pequot Private Equity Fund,
L.P.................................................... 685,714 141,179
Gerlach & Co. as nominee for The Manufacturers Life
Insurance Company (U.S.A.)(2).......................... 564,705
Hugh R. Sharkey......................................... 27,554 21,000
Gary S. Fanton, M.D..................................... 19,999 9,000
Jeffrey A. Saal, M.D.................................... 26,666
Roger H. Lipton......................................... 20,470(3)
Calvin K. Lee........................................... 6,000 7,200
- --------
(1) Patrick Latterell, a general partner of Venrock Associates, is a director
of ORATEC.
(2) Stephen Brackett, a managing director of MF Private Capital, an affiliate
of The Manufacturers Life Insurance Company, is a director of ORATEC.
(3) Issued on exercise of a warrant to purchase shares of Series B preferred
stock.
Shares held by affiliated persons and entities have been aggregated. See
"Principal Stockholders."
See "Management--Executive Compensation" for description of employment
agreements with some of our executive officers, which provide for the payment
of severance or the acceleration of unvested stock and options in some
circumstances.
We have entered into indemnification agreements with our officers and
directors containing provisions which may require us, among other things, to
indemnify our officers and directors against some liabilities that may arise by
reason of their status or service as officers or directors, other than
liabilities arising from willful misconduct of a culpable nature, and to
advance their expenses incurred as a result of any proceeding against them as
to which they could be indemnified.
48
The following table summarizes the options granted to, and the shares of
common stock purchased since January 1, 1996 and held as of June 30, 1999 by,
our executive officers, directors, holders of more than 5% of our outstanding
stock and their affiliates:
Common Issuance Vesting
Name Stock Options Price Date Schedule
---- ------ ------- ------ ---------- --------
Kenneth W. Anstey.................. 5,647(1) $ 7.08 Aug. 1998
48,000 $ 0.17 April 1996 (2)
252,000 $ 1.25 July 1997 (3)
60,000 $ 7.08 Feb. 1999 (4)
Gary S. Fanton, M.D................ 24,000 $ 0.17 April 1996 (2)
6,000 $ 2.92 Feb. 1998 (2)
6,000 $ 7.08 Mar. 1999 (2)
Richard M. Ferrari................. 48,000 $ 1.25 Aug. 1996 (2)
6,000 $ 7.08 Mar. 1999 (2)
Patrick F. Latterell............... 3,000(5) $ 1.25 Sept. 1996
Calvin K. Lee...................... 60,000 $ 1.25 Dec. 1996 (3)
6,000 $ 2.92 Jan. 1998 (4)
Roger H. Lipton.................... 16,500(6) $0.002 Jan. 1997
15,000 $ 0.17 June 1996 (7)
6,000 $ 1.25 June 1997 (2)
3,000 $ 2.92 Jan. 1998 (4)
Jeffrey A. Saal, M.D............... 24,000 $ 0.17 April 1996 (2)
6,000 $ 2.92 Feb. 1998 (2)
6,000 $ 7.08 Mar. 1999 (2)
Hugh R. Sharkey.................... 24,000(6) $ 0.17 April 1999
Nancy V. Westcott.................. 28,125(6) $ 2.50 Feb. 1999
7,500(6) $ 2.50 June 1999
54,375 $ 2.50 Nov. 1997 (7)
- --------
(1) Shares were issued as a bonus to Mr. Anstey.
(2) Shares vest at the rate of 1/24th per month after the vesting commencement
date.
(3) Shares vest at the rate of 6/48ths six months after the vesting
commencement date and 1/48th per month thereafter.
(4) Shares vest at the rate of 1/48th per month after the vesting commencement
date.
(5) Shares were purchased with cash.
(6) Shares were purchased with cash pursuant to an option exercise.
(7) Shares vest as follows: 1/4th of the total shares vest on the one year
anniversary of the vesting commencement date and 1/48th of the total shares
vest on the monthly anniversary thereafter.
49
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to
beneficial ownership of our common stock as of June 30, 1999, as adjusted to
reflect the sale of common stock offered hereby, by:
. each person, or group of affiliated persons, known by us to own
beneficially more than 5% of our outstanding common stock,
. each director,
. our Chief Executive Officer and our four other most highly
compensated executive officers, and
. all directors and officers as a group.
Percent Beneficially
Owned(2)
--------------------
Number of Before After
Name Shares Offering Offering(1)
---- --------- -------- -----------
Patrick F. Latterell(3)......................... 1,007,292 10.3% 8.2%
Entities Associated with Venrock Associates(4).. 1,004,292 10.3% 8.2%
30 Rockefeller Plaza, Suite 5508
New York, NY 10112
Entities Associated with Pequot Private Equity 826,893 8.5% 6.8%
Fund, L.P.(5)..................................
500 Nayala Farm Road
Westport, CT 06880
Entities Associated with Delphi Ventures(6)..... 812,697 8.3% 6.6%
3000 Sand Hill Road
Building 1, Suite 135
Menlo Park, CA 94025
Stephen Brackett(7)............................. 564,705 5.8% 4.6%
Gerlach & Co. as nominee for The Manufacturers 564,705 5.8% 4.6%
Life Insurance
Company (U.S.A.)...............................
45 Milk Street, Suite 600
Boston, MA 02109-5105
Hugh R. Sharkey(8).............................. 548,761 5.6% 4.5%
Gary S. Fanton, M.D.(9)......................... 392,248 4.0% 3.2%
Jeffrey A. Saal, M.D.(10)....................... 368,915 3.8% 3.0%
Kenneth W. Anstey(11)........................... 202,396 2.0% 1.6%
Roger H. Lipton(12)............................. 98,657 1.0% *
Calvin K. Lee(13)............................... 58,075 * *
Richard M. Ferrari(14).......................... 49,250 * *
Nancy V. Westcott(15)........................... 39,375 * *
All directors and officers as a group (ten
persons)(16)................................... 3,329,674 34.1% 27.1%
- --------
* Less than 1% of the outstanding shares of common stock.
(1) Assumes no exercise of the underwriters' over-allotment option. Except
under applicable community property laws or as indicated in the footnotes
to this table, to our knowledge, each stockholder identified in the table
possesses sole voting and investment power with respect to all shares of
common stock shown as beneficially owned by that stockholder.
(2) Options vested as of August 29, 1999 are included as shares beneficially
owned. For the purposes of calculating percent ownership, as of June 30,
1999, 9,745,546 shares were issued and outstanding, and, for any
individual who
50
beneficially owns shares represented by options vested as of August 29,
1999, these shares are treated as if outstanding for that person, but not
for any other person. Unless otherwise indicated, the address of each of
the individuals named below is: c/o ORATEC Interventions, Inc., 3700 Haven
Court, Menlo Park, CA 94025.
(3) Includes 1,004,292 shares held by entities associated with Venrock
Associates, of which Mr. Latterell is a general partner. Mr. Latterell
disclaims ownership of the shares held by the entities except to the
extent of his pecuniary interest therein.
(4) Consists of 477,176 shares held by Venrock Associates II, L.P. and
527,116 shares held by Venrock Associates. The general partners of these
funds who share voting and dispositive power over these shares are
Anthony B. Evnin, Ted H. McCourtney and Anthony Sun.
(5) Consists of 608,652 shares held by Pequot Private Equity Fund, L.P. and
218,241 shares held by Pequot Offshore Private Equity Fund, Inc. The
beneficial owner of these shares is Pequot Capital Management, Inc. The
investment committee of Pequot Capital Management consists of Mark
Broach, Lawrence Lenihan, Gerald A. Poch and Arthur J. Samberg, all of
whom share voting and dispositive power over these shares.
(6) Consists of 798,325 shares held by Delphi Ventures III, L.P. and 14,372
shares held by Delphi Bioinvestments III, L.P. The general partner of
these funds is Delphi Management Partners III, L.L.C., and the managing
members of Delphi Management Partners, all of whom share voting and
dispositive power over these shares, are James J. Bochnowski, David L.
Douglass and Donald J. Lothrop.
(7) Consists of 564,705 shares held by Gerlach & Co. as nominee for The
Manufacturers Life Insurance Company (U.S.A.), of which Mr. Brackett is a
managing director. Mr. Brackett disclaims beneficial ownership of these
shares except to the extent of his pecuniary interest therein. The other
managing directors of MF Private Capital, Inc., with whom Mr. Brackett
shares voting and dispositive power over these shares, are David Alpert,
Raymond Britt, Myles Gilbert and William Sheehan. In addition, Richard
Coles, an Executive Vice President of The Manufacturers Life Insurance
Company, also shares voting and dispositive power over these shares.
(8) Includes 32,153 shares held in trust for Mr. Sharkey's children and
281,400 shares held by the Sharkey-Daly Family Trust.
(9) Includes 29,750 shares issuable upon exercise of options vested as of
August 29, 1999.
(10) Includes 29,750 shares issuable upon exercise of options vested as of
August 29, 1999 and 69,600 shares held in trust for Mr. Saal's children.
(11) Includes 186,750 shares issuable upon exercise of options vested as of
August 29, 1999.
(12) Includes 61,687 shares issuable upon exercise of options vested as of
August 29, 1999.
(13) Includes 44,875 shares issuable upon exercise of options vested as of
August 29, 1999.
(14) Consists of 49,250 shares issuable upon exercise of options vested as of
August 29, 1999.
(15) Includes 3,750 shares issuable upon exercise of options vested as of
August 29, 1999.
(16) Includes 405,812 shares issuable upon exercise of options vested as of
August 29, 1999 held by all directors and officers.
51
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, we will be authorized to issue
75,000,000 shares of common stock, $0.001 par value, and 5,000,000 shares of
undesignated preferred stock, $0.001 par value.
Common Stock
As of June 30, 1999, there were 9,745,546 shares of common stock outstanding,
held of record by approximately 324 stockholders, which reflects the conversion
of all outstanding shares of preferred stock into common stock. In addition, as
of June 30, 1999, there were 1,881,607 shares of common stock subject to
outstanding options and 127,745 shares of common stock subject to outstanding
warrants. Upon completion of this offering, there will be 12,245,546 shares of
common stock outstanding, assuming no exercise of the underwriters'
overallotment option or additional exercise of outstanding options under our
stock option plan and warrants.
The holders of common stock are entitled to one vote per share on all matters
to be voted upon by stockholders. Subject to preferences that may be applicable
to any outstanding preferred stock, holders of common stock are entitled to
receive ratably dividends as may be declared by the board of directors out of
funds legally available for that purpose. See "Our Policy Regarding Dividends."
In the event of our liquidation, dissolution or winding up, the holders of
common stock are entitled to share ratably in all assets remaining after
payment of liabilities and the liquidation preference of any outstanding
preferred stock. The common stock has no preemptive or conversion rights, other
subscription rights, or redemption or sinking fund provisions. All outstanding
shares of common stock are fully paid and non-assessable, and the shares of
common stock to be issued upon completion of this offering will be fully paid
and non-assessable.
Preferred Stock
Immediately before the closing of the offering, all outstanding shares of
preferred stock will be converted into 7,247,923 shares of common stock and
automatically retired. Thereafter, the board of directors will have the
authority, without further action by the stockholders, to issue up to 5,000,000
shares of preferred stock in one or more series and to designate the rights,
preferences, privileges and restrictions of each such series. The issuance of
preferred stock could have the effect of restricting dividends on the common
stock, diluting the voting power of the common stock, impairing the liquidation
rights of the common stock or delaying or preventing our change in control
without further action by the stockholders. We have no present plans to issue
any shares of preferred stock.
Warrants
As of June 30, 1999 there were the following warrants outstanding:
. a warrant to purchase 33,333 shares of Series B preferred stock with an
exercise price of $2.25, which expires on March 20, 2001;
. warrants to purchase an aggregate of 21,000 shares of Series C preferred
stock with an exercise price of $5.00, which expire five years after the
closing of this initial public offering; and
. a warrant to purchase 73,412 shares of Series E preferred stock with an
exercise price of $7.08, which expire two years after the closing of this
initial public offering.
All of these warrants become exercisable for shares of common stock upon the
closing of this initial public offering.
Registration Rights
The holders of 7,247,923 shares of common stock, the "registrable
securities," are entitled to have their shares registered by us under the
Securities Act under the terms of an agreement between us and the holders of
52
the registrable securities. Subject to limitations specified in the agreement,
these registration rights include the following:
. The holders of at least 40% of the registrable securities may require, on
two occasions beginning six months after the date of this prospectus,
that we use our best efforts to register the registrable securities for
public resale, provided that the aggregate offering price for such
registrable securities is more than $5,000,000. This right is subject to
the ability of the underwriters to limit the number of shares included in
the offering in view of market conditions.
. If we register any common stock, either for our own account or for the
account of other security holders, the holders of registrable securities
are entitled to include their registrable securities in such
registration. This right is subject to the ability of the underwriters to
limit the number of shares included in the offering in view of market
conditions.
. The holders of at least 30% of the then outstanding registrable
securities may require us to register all or a portion of their
registrable securities on Form S-3 when use of such form becomes
available to us, provided that the proposed aggregate offering price is
more than $1,000,000. The holders of registrable securities may only
exercise these Form S-3 registration rights twice, and may not exercise
this right within six months after the effective date of a previous
registration.
Holders of warrants exercisable for a total of 127,745 shares of common stock
have the right to include these shares in a piggyback or Form S-3 registration.
We will bear all registration expenses other than underwriting discounts and
commissions, except that we shall only pay registration expenses for one Form
S-3 registration in any twelve month period. All registration rights terminate
on the date five years after the closing of this offering, or, with respect to
each holder of registrable securities, at such time as the holder owns less
than 1% of the voting stock, or can sell all of his or her shares in any three
month period under Rule 144 of the Securities Act.
Delaware Anti-Takeover Law and Provisions of our Certificate of Incorporation
and Bylaws
Provisions of Delaware law and our certificate of incorporation and bylaws
could make more difficult our acquisition by a third-party and the removal of
our incumbent officers and directors. These provisions, summarized below, are
expected to discourage coercive takeover practices and inadequate takeover bids
and to encourage persons seeking to acquire control of ORATEC to first
negotiate with us. We believe that the benefits of increased protection of our
ability to negotiate with the proponent of an unfriendly or unsolicited
acquisition proposal outweigh the disadvantages of discouraging such proposals
because, among other things, negotiation could result in an improvement of
their terms.
We are subject to Section 203 of the Delaware General Corporation Law, which
regulates corporate acquisitions. In general, Section 203 prohibits a publicly
held Delaware corporation from engaging in a business combination with an
interested stockholder for a period of three years following the date the
person became an interested stockholder, unless:
. the board of directors approved the transaction in which such stockholder
became an interested stockholder prior to the date the interested
stockholder attained such status;
. upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, he or she owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding shares owned by persons who are directors and also
officers; or
. on or subsequent to such date the business combination is approved by the
board of directors and authorized at an annual or special meeting of
stockholders.
A business combination generally includes a merger, asset or stock sale, or
other transaction resulting in a financial benefit to the interested
stockholder. In general, an interested stockholder is a person who, together
with affiliates and associates, owns, or within three years prior to the
determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock.
53
Our certificate of incorporation and bylaws do not provide for the right of
stockholders to act by written consent without a meeting or for cumulative
voting in the election of directors. Our certificate of incorporation permits
the board of directors to issue preferred stock with voting or other rights
without any stockholder action. Our bylaws provide that, upon our stock being
listed on the Nasdaq National Market and upon our having at least 800
shareholders of record at an annual meeting, shareholders will no longer be
able to call special shareholder meetings. Our certificate of incorporation
provides that at our first annual meeting of stockholders following the date on
which we have at least 800 stockholders, the board of directors shall be
divided into three classes, with staggered three year terms. As a result, only
one class of directors will be elected at each annual meeting of stockholders.
The other classes of directors will continue to serve for the remainder of
their three year terms. These provisions, which require the vote of
stockholders holding at least 66 2/3% of the outstanding common stock to amend,
may have the effect of deterring hostile takeovers or delaying changes in our
management. In addition, a director may be removed from office:
. for cause, by a vote of the holders of a majority of the outstanding
shares, and
. without cause, by a vote of the holders of at least 66 2/3% of the
outstanding shares.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is American Stock
Transfer and Trust Company, and its address and telephone number are 40 Wall
Street, New York, NY 10005 (tel.) (212) 936-5100.
54
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for our common stock. Future
sales of substantial amounts of common stock in the public market could
adversely affect prevailing market prices. As described below, only 31,200
shares currently outstanding will be available for sale immediately after this
offering because of contractual restrictions on resale. Sales of substantial
amounts of our common stock in the public market after the restrictions lapse
could adversely affect the prevailing market price and impair our ability to
raise equity capital in the future.
Upon completion of the offering, we will have 12,245,546 outstanding shares
of common stock. Of these shares, the 2,500,000 shares sold in the offering,
plus any shares issued upon exercise of the underwriters' overallotment option,
will be freely tradable without restriction under the Securities Act, unless
purchased by our affiliates as that term is defined in Rule 144 under the
Securities Act. In general, affiliates include officers, directors and 10%
stockholders.
The remaining 9,745,546 shares outstanding are "restricted securities" within
the meaning of Rule 144. Restricted securities may be sold in the public market
only if they are registered or if they qualify for an exemption from
registration under Rules 144, 144(k) or 701 promulgated under the Securities
Act, which are summarized below. Sales of the restricted securities in the
public market, or the availability of such shares for sale, could adversely
affect the market price of the common stock.
Our directors, officers and security holders have entered into lock-up
agreements in connection with this offering generally providing that they will
not offer, sell, contract to sell or grant any option to purchase or otherwise
dispose of our common stock or any securities exercisable for or convertible
into our common stock owned by them for a period of 180 days after the date of
this prospectus without the prior written consent of Merrill Lynch & Co.
Notwithstanding possible earlier eligibility for sale under the provisions of
Rules 144, 144(k) and 701, shares subject to lock-up agreements will not be
salable until such agreements expire or are waived by each of Merrill Lynch &
Co. and ORATEC. Taking into account the lock-up agreements, and assuming
Merrill Lynch & Co. and we do not release stockholders from these agreements,
the following shares will be eligible for sale in the public market at the
following times:
. Beginning on the effective date of this prospectus, the 2,500,000 shares
sold in the offering and 31,200 additional shares will be immediately
available for sale in the public market.
. Beginning 180 days after the effective date, approximately 8,109,813
shares will be eligible for sale, 2,947,862 of which will be subject to
volume, manner of sale and other limitations under Rule 144.
. The remaining 1,604,533 shares will be eligible for sale pursuant to Rule
144 upon the expiration of various one-year holding periods during the
six months following 180 days after the effective date.
In general, under Rule 144 as currently in effect, after the expiration of
the lock-up agreements, a person who has beneficially owned restricted
securities for at least one year would be entitled to sell within any three-
month period a number of shares that does not exceed the greater of:
. one percent of the number of shares of common stock then outstanding
which will equal approximately shares immediately after the offering;
or
. the average weekly trading volume of the common stock during the four
calendar weeks preceding the sale.
Sales under Rule 144 are also subject to requirements with respect to manner
of sale, notice and the availability of current public information about us.
Under Rule 144(k), a person who is not deemed to have been our affiliate at
anytime during the three months preceding a sale, and who has beneficially
owned the shares proposed to be sold for at least two years, is entitled to
sell such shares without complying with the manner of sale, public information,
volume limitation or notice provisions of Rule 144.
55
Rule 701, as currently in effect, permits our employees, officers, directors
or consultants who purchased shares pursuant to a written compensatory plan or
contract to resell such shares in reliance upon Rule 144 but without compliance
with specific restrictions. Rule 701 provides that affiliates may sell their
Rule 701 shares under Rule 144 without complying with the holding period
requirement and that non-affiliates may sell such shares in reliance on Rule
144 without complying with the holding period, public information, volume
limitation or notice provisions of Rule 144.
In addition, we intend to file registration statements under the Securities
Act as promptly as possible after the effective date to register shares to be
issued pursuant to our employee benefit plans. As a result, any options or
rights exercised under the 1995 plan, the 1999 employee stock purchase plan,
the 1999 directors' stock option plan or any other benefit plan after the
effectiveness of the registration statements will also be freely tradable in
the public market. However, shares held by affiliates will still be subject to
the volume limitation, manner of sale, notice and public information
requirements of Rule 144 unless otherwise resalable under Rule 701. As of June
30, 1999 there were outstanding options for the purchase of 1,881,607 shares of
common stock, of which options to purchase 846,342 shares were exercisable.
56
UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities
Inc. and U.S. Bancorp Piper Jaffray Inc. are acting as representatives of each
of the underwriters named below. Subject to the terms and conditions described
in a purchase agreement among us and the underwriters, we have agreed to sell
to the underwriters, and each of the underwriters severally and not jointly has
agreed to purchase from us, the number of shares of common stock listed
opposite its name below.
Number of
Underwriter Shares
----------- ---------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...........................................
J.P. Morgan Securities Inc......................................
U.S. Bancorp Piper Jaffray Inc..................................
---------
Total......................................................... 2,500,000
=========
In the purchase agreement, the several underwriters have agreed, subject to
the terms and conditions described in the purchase agreement, to purchase all
of the shares of common stock being sold pursuant to this agreement if any of
the shares of common stock being sold pursuant to the agreement are purchased.
In the event of a default by an underwriter, the purchase agreement provides
that the purchase commitments of the nondefaulting underwriters may be
increased or the purchase agreement may be terminated.
We have agreed to indemnify the underwriters against some liabilities,
including some liabilities under the Securities Act, or to contribute to
payments the underwriters may be required to make.
Commission and Discounts
The representatives have advised us that the underwriters propose initially
to offer the shares of common stock to the public at the initial public
offering price described on the cover page of this prospectus, and to some
dealers at that price less a concession not in excess of $ per share of
common stock. The underwriters may allow, and those dealers may reallow, a
discount not in excess of $ per share of common stock to other dealers. After
the initial public offering, the public offering price, concession and discount
may change.
The following table shows the per share and total public offering price, the
underwriting discount we will pay to the underwriters and the proceeds we will
receive before expenses. This information is presented assuming either no
exercise or full exercise by the underwriters of their over-allotment options.
Per Total Without Total With
Share Option Option
----- ------------- ----------
Public offering price............................ $ $ $
Underwriting discount............................ $ $ $
Proceeds, before expenses, to ORATEC............. $ $ $
The expenses of the offering, not including the underwriting discount, are
estimated at $ million and are payable by us.
The shares of common stock are being offered by the underwriters, subject to
prior sale, when, as and if issued to and accepted by them, subject to approval
of some legal matters by counsel for the underwriters and other conditions. The
underwriters reserve the right to withdraw, cancel or modify their offer and to
reject orders in whole or in part.
57
Over-allotment Options
We have granted options to the underwriters, exercisable for 30 days after
the date of this prospectus, to purchase up to an aggregate of 375,000
additional shares of common stock at the public offering price described on the
cover page of this prospectus, less the underwriting discount. The underwriters
may exercise these options solely to cover over-allotments, if any, made on the
sale of the common stock. To the extent that the underwriters exercise these
options, each underwriter will be obligated, subject to some conditions, to
purchase a number of additional shares of common stock proportionate to that
underwriter's initial amount reflected in the above table.
Reserved Shares
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 5% of the shares to be sold to directors,
officers, employees, business associates and related persons of ORATEC. The
number of shares of common stock available for sale to the general public will
be reduced to the extent those persons purchase reserved shares. Any reserved
shares which are not orally confirmed for purchase within one day of the
pricing of the offering will be offered by the underwriters to the general
public on the same terms as the other shares offered hereby. Reserved shares
will be sold at the initial public offering price.
No Sales of Similar Securities
We and our executive officers and directors and almost all of existing
stockholders have agreed, with some exceptions, not to directly or indirectly,
for a period of 180 days after the date of this prospectus:
. offer, sell, contract to sell, grant any option or warrant for the sale
of, register, or otherwise transfer, dispose of, loan, pledge or grant
any rights with respect to any shares of capital stock of ORATEC or
securities convertible into or exchangeable or exercisable for, or any
rights to purchase or acquire, shares of capital stock of ORATEC,
including, without limitation, common stock which may be deemed to be
beneficially owned by the stockholder in accordance with the rules and
regulations of the SEC.
The foregoing restriction is expressly agreed to preclude stockholders from
engaging in any hedging or other transaction which is designed to result in a
disposition of securities during the 180-day lock-up period, even if such
securities would be disposed of by someone other than the stockholder.
Initial Public Offering Price
Prior to the offering, there has been no public market for our common stock.
The initial public offering price will be determined through negotiations
between us and the representatives. The factors considered in determining the
initial public offering price, in addition to prevailing market conditions, are
. price-earnings ratios of publicly traded companies that the
representatives believe to be comparable to ORATEC;
. financial information about us and the industry in which we compete; and
. an assessment of our management, our past and present operations, our
prospects for, and timing of, future revenue, and the present state of
our development.
An active trading market for our common stock may not develop and the price
at which our stock trades after the offering may be below the initial public
offering price.
Price Stabilization, Short Positions and Penalty Bids
Until the distribution of the common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriters
and some selling group members to bid for and purchase the common stock. As an
exception to these rules, the representatives are permitted to engage in
transactions that stabilize the price of the common stock. These transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the common stock.
58
If the underwriters create a short position in the common stock in connection
with the offering, i.e., if they sell more shares of common stock than are set
forth on the cover page of this prospectus, the representatives may reduce that
short position by purchasing common stock in the open market. The
representatives may also elect to reduce any short position by exercising all
or part of the over-allotment options described above.
The representatives may also impose a penalty bid on other underwriters and
selling group members, which means that if the representatives purchase shares
of common stock in the open market to reduce the underwriters' short position
or to stabilize the price of the common stock, they may reclaim the amount of
the selling concession from the underwriters and selling group members who sold
those shares as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of those purchases. The imposition of a penalty bid
might also have an effect on the price of the common stock to the extent that
it discourages resales of the common stock.
Neither we nor any of the underwriters makes any representation or prediction
as to the direction or magnitude of any effect that the transactions described
above may have on the price of the common stock. In addition, neither we nor
any of the underwriters makes any representation that the representatives will
engage in any stabilizing transactions or that these transactions, once
commenced, will not be discontinued without notice.
LEGAL MATTERS
The validity of our common stock offered hereby will be passed upon for
ORATEC by Venture Law Group, A Professional Corporation, 2800 Sand Hill Road,
Menlo Park, California 94025. Mark Weeks, a director of Venture Law Group, is
the Secretary of ORATEC. Legal matters with respect to information contained in
this prospectus under the captions "Risk Factors--Because the medical device
industry is litigious, we are particularly susceptible to an intellectual
property suit" and "--Because of the importance of our patent portfolio to our
business, we may lose market share to our competitors if we fail to protect our
intellectual property rights" and "Business--Patents and Proprietary
Technology" will be passed upon for ORATEC by Wilson Sonsini Goodrich & Rosati,
a Professional Corporation, patent counsel to ORATEC. Legal matters in
connection with this offering will be passed upon for the underwriters by
Latham & Watkins, 650 Town Center Drive, 20th floor, Costa Mesa, CA 95626. As
of the date of this prospectus, an investment partnership controlled by Venture
Law Group beneficially owns 20,133 shares of ORATEC'S common stock. As of the
date of this prospectus, partners of Wilson Sonsini Goodrich & Rosati, a
Professional Corporation, beneficially own 27,000 shares of ORATEC's common
stock.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our financial
statements at December 31, 1997 and 1998, and for each of the three years in
the period ended December 31, 1998, as set forth in their report. We have
included our financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on
their authority as experts in accounting and auditing.
The statements set forth in this prospectus under the captions "Risk
Factors--Because the medical device industry is litigious, we are particularly
susceptible to an intellectual property suit" and "--Because of the importance
of our patent portfolio to our business, we may lose market share to our
competitors if we fail to protect our intellectual property rights" and
"Business--Patents and Proprietary Technology" have been reviewed and approved
by Wilson Sonsini Goodrich & Rosati, a Professional Corporation, patent counsel
to ORATEC, as experts in such matters, and are included herein in reliance upon
its review and approval.
59
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement, which includes any amendments to the registration statement, on Form
S-1 under the Securities Act with respect to the common stock offered by this
prospectus. This prospectus, which constitutes a part of the registration
statement, does not contain all of the information set forth in the
registration statement. Some items are contained in exhibits to the
registration statement as permitted by the rules and regulations of the
Securities and Exchange Commission. For further information with respect to
ORATEC and the common stock offered by this prospectus, reference is made to
the registration statement and its exhibits, and the financial statements and
notes filed as a part of the registration statement. Statements made in this
prospectus concerning the contents of any document are not necessarily
complete. With respect to each document filed with the Securities and Exchange
Commission as an exhibit to the registration statement, reference is made to
the exhibit for a more complete description of the matter involved. The
registration statement, including the exhibits, financial statements and notes
filed as a part of the registration statement, as well as reports and other
information filed with the Securities and Exchange Commission, may be inspected
without charge at the public reference facilities maintained by the Securities
and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the regional offices of the Securities and Exchange Commission located at
Seven World Trade Center, 13th Floor, New York, New York, 10048, and the
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of all or any part thereof may be obtained from the Securities and
Exchange Commission upon payment of fees prescribed by the Securities and
Exchange Commission. These reports and other information may also be inspected
without charge at a website maintained by the Securities and Exchange
Commission. The address of the SEC site is http://www.sec.gov.
60
ORATEC INTERVENTIONS, INC.
INDEX TO FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors......................... F-2
Balance Sheets............................................................ F-3
Statements of Operations.................................................. F-4
Statement of Redeemable Convertible Preferred Stock and Stockholders'
Equity................................................................... F-5
Statements of Cash Flows.................................................. F-6
Notes to Financial Statements............................................. F-7
F-1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
ORATEC Interventions, Inc.
We have audited the accompanying balance sheets of ORATEC Interventions, Inc.
as of December 31, 1997 and 1998, and the related statements of operations,
cash flows, and statement of redeemable convertible preferred stock and
stockholders' equity for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of ORATEC's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ORATEC Interventions, Inc. at
December 31, 1997 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Palo Alto, California
February 25, 1999
The foregoing report is in the form that will be signed upon the completion
of the stock split described in Note 14 to the financial statements.
/s/ Ernst & Young LLP
Palo Alto, California
February 25, 1999
F-2
ORATEC INTERVENTIONS, INC.
BALANCE SHEETS
(In thousands, except share and per share data)
December 31, Pro forma at
----------------- June 30, June 30,
1997 1998 1999 1999
------- -------- -------- ------------
(unaudited)
Assets
Current assets:
Cash and cash equivalents......... $ 5,535 $ 11,583 $ 10,157
Short term investments............ 3,650 3,998 3,022
Accounts receivable, less
allowance for doubtful accounts
of $106 in 1997, $216 in 1998,
and $287 in 1999................. 897 2,905 4,961
Inventories....................... 502 1,421 2,340
Prepaid expenses and other current
assets........................... 593 513 1,267
------- -------- --------
Total current assets............ 11,177 20,420 21,747
Property and equipment, net......... 2,241 3,775 3,273
------- -------- --------
$13,418 $ 24,195 $ 25,020
======= ======== ========
Liabilities and stockholders' equity
Current liabilities:
Bank borrowings................... $ -- $ 1,178 $ 1,178
Accounts payable.................. 1,469 1,672 2,116
Accrued compensation and
benefits......................... 276 1,327 1,498
Other accrued liabilities......... 432 1,637 2,494
Current portion of notes payable.. -- -- 750
Current portion of equipment
financing obligations............ 283 609 859
------- -------- --------
Total current liabilities....... 2,460 6,423 8,895
Long term notes payable............. -- -- 3,250
Long term equipment financing
obligations........................ 404 2,702 2,701
Commitments
Redeemable convertible preferred
stock, $0.001 par value, issuable
in series; 5,400,000 shares
authorized in 1997, 7,440,000
shares authorized in 1998 and 1999
(5,000,000 shares pro forma);
4,972,775, 7,227,453, and 7,247,923
shares issued and outstanding in
1997, 1998, and 1999, respectively
(none pro forma); aggregate
redemption value of $36,380 at
December 31, 1998 and $36,426 at
June 30, 1999 (none pro forma)..... 20,324 35,816 35,816 $ --
Common stock, $0.001 par value;
9,600,000 shares authorized in
1997, 11,940,000 shares authorized
in 1998 and 1999 (75,000,000 shares
pro forma); 2,370,632, 2,415,805,
and 2,497,623 shares issued and
outstanding in 1997, 1998, and
1999, respectively (9,745,546
shares pro forma).................. 2 2 2 10
Additional paid-in capital.......... 26 268 966 36,774
Deferred stock compensation......... -- -- (310) (310)
Receivable from stockholder......... (124) -- -- --
Accumulated deficit................. (9,674) (21,016) (26,300) (26,300)
------- -------- --------
$13,418 $ 24,195 $ 25,020
======= ======== ========
See accompanying notes.
F-3
ORATEC INTERVENTIONS, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Six months
Years ended December 31, ended June 30,
-------------------------- ----------------
1996 1997 1998 1998 1999
------- ------- -------- ------- -------
(unaudited)
Sales............................ $ -- $ 2,600 $ 11,129 $ 4,106 $12,899
Cost of sales.................... -- 1,741 6,566 2,354 6,261
------- ------- -------- ------- -------
Gross profit..................... -- 859 4,563 1,752 6,638
Operating expenses:
Research and development....... 878 2,514 4,706 2,094 2,624
Sales and marketing............ 561 2,622 8,318 3,390 7,494
General and administrative..... 945 2,721 2,724 1,192 1,465
------- ------- -------- ------- -------
Total operating expenses......... 2,384 7,857 15,748 6,676 11,583
------- ------- -------- ------- -------
Loss from operations............. (2,384) (6,998) (11,185) (4,924) (4,945)
Interest and other income........ 100 196 265 168 341
Interest and other expense....... (18) (30) (422) (44) (680)
------- ------- -------- ------- -------
Net loss......................... $(2,302) $(6,832) $(11,342) $(4,800) $(5,284)
======= ======= ======== ======= =======
Net loss per common share, basic
and diluted..................... $ (1.00) $ (2.91) $ (4.72) $ (2.01) $ (2.16)
======= ======= ======== ======= =======
Shares used in computing net loss
per common share, basic and
diluted......................... 2,304 2,347 2,403 2,393 2,447
Pro forma net loss per share,
basic and diluted (unaudited)... $ (1.51) $ (0.55)
======== =======
Shares used in computing pro
forma net loss per share, basic
and diluted (unaudited)......... 7,525 9,688
See accompanying notes.
F-4
ORATEC INTERVENTIONS, INC.
STATEMENT OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
(In thousands, except share data)
Redeemable
Convertible
Preferred Stock Common Stock Additional Deferred
----------------- ---------------- Paid-In Stock Receivable from Accumulated
Shares Amount Shares Amount Capital Compensation Stockholder Deficit
--------- ------- --------- ------ ---------- ------------ --------------- -----------
Balances at December 31,
1995................... 255,933 $ 474 2,298,000 $ 2 $ 2 $-- $ (45) $ (540)
Cash payments on
receivables from
stockholders........... -- -- -- -- -- -- 45 --
Issuance of common stock
upon exercise of stock
options, net........... -- -- 21,450 -- 1 -- -- --
Issuance of Series B
redeemable convertible
preferred stock........ 1,914,198 4,307 -- -- -- -- -- --
Issuance of warrants to
purchase 30,000 shares
of Series B redeemable
convertible preferred
stock.................. -- 11 -- -- -- -- -- --
Net and comprehensive
loss................... -- -- -- -- -- -- -- (2,302)
--------- ------- --------- --- ---- ----- ----- --------
Balances at December 31,
1996................... 2,170,131 4,792 2,319,450 2 3 -- -- (2,842)
Issuance of Series C
redeemable convertible
preferred stock........ 865,511 4,328 -- -- -- -- -- --
Issuance of Series D
redeemable convertible
preferred stock (net of
issuance costs of
$96)................... 1,937,133 11,204 -- -- -- -- (124) --
Issuance of common stock
upon exercise of stock
options................ -- -- 51,182 -- 23 -- -- --
Net and comprehensive
loss................... -- -- -- -- -- -- -- (6,832)
--------- ------- --------- --- ---- ----- ----- --------
Balances at December 31,
1997................... 4,972,775 20,324 2,370,632 2 26 -- (124) (9,674)
Warrants to purchase
73,412 shares of Series
E preferred stock for
loan arrangement....... -- 146 -- -- -- -- -- --
Compensation expense for
non-employee options... -- -- -- -- 102 -- -- --
Issuance of common stock
upon exercise of
options, net........... -- -- 39,526 -- 100 -- -- --
Grant of common stock in
lieu of compensation... -- -- 5,647 -- 40 -- -- --
Cash payments on
receivable from
stockholders........... -- -- -- -- -- -- 124 --
Issuance of Series E
preferred stock (net of
issuance costs of
$625).................. 2,254,678 15,346 -- -- -- -- -- --
Net and comprehensive
loss................... -- -- -- -- -- -- -- (11,342)
--------- ------- --------- --- ---- ----- ----- --------
Balances at December 31,
1998................... 7,227,453 35,816 2,415,805 2 268 -- -- (21,016)
Issuance of common stock
upon exercise of
options (unaudited).... -- -- 78,818 -- 132 -- -- --
Compensation expense for
non-employee options
(unaudited)............ -- -- -- -- 216 -- -- --
Grant of common stock in
lieu of compensation
(unaudited)............ -- -- 3,000 -- 40 -- -- --
Deferred stock
compensation related to
options granted to
employees and
consultants
(unaudited)............ -- -- -- -- 310 (310) -- --
Exercise of warrants for
Series B redeemable
convertible preferred
stock (unaudited)...... 20,470 -- -- -- -- -- -- --
Net and comprehensive
loss (unaudited)....... -- -- -- -- -- -- -- (5,284)
--------- ------- --------- --- ---- ----- ----- --------
Balances at June 30,
1999 (unaudited)....... 7,247,923 $35,816 2,497,623 $ 2 $966 $(310) $ -- $(26,300)
========= ======= ========= === ==== ===== ===== ========
See accompanying notes.
F-5
ORATEC INTERVENTIONS, INC.
STATEMENTS OF CASH FLOWS
Increase in cash and cash equivalents
(In thousands)
Six months
Years ended December 31, ended June 30,
-------------------------- ----------------
1996 1997 1998 1998 1999
------- ------- -------- ------- -------
(unaudited)
Operating activities
Net loss........................ $(2,302) $(6,832) $(11,342) $(4,800) $(5,284)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and
amortization................. 69 573 2,097 949 1,825
Compensation expense for
options granted to non-
employees.................... -- -- 102 -- 216
Issuance of equity for non-
cash benefits................ -- -- 186 -- 36
Changes in operating assets
and liabilities:
Accounts receivable......... -- (897) (2,008) (1,386) (2,056)
Inventories................. (84) (419) (919) (729) (919)
Prepaid expenses and other
current assets............. (93) (491) 80 (164) (754)
Accounts payable............ 138 1,654 203 1,438 444
Accrued compensation and
benefits................... (13) 228 1,051 (40) 171
Other accrued liabilities... -- -- 1,205 (379) 857
------- ------- -------- ------- -------
Net cash used in operating
activities..................... (2,285) (6,184) (9,345) (5,111) (5,464)
------- ------- -------- ------- -------
Investing activities
Purchases of short term
investments.................... (561) (3,500) (3,998) (1,374) (2,998)
Sales of short term
investments.................... -- 411 3,650 4,003 3,974
Capital expenditures............ (674) (2,183) (3,631) (2,351) (1,323)
------- ------- -------- ------- -------
Net cash (used in) provided by
investing activities........... (1,235) (5,272) (3,979) 278 (347)
------- ------- -------- ------- -------
Financing activities
Proceeds from issuance of
preferred stock................ 4,318 15,408 15,346 -- --
Proceeds from issuance of common
stock.......................... 1 23 100 48 136
Receipts from stockholder
receivables.................... 45 -- 124 124 --
Payment of note payable......... (35) -- -- -- --
Proceeds from bank borrowings... -- -- 1,178 889 --
Proceeds from notes payable..... -- -- -- -- 4,000
Proceeds from equipment
financing obligations.......... 395 506 3,000 456 386
Repayment of equipment financing
obligations.................... (51) (163) (376) (137) (137)
------- ------- -------- ------- -------
Net cash provided by financing
activities..................... 4,673 15,774 19,372 1,380 4,385
------- ------- -------- ------- -------
Net increase (decrease) in cash
and cash equivalents........... 1,153 4,318 6,048 (3,453) (1,426)
Cash and cash equivalents at
beginning of period............ 64 1,217 5,535 5,535 11,583
------- ------- -------- ------- -------
Cash and cash equivalents at end
of period...................... $ 1,217 $ 5,535 $ 11,583 $ 2,082 $10,157
======= ======= ======== ======= =======
Supplemental schedule of noncash
investing and financing
activities
Issuance of stock to
stockholders for receivables... $ -- $ 124 $ -- $ -- $ --
======= ======= ======== ======= =======
Deferred stock compensation..... $ -- $ -- $ -- $ -- $ 310
======= ======= ======== ======= =======
Supplemental disclosure of cash
flow information
Cash payments for interest...... $ 18 $ 30 $ 272 $ 44 $ 680
======= ======= ======== ======= =======
See accompanying notes.
F-6
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
1. Organization and Summary of Significant Accounting Policies
The Company
ORATEC Interventions, Inc. was incorporated in the State of California on May
26, 1993 to develop medical devices which use controlled thermal energy to
treat spine and joint disorders. ORATEC's products use heat to shrink and
repair damaged or stretched soft tissue.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from these estimates.
Interim Financial Information
The financial information at June 30, 1999 and for the six months ended June
30, 1998 and 1999 is unaudited but, in the opinion of management, has been
prepared on the same basis as the annual financial statements and includes all
adjustments (consisting only of normal recurring adjustments) that ORATEC
considers necessary for a fair presentation of the financial position at such
date and the operating results and cash flows for such periods. Results for the
six months ended June 30, 1999 are not necessarily indicative of the results to
be expected for any subsequent period.
Unaudited Pro Forma Redeemable Convertible Preferred Stock and Stockholders'
Equity
If ORATEC's initial public offering as described in Note 14 is consummated,
all of the redeemable convertible preferred stock outstanding will
automatically be converted into common stock. The unaudited pro forma
redeemable convertible preferred stock and stockholders' equity at June 30,
1999 has been adjusted for the assumed conversion of redeemable convertible
preferred stock based on the shares of redeemable convertible preferred stock
outstanding at June 30, 1999.
Cash Equivalents and Short Term Investments
ORATEC considers all highly liquid investments purchased with original
maturities of three months or less at the date of purchase to be cash
equivalents.
In accordance with the Financial Accounting Standards Board's Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," ORATEC classifies its debt securities as
"available-for-sale" securities for use in its current operations. Such debt
securities are carried at amortized cost which approximates fair value. The
cost of the securities sold is based on specific identification.
Fair Value of Financial Instruments
The fair values of marketable securities, as described in Note 5, are based
on quoted market prices and are not necessarily indicative of the amounts that
ORATEC could realize in a current market exchange. The carrying value of those
securities approximates their fair value.
F-7
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
The fair value of notes payable, as described in Note 10, are estimated by
discounting the future cash flows using the current interest rates at which
similar loans would be made to borrowers with similar credit ratings and for
the same remaining maturities. The carrying values of these obligations
approximate their respective fair values.
The fair value of short term and long term equipment financing obligations
and bank borrowings, as described in Notes 8 and 9, are estimated based on
current interest rates available to ORATEC for debt instruments with similar
terms, degrees of risk and remaining maturities. The carrying values of these
obligations approximate their respective fair values.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is provided using the straight line method over the estimated
useful lives of the respective assets, generally two to seven years. The cost
of generators in service is depreciated into cost of sales over an estimated
useful life of two years.
Impairment of Long-Lived Assets
In accordance with the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" ("SFAS 121"), ORATEC reviews long-lived
assets, including property and equipment, for impairment whenever events or
changes in business circumstances indicate that the carrying amount of the
assets may not be fully recoverable. Under SFAS 121, an impairment loss would
be recognized when estimated undiscounted future cash flows expected to result
from the use of the asset and its eventual disposition is less than its
carrying amount. Impairment, if any, is assessed using discounted cash flows.
Through June 30, 1999 there have been no such losses.
Revenue Recognition
ORATEC recognizes revenue upon shipment of products to customers, and, in
some cases, when inventory provided to customers has been used at their
facility as evidenced by receipt of a purchase order. If title to the products
does not pass until receipt by the customer, revenue is deferred until proof of
receipt is obtained. ORATEC's return policy allows customers to return new
products up to 90 days after a sale. To date, returns have been insignificant.
Title has been retained to the majority of arthroscopy generators, which have
been placed with customers for their use with ORATEC's disposable arthroscopy
probes. ORATEC is selling its spine generators following placement with
customers for a demonstration period. Revenue is recognized upon customer
acceptance evidenced by the issuance of a customer purchase order.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs were not
material in 1996, 1997, 1998, and the six months ended June 30, 1999.
Dependence on Single Supplier
ORATEC purchases all of its electrothermal generators from a sole source
third party supplier. There are no other third party contractors who could
readily assume this manufacturing function. Any delay in production
F-8
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
of generators could result in the failure to meet customer demand. At June 30,
1999, ORATEC had a commitment of $2.4 million to purchase electrothermal
generators which are expected to be purchased from August through November
1999.
Product Liability and Patent Litigation Risks
The medical device market is litigious and ORATEC may become a party to
product liabilty or patent proceedings. The costs of such lawsuits may be
material and could effect our earnings and financial position.
Stock-Based Compensation
ORATEC accounts for grants of stock options and common stock purchase rights
in accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees and Related Interpretations." Information regarding
pro forma adjustments to net loss, as required by Financial Accounting
Standards Board Statement No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), is included in Note 11.
Comprehensive Income (Loss)
As of January 1, 1998, ORATEC adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
requires unrealized gains or losses on ORATEC's available-for-sale investments
to be included in other comprehensive income. For the year ended December 31,
1997 and 1998, and for the six months ended June 30, 1999, comprehensive loss
approximated net loss as other comprehensive income was not material.
Net Loss Per Share
Basic earnings per share is calculated based on the weighted-average number
of common shares outstanding during the period. Diluted earnings per share
gives effect to the dilutive effect of common stock equivalents consisting of
stock options and warrants (calculated using the treasury stock method).
The computation of pro forma net loss per share includes shares issuable upon
the conversion of outstanding shares of convertible preferred stock (using the
as-if converted method) from the original date of issuance.
A reconciliation of shares used in the calculations is as follows (in
thousands):
Six months
Years ended ended June
December 31, 30,
----------------- -----------
1996 1997 1998 1998 1999
----- ----- ----- ----- -----
(unaudited)
Basic and diluted:
Weighted-average shares of common stock
outstanding................................... 2,304 2,347 2,403 2,393 2,447
===== ===== ===== ===== =====
Pro forma basic and diluted:
Shares used above.............................. 2,403 2,447
Pro forma adjustment to reflect weighted-
average effect of assumed conversion of
redeemable convertible preferred stock........ 5,122 7,241
----- -----
7,525 9,688
===== =====
F-9
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
The following outstanding options, warrants, and redeemable convertible
preferred stock (on an as converted basis and including a warrant to purchase
73,412 shares of Series E preferred stock due to be issued at December 31,
1998) were excluded from the computation of diluted net loss per share as they
had an antidilutive effect (in thousands):
December 31, June 30,
----------------- -----------
1996 1997 1998 1998 1999
----- ----- ----- ----- -----
(unaudited)
Options and warrants.............................. 790 1,421 1,791 1,565 2,009
Redeemable convertible preferred stock............ 2,170 4,973 7,227 4,973 7,248
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Financial
Instruments and for Hedging Activities" ("SFAS 133") which provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities. SFAS 133 is effective for fiscal years
beginning after June 15, 1999 and is not anticipated to have an impact on
ORATEC's results of operations or financial condition when adopted as ORATEC
holds no derivative financial instruments and does not currently engage in
hedging activities.
2. Accounts Receivable
Accounts receivable is stated net of allowance for doubtful accounts. A
summary of movement in the allowance is as follows (in thousands):
December 31,
--------------- June 30,
1996 1997 1998 1999
---- ---- ---- --------
Balance at beginning of period..................... $ 20 $-- $106 $216
Additions charged to costs and expenses............ -- 106 151 71
Write-off of uncollectible accounts................ (20) -- (41) --
---- ---- ---- ----
Balance at end of period........................... $-- $106 $216 $287
==== ==== ==== ====
3. Inventories
Inventories are stated at the lower of standard cost or market. Standard
costs approximate average actual costs. Inventories are summarized below (in
thousands):
December 31,
------------- June 30,
1997 1998 1999
------------- --------
Raw materials......................................... $ 122 $ 432 $ 617
Work in-process....................................... 58 41 136
Finished goods........................................ 87 370 424
Electrothermal generators held for sale............... 235 578 1,163
----- ------- ------
$ 502 $ 1,421 $2,340
===== ======= ======
F-10
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
4. Property and Equipment
Property and equipment consists of the following (in thousands):
December 31,
--------------- June 30,
1997 1998 1999
------ ------- --------
Electrothermal generators........................ $1,807 $ 4,692 $ 5,761
Computers, machinery, and equipment.............. 760 1,148 1,438
Furniture and fixtures........................... 224 459 411
Leasehold improvements........................... 95 218 230
------ ------- -------
2,886 6,517 7,840
Less accumulated depreciation and amortization... (645) (2,742) (4,567)
------ ------- -------
Property and equipment, net...................... $2,241 $ 3,775 $ 3,273
====== ======= =======
5. Marketable Securities
Marketable securities consist of the following (in thousands):
Amortized Cost and Fair Value at
---------------------------------
December 31,
--------------------- June 30,
1997 1998 1999
---------- ---------- -----------
Certificates of deposit................... $ 150 $ 1,000 $ --
Corporate commercial paper................ 3,500 2,998 6,967
Asset-backed auction rate securities...... 900 4,500 4,000
---------- ---------- -----------
$ 4,550 $ 8,498 $ 10,967
========== ========== ===========
Reported as:
Cash equivalents........................ $ 900 $ 4,500 $ 7,945
Short term investments.................. 3,650 3,998 3,022
---------- ---------- -----------
$ 4,550 $ 8,498 $ 10,967
========== ========== ===========
At December 31, 1998 and June 30, 1999, the average maturity of the
investments was approximately two months.
There were no material gross realized gains or losses from sales of
securities in the periods presented. Unrealized gains and losses on investments
were not material at December 31, 1997 and 1998, or June 30, 1999.
6. Other Accrued Liabilities
Other accrued liabilities consisted of the following (in thousands):
December 31,
------------- June 30,
1997 1998 1999
------------- --------
Professional fees..................................... $ 50 $ 529 $ 620
Dealer commissions.................................... 156 138 221
Clinical and development costs........................ 200 452 654
Other................................................. 26 518 999
----- ------- ------
$ 432 $ 1,637 $2,494
===== ======= ======
F-11
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
7. Operating Lease Commitments
ORATEC leases its facilities under various agreements expiring through July
2003. Rent expense was approximately $90,000, $230,000, and $320,000 for the
years ended December 31, 1996, 1997, and 1998. ORATEC has the option to extend
the term of its operating leases for three additional years. At December 31,
1998, minimum future rental payments under operating leases are as follows (in
thousands):
Year ended December 31,
1999................................................................. $ 476
2000................................................................. 425
2001................................................................. 246
2002................................................................. 255
2003................................................................. 130
------
$1,532
======
8. Equipment Financing Obligations
In March 1996, a financial institution made available to ORATEC equipment
loans of up to $500,000 on which interest accrues at a rate of 8% per annum.
Final drawdown under this line was made in September 1997.
In October 1997, two financial institutions made available to ORATEC
equipment loans of up to an aggregate $1,000,000 on which interest is fixed at
the time of each drawdown. At December 31, 1998, approximately $924,000 had
been drawn down under three promissory notes with interest ranging between 7%
and 8%. Principal and interest under the notes must be repaid according to the
terms of each promissory note issued. In accordance with the loan agreements,
ORATEC granted the lenders perfected security interests in some specified
computer, manufacturing, laboratory and office equipment and furniture.
In August 1998, a financial institution made available to ORATEC an equipment
loan on which the interest is fixed at the time of each drawdown. The loan is
secured by a security interest in the equipment financed and a junior interest
in the other assets of ORATEC. At June 30, 1999, ORATEC had drawn down
$2,562,415 of the loan with interest rates of 12% to 13%.
Future minimum payments under equipment financing obligations are as follows
at December 31, 1998 (in thousands):
Fiscal year ended December 31,
1999............................................................... $ 965
2000............................................................... 1,359
2001............................................................... 1,936
------
Total minimum payments............................................... 4,260
Less amount representing interest.................................... (949)
------
Present value of minimum payments.................................... 3,311
Less current portion................................................. (609)
------
Long term portion.................................................... $2,702
======
F-12
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
9. Bank Borrowings
In June 1998, ORATEC entered into a loan and security agreement for a
revolving line of credit of up to $2,500,000. The line of credit bears interest
at 1% above the prime rate and has a first priority security interest over the
assets of ORATEC. ORATEC is subject to some covenants under the terms of the
agreement including a maximum debt to tangible net worth ratio of 2:1, and was
not in compliance for the month of September 30, 1998 and the quarter then
ended, for which ORATEC received a waiver. At December 31, 1998 and June 30,
1999, the balance outstanding under this agreement was $1,177,579 and the
unused line of credit was $1,322,421. The facility is being extended from its
initial expiration date of June 30, 1999. The weighted-average interest rate
for 1998 was 9.2%.
In association with the loan and security agreement above, ORATEC received a
letter of credit for $75,000 which expires in August 2000 to secure a building
lease obligation. At December 31, 1998, no amount has been drawn against the
letter of credit.
10. Notes Payable
In December 1998, a financial institution made available to ORATEC a loan
facility of up to $4,000,000 which bears interest at 13.5% per annum, subject
to changes in the three year treasury rates. The loan is covered by a
subordinated security interest in the assets of ORATEC. In connection with set
up of the loan arrangement, ORATEC agreed to issue to the financial institution
a warrant to purchase 73,412 shares of ORATEC's Series E preferred stock at
$7.08 per share. For accounting purposes, the warrant was valued at $145,821
and has been fully expensed in 1998. At December 31, 1998, no amounts had been
drawn down against this loan.
At June 30, 1999, the total loan of $4,000,000 was outstanding in the form of
two notes payable of $2,000,000 each bearing interest at 13.1% per annum. The
notes are repayable over three years after an initial twelve months of
interest-only payments. The annual maturities of the notes at June 30, 1999
were as follows: zero through December 31, 1999, $1,705,000, $2,107,000 and
$188,000 for the years ended December 31, 2000, 2001 and 2002, respectively.
11. Redeemable Convertible Preferred Stock and Common Stock
Redeemable Convertible Preferred Stock
A summary of redeemable convertible preferred stock ("preferred stock") is as
follows:
December 31, 1997 December 31, 1998 June 30, 1999
---------------------------------- ---------------------------------- ----------------------------------
Redemption/ Redemption/ Redemption/
Issued and Liquidation Issued and Liquidation Issued and Liquidation
Authorized Outstanding Value Authorized Outstanding Value Authorized Outstanding Value
---------- ----------- ----------- ---------- ----------- ----------- ---------- ----------- -----------
Series A........ 180,000 156,245 $ 250,000 156,245 156,245 $ 250,000 156,245 156,245 $ 250,000
Series B........ 2,222,222 2,013,886 4,531,268 2,077,234 2,013,886 4,531,268 2,077,234 2,034,356 4,577,326
Series C........ 900,000 865,511 4,327,638 886,531 865,511 4,327,638 886,531 865,511 4,327,638
Series D........ 1,971,428 1,937,133 11,299,998 1,937,133 1,937,133 11,299,998 1,937,133 1,937,133 11,299,998
Series E........ -- -- -- 2,382,457 2,254,678 15,970,680 2,382,857 2,254,678 15,970,680
Undesignated
preferred
stock.......... 126,350 -- -- -- -- -- -- -- --
--------- --------- ----------- --------- --------- ----------- --------- --------- -----------
5,400,000 4,972,775 $20,408,904 7,440,000 7,227,453 $36,379,584 7,440,000 7,247,923 $36,425,642
========= ========= =========== ========= ========= =========== ========= ========= ===========
F-13
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
Each share of Series A, B, C, D, and E preferred stock is convertible, at the
option of the holder, into one share of common stock, subject to adjustments
for antidilution. Upon the approval of the holders of a majority of the
outstanding shares of the Series A, B, C, D, or E preferred stock, voting as a
single class, and a majority of the Series D and E preferred stock, together
voting as a single class, the Series A, B, C, D, or E preferred stock are
convertible to one share of common stock, subject to adjustments for
antidilution. Additionally, the preferred stock will automatically convert into
common stock concurrent with the closing of an underwritten public offering of
common stock under the Securities Act of 1933 in which ORATEC receives at least
$20,000,000 in gross proceeds and the price per share is at least $11.67
(subject to adjustment for a recapitalization, stock splits, or stock
dividends).
Series A, B, C, D, and E preferred stockholders are entitled to annual
noncumulative dividends at a rate of $0.13, $0.18, $0.40, $0.48, and $0.57 per
share, before and in preference to any dividends paid on common stock, when and
as declared by the board of directors. No dividends have been declared as of
December 31, 1998.
The Series A, B, C, D, and E preferred stockholders are entitled to receive,
upon liquidation or certain merger transactions, a distribution of $1.60,
$2.25, $5.00, $5.83, and $7.08 per share, (subject to adjustment for a
recapitalization) plus all declared but unpaid dividends. Thereafter, the
remaining assets and funds, if any, shall be distributed among the holders of
the Series D and E preferred stock and the common stock pro rata based on the
number of shares held by each until the Series D and E preferred stockholders
have received an aggregate of $17.50 per share. Thereafter, the remaining
assets and funds, if any, shall be distributed ratably on a per share basis
among the common stockholders.
If, upon liquidation, dissolution, or winding up of ORATEC, the assets and
funds distributed among the preferred stockholders are insufficient to permit
the payment to which they are entitled as set forth above, the entire assets
and funds of ORATEC legally available for distribution shall be distributed
ratably among the holders of Series A, B, C, D, and E preferred stock in
proportion to the aggregate preferential amounts owed to each such holder.
The Series A, B, C, D, and E preferred stockholders have voting rights
substantially equal to the common shares they would own upon conversion, with
additional protective provisions requiring a separate class vote of the
preferred stock.
As long as at least 600,000 shares of Series D preferred stock remains
outstanding, the Series D preferred stockholders shall have the right to elect
one member of the board of directors of the corporation. As long as at least
600,000 shares of Series E preferred stock remains outstanding, the Series E
preferred stockholders shall have the right to elect one member of the board of
directors of the corporation. All other members of the board of directors shall
be elected by the Series A, B, C, D, and E and common stockholders, voting as a
single class on an as-converted basis.
In accordance with the amended and restated Investor Rights Agreement that
ORATEC entered into in December 1998, holders of at least 40% of the common
stock issued or issuable upon conversion of the Series A, B, C, D, and E
preferred stock may request ORATEC to file a registration statement covering
the registration of those securities outstanding, if the aggregate offering
price to the public exceeds $5,000,000 after the earlier of December 31, 2000
or six months after the effective date of the first registration statement for
a public offering of ORATEC's securities. The Investor Rights Agreement also
contains additional registration and information rights for the benefit of the
holders of the Series A, B, C, D, and E preferred stock.
F-14
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
1995 Stock Plan
In July 1995, ORATEC adopted the 1995 Stock Plan (the "Plan") which provides
for the issuance of common stock options and common stock purchase rights to
employees and consultants of ORATEC. The Plan permits ORATEC to (i) grant
incentive stock options to employees at no less than 100% of fair value at date
of grant as determined by the board of directors; (ii) grant nonstatutory stock
options at no less than 85% of fair value; and (iii) sell common stock at no
less than 85% of fair value subject to stock purchase agreements. At December
31, 1998, ORATEC had issued 8,647 shares of common stock under the Plan.
Incentive stock options become exercisable ratably generally over four years
from the date of grant. Nonstatutory stock options become exercisable ratably
generally over two years from the date of grant. The term of the Plan is 10
years. At December 31, 1998, ORATEC had 454,054 options available for future
grant (123,768 at June 30, 1999).
F-15
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
A summary of option activity under the Plan is as follows:
Years ended December 31,
------------------------------------------------------------ Six months ended
1996 1997 1998 June 30, 1999
------------------ -------------------- -------------------- --------------------
Weighted- Weighted- Weighted- Weighted-
Average Average Average Average
Exercise Exercise Exercise Exercise
Options Price Options Price Options Price Options Price
------- --------- --------- --------- --------- --------- --------- ---------
Outstanding at
beginning of period....... 132,000 $0.002 727,050 $0.58 1,337,052 $1.12 1,633,098 $2.43
Granted................... 613,500 $ 0.70 734,760 $1.65 494,213 $5.77 397,200 $7.30
Canceled.................. -- -- (72,782) $0.47 (114,392) $3.13 (69,873) $5.11
Exercised................. (18,450) $ 0.03 (51,976) $0.38 (83,775) $1.27 (78,818) $1.67
------- --------- --------- ---------
Outstanding at
end of period............. 727,050 $ 0.58 1,337,052 $1.12 1,633,098 $2.43 1,881,607 $3.39
======= ========= ========= =========
Weighted-average
fair value of options
granted during the period.. $ 0.13 $0.25 $0.97 $1.28
====== ===== ===== =====
December 31, 1998
-------------------------------------------------
Options
Options Outstanding Exercisable
------------------------------- -----------------
Weighted-
Average Weighted- Weighted-
Remaining Average Number Average
Number of Contractual Exercise of Exercise
Range of Exercise Prices Options Life Price Options Price
- ------------------------ --------- ----------- --------- ------- ---------
$0.002 - $0.17 321,044 8.08 $ 0.13 277,184 $ 0.15
$1.25 - $4.17 1,026,571 9.72 $ 1.78 441,512 $ 1.53
$5.83 - $8.33 285,483 9.72 $ 7.37 13,364 $ 6.87
--------- -------
1,633,098 9.39 $ 2.43 732,060 $ 1.10
========= =======
June 30, 1999
-------------------------------------------------
Options
Options Outstanding Exercisable
------------------------------- -----------------
Weighted-
Average Weighted- Weighted-
Remaining Average Number Average
Number of Contractual Exercise of Exercise
Range of Exercise Prices Options Life Price Options Price
- ------------------------ --------- ----------- --------- ------- ---------
$0.002 - $0.17 293,564 7.66 $ 0.14 268,214 $ 0.14
$1.25 - $4.17 943,022 9.22 $ 1.71 526,080 $ 1.55
$5.83 - $8.33 629,121 9.52 $ 7.21 46,648 $ 7.19
$12.50 - $12.50 15,900 9.90 $12.50 5,400 $12.50
--------- -------
1,881,607 9.08 $ 3.39 846,342 $ 1.49
========= =======
Options exercisable at December 31, 1996 and 1997 were 153,857 and 457,098.
On May 14, 1999, ORATEC granted options to purchase 96,300 shares of common
stock at $7.08 per share. On May 24, 1999, ORATEC granted options to purchase
15,900 shares of common stock at $12.50 per share. Deferred compensation of
$310,000 has been recorded in the six months ended June 30, 1999 for these
F-16
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
option grants based on the deemed fair value of the common stock. The deferred
compensation will be amortized to expense over the four year average vesting
period of the options.
Pro forma information regarding net loss is required by SFAS 123, and has
been determined as if ORATEC had accounted for its employee stock options
issued under the fair value method of that Statement. The fair value of these
options was estimated at the date of grant using the minimum value method and
assumptions for 1996, 1997, and 1998 as follows: risk-free interest rates of
6%, 6%, and 4.5%; weighted-average expected life of the options was
approximately 48 months and no dividends. The effect of applying SFAS 123 to
ORATEC's stock option awards would have resulted in a net loss of $11,487,000
(or $4.78 per common share) for the year ended December 31, 1998. The pro forma
effect for the years ended December 31, 1996 and 1997 were not materially
different from the actual net losses reported. The pro forma net loss is not
necessarily indicative of potential pro forma effects on results for future
years.
ORATEC has granted 52,382 options to nonemployees in 1998, which resulted in
compensation expense of $102,000 for the year. The options vest primarily over
a two-year period and, therefore, ORATEC will record additional expense related
to these options in 1999 and 2000.
Warrants
In February 1996, ORATEC issued to an employee a warrant to purchase 30,000
shares of Series B preferred stock at a purchase price of $2.25 per share. In
the six months ended June 30, 1999, these warrants were exercised or cancelled.
In March 1996, ORATEC issued a warrant to purchase 33,333 shares of Series B
preferred stock at a purchase price of $2.25 per share in conjunction with
obtaining equipment financing from a lender. The warrant expires in five years
from the issuance date.
In October 1997, ORATEC issued warrants to purchase 21,000 shares of Series C
preferred stock at $5.00 per share in conjunction with obtaining an equipment
financing facility. The warrants expire at the later of ten years from the
issuance date or five years after the closing of ORATEC's initial public
offering.
In December 1998, ORATEC entered into negotiations with a lender to obtain
debt financing (see Note 10). As an inducement to conduct negotiations, ORATEC
agreed to issue a warrant to purchase 73,412 shares of Series E preferred stock
at a purchase price of $7.08 per share. The warrant expires on the earlier of
(i) January 2004 or (ii) the earlier of the second anniversary of either
ORATEC's initial public offering or an acquisition of ORATEC by a publicly
traded company.
As of December 31, 1998, warrants to purchase a total of 63,333 shares of
Series B preferred stock and the warrants to purchase 21,000 shares of Series C
preferred stock were outstanding. The warrant to purchase 73,412 shares of
Series E preferred stock was due to be issued at December 31, 1998.
F-17
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
Reserved Stock
As of December 31, 1998, ORATEC has reserved shares of common stock for
future issuance as follows:
Stock plan......................................................... 2,087,152
Redeemable convertible preferred stock and warrants................ 7,385,198
---------
9,472,350
=========
In addition, ORATEC has reserved the following shares of preferred stock for
issuance upon exercise of stock warrants:
Series B preferred stock.............................................. 63,333
Series C preferred stock.............................................. 21,000
Series E preferred stock.............................................. 73,412
12. Income Taxes
As of December 31, 1998, ORATEC had federal and state net operating loss
carryforwards of approximately $20,000,000 and $6,400,000. ORATEC also had
federal research and development tax credit carryforwards of approximately
$200,000. The net operating loss and credit carryforwards will expire at
various dates beginning in 2009 through 2018, if not utilized.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses before utilization.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
and the amounts used for income tax purposes. Significant components of
ORATEC's deferred tax assets and liabilities for federal and state income taxes
are as follows:
December 31
------------------------
1997 1998
----------- -----------
Net operating loss carryforwards................... $ 3,360,000 $ 7,200,000
Research credit carryforwards...................... 180,000 400,000
Capitalized research & development................. 110,000 300,000
Other-net.......................................... 50,000 100,000
----------- -----------
Net deferred tax assets............................ 3,700,000 8,000,000
Valuation allowance................................ (3,700,000) (8,000,000)
----------- -----------
TOTAL $ -- $ --
=========== ===========
Because of ORATEC's lack of earnings history, the deferred tax assets have
been fully offset by a valuation allowance. The valuation allowance increased
by $950,000, $2,500,000 and $4,300,000 during the years ended December 31,
1996, 1997 and 1998.
F-18
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the six months ended June 30, 1998 and 1999 is unaudited)
13. Segment Reporting
In 1998, ORATEC adopted Statement of Financial Accounting Standards No. 131,
"Disclosure about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 establishes standards for the reporting of selected financial
information about a company's operating segments and disclosures about a
company's products, geographical areas and major customers.
Since inception, ORATEC has been primarily engaged in one reportable
operating segment, providing medical devices which use controlled thermal
energy to treat spine and joint disorders. At the present time, ORATEC is
organized and managed along functional lines. ORATEC's President and Chief
Executive Officer evaluates performance and allocates resources based on the
operating results of the whole company. Revenues are tracked per product line
(spine and arthroscopy) but operating expenses are not allocated to individual
product lines so that no measure of profit or loss for any individual product
line is available. ORATEC attributes revenues from customers to individual
countries based on the location of the customer. Substantially all of ORATEC's
revenues to date have been derived from sales to customers in the U.S. Further,
all of ORATEC's assets have been located in the U.S. for all periods presented.
ORATEC's current products consist of two minimally invasive systems for the
treatment of spine and joint disorders.
ORATEC's spine and arthroscopy product sales are as follows (in thousands):
Six months
Years ended ended
December 31, June 30,
------------------- --------------
1996 1997 1998 1998 1999
---- ------ ------- ------ -------
Spine........................................ $-- $ -- $ 1,246 $ 132 $ 5,619
Arthroscopy.................................. -- 2,600 9,883 3,974 7,280
---- ------ ------- ------ -------
$-- $2,600 $11,129 $4,106 $12,899
==== ====== ======= ====== =======
14. Initial Public Offering, Reincorporation in Delaware and Stock Split
(Unaudited)
In May 1999, ORATEC's board of directors authorized management to file a
registration statement with the Securities and Exchange Commission to permit
ORATEC to sell shares of its common stock to the public. Upon completion of
ORATEC's initial public offering, all of the outstanding redeemable convertible
preferred stock will be converted into 7,247,923 shares of common stock.
On July 1, 1999, ORATEC's board of directors authorized the reincorporation
of ORATEC in the State of Delaware. This reincorporation is to be effective
prior to ORATEC's initial public offering. Upon reincorporation and the closing
of the initial public offering, ORATEC will be authorized to issue 75,000,000
shares of common stock and 5,000,000 shares of preferred stock. The change in
authorized common stock has been reflected in the pro forma redeemable
convertible preferred stock and stockholders' equity as of June 30, 1999. The
accompanying financial statements have been adjusted retroactively to reflect
all other effects of the reincorporation.
On July 1, 1999, ORATEC's board of directors approved a reverse stock split
of three shares for every five shares of common and preferred stock then
outstanding. The reverse stock split will become effective prior to the time of
ORATEC's initial public offering. Accordingly, the accompanying financial
statements have been adjusted retroactively to reflect the reverse split.
F-19
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998
(Information for the three months ended March 31, 1998 and 1999 is unaudited)
15. Subsequent Events (Unaudited)
On July 1, ORATEC granted options to purchase 113,850 shares of common stock
at $12.50 to $13.33 per share. On July 22, ORATEC granted options to purchase
10,350 shares of common stock at $13.33 per share. Deferred compensation of
approximately $50,000 will be recorded in the quarter ended September 30, 1999
for these option grants based on the deemed fair value of the common stock. The
deferred compensation will be amortized to expense over the four year average
vesting period of the options.
On July 1, 1999, the board of directors approved an amendment to the 1995
Plan, subject to stockholder approval, to increase the number of shares
reserved for issuance by 750,000 shares. Further, the number of shares reserved
for issuance are subject to an automatic annual increase on January 1, 2000,
2001 and 2002 equal to the lesser of (i) 750,000 shares, (ii) 4% of the shares
of common stock outstanding on the last day of the immediately preceding fiscal
year, or (iii) such lesser number of shares as the board of directors
determines.
On July 1, 1999, the board of directors approved the adoption of the 1999
Employee Stock Purchase Plan (the "1999 Purchase Plan"), subject to stockholder
approval. A total of 250,000 shares of common stock has been reserved for
issuance under the 1999 Purchase Plan. The number of shares reserved for
issuance is subject to an automatic annual increase on January 1, 2001, 2002
and 2003 equal to the lesser of (i) 250,000 shares, (ii) 2% of the outstanding
common stock on the last day of the immediately preceding fiscal year, or (iii)
such lesser number of shares as the board of directors determines. The 1999
Purchase Plan permits eligible employees to acquire shares of ORATEC's common
stock through periodic payroll deductions of up to 15% of total compensation.
An employee may purchase no more than 2,000 shares during any given offering
period. Each offering period will have a maximum duration of approximately six
months. The price at which the common stock may be purchased is 85% of the
lesser of the fair market value of ORATEC's common stock at the beginning or
the end of each offering period. The initial offering period will commence on
the effectiveness of the initial public offering and will end on April 30,
2000.
On July 1, 1999 the board of directors, subject to stockholder approval,
approved the 1999 Directors' Option Plan (the "Directors' Plan"), which
provides for the grant of nonqualified stock options to nonemployee directors
of ORATEC. A total of 200,000 shares of common stock have been reserved for
issuance under the Directors' Plan.
F-20
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2,500,000 Shares
[LOGO OF ORATEC(R)]
Common Stock
------------
PROSPECTUS
------------
Merrill Lynch & Co.
J.P. Morgan & Co.
U.S. Bancorp Piper Jaffray
, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses, other than the
underwriting discount and commissions, payable by ORATEC in connection with the
sale of common stock being registered. All amounts are estimates except the
Securities and Exchange Commission registration fee, the NASD filing fee and
the Nasdaq National Market listing fee.
Amount to
be Paid
----------
Securities and Exchange Commission registration fee.............. $ 13,588
NASD filing fee.................................................. 5,388
Nasdaq National Market listing fee............................... 84,875
Printing and engraving expenses.................................. 200,000
Legal fees and expenses.......................................... 385,000
Accounting fees and expenses..................................... 350,000
Blue Sky qualification fees and expenses......................... 5,000
Transfer Agent and Registrar fees................................ 15,000
Miscellaneous fees and expenses.................................. 41,149
----------
Total.......................................................... $1,100,000
==========
Item 14. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's board of directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit such indemnification under
some circumstances for liabilities, including reimbursement for expenses
incurred, arising under the Securities Act of 1933, as amended. Article XII of
ORATEC's certificate of incorporation (Exhibit 3.4) and Article VI of ORATEC's
Bylaws (Exhibit 3.7) provide for indemnification of ORATEC's directors,
officers, employees and other agents to the maximum extent permitted by
Delaware Law. In addition, ORATEC has entered into Indemnification Agreements
(Exhibit 10.11) with its officers and directors. The Underwriting Agreement
(Exhibit 1.1) also provides for cross-indemnification among ORATEC and the
underwriters with respect to some matters, including matters arising under the
Securities Act.
Item 15. Recent Sales of Unregistered Securities
Since June 30, 1996, ORATEC has sold and issued the following securities:
(1) In March through December 1997, we issued and sold shares of Series C
preferred stock convertible into an aggregate of 865,511 shares of common
stock to a total of 120 investors for an aggregate purchase price of
$4,327,638.
(2) In October 1997, we issued warrants to purchase shares of Series C
preferred stock convertible into an aggregate of 21,000 shares of common
stock to two lenders.
(3) In November and December 1997, we issued and sold shares of Series D
preferred stock convertible into an aggregate of 1,937,133 shares of common
stock to a total of 60 investors for an aggregate purchase price of
$11,299,998.
(4) In December 1998, we issued and sold shares of Series E preferred
stock convertible into an aggregate of 2,254,678 shares of common stock to
a total of 59 investors for an aggregate purchase price of $15,970,680.
(5) In January 1999, we issued a warrant to purchase Series E preferred
stock convertible into an aggregate of 73,412 shares of common stock to one
lender.
(6) In February 1999, we issued and sold 20,470 shares of Series B
preferred stock to an executive officer upon his exercise of a warrant.
II-1
(7) From July 1995 through June 30, 1999, under our 1995 Stock Plan,
232,978 shares of common stock had been issued upon exercise of options,
11,647 shares of common stock had been issued pursuant to restricted stock
purchase agreements and 1,881,607 shares of common stock were issuable upon
exercise of outstanding options.
The issuances of the above securities were deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act as transactions by an issuer not involving any public offering.
In addition, the issuances described in Item 7 were deemed exempt from
registration under the Securities Act in reliance upon Rule 701 promulgated
under the Securities Act. The recipients of securities in each transaction
represented their intentions to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution and
appropriate legends were affixed to the share certificates and warrants issued
in the transactions. All recipients had adequate access, through their
relationships with us, to information about us.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
Number Description
------ -----------
1.1 Form of Underwriting Agreement (subject to negotiation).
3.1+ Amended and Restated Articles of Incorporation.
3.2+ Certificate of Incorporation for reincorporation in Delaware.
3.3+ Amended and Restated Certificate of Incorporation for reverse
stock split.
3.4+ Amended and Restated Certificate of Incorporation, post-IPO.
3.5+ Bylaws, as amended.
3.6+ Bylaws for reincorporation in Delaware.
3.7++ Amended and Restated Bylaws, post-IPO.
4.1* Specimen Stock Certificate.
5.1* Opinion of Venture Law Group regarding the legality of the common
stock being registered.
10.1+ Amended and Restated Investors' Rights Agreement dated December 7,
1998 among ORATEC and certain investors.
10.2+ Employment Letter Agreement dated October 29, 1997 between ORATEC
and Nancy V. Westcott.
10.3+ Employment Agreement dated July 14, 1997 between ORATEC and
Kenneth W. Anstey.
10.4+ Employment Agreement dated August 21, 1996 and First Amendment to
Employment Agreement dated July 14, 1997 between ORATEC and Hugh
Sharkey.
10.5+ Change of Control Letter Agreement dated 1996 between ORATEC and
Roger Lipton.
10.6++ 1995 Stock Plan, as amended, and form of option agreement.
10.7++ 1999 Directors' Stock Option Plan and form of option agreement.
10.8++ 1999 Employee Stock Purchase Plan and form of subscription
agreement.
10.9+ Lease dated May 7, 1998 between ORATEC and White Properties Joint
Venture (as amended).
10.10+ Lease dated August 2, 1996 between ORATEC and Huettig &
Schromm/Heaton & Keyser.
10.11+ Form of Indemnification Agreement between ORATEC and officers and
directors.
10.12** International Distribution Agreement dated March 30, 1999 between
ORATEC and DePuy Acromed, Inc.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2* Consent of Venture Law Group, A Professional Corporation (See
Exhibit 5.1).
23.3+ Consent of Wilson Sonsini Goodrich & Rosati, a Professional
Corporation.
II-2
23.4+ Power of Attorney (See page II-4).
27.1 Financial Data Schedule.
- --------
+ Previously filed.
++ Supersedes previously filed exhibit.
* To be filed by amendment.
** Confidential treatment has been requested with respect to portions of this
exhibit.
(b) Financial Statement Schedules
Schedules not listed above have been omitted because the information required
to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
Item 17. Undertakings
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement certificates in the
denominations and registered in the names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment to its registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the city of Menlo
Park, State of California, on August 16, 1999.
ORATEC INTERVENTIONS, INC.
/s/ Nancy V. Westcott
By: _________________________________
Nancy V. Westcott
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, this amendment to
its Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
Signature Title Date
* President, Chief Executive August 16, 1999
______________________________________ Officer and Director
Kenneth W. Anstey (Principal Executive
Officer)
/s/ Nancy V. Westcott Chief Financial Officer August 16, 1999
______________________________________ (Principal Financial and
Nancy V. Westcott Accounting Officer)
* Director August 16, 1999
______________________________________
Stephen Brackett
* Director August 16, 1999
______________________________________
Gary S. Fanton, M.D.
* Director August 16, 1999
______________________________________
Richard M. Ferrari
* Director August 16, 1999
______________________________________
Patrick F. Latterell
* Director August 16, 1999
______________________________________
Jeffrey A. Saal, M.D.
* Director August 16, 1999
______________________________________
Hugh R. Sharkey
*By: /s/ Nancy V. Westcott
__________________________________
(Attorney-in-fact)
II-4
EXHIBIT INDEX
Number Description
------ -----------
1.1 Form of Underwriting Agreement (subject to negotiation).
3.1+ Amended and Restated Articles of Incorporation.
3.2+ Certificate of Incorporation for reincorporation in Delaware.
3.3+ Amended and Restated Certificate of Incorporation for reverse stock
split.
3.4+ Amended and Restated Certificate of Incorporation, post-IPO.
3.5+ Bylaws, as amended.
3.6+ Bylaws for reincorporation in Delaware.
3.7++ Amended and Restated Bylaws, post-IPO.
4.1* Specimen Stock Certificate.
5.1* Opinion of Venture Law Group regarding the legality of the common
stock being registered.
10.1+ Amended and Restated Investors' Rights Agreement dated December 7,
1998 among ORATEC and certain investors.
10.2+ Employment Letter Agreement dated October 29, 1997 between ORATEC and
Nancy V. Westcott.
10.3+ Employment Agreement dated July 14, 1997 between ORATEC and Kenneth W.
Anstey.
10.4+ Employment Agreement dated August 21, 1996 and First Amendment to
Employment Agreement dated July 14, 1997 between ORATEC and Hugh
Sharkey.
10.5+ Change of Control Letter Agreement dated 1996 between ORATEC and Roger
Lipton.
10.6++ 1995 Stock Plan, as amended, and form of option agreement.
10.7++ 1999 Directors' Stock Option Plan and form of option agreement.
10.8++ 1999 Employee Stock Purchase Plan and form of subscription agreement.
10.9+ Lease dated May 7, 1998 between ORATEC and White Properties Joint
Venture (as amended).
10.10+ Lease dated August 2, 1996 between ORATEC and Huettig & Schromm/Heaton
& Keyser.
10.11+ Form of Indemnification Agreement between ORATEC and officers and
directors.
10.12** International Distribution Agreement dated March 30, 1999 between
ORATEC and DePuy Acromed, Inc.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2* Consent of Venture Law Group, A Professional Corporation (See Exhibit
5.1).
23.3+ Consent of Wilson Sonsini Goodrich & Rosati, a Professional
Corporation.
23.4+ Power of Attorney (See page II-4).
27.1 Financial Data Schedule.
- --------
+ Previously filed.
++ Supersedes previously filed exhibit.
* To be filed by amendment.
** Confidential treatment has been requested with respect to portions of this
exhibit.