U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
Commission file number 0-28288
----------------------------
ECLIPSE SURGICAL TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
----------------------------
CALIFORNIA 77-0223740
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
559 WEDDELL DRIVE
SUNNYVALE, CALIFORNIA 94089
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(408) 747-0120
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock outstanding as of the latest practicable date.
17,435,963 shares
As of October 31, 1998
ECLIPSE SURGICAL TECHNOLOGIES, INC.
TABLE OF CONTENTS
PART 1
FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements:
a. Consolidated Balance Sheets
as of September 30, 1998 and December 31, 1997........................... 1
b. Consolidated Statements of Operations
for the three and nine months ended September 30, 1998 and 1997........... 2
c. Consolidated Statements of Cash Flows
for the nine months ended September 30, 1998 and 1997..................... 3
d. Notes to Financial Statements.............................................. 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................... 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 17
PART II
OTHER INFORMATION
Item 1. Legal Proceedings............................................................. 18
Item 2(d). Changes in Securities and Use of Proceeds..................................... 18
Item 5. Other Information............................................................. 18
Item 6. Exhibits and Reports on Form 8-K.............................................. 18
Signatures.................................................................... 19
ECLIPSE SURGICAL TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
SEPTEMBER 30, 1998 DECEMBER 31,
(UNAUDITED) 1997
-------- --------
Current assets:
Cash and cash equivalents ............................................ $ 2,134 $ 16,997
Marketable securities ................................................ 252 18,197
Accounts receivable, net of allowance for doubtful accounts of $1,062
at September 30, 1998 and $757 at December 31, 1997, respectively .. 3,271 2,054
Inventories ........................................................... 5,350 3,866
Prepaids and other current assets ..................................... 640 556
-------- --------
Total current assets ............................................... 11,647 41,670
Property and equipment, net .............................................. 1,269 1,420
Marketable securities .................................................... 14,534 --
Other assets ............................................................. 1,342 384
-------- --------
Total assets ....................................................... $ 28,792 $ 43,474
-------- --------
-------- --------
LIABILITIES
Current liabilities:
Accounts payable ...................................................... $ 3,640 $ 3,190
Accrued liabilities ................................................... 1,236 965
Customer deposits ..................................................... 217 71
Note payable .......................................................... 1,000 1,000
Current portion of long-term debt ..................................... 8 10
-------- --------
Total current liabilities ......................................... 6,101 5,236
Long-term debt, less current portion .................................... 5 10
-------- --------
Total liabilities ................................................. 6,106 5,246
-------- --------
SHAREHOLDERS' EQUITY
Common stock, no par value:
Authorized: 50,000 shares;
Issued and outstanding: 17,396 shares at September 30, 1998 and
16,858 shares at December 31, 1997 ................................ 67,943 66,596
Unrealized gain (loss) on marketable securities .......................... 43 50
Accumulated deficit ...................................................... (45,300) (28,418)
-------- --------
Total shareholders' equity ........................................ 22,686 38,228
-------- --------
Total liabilities and shareholders' equity ........................ $ 28,792 $ 43,474
-------- --------
-------- --------
The accompanying notes are an integral part of these
consolidated financial statements
1
ECLIPSE SURGICAL TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------- ------- -------- --------
Net revenues ........................................ $ 2,012 $ 1,401 $ 6,656 $ 3,863
Cost of revenues .................................... 1,000 721 3,280 1,985
------- ------- -------- --------
Gross profit ...................................... 1,012 680 3,376 1,878
------- ------- -------- --------
Operating expenses:
Research and development .......................... 3,709 2,982 11,022 8,626
Sales and marketing ............................... 2,348 1,864 7,852 4,741
General and administrative ........................ 762 969 2,443 3,226
------- ------- -------- --------
Total operating expenses ........................ 6,819 5,815 21,317 16,593
------- ------- -------- --------
Operating loss ................................ (5,807) (5,135) (17,941) (14,715)
Interest expense .................................... (21) (13) (74) (19)
Interest and other income ........................... 313 632 1,133 1,719
------- ------- -------- --------
Net loss ...................................... $(5,515) $(4,516) $(16,882) $(13,015)
Unrealized gain (loss) on marketable
securities .................................. $ 69 $ (28) $ 43 $ 284
------- ------- -------- --------
------- ------- -------- --------
Comprehensive loss .......................... $(5,446) $(4,544) $(16,839) $(12,731)
------- ------- -------- --------
------- ------- -------- --------
Net loss per share: basic and diluted .............. $ (0.32) $ (0.27) $ (0.99) $ (0.80)
------- ------- -------- --------
------- ------- -------- --------
Weighted average shares outstanding: basic and
diluted ............................................. 17,374 16,441 17,126 16,303
------- ------- -------- --------
------- ------- -------- --------
The accompanying notes are an integral part of these
consolidated financial statements
2
ECLIPSE SURGICAL TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER
1998 1997
-------- --------
Cash flows from operating activities:
Net loss .................................................................... $(16,882) $(13,015)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................. 613 414
Provision for doubtful accounts ........................................... 305 1,013
Changes in operating assets and liabilities:
Increase in accounts receivable ........................................ (1,522) (84)
Increase in inventories ................................................ (1,484) (1,085)
Increase in prepaids and other current assets .......................... (84) (279)
Increase in other assets ............................................... (958) --
Increase in accounts payable ........................................... 450 338
Increase in customer deposits .......................................... 146 25
Increase in accrued liabilities ........................................ 271 631
-------- --------
Net cash used in operating activities ............................... (19,145) (12,042)
-------- --------
Cash flows from investing activities:
Purchase of marketable securities ........................................... (14,534) --
Sale of marketable securites ................................................ 17,938 9,666
Acquisition of property and equipment ...................................... (462) (1,167)
-------- --------
Net cash provided by investing activities ........................... 2,942 8,499
-------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock and warrants ..................... 1,347 699
Payments on short-term borrowings ........................................... (2) --
Payments on long-term debt .................................................. (5) (39)
-------- --------
Net cash provided by financing activities ........................... 1,340 660
-------- --------
Net decrease in cash and cash equivalents ........................ (14,863) (2,883)
Cash and cash equivalents at beginning of period .............................. 16,997 24,106
-------- --------
Cash and cash equivalents at end of period .................................... $ 2,134 $ 21,223
-------- --------
-------- --------
Supplemental schedule of noncash investing and financing activities:
Unrealized gain (loss) on marketable securities ............................. $ 43 $ 284
-------- --------
-------- --------
The accompanying notes are an integral part of these
consolidated financial statements
3
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies:
INTERIM FINANCIAL INFORMATION (UNAUDITED):
The interim financial statements in this report reflect all adjustments,
consisting of normal recurring adjustments, that are, in the opinion of
management, necessary for a fair presentation of the results of operations
and cash flows for the interim periods covered and of the financial condition
of the Company at the interim balance sheet dates. Results for interim
periods are not necessarily indicative of results to be expected for the full
fiscal year. The year-end balance sheet information was derived from audited
financial statements but does not include all disclosures required by
generally accepted accounting principles. These financial statements should
be read in conjunction with the Company's audited financial statements and
notes thereto for the year ended December 31, 1997, contained in the
Company's Annual Report on Form 10-K as filed with the U.S. Securities and
Exchange Commission (SEC).
NET LOSS PER SHARE:
Earnings per share are calculated in accordance with the provisions of
Statement of Accounting Standards No. 128, "Earnings per Share," (SFAS 128).
SFAS 128 requires the Company to report both basic earnings per share, which
is the weighted-average number of common shares outstanding, and diluted
earnings per share, which includes the weighted-average common shares
outstanding and all dilutive potential common shares outstanding. All periods
presented herein have been restated to reflect the adoption of SFAS 128. For
the three and nine months ended September 30, 1998 and September 30, 1997
dilutive potential common shares outstanding reflects shares issuable under
the Company's stock option plans.
Basic EPS is computed by dividing loss available to common shareholders
by the weighted average number of common shares outstanding for the period.
Diluted EPS is computed giving effect to all dilutive potential common shares
that were outstanding during the period.
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follows (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------- ------- -------- --------
Numerator - Basic and Diluted EPS
Loss available to common stockholders....... $(5,515) $(4,516) $(16,882) $(13,015)
Denominator - Basic and Diluted EPS
Weighted average shares outstanding......... 17,374 16,441 17,126 16,303
------- ------- -------- --------
Basic and diluted earnings per share ......... $ (0.32) $ (0.27) $ (0.99) $ (0.80)
------- ------- -------- --------
------- ------- -------- --------
Options to purchase 2,796,662 and 3,128,029 shares of common stock were
outstanding at September 30, 1998 and 1997 respectively, but were not
included in the calculation of diluted EPS because their inclusion would have
been antidilutive.
4
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies -- (CONTINUED):
COMPREHENSIVE INCOME:
Comprehensive income is presented in accordance with Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," and
comprises net income plus revenues, expenses, gains and losses that, under
generally accepted accounting principles, are excluded from net income.
RECENT PRONOUNCEMENTS:
In June 1997, FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS 131"), which supersedes SFAS 14, "Financial Reporting for
Segments of a Business Enterprise." SFAS 131 changes current practice under
SFAS 14 by establishing a new framework on which to base segment reporting
and also requires interim reporting of segment information. The Company is
evaluating the impact of SFAS 131 which is effective for the Company's fiscal
year ended December 31, 1998 with interim reporting disclosures required the
first quarter of 1999.
In June 1998, FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133") which is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. SFAS 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. The
Company does not use derivative instruments and is not involved in hedging
activities and has no plans to do so given the Company's current business
operations.
2. Recent Events
On October 22, 1998, the Company announced the signing of a definitive
agreement that provides for a business combination with CardioGenesis
Corporation ("CardioGenesis"). Under the terms of the definitive agreement,
each share of CardioGenesis common stock will be converted into the right to
receive 0.8 shares of Eclipse common stock, and Eclipse will assume all
outstanding CardioGenesis stock options. CardioGenesis will survive as a
wholly-owned subsidiary of Eclipse. The transaction is structured to qualify
as a tax-free reorganization to be accounted for as a pooling of interests.
The Boards of Directors of the Company and CardioGenesis have approved the
definitive agreement, but the combination is subject to approval by
shareholders of each company and to certain other customary conditions to
closing. The parties anticipate the transaction will close in the first
calendar quarter of 1999.
3. Inventories:
Inventories are stated at lower of cost (first-in, first-out) or market
and consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
Raw materials ....................... $2,172 $1,446
Work in process ..................... 411 --
Finished goods ...................... 2,767 2,420
------ ------
$5,350 $3,866
------ ------
------ ------
5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS CONTAINS DESCRIPTIONS OF THE COMPANY'S EXPECTATIONS
REGARDING FUTURE TRENDS AFFECTING ITS BUSINESS. THESE FORWARD-LOOKING
STATEMENTS AND OTHER FORWARD-LOOKING STATEMENTS MADE ELSEWHERE IN THIS
DOCUMENT ARE MADE IN RELIANCE UPON THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. PLEASE READ THE SECTION BELOW
TITLED "FACTORS THAT MAY AFFECT FUTURE RESULTS" TO REVIEW CONDITIONS WHICH
THE COMPANY BELIEVES COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
THOSE CONTEMPLATED BY THE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING
STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, THOSE ITEMS IDENTIFIED WITH A
FOOTNOTE (1) SYMBOL. THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE THE
INFORMATION CONTAINED HEREIN. THE COMPANY MAY ALSO MAKE ORAL FORWARD-LOOKING
STATEMENTS FROM TIME TO TIME. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
PROJECTED IN ANY SUCH FORWARD-LOOKING STATEMENTS DUE TO A NUMBER OF FACTORS,
INCLUDING THOSE SET FORTH BELOW AND ELSEWHERE IN THIS FORM 10-Q.
THE COMPANY OPERATES IN A DYNAMIC AND RAPIDLY CHANGING ENVIRONMENT THAT
INVOLVES NUMEROUS RISKS AND UNCERTAINTIES. THE FOLLOWING SECTION LISTS SOME,
BUT NOT ALL, OF THOSE RISKS AND UNCERTAINTIES WHICH MAY HAVE A MATERIAL
ADVERSE EFFECT ON THE COMPANY'S BUSINESS, FINANCIAL CONDITION OR RESULTS OF
OPERATIONS. THIS SECTION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED IN PART I --ITEM
1 OF THIS QUARTERLY REPORT ON FORM 10-Q AND THE AUDITED FINANCIAL STATEMENTS
THERETO AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997, CONTAINED IN THE
COMPANY'S 1997 ANNUAL REPORT TO STOCKHOLDERS ON FORM 10-K.
OVERVIEW
The Company was founded in 1989 to use laser technology to treat
cardiovascular disease. From 1989 through September 1995, the Company engaged
in research, development and sale of surgical laser products principally for
procedures such as atherectomy and arthroscopy. In 1995, the Company
determined that there was a significant opportunity in the Transmyocardial
Revascularization ("TMR") market, and that the Company was well-positioned to
enter this market because of the Company's expertise with laser-based
surgical techniques and the treatment of cardiovascular disease. Accordingly,
in late 1995, the Company changed its strategic direction to enter the TMR
market.
Prior to 1996, the Company had focused almost exclusively on research
and development activities relating to surgical laser products, substantially
contributing to operating losses since inception. Since 1996, the Company has
focused on TMR and Percutaneous Transmyocardial Revascularization ("PTMR")
activities, particularly research and development activities and clinical
trials. At September 30, 1998, the Company had an accumulated deficit of
$45,300,000. Three clinical trials have been concluded and a number of
clinical trials are in progress in either TMR or PTMR. The Company has
submitted an application to the U.S. Food and Drug Administration ("FDA") for
marketing clearance ("PMA" or Pre-Market Approval) of its TMR products in the
United States. On October 27, 1998, the Circulatory System Devices Advisory
Panel of the FDA recommended approval of the Company's PMA application for
its TMR laser system. Along with approval, the Panel requested that the
Company conduct post-market surveillance in a manner to be decided in
discussions with the FDA. The Company has received the European Conforming
Mark ("CE Mark") allowing the commercial sale of its TMR and PTMR products to
the European Community.
On October 22, 1998, the Company announced the signing of a definitive
agreement that provides for a business combination with CardioGenesis
Corporation. Under the terms of the definitive agreement, each share of
CardioGenesis common stock will be converted into the right to receive 0.8
shares of Eclipse common stock, and Eclipse will assume all outstanding
CardioGenesis stock options. CardioGenesis will survive as a wholly-owned
subsidiary of Eclipse. As a result of the transaction, Eclipse will increase
its shares outstanding by approximately 9.8 million shares, which will be
issued to CardioGenesis stockholders. These shares will represent
approximately 36% of Eclipse's outstanding shares after the transaction. The
transaction is structured to qualify as a tax-free reorganization to be
accounted for as a pooling of interests. The Boards of Directors of the
Company and
- -----------------------
(1) Forward-Looking Statement
6
CardioGenesis have approved the definitive agreement, but the combination is
subject to approval by shareholders of each company and to certain other
customary conditions to closing. The parties anticipate the transaction will
close in the first calendar quarter of 1999(1).
The Company expects to continue to incur operating losses related to the
expansion of sales and marketing resources, research and development
activities, including clinical studies, and the continued development of
corporate infrastructure.(1) The timing and amounts of the Company's
expenditures will depend upon a number of factors, including the timing of
the closing of the transaction with CardioGenesis, progress of the Company's
clinical trials, the status and timing of regulatory approvals, the timing of
market acceptance, if any, of the Company's products, and the efforts
required to develop the Company's sales and marketing organization.
RESULTS OF OPERATIONS
NET REVENUES
Net revenues increased 44% to $2,012,000 for the three months ended
September 30, 1998 from $1,401,000 for the three months ended September 30,
1997. Net revenues increased 72% to $6,656,000 for the nine months ended
September 30, 1998 from $3,863,000 for the nine months ended September 30,
1997. These increases resulted primarily from growth in the number of
hospital sites, protocols and clinical trials.
The Company's net revenues continue to be adversely affected by a change
in Health Care Financing Administration ("HCFA") policy effective May 19,
1997 which restricts Medicare reimbursement for TMR equipment and the
Company's systems. Prior to May 19, 1997, the Company's products were
eligible for third party reimbursement under HCFA policy. Third party
reimbursement is a significant factor considered by hospitals in determining
whether to acquire the Company's systems.
Future revenues may be adversely affected by restrictions on third party
reimbursement and the timing and manner of sale of TMR and PTMR laser
systems. The Company intends to continue selling the systems to hospitals
outright or placing the system with hospitals for a placement fee plus an
additional fee for each procedure performed. The Company has also entered
contingent arrangements where the sale of the Company's systems are
contingent upon FDA approval or HCFA reimbursement. As a result of the HCFA
policy restricting Medicare reimbursement for TMR equipment and procedures,
the Company anticipates continued difficulties in selling its systems.
GROSS PROFIT
Gross profit increased to $1,012,000 or 50% of net revenues and
$3,376,000 or 51% of net revenues for the three and nine months ended
September 30, 1998, respectively, compared to $680,000 or 49% of net revenues
and $1,878,000 or 49% of net revenues for the three and nine months ended
September 30, 1997, respectively. The slight improvement in gross profit
percentage in 1998 versus 1997 is due to improved efficiency from higher
production volumes.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenditures increased to $3,709,000 or 184% of
net revenues and $11,022,000 or 166% of net revenues for the three and nine
months ended September 30, 1998, respectively, compared to $2,982,000 or 213%
of net revenues and $8,626,000 or 223% of net revenues for the three and nine
months ended September 30, 1997, respectively. The absolute cost increase in
these expenses reflected the higher costs of supporting additional clinical
trials and an increase in research and development activities.
The Company's products are currently in clinical trials and therefore
subject to limitations by the FDA. The Company believes that continued
investment in the development of new and improved products and procedures and
- -----------------------
(1) Forward-Looking Statement
7
continued investment in the Company's clinical trials is critical to its
future success.(1) As a result of the HCFA policy restricting Medicare
reimbursement for TMR and PTMR equipment and procedures, the Company
reimbursed clinical sites for expenses incurred in conjunction with
performing clinical trials. The Company anticipates a continued increase in
expenditures related to hospital support of the Company's clinical trials as
the number of its clinical trials increases.(1) Accordingly, the Company
believes that research and development expenses will continue to increase as
long as HCFA policy restricts reimbursement for the Company's equipment and
procedures.(1) There can be no assurance that the Company's future revenues,
if any, will be sufficient to offset the research and development expenses
required in connection with ongoing efforts including current and future
clinical trials.
SALES AND MARKETING
Sales and marketing expenses increased to $2,348,000 or 117% of net
revenues and $7,852,000 or 118% of net revenues for the three and nine months
ended September 30, 1998, respectively, from $1,864,000 or 133% of net
revenues and $4,741,000 or 123% of net revenues for the three and nine months
ended September 30, 1997, respectively. The increases reflected the Company's
application of additional resources to both the TMR and PTMR markets,
including the expansion of its international sales staff and related travel
expenses. Additionally, the Company incurred increased depreciation expense
associated with lasers placed as demonstration units. The Company expects
that sales and marketing expenses will continue to increase as the Company
continues to focus resources on the development of the TMR and PTMR
markets.(1)
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased to $762,000 or 38% of net
revenues and $2,443,000 or 37% of net revenues for the three and nine months
ended September 30, 1998, respectively, compared to $969,000 or 69% of net
revenues and $3,226,000 or 84% of net revenues for the three and nine months
ended September 30, 1997, respectively. The decreases were due to reduced
expenses related to legal, investor and public relations services.
INTEREST INCOME AND EXPENSE, NET
Interest income decreased 50% to $313,000 and 34% to $1,133,000 for the
three and nine months ended September 30, 1998, respectively, compared to
$632,000 and $1,719,000 for the three and nine months ended September 30,
1997, respectively. These decreases were due to lower cash balances and lower
investments in marketable securities in 1998. Interest expense of $21,000 and
$74,000 for the three and nine months ended September 30, 1998, respectively,
increased as a result of a note payable held by the Company's subsidiary,
MicroHeart.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has satisfied its capital requirements
primarily through sales of its equity securities and, to a lesser extent,
loans from shareholders. In addition, the Company's operations have been
funded in part through sales of the Company's products. At September 30,
1998, the Company had aggregate cash and marketable securities of $16,920,000
compared to $35,194,000 at December 31, 1997. The Company used $19,145,000
for operating activities for the nine months ended September 30, 1998. The
Company's investing activities provided $2,942,000 of cash for the nine
months ended September 30, 1998. Net cash provided by financing activities
was $1,340,000 for the nine months ended September 30, 1998. At September 30,
1998, the Company had an accumulated deficit of $45,300,000.
The Company anticipates that its current cash and marketable securities,
together with sales of products for investigational use, will be sufficient
to meet the Company's capital requirements through the next twelve months.(1)
There can be no assurance, however, that the Company will not require
additional sources of cash at an earlier date in the future, depending upon
the progress of expansion of the Company's clinical trials, any need for
additional
- -----------------------
(1) Forward-Looking Statement
8
clinical trials or other testing of the Company's products, expenses
associated with the Company's pending business combination with CardioGenesis
and the timing of other required expenditures as indicated above. If the
Company is required to obtain additional financing in the future, there can
be no assurance that capital will be available on terms acceptable to the
Company, if at all.
FACTORS THAT MAY AFFECT FUTURE RESULTS
THE COMPANY HAS IDENTIFIED CERTAIN FORWARD-LOOKING STATEMENTS IN THE
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS WITH A FOOTNOTE(1) SYMBOL. THE COMPANY MAY ALSO MAKE ORAL
FORWARD-LOOKING STATEMENTS FROM TIME TO TIME. ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE PROJECTED IN ANY SUCH FORWARD-LOOKING STATEMENTS DUE TO
A NUMBER OF FACTORS, INCLUDING THOSE SET FORTH BELOW AND ELSEWHERE IN THIS
FORM 10-Q.
THE COMPANY OPERATES IN A DYNAMIC AND RAPIDLY CHANGING ENVIRONMENT THAT
INVOLVES NUMEROUS RISKS AND UNCERTAINTIES. THE FOLLOWING SECTION LISTS SOME,
BUT NOT ALL, OF THOSE RISKS AND UNCERTAINTIES WHICH MAY HAVE A MATERIAL
ADVERSE EFFECT ON THE COMPANY'S BUSINESS, FINANCIAL CONDITION OR RESULTS OF
OPERATIONS. THIS SECTION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED IN PART I --ITEM
1 OF THIS QUARTERLY REPORT ON FORM 10-Q AND THE AUDITED FINANCIAL STATEMENTS
THERETO AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997, CONTAINED IN THE
COMPANY'S 1997 ANNUAL REPORT TO STOCKHOLDERS ON FORM 10-K.
NO ASSURANCE OF FDA OR OTHER REQUIRED GOVERNMENTAL APPROVALS
In the U.S., the FDA regulates our TMR and PTMR products as medical
devices under the federal Food, Drug, and Cosmetic Act (the "FD&C Act"). We
must obtain FDA approval of a PMA application before we can sell our products
commercially in the U.S. The FDA approves PMA applications for specific
indications only and FDA regulations prohibit commercial marketing in the
U.S. of devices for indications that the FDA has not approved. The process of
obtaining the required regulatory approvals from the FDA and other regulatory
authorities is lengthy, expensive and inherently uncertain. This regulatory
approval process generally takes several years or more to complete, if
approval is obtained at all, and requires the submission of extensive
clinical data and supporting information to the FDA.
Completion of clinical testing to demonstrate the safety and
effectiveness of our TMR and PTMR products is a prerequisite to the
submission of a PMA application. On July 1, 1997, we initially submitted a
PMA application to the FDA for use of our TMR laser system to treat patients
with Class IV angina (chest pain) caused by coronary artery disease. We later
amended that application to include data regarding TMR when used in
conjunction with bypass surgery. On March 16, 1998, the FDA accepted our
amended application for filing. On October 27, 1998, the Circulatory System
Devices Advisory Panel of the FDA recommended approval of our PMA application
for our TMR laser system. Along with its approval, the FDA Panel requested
that we conduct post-market surveillance in a form to be determined through
further discussions with the FDA.
On May 30, 1997, we received an Investigational Device Exemption ("IDE")
from the FDA to begin our first PTMR clinical trial, which compares patients
treated with PTMR to patients receiving drug therapy alone. In November 1997,
the FDA authorized us to begin Phase II of this trial. On October 17, 1997,
we received an IDE from the FDA, authorizing commencement of Phase I of
another PTMR clinical trial, this time comparing patients treated with PTMR
in conjunction with balloon angioplasty treatments (also known as
percutaneous transluminal coronary angioplasty ("PTCA")) or various other
interventional procedures, to patients receiving only PTCA or other
interventions. On April 24, 1998, the FDA authorized us to begin Phase II of
this trial. The FDA review process for our products and procedures can be
lengthy and the results are uncertain. We cannot assure you when, if at all,
the FDA will approve any of these applications. If the FDA does not approve
these applications, or if it takes longer than expected to obtain FDA
approvals, our business and results of operations could be materially
adversely affected.
Our completion of clinical studies on a timely basis will depend in part
on our ability to successfully
9
establish TMR and PTMR sites and to continue to identify and enroll
participating patients in a timely fashion. Our clinical studies continue to
require substantial financial and management resources. We may not have the
resources necessary to complete our clinical studies. In addition, we cannot
assure you that we will complete our clinical studies in the currently
anticipated time frame or otherwise in a timely manner, or that our clinical
studies will demonstrate the safety and effectiveness of our products to the
extent necessary to obtain FDA and other regulatory approvals and to
establish a commercial market for our products. In addition, results of
initial clinical studies are not necessarily predictive of results to be
achieved in later clinical studies, if undertaken, or commercially, if PMA
approval is obtained. Failure to complete our clinical studies in a timely
manner, or failure of our studies to demonstrate the safety and effectiveness
of our TMR and PTMR products, could delay or prevent us from obtaining
regulatory approval and could materially adversely affect our business and
results of operations.
We are also required to follow applicable Good Manufacturing Practices
("GMP") regulations of the FDA. The GMP regulations include testing, control
and documentation requirements. In addition, we are required to follow
similar laws in other countries, including but not limited to International
Standards Organization ("ISO") 9001 standards. We became ISO 9001 certified
in May 1997. Failure to meet or to continue to satisfy any regulatory
requirements in the future could preclude us from marketing our products on a
commercial basis and would therefore materially adversely affect our business
and results of operations.
Commercial sales of medical devices such as ours outside of the U.S. are
subject to foreign regulatory requirements that vary widely by country. The
FDA must also approve the export of any device that requires a PMA but has
not yet been approved domestically. Foreign and domestic regulatory
approvals, if they are granted, may include significant limitations on the
indicated uses for which the product may be marketed. In order to obtain such
approvals, we must comply with numerous other requirements of the FDA and
certain foreign regulatory authorities. For example, a CE Mark is required to
sell products in European Union countries. We received the CE Mark for our
TMR laser in December 1996 and for our PTMR laser in July 1998. However,
regulatory agencies can withdraw product approvals such as CE Marks for
various reasons, such as failure to comply with regulatory standards or
unforeseen problems following initial marketing. Failure to obtain regulatory
approvals for our products or withdrawal of regulatory approvals would
materially adversely affect our business and results of operations.
RISKS ASSOCIATED WITH NEW SURGICAL PROCEDURES; NO ASSURANCE OF MARKET
ACCEPTANCE
In order to successfully commercialize our TMR and PTMR products, our
products must achieve acceptance among cardiologists, cardiac surgeons and
other members of the medical community, as well as prospective patients. In
order to achieve such acceptance, we must demonstrate that our TMR and PTMR
products are safe, efficacious and cost-effective solutions. Even if the
clinical safety and effectiveness of our products are established,
cardiologists, cardiac surgeons and other members of the medical community
may nevertheless elect not to recommend TMR or PTMR for any number of other
reasons. Commercialization of our products will require the training of
numerous physicians in the use of our products and procedures, and the time
required to complete such training could delay and adversely affect market
acceptance. Moreover, even if TMR and PTMR become generally accepted by the
medical community, individual physicians trained in the use of competitive
products may elect not to consider our products or may instead recommend a
competitor's products. Failure of our products to achieve significant market
acceptance would materially adversely affect our business and results of
operations.
DEPENDENCE ON SINGLE PRODUCT LINE
We have elected to focus our resources on the continued development and
refinement of our TMR and PTMR products. If we are unable to obtain the
required regulatory approvals or if these products do not achieve commercial
acceptance, our business and results of operations would be materially
adversely affected.
UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY; RISKS
OF FUTURE LITIGATION
Our success will depend, in part, on our ability to obtain patent
protection for our products, preserve our trade secrets and operate without
infringing the proprietary rights of other parties. We seek to protect our
proprietary technology by, among other things, filing U.S. and foreign patent
applications related to our technology, inventions and improvements that are
important to the development of our business. Although we have a number of
patents and
10
patent applications pending that relate to various aspects of our TMR and
PTMR products and systems and other cardiovascular therapies, it is possible
that any of our patents or patent applications may be challenged, invalidated
or circumvented in the future. We cannot assure you that the rights subject
to our patents or patent applications will provide us with a competitive
advantage in our markets. In addition, we cannot be certain that patent
protection will continue to be available for surgical methods in the future.
Failure to secure and maintain protection for our intellectual property could
materially adversely affect our business and results of operations.
We intend to vigorously protect and defend our intellectual property
rights. In that regard, we may have to assert claims against third parties in
order to enforce our patents, protect our trade secrets or know-how or to
determine the enforceability, scope and validity of the proprietary rights of
others. Litigation to protect our intellectual property rights would be
costly and time consuming and a negative outcome could materially adversely
affect our business and financial condition.
We rely upon trade secrets, technical know-how and continuing
technological innovation to develop and maintain our competitive position. We
typically require our employees, consultants and advisors to execute
confidentiality and invention assignment agreements. It is possible that an
employee, consultant or advisor may breach their agreement with us and that
we may not have an adequate remedy for such breach. In addition, it is
possible that our competitors may independently develop proprietary
information and techniques that are substantially equivalent to ours or that
competitors may somehow otherwise gain access to our proprietary technology.
We cannot assure you that we will be able to provide meaningful protection
for our rights in unpatented proprietary technology, and our failure to do so
could materially adversely affect our business and results of operations.
The medical device industry in general, and in particular the industry
segment that includes products for the treatment of cardiovascular disease
such as ours, has been characterized by substantial competition and
litigation regarding patent and other intellectual property rights. Companies
that compete with us have received patents related to TMR technology. In
September 1995, one of our competitors sent us a notice of potential
infringement of their patent regarding a method for TMR utilizing
synchronization of laser pulses to the electrical signals from the heart. In
January 1996, another competitor sent us a notice of potential infringement
of their patent regarding a method to perform TMR using fiber optics. In each
of these cases, after discussion with our patent counsel, we concluded that
we did not utilize the process and/or apparatus that was the subject of the
patent at issue, and we provided a response to each competitor to that
effect. We have not received any additional correspondence from either of
these competitors on these matters. However, it is possible that one or both
of these competitors may assert claims or proceedings against us in the
future regarding these matters. It is possible that other parties may bring
such claims to our attention in the future as well. Any such claims brought
against us in the future, regardless of whether they have merit, could
require expensive and time consuming responses from our company and could
divert the attention of our technical and management personnel. A
determination in a litigation or administrative proceeding that the claims of
a third party are valid and enforceable could prevent us from practicing the
processes claimed in such patents, require us to obtain licenses from patent
owners or force us to redesign our products or processes to avoid infringing
the rights of others, any of which could materially adversely affect our
business and results of operations.
Patent applications in the U.S. are maintained in secrecy until a patent
issues, and patent applications in foreign countries are maintained in
secrecy for a period after filing. Publication of discoveries in scientific
or patent literature tends to lag behind actual discoveries and the filing of
related patent applications. Accordingly, we cannot be sure that current and
potential competitors or other third parties have not filed or in the future
will not file applications for, or have not received or in the future will
not receive, patents or other proprietary rights that will prevent, limit or
interfere with our ability to manufacture, use or sell our products either in
the U.S. or internationally. If we need to obtain licenses to patents issued
to third parties, it is possible that such licenses will not be available to
us or that they will not be available on acceptable terms. Failure to obtain
a necessary license on acceptable terms would materially adversely affect our
business and results of operations.
EXPECTATION OF INTENSE MARKET COMPETITION
The markets for our TMR and PTMR products are evolving, and we expect
that they will be intensely competitive. We expect that our competitors will
include the following companies:
11
- PLC Systems, Inc. ("PLC");
- CardioGenesis Corporation ("CardioGenesis");
- U.S. Surgical Corporation ("U.S. Surgical"); and
- Johnson & Johnson ("J & J").
All of the companies listed above are currently selling TMR and/or PTMR
products for investigational use in the U.S. and abroad. On October 22, 1998,
we announced the signing of a definitive agreement that provides for a
business consolidation with CardioGenesis. We also may face competition from
additional companies that may elect to enter our markets, such as large
companies in the laser, cardiac devices and cardiac surgery markets. We
believe that a number of significant companies, including but not limited to
Boston Scientific Corp., Baxter International, Inc. and Arterial Vascular
Engineering, Inc., have distribution rights to currently available TMR or
PTMR products or to such products developed in the future. Many of these
companies are larger than we are and have significantly greater financial,
development, marketing and other resources than we have. If one of our
competitors obtains a PMA for its products before we do, our ability to
compete, and our business and results of operations, could be materially
adversely affected.
Our TMR and PTMR products and procedures also compete with other more
conventional or more established methods for the treatment of cardiovascular
disease, including but not limited to drug therapy, PTCA and coronary artery
bypass graft ("CABG"). We are seeking to demonstrate that our TMR and PTMR
products and procedures are safe and effective treatments for patients for
whom other cardiovascular treatments are not likely to provide relief, and in
the future we will seek to demonstrate that our TMR and PTMR products and
procedures provide safe and effective treatments when used in conjunction
with other treatments for cardiovascular disease. However, we cannot assure
you that our TMR and PTMR products and procedures will become accepted
treatments for cardiovascular disease, that cardiologists, cardiac surgeons
and other physicians will use our TMR and PTMR products and procedures
instead of or in conjunction with more established treatments or that our
products and procedures will be competitive with other currently available or
later developed technologies. Any of these possibilities could materially
adversely affect our business and results of operations.
Once we obtain regulatory approval for one of our products, in the event
that such regulatory approval is obtained, we will face competition for
market acceptance and market share for that product. Our ability to compete
may depend in significant part on the timing of introduction of competitive
products into the market and will thus be affected by the pace, relative to
our competitors, at which we develop our products, complete clinical testing
and regulatory approval processes, obtain third party reimbursement
acceptance and supply commercial quantities of the product to the market. We
cannot assure you that we will be able to compete successfully against
current and future competitors. Failure to compete successfully would
materially adversely affect our business and results of operations.
COMPLETION OF BUSINESS COMBINATION WITH CARDIOGENESIS
On October 22, 1998, the Company announced that it signed a definitive
agreement that provides for the business combination with CardioGenesis and
the Company. The Company may, from time to time, acquire or invest in other
complementary businesses, products or technologies. While there are currently
no commitments with respect to any particular acquisition or investment,
other than the transaction with CardioGenesis, the Company's management
frequently evaluates the strategic opportunity available related to
complimentary businesses, products or technologies. The process of
integrating an acquired company's business into the Company's operations may
result in unforeseen operating difficulties and expenditures and may absorb
significant management attention that would otherwise be available for the
ongoing development of the Company's business. Moreover, there can be no
assurance that the anticipated benefits of any acquisition or investment will
be realized. In particular, the recently announced business combination with
CardioGenesis has been approved by the respective Boards of each of the
companies, but is still subject to approval by the shareholders of both
companies and certain other customary closing conditions and there can be no
assurance that such conditions will be met. The business combination with
CardioGenesis or any future acquisitions or investments by the Company could
result in potentially dilutive issuances of equity securities, the incurrence
of debt and contingent liabilities, amortization expenses related to goodwill
and other intangible assets, any of which could materially adversely affect
the Company's operating results and financial condition.
12
HISTORY OF OPERATING LOSSES
From our inception to September 30, 1998, we have incurred cumulative
net losses of approximately $45 million. Our revenues and operating income
will be constrained until such time, if ever, as we obtain FDA and other
regulatory approvals for our products, and for an uncertain period of time
after we obtain any such approval. We anticipate that our expenses in all
categories will increase due to our expected expansion of our clinical trials
and other business activities and due to the absence of Medicare
reimbursement. We may not achieve or sustain profitability in the future.
Failure to achieve significant commercial revenues or profitability would
materially adversely affect our business and results of operations.
RISKS OF TECHNOLOGICAL CHANGE
Other parties continually expend significant resources to develop new
and improved treatment methodologies for coronary disease. The market
acceptance and commercial success of our TMR and PTMR products and procedures
will depend not only upon their safety and effectiveness but also upon the
relative safety and effectiveness of alternative treatments. Development of
new treatments or improvements to existing treatments that are safer and/or
more effective than our TMR and PTMR products and procedures could materially
adversely affect our business and results of operations.
POTENTIAL DIFFICULTIES IN MANAGING A BUSINESS UNDERGOING RAPID CHANGE
Our future success will depend in significant part on the ability of our
current and future management personnel to perform effectively as individuals
and as a group. A number of the members of our senior management team have
joined our company recently. Moreover, certain members of the management team
have limited experience in serving as a senior executive of a public
corporation. We cannot assure you that our senior managers will operate
effectively as a team. If our management is not able to perform effectively
as a team, our business and results of operations could be materially
adversely affected.
In order to complete the clinical trials that are currently in progress,
prepare additional products for clinical trials, develop future products and
generally compete successfully, we believe that we must continue to expand
our operations, particularly in the areas of research and development, sales
and marketing, training and manufacturing. If we expand our operations and
experience significant growth in the future, our management personnel will
face additional responsibilities. Such expansion and growth could place a
significant strain on our managerial, operational and financial systems and
resources. In order to accommodate such expansion and growth and compete
effectively, we must continue to improve our information systems, procedures
and controls and to expand, train, motivate and manage our employees. We
cannot assure you that our personnel, systems, procedures and controls will
be adequate to support our future operations. Failure to improve our
operational, financial and management systems or implement new systems as
necessary, or to expand, train, motivate and manage our employees, could
materially adversely affect our business and results of operations.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products
experience difficulty in functionality with respect to distinguishing between
twenty-first century dates and twentieth century dates, commonly known as the
Year 2000 Problem. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to function properly in the
future. In order to address these issues, we have assembled a
cross-functional project team to review and assess our internal software,
data management, accounting, manufacturing and operational systems to ensure
that they do not malfunction as a result of the Year 2000 date transition.
Our project team has identified and is evaluating the following systems:
- Security systems;
- Facility systems;
- Telephony;
13
- Network servers;
- Personal computers;
- Network equipment;
- Printer, copiers and fax machines;
- Server tape backups;
- Testing equipment; and
- Miscellaneous software.
In connection with our review and assessment of our systems, we will estimate
the cost of system modifications to achieve Year 2000 compliance. At present,
we do not anticipate that the costs of achieving Year 2000 compliance for our
systems will be material to our financial condition or results of operations;
however, our estimate of expected costs is subject to change as our Year 2000
project progresses and does not include the potential costs of internal
software and hardware replaced in the normal course of business.
We are also working with suppliers of our products and systems to ensure
that the products supplied to us are Year 2000 compliant. As the products
that we supply to our customers are not dependent upon date data processing
and do not have electrical ports for the connection of other devices, we
believe that they are Year 2000 compliant.
We have not found it necessary to delay or cancel any of our internal
services, programs or projects as a result of our preparatory activities to
ensure Year 2000 compliance. We expect that our Year 2000 compliance project
will be completed by the second quarter of fiscal 1999. We do not anticipate
any material disruption in our operations as a result of any internal or
external Year 2000 compliance problems, but we are preparing for minor delays
in the receipt of materials and services as a result of third party's
failures to meet Year 2000 requirements. We cannot assure you that we will
not experience unexpected delays or problems as a result of Year 2000
problems, including noncompliance by products or systems supplied to us by
third parties, which could materially adversely affect our business and
results of operations.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
Our operating results are expected to fluctuate significantly from
quarter to quarter for many reasons, including without limitation:
- timing and results of clinical trials;
- delays associated with the FDA and other regulatory approval
processes;
- health care reform and third party reimbursement policies;
- demand for our products;
- changes in our pricing policies or those of our competitors;
- our ability to develop, introduce and market new and enhanced
versions of our products on a timely basis;
- deferrals in customer orders in anticipation of new or enhanced
products offered by us or our competitors;
- product quality problems;
- personnel changes;
- changes in our strategy; and
- changes in the level of international sales.
In addition, the timing of the receipt of individual customer orders,
order fulfillment and revenue recognition with respect to small numbers of
individual laser base units, which carry a high price per unit, may also
affect quarter to quarter operating results.
UNCERTAINTY REGARDING THIRD PARTY REIMBURSEMENT
We expect that our ability to successfully commercialize our products
will depend in significant part on whether third party payors such as
governmental programs, private insurance and private health plans provide
14
reimbursement for surgical procedures using our products. In determining
whether to acquire new equipment, hospitals strongly consider the
availability of reimbursement for such products. Even if FDA approvals are
granted, third party payors may deny reimbursement if they determine that a
therapeutic medical device is unnecessary, inappropriate, not cost-effective,
experimental or used for non-approved indications.
Medicare reimburses hospitals on a prospectively determined fixed amount
for the costs associated with an in-patient hospitalization based on the
patient's anticipated discharge date and physical condition. Medicare
reimburses physicians on a prospectively determined fixed amount based on the
procedure performed. These reimbursements are determined regardless of the
actual costs incurred by a hospital or physician in furnishing care to a
patient and are not related to the actual devices used in the patient's
procedures. Medicare and other third party payors increasingly are
scrutinizing whether to cover new products and the amount of coverage to
provide. Medicare traditionally has precluded coverage for items and services
involving devices that the FDA has not approved or cleared for marketing.
Pursuant to a Health Care Finance Administration ("HCFA") policy effective
November 1, 1995, Medicare coverage was not precluded for items and related
services involving devices that the FDA has classified as
"non-experimental/investigational" ("Category B") devices and that are
furnished in accordance with FDA-approved protocols governing clinical
trials. However, even if items or services involve Category B devices,
Medicare coverage may be denied for failure to meet various other coverage
requirements, such as the requirement that the treatment is medically needed
by the specific patient.
In November 1995, we received a Category B designation for our TMR
procedure from the HCFA. Accordingly, for a period of time our TMR procedures
received third party reimbursement in many cases under the HCFA's policy.
However, in May 1997, HCFA determined that Medicare would no longer provide
coverage for any manufacturer's TMR procedures. At the present time, HCFA is
reviewing whether it will reinstate such coverage. We cannot assure you that
HCFA will reinstate this coverage or that Medicare will adequately reimburse
the costs of our TMR and PTMR procedures when and if we receive a PMA. We
currently are not able to determine the ultimate effect of HCFA's policy
change on our business and operating results, but we do anticipate that our
research and development expenses will increase significantly as a result of
increases in expenses to support our clinical trials. We also anticipate that
our revenues from the sales of investigational products will decrease, at
least over the short term and possibly thereafter.
It is not certain whether third party payors will cover our TMR and PTMR
procedures or what levels of reimbursement they will provide. It is possible
that levels of reimbursement, if established, may decrease in the future, or
that future legislation, regulations or the reimbursement policies of third
party payors will adversely affect the demand for our products or our ability
to sell our products on a profitable basis. Proposed fundamental health care
reforms in both the U.S. and Europe could, if enacted, affect the
availability of third party reimbursement. We cannot predict the timing or
ultimate outcomes of these proposals. Unavailability or inadequate amounts of
third party payor coverage could materially adversely affect our business and
results of operations.
LIMITED SALES, MARKETING AND DISTRIBUTION SYSTEMS
To date, we have made only limited sales, primarily for investigational
use only, of our TMR and PTMR products and therefore we have maintained a
limited sales and marketing organization in the U.S. and abroad. If our TMR
and PTMR products are approved, we plan to market them through a direct sales
force and through relationships with distributors or agents. We will have to
expend substantial management efforts and financial resources in order to
establish a sales force capable of effectively commercializing our products.
We may not be able to establish such a sales capability on a timely basis or
at all. In addition, we will depend on our distributors to devote sufficient
resources to the development of markets for our products and to successfully
commercialize our products. If we are not able to establish relationships
with distributors, or if such distributors are not effective, our business
and results of operations could be materially adversely affected.
POTENTIAL NEED FOR ADDITIONAL CAPITAL
Although we anticipate that our current cash balances, together with
sales of our products for investigational use, will be sufficient to meet our
capital requirements for the next twelve months, we may require additional
sources of cash at an earlier date. Our need for additional cash will depend
upon the progress of expansion of our clinical
15
trials and any need for additional trials or other testing of our products
and the timing of these expenditures. If we need additional financing in the
future, we may not be able to obtain capital on terms acceptable to us or at
all.
RISK OF PRODUCT LIABILITY
Our products are used to treat critically ill patients. As a result, we
are exposed to product liability claims in the event that the use of our
products results in personal injury or death. We maintain insurance against
product liability claims in the amount of $10 million per occurrence and $10
million in the aggregate. If a product liability claim is brought against us,
our insurance may not provide adequate coverage for the liabilities actually
incurred. In addition, such insurance may not always be available in the
amounts that we desire or on terms that are acceptable to us. If one of our
products proved defective, we might be required to recall or redesign the
product. Any uninsured or underinsured product liability claim against us or
any product recall could result in significant costs and negative publicity,
which could materially adversely affect our business and results of
operations.
LIMITED MANUFACTURING EXPERIENCE; DEPENDENCE ON KEY SUPPLIERS
Our future success will depend in part on our ability to manufacture our
products in a timely, cost-effective manner and in compliance with regulatory
requirements, such as GMP and ISO 9001, among others. Our manufacturing
process is a labor-intensive, complex operation that involves a number of
separate processes and components. To date, our manufacturing activities have
consisted primarily of manufacturing limited quantities of our systems for
use in clinical trials. We do not have experience manufacturing our products
in the large quantities that might be required for commercial sales if we
receive regulatory approval for our TMR and PTMR products. As a condition to
our receipt of PMA approval, our facilities, procedures and practices have
been subject to pre-approval and will be subject to ongoing GMP inspections
by the FDA.
Manufacturers of products such as ours often encounter difficulties when
increasing their manufacture of new products. Such difficulties may include:
- uncertainty of product yields;
- quality control and assurance;
- adequacy of control policies and procedures;
- lack of qualified personnel;
- compliance with FDA regulations; and
- need for further FDA approval of new processes and facilities.
Our manufacturing yields, costs and product quality may be adversely affected
as we seek to increase production, which could materially adversely affect
our business and results of operations.
We currently purchase certain critical laser and fiber-optic components
from single sources. Although we have identified alternative suppliers of
these components, a lengthy process would be required in order to qualify
them as additional or replacement suppliers. Any significant interruption in
the supply of critical materials or components could adversely affect our
ability to manufacture our products and could materially adversely affect our
manufacturing operations and our business and results of operations.
We anticipate manufacturing our products based on forecasted demand and
we intend to purchase subassemblies and components in anticipation of the
actual receipt of purchase orders from our customers. Lead times for
materials and components that we order vary significantly and depend on
factors such as the business practices of each specific supplier and the
terms of particular contracts, as well as the overall market demand for such
materials and components at any given time. If our forecasts are inaccurate,
we could experience fluctuations in inventory levels, resulting in excess
inventory, on the one hand, or shortages of critical components, either of
which could materially adversely affect our business and results of
operations.
DEPENDENCE ON KEY PERSONNEL
Our future business and results of operations depend in significant part
upon the continued contributions of
16
our key technical and senior management personnel, including Douglas
Murphy-Chutorian, M.D., our Chief Executive Officer, and Richard L. Mueller,
Jr., our President and Chief Operating Officer. We maintain key person life
insurance policies on both Dr. Murphy-Chutorian and Mr. Mueller in the amount
of $2 million.
Our future business and results of operations also depend in significant
part upon our ability to attract and retain additional qualified management,
manufacturing, technical, marketing and sales and support personnel for our
operations. Competition for such personnel is intense, and we may not be
successful in attracting or retaining such personnel. If we lose a key
employee or if a key employee fails to perform in his or her current
position, or if we are not able to attract and retain skilled employees as
needed, our business and results of operations could be materially adversely
affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has an investment portfolio of fixed income securities that
are classified as "available for sale securities". These securities are
subject to interest rate risk and will fall in value if market interest rates
increase. The Company attempts to limit this exposure by investing in
securities that will mature within 24 months.
17
ECLIPSE SURGICAL TECHNOLOGIES, INC.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not involved in any material litigation outside of the
ordinary course of business.
ITEM 2(d) CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with its initial public offering in 1996 the Company filed
a Registration Statement on Form S-1, SEC File No. 333-03770 (the
"Registration Statement"), which was declared effective by the
Commission on May 31, 1996. The Company registered 4,600,000 shares of
its Common Stock, no par value per share. The offering commenced on May
31, 1996 and 4,000,000 shares were sold. The aggregate offering price of
the registered shares was $64,000,000. The managing underwriters of the
offering were PaineWebber Incorporated, Deutsche Morgan Grenfell, and
Jefferies & Company, Inc. The Company incurred the following expenses
expenses in connection with the offering:
Underwriting discounts and commissions: $4,480,000
Other expenses: $1,565,000
----------
Total expenses: $6,045,000
----------
----------
All of such expenses were payments to others.
The net offering proceeds to the Company after deducting the total
expenses above were approximately $57,955,000. From May 31, 1996 to
September 30, 1998, the Company used such net offering proceeds, in
direct or indirect payments to others, as follows:
Purchase and installment of machinery and equipment: $ 2,485,000
Working capital: $36,773,000
Investment in short-term, interest- bearing obligations: $14,534,000
Repayment of indebtedness: $ 1,777,000
-----------
Total $55,569,000
-----------
-----------
Each of such amounts is a reasonable estimate of the application of the
net offering proceeds. This use of proceeds does not represent a
material change in the use of proceeds described in the prospectus of
the Registration Statement.
ITEM 5. OTHER INFORMATION
Stockholder proposals related to the Company's 1999 Annual Meeting of
Stockholders, but submitted outside the processes of Rule 14a-8 under
the Securities Exchange Act of 1934, must be received by the Company
prior to February 3, 1999 in order to withhold authority of management
proxies to use their discretionary voting authority with respect to any
such proposal.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibit 27
b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the
three month period ended September 30, 1998.
18
ECLIPSE SURGICAL TECHNOLOGIES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ECLIPSE SURGICAL TECHNOLOGIES, INC.
Registrant
Date: November 11, 1998 /s/ Douglas Murphy-Chutorian, M.D.
-----------------------------------
Douglas Murphy-Chutorian, M.D.
Chief Executive Officer
Date: November 11, 1998 /s/ Kenneth E. Bennert
-----------------------
Kenneth E. Bennert
Chief Financial Officer
(Principal Financial and
Accounting Officer)
19