UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934.
For the quarterly period ended April 2, 1999 or
Transition report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934. For the transition period from to .
----- -----
Commission File Number
0-27880
CardioThoracic Systems, Inc.
----------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 94-3228757
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10600 N. Tantau Ave., Cupertino, CA 95014-0739
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone, including area code: (408) 342-1700
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days. Yes X No
--- ---
As of April 27, 1999, there were 14,334,849 shares of the Registrant's Common
Stock outstanding.
CARDIOTHORACIC SYSTEMS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1. Financial Statements
Consolidated Condensed Balance Sheets as of April 2, 1999 and
January 1, 1999 3
Consolidated Condensed Statements of Operations for the three
months ended April 2, 1999 and April 3, 1998 4
Consolidated Condensed Statements of Cash Flows for the three
months ended April 2, 1999 and April 3, 1998 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION 19
SIGNATURES 23
EXHIBIT INDEX 24
2
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
April 2, January 1,
1999 1999
------------------- ------------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,377,000 $ 1,651,000
Available-for-sale securities 23,566,000 27,513,000
Trade accounts receivable, net 4,227,000 2,894,000
Inventories, net 1,906,000 963,000
Interest receivable 418,000 611,000
Prepaid expenses and other current assets 541,000 510,000
------------------- ------------------
Total current assets 33,035,000 34,142,000
Property and equipment, net 3,006,000 3,374,000
Available-for-sale securities 8,554,000 11,089,000
Notes receivable from officers 1,015,000 1,045,000
Other assets 109,000 116,000
------------------- ------------------
Total assets $ 45,719,000 $ 49,766,000
------------------- ------------------
------------------- ------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Equipment note, current portion $ 514,000 $ 500,000
Accounts payable 2,052,000 1,871,000
Accrued liabilities 5,014,000 6,021,000
------------------- ------------------
Total current liabilities 7,580,000 8,392,000
Equipment note, less current portion 1,278,000 1,411,000
------------------- ------------------
Total liabilities 8,858,000 9,803,000
------------------- ------------------
Stockholders' equity:
Common stock, par value $0.001 14,000 14,000
Additional paid-in capital 103,646,000 103,317,000
Deferred compensation, net (1,009,000) (1,460,000)
Accumulated other comprehensive income 46,000 93,000
Accumulated deficit (65,836,000) (62,001,000)
------------------- ------------------
Total stockholders' equity 36,861,000 39,963,000
------------------- ------------------
Total liabilities and stockholders' equity $ 45,719,000 $ 49,766,000
------------------- ------------------
------------------- ------------------
3
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Three Months Ended
April 2, 1999 April 3, 1998
-------------------- --------------------
Net sales $ 6,331,000 $ 2,962,000
Cost of sales 2,338,000 1,603,000
-------------------- --------------------
Gross profit 3,993,000 1,359,000
-------------------- --------------------
Operating expenses:
Research and development 2,657,000 2,677,000
Sales, marketing, general, and administrative 5,630,000 5,130,000
-------------------- --------------------
Total operating expenses 8,287,000 7,807,000
-------------------- --------------------
Loss from operations (4,294,000) (6,448,000)
Interest income, net 459,000 698,000
-------------------- --------------------
Net loss $ (3,835,000) $ (5,750,000)
-------------------- --------------------
-------------------- --------------------
Net loss per common share and per
common share - assuming dilution $ (0.27) $ (0.42)
-------------------- --------------------
-------------------- --------------------
Shares used in computing net loss per
common share and per common
share - assuming dilution 14,306,000 13,767,000
-------------------- --------------------
-------------------- --------------------
4
CARDIOTHORACIC SYSTEMS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended Three Months Ended
April 2, 1999 April 3, 1998
----------------------- ------------------------
OPERATING ACTIVITIES
Net loss $ (3,835,000) $ (5,750,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 576,000 421,000
Amortization of notes receivable from officer - 22,000
Allowance for bad debts and product returns 17,000 30,000
Amortization of deferred compensation 409,000 483,000
Changes in operating assets and liabilities:
Trade accounts receivable (1,350,000) (420,000)
Inventory (943,000) 84,000
Interest receivable 193,000 152,000
Prepaid expenses and other current assets (1,000) (262,000)
Other assets 7,000 (21,000)
Accounts payable 181,000 341,000
Accrued liabilities (941,000) (671,000)
----------------------- ------------------------
Net cash used in operating activities (5,687,000) (5,591,000)
----------------------- ------------------------
INVESTING ACTIVITIES
Purchases of property and equipment (274,000) (485,000)
Purchase of available-for-sale securities (5,215,000) (18,619,000)
Proceeds from maturities of available-for-sale securities 11,650,000 24,356,000
----------------------- ------------------------
Net cash provided by investing activities 6,161,000 5,252,000
----------------------- ------------------------
FINANCING ACTIVITIES
Repayment of equipment note (119,000) (107,000)
Proceeds from issuance of common stock 371,000 44,000
----------------------- ------------------------
Net cash provided by (used in) financing activies 252,000 (63,000)
----------------------- ------------------------
Net increase (decrease) in cash and cash equivalents 726,000 (402,000)
Cash and cash equivalents at beginning of period 1,651,000 4,681,000
----------------------- ------------------------
Cash and cash equivalents at end of period $ 2,377,000 $ 4,279,000
----------------------- ------------------------
----------------------- ------------------------
5
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
April 2, 1999
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated condensed financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and in accordance with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included.
The operating results of the interim periods presented are not
necessarily indicative of the results for the year ending December 31, 1999 or
for any other interim period. The accompanying financial statements should be
read in conjunction with the audited financial statements and notes thereto for
the year ended January 1, 1999 included in the Company's Form 10-K filed with
the Securities and Exchange Commission.
Note 2. Formation and Business of the Company
CardioThoracic Systems, Inc. (the Company) was incorporated on June 15,
1995 to design, develop, manufacture and market surgical products and systems
for minimally invasive cardiac surgery.
6
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
April 2, 1999
(Unaudited)
Note 3. Available-for-Sale Securities
The Company has classified its investments as available-for-sale
securities. Available-for-sale securities are carried at fair value with
unrealized gains and losses, net of tax, reported as a separate component of
stockholders' equity. The amortized cost of available-for-sale debt securities
is adjusted for the amortization of premiums and the accretion of discounts to
maturity. Such amortization is included in interest income. Realized gains and
losses and declines in value judged to be other than temporary on
available-for-sale securities are included in interest income. The cost of
securities sold is based on the specific identification method.
At April 2, 1999, available-for-sale securities consist of the
following:
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------ ----------- ------------- ------------
U.S. Gov't notes and bonds $ 2,492,000 $ - $ - $ 2,492,000
Gov't agency notes and bonds 12,769,000 52,000 (5,000) 12,816,000
Corporate notes and bonds 16,813,000 10,000 (11,000) 16,812,000
------------ ----------- ------------- ------------
$32,074,000 $ 62,000 $ (16,000) $32,120,000
------------ ----------- ------------- ------------
------------ ----------- ------------- ------------
At January 1, 1999, available-for-sale securities consist of the
following:
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------ ------------ ------------ ------------
U. S. Gov't notes and bonds $ 967,000 $ -- $ -- $ 967,000
Gov't agency notes and bonds 12,777,000 77,000 -- 12,854,000
Corporate notes and bonds 24,765,000 20,000 (4,000) 24,781,000
------------ ------------ ------------ ------------
$ 38,509,000 $ 97,000 $ (4,000) $ 38,602,000
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Available-for-sale securities by contractual maturity at April 2, 1999
are shown below:
Amortized Estimated
Cost Fair Value
----------- -----------
Less than one year $23,523,000 $23,566,000
Due in one to two years 8,551,000 8,554,000
----------- -----------
$32,074,000 $32,120,000
----------- -----------
----------- -----------
7
CARDIOTHORACIC SYSTEMS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued)
April 2, 1999
(Unaudited)
Note 4. Inventories
Inventories, net consist of the following:
April 2, January 1,
1999 1999
---------- ----------
Raw materials $ 603,000 $ 503,000
Work in progress 650,000 146,000
Finished goods 653,000 314,000
---------- ----------
$1,906,000 $ 963,000
---------- ----------
---------- ----------
Note 5. Restructuring
In the fourth quarter of fiscal 1998, the Company recorded a
restructuring charge of $736,000 in connection with the closure of its German
subsidiary. In accordance with the restructuring plan, this closure resulted in
the termination of four German employees which represented all the employees of
the German subsidiary. The charge associated with employee termination benefits
was $349,000. The balance of the restructuring charge was an $88,000 non-cash
charge for the loss on property and equipment and the write-down of other
recorded assets, $235,000 for lease cancellation expenses and $64,000 for other
exit related costs. The first quarter 1999 activity in the restructuring accrual
is summarized in the following table:
Charges
January 1, Against April 2,
1999 Reserve 1999
--------- --------- ---------
Employee termination benefits $ 349,000 $ (35,000) $ 314,000
Property, equipment and other
asset write-down 88,000 (66,000) 22,000
Lease cancellations 235,000 (99,000) 136,000
Other exit costs 64,000 (14,000) 50,000
--------- --------- ---------
$ 736,000 $(214,000) $ 522,000
--------- --------- ---------
--------- --------- ---------
Note 6. Net Loss Per Share
Net loss per common share and per common share-assuming dilution, are
computed using the weighted average number of shares of common stock
outstanding. Common equivalent shares from stock options and preferred stock are
excluded from the computation of net loss per common share-assuming dilution as
their effect is antidilutive.
8
Note 7. Industry and Geographic Segment Information
Management uses one measurement of profitability for its business. The
Company's cardiac surgery products are developed and marketed to cardiac
surgeons and hospitals. The Company markets its products to customers in the
United States, Canada, Europe, South America, Middle East and Asia Pacific and
operates in one business segment. All of the Company's long-lived assets are in
the United States. Revenue information by geographic area is as follows:
Three Months Ended
--------------------------------
April 2, April 3,
1999 1998
---------- ----------
United States $5,804,000 $2,329,000
International 527,000 633,000
---------- ----------
Total $6,331,000 $2,962,000
---------- ----------
---------- ----------
Note 8. Subsequent Event
In January 1999, the Company's Board of Directors approved a proposed
amendment of the Company's Incentive Stock Plan to increase the number of shares
of Common Stock available for issuance thereunder by 500,000, bringing the total
number of shares issuable under the Incentive Stock Plan to 3,300,000. This
proposed amendment is subject to stockholder approval at the Annual Meeting of
Stockholders on May 4, 1999.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial condition and results of
operations of CardioThoracic Systems, Inc. ("CTS" or the "Company") should be
read in conjunction with the Condensed Consolidated Financial Statements and the
related Notes thereto included herein.
This report contains forward looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's future results of operations could vary
significantly from those anticipated by such statements as a result of factors
described in this Management's Discussion and Analysis of Financial Condition
and Results of Operations and under "Factors Affecting Results of Operations".
OVERVIEW
The business of the Company commenced in November 1993 as a sole
proprietorship, Informed Creation. In June 1995, the business was incorporated
and as part of the Company's initial financing in September 1995, the Company
acquired all intellectual property assets of Informed Creation. The Company has
a limited operating history upon which evaluation of its prospects can be made.
Such prospects must be considered in light of the substantial risks, expenses
and difficulties encountered by entrants into the medical device industry, which
is characterized by an increasing number of participants, intense competition
and a high failure rate. The Company began commercial sales of its products in
December 1996 and has limited experience in manufacturing, marketing and selling
its products. The Company has experienced operating losses since its inception,
and, as of April 2, 1999, the Company had an accumulated deficit of
approximately $65,836,000. The development and commercialization of the
Company's products will continue to require substantial development, regulatory,
sales and marketing, manufacturing and other expenditures. The Company expects
its operating losses to continue at least through 1999 as it expends substantial
resources to continue development of its products, obtain additional regulatory
clearances or approvals, continue to market, sell and manufacture its products,
support its finance and administrative organizations and conduct further
research and development. There can be no assurance that the Company's products
will gain enough commercial acceptance to allow the Company to generate the
revenues necessary to achieve profitability.
Most of the Company's current products are designed to enable the
majority of cardiothoracic surgeons to perform minimally invasive cardiac
surgery ("MICS") on a beating heart. Accordingly, the Company's success is
dependent upon acceptance of this procedure by the medical community as a
reliable, safe and cost effective alternative to existing treatments for
revascularizing blocked coronary arteries. The Company is unable to predict how
quickly, if at all, MICS will be adopted by the medical community or, if it is
adopted, the number of MICS procedures that will be performed. The medical
conditions that can be treated with MICS can also be treated with widely
accepted surgical procedures such as CABG surgery and catheter-based treatments,
including balloon angioplasty, atherectomy and coronary stenting. Although the
Company believes that MICS has significant advantages over competing procedures,
broad-based clinical adoption of MICS will not occur until physicians determine
that the approach is an attractive alternative to current treatments for
coronary artery disease. The Company believes that continued physician
endorsements will be essential for clinical adoption of MICS, and there can be
no assurance that such endorsements will be continued. Clinical adoption will
also depend upon the Company's ability to facilitate training of cardiothoracic
surgeons to perform
10
MICS, and the willingness of such surgeons to perform MICS
procedures. Patient acceptance of MICS will depend in part upon physician
recommendations as well as other factors, including the degree of invasiveness,
the effectiveness of the procedure and rate and severity of complications
associated with MICS as compared to other treatments. Even if the clinical
efficacy of MICS is established, physicians may elect not to recommend the
procedure unless acceptable reimbursement from health care payors is available.
Health care payor acceptance may require evidence of the cost effectiveness of
the MICS as compared to other currently available treatments. For all of these
reasons, there can be no assurance that MICS will gain clinical adoption.
Failure of MICS to achieve significant clinical adoption would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Most of the Company's current products are designed for beating heart
MICS and are expected to account for the great majority of the Company's
revenues in 1999. The Company manufactured and sold approximately 30,000 beating
heart MICS systems since January 1997, but there can be no assurance that demand
for the Company's current or future products will be sufficient to allow
profitable operations. Failure of the Company's current and future products to
be successfully commercialized at significantly higher volumes would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Before the Company can market certain products under development in the
United States, the Company must obtain clearance or approval from the United
States Food and Drug Administration ("FDA"). The Company has filed or will be
filing 510(k) premarket notifications or premarket approval ("PMA") applications
with the FDA for clearance or approval to market current products and certain
products under development. There can be no assurance that the FDA will act
favorably or quickly on the Company's submissions, or that significant
difficulties and costs will not be encountered by the Company in its efforts to
obtain FDA clearance or approval for its products under development. Any such
difficulties could delay or preclude obtaining regulatory clearance or approval.
In addition, there can be no assurance that the FDA will not impose strict
labeling or other requirements as a condition of its 510(k) clearance or PMA
approval, any of which could limit the Company's ability to market its products
under development. Further, if the Company wishes to modify a product after FDA
clearance or approval, including changes in indications or other modifications
that could affect safety and efficacy, additional clearances or approvals will
be required from the FDA. Failure to receive, or delays in receipt of, FDA
clearances or approvals, including delays resulting from an FDA request for
clinical trials or additional data as a prerequisite to clearance or approval,
or any FDA conditions that limit the ability of the Company to market its
products under development, could have a material adverse effect on the
Company's business, financial condition and results of operations.
In order for the Company to market its products under development in
Europe and certain other international jurisdictions, the Company and its
distributors will have to obtain required regulatory registrations or approvals
and otherwise comply with extensive regulations regarding safety, efficacy and
quality. These regulations, including the requirements for registrations or
approvals and the time required for regulatory review, vary from country to
country. The Company has received ISO 9001 certification and the CE Mark
approval for sale of its current products. The CE Mark evidences receipt of the
regulatory approval necessary for commercialization in European Union countries
and eliminates the requirement to obtain individual country approvals. There can
be no assurance that the Company will obtain future regulatory registrations or
approvals in other such countries or that it will not be required to incur
significant costs in obtaining or maintaining its foreign regulatory
registrations or approvals. Delays in receipt of these registrations or
approvals, failure to receive these clearances or approvals, or the loss of
received registrations or approvals could have a material adverse effect on the
Company's business, financial condition and results of operations.
11
RESULTS OF OPERATIONS
THREE MONTHS ENDED APRIL 2, 1999 COMPARED TO THE THREE MONTHS ENDED
APRIL 3, 1998.
Net sales increased 114% to $6.3 million in the three months ended
April 2, 1999 compared to $3.0 million in the three months ended April 3, 1998.
The increase in net sales was due primarily to a 99% increase in unit shipments
of the Company's beating heart products and a 1,186% increase in ancillary
product sales, offset by approximately a 6% drop in the average selling price
per unit for the beating heart products. In January 1999 the Company began
shipping its next generation beating heart product, the CTS-Registered
Trademark- Access Ultima-TM- System.
Gross profit increased to $4.0 million (63% of net sales) in the three
months ended April 2, 1999 compared to $1.4 million (46% of net sales) in the
same period last year. This improvement in gross profit is primarily due to
lower material costs per unit, higher production volumes which resulted in
increased manufacturing efficiencies and higher inventory levels, and lower
international sales.
Research and development expenses in the three months ended April 2,
1999 were $2.7 million compared to $2.7 million in the three months ended
April 3, 1998. The Company is continuing development and prototyping of
instruments and future generations of products associated with the
CTS-Registered Trademark- Access Ultima-TM-System, CTS-Registered Trademark-
Ceres-TM- Saphenous Vein Harvesting System, CTS-Registered Trademark-
Aurora-TM-MultiTrac System, CTS-Registered Trademark- Voyager-TM- Quad
Cannula and other cannulation systems.
The Company has entered into development and licensing agreements, and
expects to enter into additional agreements in the future, that require
milestone payments which are tied to certain events. The timing of these
milestone payments is uncertain and could have a material impact on the
operating results in the quarter and year in which they are expensed. No such
milestone payments were expensed in either the three months ended April 2, 1999
or April 3, 1998.
Sales, marketing, general and administrative expenses increased to $5.6
million in the three months ended April 2, 1999 compared to $5.1 million in the
same period last year. This increase was due primarily to additional sales
personnel and the costs associated with the support of a larger field sales
organization. The Company expects that sales and marketing and administrative
expenses for 1999 will remain relatively flat compared to 1998.
The Company has recorded deferred compensation of $14.6 million, less
cancellations of $2.1 million, for the difference between the option exercise
price or restricted stock purchase price and the deemed fair value of the
Company's Common Stock for options granted and restricted stock sold in 1995 and
early 1996 and the deemed fair value of the Company's Common Stock for options
granted to non-employees since inception. The deferred compensation is being
amortized to operating expenses over the related vesting period of the shares
(one to four years) and will, therefore, continue to have an adverse effect on
the Company's results of operations through 2000. Amortization of deferred
compensation charged to operating expenses in the three months ended April 2,
1999 totaled $409,000 compared to $483,000 for the same period last year.
Net interest income decreased to $459,000 in the three months ended
April 2, 1999 compared to $698,000 in the same period last year. This decrease
was primarily due to lower average cash and investment balances.
12
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily from
the sale of equity securities. As of April 2, 1999, the Company had raised
approximately $91.3 million (net of stock issuance costs) from the sale of
equity securities. As of April 2, 1999, cash, cash equivalents and
available-for-sale securities totaled $34.5 million. The Company's cash used in
operations was $5.7 million for the three months ended April 2, 1999, reflecting
expenditures made primarily to continue research and development and sales and
marketing activities, to support its administrative infrastructure, payment of a
licensing fee and working capital investments in accounts receivable and
inventory due to higher revenue levels. The Company also spent $274,000 for the
purchases of property and equipment and $119,000 for repayment of an equipment
note in the three months ended April 2, 1999.
The Company plans to finance its operations principally from existing
cash, cash equivalents and available-for-sale securities and interest thereon,
and product revenues. The Company believes that its existing cash balances and
available-for-sale securities and interest thereon, and product revenues will be
sufficient to fund its operations through 2000. The Company's capital
requirements, and the availability of product revenues, depend on numerous
factors, including the progress of the Company's product development programs,
the receipt of and the time required to obtain regulatory clearances or
approvals, the resources the Company devotes to developing, manufacturing and
marketing its products, the extent to which the Company's products receive
market acceptance, and other factors. The Company expects to devote substantial
capital resources to research and development, to support a direct sales force
and marketing operation in the United States and to continue to support its
manufacturing capacity and facilities. Consequently, the Company may be required
to raise additional funds through public or private financing, collaborative
relationships or other arrangements. There can be no assurance that the Company
will not require additional funding or that such additional funding, if needed,
will be available on terms attractive to the Company, or at all, which could
have a material adverse effect on the Company's business, financial condition
and results of operations. Any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve restrictive
convenants.
At April 2, 1999, the Company had approximately $51.4 million in
federal and $36.9 million in state net operating loss carryforwards, which will
expire in the years 2001 through 2019, if not utilized. In addition, the Company
has federal and state research and development credits of $1.5 million and
$855,000, respectively. These credits will expire beginning in 2011, if not
utilized. Utilization of federal income tax carryforwards is subject to certain
limitations under Section 382 of the Internal Revenue Code of 1986. These annual
limitations may result in expiration of net operating loss carryforwards and
research and development credits before they can be fully utilized.
IMPACT OF THE YEAR 2000 ISSUE
The year 2000 Issue is the result of computer programs written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
13
The Company has completed an inventory of all mission critical software
utilized by the Company and has determined that this software is year 2000
compliant. In late 1996 the Company acquired its manufacturing, order entry,
finance and network software from third party vendors that have certified such
software to be year 2000 compliant. The Company has no custom software in its
manufacturing or development processes which requires modification.
The Company is also surveying its major suppliers to determine their
year 2000 readiness. It is expected that the survey will be completed in mid
1999. The Company currently has no plans to contact its customers concerning
their year 2000 readiness. The Company's products have no date sensitive
software or embedded chip technology. The Company has sold its products to over
500 hospitals and distributors worldwide and no one customer represents more
than 10% of the Company's revenue.
Virtually all of the computer hardware currently owned by the Company
is year 2000 compliant and in any event non-compliant computer hardware will be
replaced, if necessary.
Based on the Company's assessment, it believes that there will be no
material impact on the operations of the Company due to the year 2000 issue. As
a result the Company is not developing any formal contingency plans.
The costs incurred to date to determine the impact of the year 2000
issue are immaterial and no significant future costs are anticipated.
FINANCIAL RISK MANAGEMENT
As a Company with international sales, the Company faces exposure to
adverse movements in foreign currency exchange rates. These exposures may change
over time as the Company's international business grows and the Company's
business practices evolve and could have a material adverse effect on the
Company's business, financial condition and results of operations. All of the
Company's international sales are currently denominated in U.S. dollars. An
increase in the value of the U.S. dollar relative to foreign currencies could
make the Company's products more expensive and therefore, reduce demand for the
products or force the Company to reduce its selling price. Reduced demand or
lower selling prices could have a material adverse effect on the Company's
business, financial condition and results of operations. Currently, the Company
does not hedge against any foreign currencies.
The Company maintains an investment portfolio of various issuers, types
and maturities. These securities are classified as available-for-sale, and
consequently, are recorded on the balance sheet at fair value with unrealized
gains or losses reported as a separate component of stockholders' equity. At any
time, a sharp rise in interest rates could have a material adverse effect on the
fair value of the Company's investment portfolio. Conversely, declines in
interest rates could have a material adverse effect on the interest earnings of
the Company's investment portfolio. Currently, the Company does not hedge these
interest rate exposures.
14
FACTORS AFFECTING RESULTS OF OPERATIONS
HIGHLY COMPETITIVE MARKET; RISK OF ALTERNATIVE THERAPIES; RISK OF
REUSE. The medical device industry and the market for treatment of
cardiovascular disease, in particular, are characterized by rapidly evolving
technology and intense competition. A number of companies, including Johnson &
Johnson, Boston Scientific Corporation, Guidant Corporation and Medtronic, Inc.,
are currently marketing stents, catheters, lasers, drugs and other less invasive
means of treating cardiovascular disease. Many of these less invasive
treatments, as well as CABG surgery, are widely accepted in the medical
community and have a long history of safe and effective use. Many of the
Company's competitors have substantially greater capital resources, name
recognition and expertise in and resources devoted to research and development,
manufacturing and marketing and obtaining regulatory clearances or approvals.
Furthermore, competition in the emerging market for minimally invasive cardiac
surgery is intense and is expected to increase. Medtronic, Inc., Genzyme
Surgical Products Corp., Johnson & Johnson, Guidant Corporation, Baxter
International, Inc., Heartport, Inc. and United States Surgical Corp. are
marketing or have announced that they are developing products to be used in MICS
procedures. There can be no assurance that MICS procedures will replace any
current treatments. Additionally, even if MICS procedures are widely adopted,
there can be no assurance that the Company's competitors will not succeed in
developing or marketing alternative procedures and technologies, competing
devices to perform the same procedures, or therapeutic drugs that are more
effective than the Company's products or that render the Company's products or
technologies obsolete or not competitive. In addition, there can be no assurance
that existing products for other surgical uses will not be used in MICS
procedures. Furthermore, sales of the Company's products could be adversely
affected by reuse, notwithstanding the instructions in the Company's clinical
protocols and product labeling indicating that certain components of the
Company's products are single-use devices. Such competition or reuse could have
a material adverse effect on the Company's business, financial condition and
results of operations.
LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE. The Company
currently has a small sales and marketing organization when compared to most of
its competitors. The Company sells its products in the United States through a
direct sales force. In certain international markets, the Company sells its
products through distributors. There can be no assurance that the Company will
be able to build a larger direct sales force or marketing organization, that
maintaining a direct sales force or marketing organization will be cost
effective, or that the Company's sales and marketing efforts will be successful.
There can be no assurance that the Company will be able to maintain agreements
with distributors, or that such distributors will devote adequate resources to
selling the Company's products. Since the Company has entered into distribution
agreements for the sale of its products in certain countries, it will be
dependent upon the efforts of these third parties, and there can be no assurance
that such efforts will be successful. Failure to maintain or grow an effective
direct sales and marketing organization or to maintain effective distributors
could have a material adverse effect on the Company's business, financial
condition and results of operations.
15
DEPENDENCE ON LICENSES, PATENTS AND PROPRIETARY TECHNOLOGY. The
Company's ability to compete effectively will depend in part on its ability to
develop and maintain proprietary aspects of its technology. The Company owns
fifteen issued United States patents. Additionally, the Company has fifty-one
United States patent applications and various foreign patent applications
pending. The Company is the licensee of a United States patent and several
related pending applications for a heart valve insertion and stapling device,
and a United States patent application for bipolar electrosurgical scissors.
Additionally, the Company has acquired exclusive rights to a United States
Patent covering methods of minimally invasive vessel harvesting.
There can be no assurance that any issued patents or any patents which
may be issued as a result of the Company's licensed patent applications or
pending United States and foreign patent applications will provide any
competitive advantages for the Company's products or that they will not be
successfully challenged, invalidated or designed around in the future. In
addition, there can be no assurance that competitors, many of which have
substantial resources and have made substantial investments in competing
technologies, will not seek to apply for and obtain patents that will prevent,
limit or interfere with the Company's ability to make, use and sell its products
either in the United States or in international markets.
The medical device industry has been characterized by extensive
litigation regarding patents and other intellectual property rights, and
companies in the medical device industry have employed intellectual property
litigation to gain a competitive advantage. There can be no assurance that the
Company will not become subject to patent infringement claims or litigation or
interference proceedings declared by the USPTO to determine the priority of
inventions. The defense and prosecution of intellectual property suits, USPTO
interference proceedings and related legal and administrative proceedings are
both costly and time-consuming. Litigation may be necessary to enforce patents
issued to the Company, to protect trade secrets or know-how owned by the Company
or to determine the enforceability, scope and validity of the proprietary rights
of others. Any litigation or interference proceedings will result in substantial
expense to the Company and significant diversion of effort by the Company's
technical and management personnel. An adverse determination in litigation or
interference proceeding to which the Company becomes a party, including any
litigation that may arise against the Company as described in "Potential
Litigation" below, could subject the Company to significant liabilities to third
parties or require the Company to seek licenses from third parties or prevent
the Company from selling its products in certain markets, or at all. Costs
associated with settlements, licensing and similar arrangements may be
substantial and could include ongoing royalties. Furthermore, there can be no
assurance that the necessary licenses would be available to the Company on
satisfactory terms, if at all. Adverse determinations in a judicial or
administrative proceeding or failure to obtain necessary licenses could prevent
the Company from manufacturing and selling its products, which would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Congress enacted legislation, which became effective October 1, 1996,
that places certain restrictions on the ability of medical device manufacturers
to enforce certain patent claims, relating to surgical and medical methods,
against medical practitioners. Such limitations on the enforceability of patent
claims, relating to medical and surgical methods, against medical practitioners
could have a material adverse effect on the Company's ability to protect its
proprietary methods and procedures against medical practitioners.
16
In addition to patents, the Company relies on trade secrets and
proprietary know-how, which it seeks to protect, in part, through
confidentiality and proprietary information agreements. There can be no
assurance that such confidentiality or proprietary information agreements will
not be breached, that the Company would have adequate remedies for any breach,
or that the Company's trade secrets will not otherwise become known to or be
independently developed by competitors.
CONTINUING GOVERNMENT REGULATION. Regulatory clearances or approvals,
if granted, may include significant limitations on the indicated uses for which
the Company's products may be marketed. FDA enforcement policy strictly
prohibits the marketing of FDA cleared or approved medical devices for
unapproved uses. In addition, the Company's manufacturing processes are required
to comply with the Good Manufacturing Practices ("GMP") regulations of the FDA
which are currently referred to as Quality System Regulations. These regulations
include design, testing, production, control, documentation and other
requirements. Enforcement of Quality System Regulations has increased
significantly in the last several years, and the FDA has publicly stated that
compliance will be more strictly scrutinized. The Company's facilities and
manufacturing processes, as well as those of any future third-party suppliers,
will be subject to periodic inspection by the FDA, the California Department of
Health Services and other agencies. The Company has received ISO 9001
certification, has obtained its California Device Manufacturing license and has
successfully undergone a facility inspection by the FDA. Failure to comply with
these and other applicable regulatory requirements could result in, among other
things, warning letters, fines, injunctions, civil penalties, recall or seizure
of products, total or partial suspension of production, refusal of the
government to grant premarket clearance or premarket approval for devices,
withdrawal of clearances or approvals and criminal prosecution, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
POTENTIAL LITIGATION. Heartport, Inc. (formerly Stanford Surgical
Technologies, Inc.), the former employer of the Company's founder and Chief
Technical Officer, Charles S. Taylor, has alleged in certain correspondence in
late 1995 and again in September 1997 that Mr. Taylor and the Company may have
misappropriated trade secrets of the former employer and breached
confidentiality obligations to the former employer. The former employer has also
claimed in such correspondence an ownership interest in certain developments and
products of the Company. The Company has agreed to provide for the defense of
Mr. Taylor in the event that litigation is commenced. Litigation is subject to
inherent uncertainties, especially in cases where complex technical issues are
decided by a lay jury. Accordingly, no assurance can be given that if a lawsuit
is commenced it would not be decided against the Company. Such an adverse
determination could have a material adverse effect upon the Company's business,
financial condition and results of operations.
POTENTIAL COMPONENT SHORTAGES; DEPENDENCE ON SOLE SOURCES OF SUPPLY.
The Company contracts with third parties for the manufacture of certain
components or the performance of certain processes involved in the manufacturing
cycle. Some of these components and processes may only be available from
single-source vendors. Any prolonged supply interruption or yield problems
experienced by the Company due to a single-source vendor could have a material
adverse effect on the Company's ability to manufacture its products until a new
source of supply is qualified. Many of the Company's components are molded parts
that require custom tooling which is manufactured and maintained by third party
vendors. Should such custom tooling be damaged it could result in a supply
interruption that could have a material adverse effect on the Company's ability
to manufacture its products until a new tool is manufactured. Also, the
Company's new product development efforts and the timeliness of new product
launches could be significantly affected by tooling vendors ability to
17
meet completion and quality commitments on the manufacture of custom tooling. As
the Company increases production, it may from time to time experience lower than
anticipated yields or production constraints, resulting in delayed product
shipments, which could have a material adverse effect on the Company's business,
financial condition and results of operation.
LIMITED MANUFACTURING EXPERIENCE; SCALE-UP RISK. The Company has no
experience manufacturing its products in the volumes that would be necessary for
the Company to achieve profitable operations. There can be no assurance that
reliable, high-volume manufacturing can be established or maintained at
commercially reasonable costs. Companies often encounter difficulties in scaling
up production, including problems involving production yield, quality control
and assurance, and shortages of qualified personnel. In addition, the Company's
manufacturing facilities are subject to GMP regulations, international quality
standards and other regulatory requirements. Difficulties encountered by the
Company in manufacturing scale-up or failure by the Company to implement and
maintain its facilities in accordance with GMP regulations, international
quality standards or other regulatory requirements could entail a delay or
termination of production, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
UNCERTAINTY RELATING TO THIRD-PARTY REIMBURSEMENT. In the United
States, health care providers, such as hospitals and physicians, that purchase
medical devices such as the Company's products, generally rely on third-party
payors, principally Medicare, Medicaid and private health insurance plans, to
reimburse all or part of the cost of the procedure in which the medical device
is being used. Reimbursement for cardiovascular surgery, including CABG surgery,
using devices that have received FDA approval, has generally been available in
the United States. In addition, certain health care providers are moving toward
a managed care system in which such providers contract to provide comprehensive
health care for a fixed cost per person. The Company is unable to predict what
changes, if any, may be made in the reimbursement methods utilized by
third-party health care payors. The Company could be adversely affected by
changes in reimbursement policies of government or private health care payors,
particularly to the extent any such changes affect reimbursement for the
procedures in which the Company's products are intended to be used. Failure by
physicians, hospitals and other potential users of the Company's products to
obtain sufficient reimbursement from health care payors for the procedures in
which the Company's products are intended to be used or adverse changes in
government and private third-party payors' policies toward reimbursement for
such procedures could have a material adverse effect on the Company's business,
financial condition and results of operations.
Market acceptance of the Company's products in international markets is
dependent, in part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care payment systems in
international markets vary significantly by country, and include both government
sponsored health care and private insurance. The Company intends to seek
international reimbursement approvals, although there can be no assurance that
any such approvals will be obtained in a timely manner, if at all, and failure
to receive international reimbursement approvals could have a material adverse
effect on market acceptance of the Company's products in the international
markets in which such approvals are sought.
18
PRODUCT LIABILITY RISK; LIMITED INSURANCE COVERAGE. The development,
manufacture and sale of medical products entail significant risk of product
liability claims and product recalls. The Company's current product liability
insurance coverage limits are $5,000,000 per occurrence and $5,000,000 in the
aggregate, and there can be no assurance that such coverage limits are adequate
to protect the Company from any liabilities it might incur in connection with
the development, manufacture and sale of its products. In addition, the Company
may require increased product liability insurance coverage as product sales
increase. Product liability insurance is expensive and in the future may not be
available to the Company on acceptable terms, if at all. A successful product
liability claim or series of claims brought against the Company in excess of its
insurance coverage, or a product recall, could have a material adverse effect on
the Company's business, financial condition and results of operations.
19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
The following information is provided as an amendment to the
initial report on Form SR, "Report of Sales and Securities and Use of
Proceeds Therefrom", regarding the use of proceeds from the sale of
securities under the Company's Registration Statement Form S-1
(333-1840), which was declared effective on April 18, 1996 (CUSIP
number 141907). The information provided is for the period from April
18, 1996 through April 2, 1999.
Use of Proceeds Amount
--------------- ------
Construction of plant, building and facilities $ --
Purchase and installation of machinery and equipment 6,602,000
Purchase of real estate --
Acquisition of other businesses --
Repayment of indebtedness --
Working capital 6,549,000
Cost of operations 37,936,000
Temporary Investment
--------------------
Cash 1,099,000
Commercial paper, notes and bonds 32,120,000
All amounts above represent estimates of direct or indirect payments to
third parties.
The amounts below were paid directly to officers of the Company.
Use of Proceeds Amount
--------------- ------
Loans to officers $ 625,000
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
20
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits
Exhibit
No. Description
--- -----------
3.2(1) Restated Certificate of Incorporation.
3.3(7) Bylaws (as amended).
3.4(4) Certificate of Designations of Rights, Preferences and
Privileges of Series A Participating Preferred Stock
3.5(4) Preferred Shares Rights Agreement, dated as of February 14,
1997.
3.6(7) Certificate of Amendment to Restated Certificate of
Incorporation.
4.1(1) Specimen Common Stock Certificate.
10.1(1) Form of Indemnification Agreement between the Company and
each of its directors and officers.
10.2(8) Incentive Stock Plan and forms of Agreements thereunder (as
amended).
10.3(1) Director Option Plan and form of Director Stock Option
Agreement thereunder.
10.4(1) Employee Stock Purchase Plan and forms of agreements
thereunder.
10.5(5) Nonstatutory Stock Option Plan and form of Nonstatutory
Stock Option Agreement thereunder (as amended).
10.6(1) Form of Employment, Confidential Information and Invention
Assignment Agreement.
10.8(1) Consulting Agreement, dated June 30, 1995, between the
Company and Federico Benetti, M.D.
10.9(1) Assignment Agreement, dated June 30, 1995 (as amended by
Amendment Agreement dated August 31, 1995), between the
Company and Federico Benetti, M.D.
10.10(1) Employment Letter Agreement, dated September 5, 1995,
between the Company and Charles S. Taylor.
10.11(1) Assignment Agreement, dated September 7, 1995, between the
Company and Charles S. Taylor.
10.12(1) Shareholder Rights Agreement dated September 8, 1995 (as
amended January 3, 1996) between the Company and certain
holders of the Registrant's securities.
10.13(1) Letter Agreement regarding Heartport trade secret
allegations, dated October 11, 1995, between the Company and
Charles S. Taylor.
10.14(1) Assignment, Assumption of Lease and Consent, dated November
9, 1995, between the Company and Cardiovascular Concepts,
Inc. ("CVC") for the premises located at 3260 Alpine Road,
Portola Valley, California 94028.
21
10.17(1) Consent to Assignment, dated December 22, 1995, among the
Company, Viking Partners, Inc. ("Viking"), CVC and Fogarty
Engineering, Inc. for the premises located at 3260 Alpine
Road, Portola Valley, California 94028.
10.19(1) First Amendment to Assignment, Assumption of Lease and
Consent, dated December 22, 1995, between the Company and
CVC for the premises located at 3260 Alpine Road, Portola
Valley, California 94028.
10.21(1) Consulting Agreement, dated February 21, 1996, between the
Company and Thomas J. Fogarty, M.D.
10.22(1) Development and License Agreement, dated February 19, 1996,
between the Company and Enable Medical Corp.
10.23(1) Employment Letter Agreement, dated March 15, 1996, between
the Company and Steve M. Van Dick.
10.24(1) Lease dated March 29, 1996 for space located at 10600 North
Tantau Avenue, Cupertino, California between the Company and
Spieker Properties, L.P.
10.27(2) Employment Agreement, dated April 19, 1996, between the
Company and Steve Van Dick.
10.29(2) Promissory Note for $35,000 dated May 20, 1996, between the
Company and Michael Billig.
10.31(3) Promissory Note for $750,000 and Security Agreement dated
August 16, 1996, between the Company and Richard Ferrari.
10.32(5) Promissory Note for $200,000 dated December 3, 1996, between
the Company and Steve Van Dick.
10.33(6) Employment Letter Agreement, dated February 25, 1997,
between the Company and Jeffrey Gold.
10.34(7) Employment Letter Agreement, dated July 17, 1997, between
the Company and Geoffrey Dillon.
10.35(7) Employment Letter Agreement, dated November 24, 1997,
between the Company and Richard Lotti.
10.36(8) 1998 Nonstatutory Stock Option Plan and forms of Agreements
thereunder.
10.37(9) 1998 Employee Stock Purchase Plan and forms of agreements
thereunder.
27.1 Financial Data Schedule
- -----------------
22
(1) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Registration Statement on Form S-1
(Registration No. 333-1840).
(2) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-Q for the period ended June
30, 1996.
(3) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-Q for the period ended
September 30, 1996.
(4) Incorporated herein by reference to the Company's Registration
Statement on Form 8-A, filed with the Securities and Exchange
Commission on February 28, 1997.
(5) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-K for the period ended
December 31, 1996.
(6) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-Q for the period ended June
27, 1997.
(7) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Company's Form 10-K for the period ended
January 2, 1998.
(8) Incorporated herein by reference to the Company's Registration
Statement on Form S-8, filed with the Securities and Exchange
Commission on May 27, 1998.
(9) Incorporated herein by reference to the Company's Registration
Statement on Form S-8, filed with the Securities and Exchange
Commission on January 22, 1999.
- -----------------
b) Reports on Form 8-K
None
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 13, 1999 CARDIOTHORACIC SYSTEMS, INC.
/S/ Richard M. Ferrari
--------------------------------------
Richard M. Ferrari
President and Chief Executive Officer
/S/ Steve Van Dick
--------------------------------------
Steve Van Dick
Vice President, Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer)
24
EXHIBIT INDEX
Exhibit
Number Exhibit Description
- ------- ---------------------------------------
27.1 Financial Data Schedule
25