<PAGE>
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 September 30, 1996 or
Transition report pursuant to Section 13 or 15(d) of the Securities
- -----Exchange Act of 1934. For the transition period from to .
--------- ---------
Commission File Number
0-27880
CardioThoracic Systems, Inc.
----------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 94-3228757
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10600 N. Tantau Ave., Cupertino, CA 95014-0739
----------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone, including area code: (408) 342-1700
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days. Yes X No
----- -----
As of November 4, 1996, there were 12,991,672 shares of the Registrant's Common
Stock outstanding.
Exhibit Index on page: 27
Total number of pages: 33
<PAGE>
CARDIOTHORACIC SYSTEMS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------
Item 1. Financial Statements
Condensed Balance Sheets as of September 30, 1996 and
December 31, 1995 3
Statements of Operations for the three months ended
September 30, 1996 and 1995 4
Statements of Operations for the nine months ended September 30,
1996 and the cumulative period from June 15, 1995 (date of
inception) through September 30, 1996 for CardioThoracic
Systems, Inc. Statement of Operations for the period
January 1, 1995 through June 14, 1995 for Informed Creation.
Statement of Operations for the period June 15, 1995 through
September 30, 1995 for CardioThoracic Systems, Inc.
Statement of Operations for the nine months ended
September 30, 1995 for the Combined entity 5
Statements of Cash Flows for the nine months ended September 30,
1996 and the cumulative period from June 15, 1995 (date of
inception) through September 30, 1996 for CardioThoracic
Systems, Inc. Statement of Cash Flows for the period
January 1, 1995 through June 14, 1995 for Informed Creation.
Statement of Cash Flows for the period June 15, 1995 through
September 30, 1995 for CardioThoracic Systems, Inc.
Statement of Cash Flows for the nine months ended September
30, 1995 for the Combined entity 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION 23
SIGNATURES 26
EXHIBIT INDEX 27
2
<PAGE>
Item 1. Financial Statements
CARDIOTHORACIC SYSTEMS, INC.
(a company in the development stage)
CONDENSED BALANCE SHEETS
September 30, December 31,
1996 1995
-------------- -------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 48,892,562 $ 711,620
Available-for-sale securities 32,408,328 2,582,782
Notes receivable from officers 115,000 -
Prepaid expenses and other current assets 175,484 30,571
-------------- -------------
Total current assets 81,591,374 3,324,973
Property and equipment 2,221,153 66,244
Less accumulated depreciation (116,159) (1,781)
-------------- -------------
2,104,994 64,463
Notes receivable from officers 984,583 -
Other assets 51,659 -
-------------- -------------
Total assets $ 84,732,610 $ 3,389,436
-------------- -------------
-------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 574,189 $ 87,260
Accrued liabilities 1,812,611 88,499
-------------- -------------
Total current liabilities 2,386,800 175,759
Stockholders' equity:
Convertible preferred stock, par value $0.001 - 4,025
Common stock, par value $0.001 12,984 2,800
Additional paid-in capital 103,182,203 6,006,335
Accumulated deficit (12,159,875) (997,213)
Deferred compensation (8,689,502) (1,802,270)
-------------- -------------
Total stockholders' equity 82,345,810 3,213,677
-------------- -------------
Total liabilities and stockholders' equity $ 84,732,610 $ 3,389,436
-------------- -------------
-------------- -------------
See accompanying notes.
3
<PAGE>
CARDIOTHORACIC SYSTEMS, INC.
(a company in the development stage)
STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
September 30, 1996 September 30, 1995
------------------ ------------------
<S> <C> <C>
Operating expenses:
Manufacturing start-up expenses $ 213,218 $ -
Research and development 3,130,895 76,815
Marketing, general, and administrative 2,070,676 153,061
------------------ ------------------
Total operating expenses 5,414,789 229,876
------------------ ------------------
Loss from operations (5,414,789) (229,876)
Interest income 1,097,259 278
------------------ ------------------
Net loss $ (4,317,530) $ (229,598)
------------------ ------------------
------------------ ------------------
Net loss per share $ (0.33) $ (0.02)
------------------ ------------------
------------------ ------------------
Shares used in computing
net loss per share 12,966,283 9,449,054
------------------ ------------------
------------------ ------------------
</TABLE>
See accompanying notes.
4
<PAGE>
STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
CardioThoracic Systems, Informed Creation CardioThoracic Systems,
Inc.(a company in the (a development Inc.(a company in the
development stage) stage entity) development stage)
Nine Months Ended January 1, 1995 to June 15, 1995 to
September 30, 1996 June 14, 1995 September 30, 1995
----------------------------------------------------------------------------
<S> <C> <C> <C>
Operating expenses:
Manufacturing start-up expenses $ 213,218 $ - $ -
Research and development 8,279,667 2,808 79,391
Marketing, general, and administrative 4,659,093 5,537 153,259
----------------------------------------------------------------------------
Total operating expenses 13,151,978 8,345 232,650
----------------------------------------------------------------------------
Loss from operations (13,151,978) (8,345) (232,650)
Interest income 1,989,316 24 278
----------------------------------------------------------------------------
Net loss $ (11,162,662) $ (8,321) $ (232,372)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net loss per share $ (0.98) $ (0.02)
----------------------- -------------------
----------------------- -------------------
Shares used in computing
net loss per share 11,418,958 9,449,054
----------------------- -------------------
----------------------- -------------------
CardioThoracic Systems,
Inc. (a company in the
CardioThoracic Systems, development stage)
Inc. and Informed Creation June 15, 1995
Combined January 1, 1995 (date of inception) to
to September 30, 1995 September 30, 1996
-----------------------------------------------------
Operating expenses:
Manufacturing start-up expenses $ - $ 213,218
Research and development 82,199 8,768,214
Marketing, general, and administrative 158,796 5,214,766
-----------------------------------------------------
Total operating expenses 240,995 14,196,198
-----------------------------------------------------
Loss from operations (240,995) (14,196,198)
Interest income 302 2,036,323
-----------------------------------------------------
Net loss $ (240,693) $ (12,159,875)
-----------------------------------------------------
-----------------------------------------------------
Net loss per share $ (1.15)
---------------------
---------------------
Shares used in computing
net loss per share 10,588,771
---------------------
---------------------
</TABLE>
5
<PAGE>
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
CardioThoracic Systems, Informed Creation CardioThoracic Systems,
Inc.(a company in the (a development Inc.(a company in the
development stage) stage entity) development stage)
Nine Months Ended January 1, 1995 to June 15, 1995 to
September 30, 1996 June 14, 1995 September 30, 1995
----------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (11,162,662) $ (8,321) $ (232,372)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 114,378 1,559
Amortization of deferred compensation 5,062,965
Changes in operating assets and liabilities:
Notes receivable from officers (1,099,583)
Prepaid expenses and other current assets (144,913) (1,765)
Accounts payable 486,929 513 76,946
Accrued liabilities 1,724,112 51,682
----------------------------------------------------------------------------
Net cash used in operating activities (5,018,774) (6,249) (105,509)
INVESTING ACTIVITIES
Purchases of property and equipment (2,154,909) (8,642)
Purchase of available-for-sale securities (32,408,328)
Proceeds from maturities of
available-for-sale securities 2,582,782
Increase in other assets (51,659)
----------------------------------------------------------------------------
Net cash used in investing activities (32,032,114) - (8,642)
FINANCING ACTIVITIES
Capital contributed 27,406
Distributions to sole proprietor (18,344)
Proceeds from issuance of promissory note 100,000
Repayment of promissory note (100,000)
Proceeds from issuance of convertible
promissory notes, net 196,173
Proceeds from issuance of convertible preferred
stock 996,278 3,777,206
Proceeds from issuance of common stock 84,235,552 2,717
----------------------------------------------------------------------------
Net cash provided by financing activies 85,231,830 9,062 3,976,096
Net increase in cash and cash equivalents 48,180,942 2,813 3,861,945
Cash and cash equivalents at beginning of
period 711,620 3,333 -
----------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 48,892,562 $ 6,146 $ 3,861,945
----------------------------------------------------------------------------
----------------------------------------------------------------------------
CardioThoracic Systems,
Inc. (a company in the
CardioThoracic Systems, development stage)
Inc. and Informed Creation June 15, 1995
Combined January 1, 1995 (date of inception) to
to September 30, 1995 September 30, 1996
-----------------------------------------------------
OPERATING ACTIVITIES
Net loss $ (240,693) $ (12,159,875)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 1,559 116,159
Amortization of deferred compensation 5,323,150
Changes in operating assets and liabilities:
Notes receivable from officers (1,099,583)
Prepaid expenses and other current assets (1,765) (175,484)
Accounts payable 77,459 574,189
Accrued liabilities 51,682 1,812,611
------------------------------------------------------
Net cash used in operating activities (111,758) (5,608,833)
INVESTING ACTIVITIES
Purchases of property and equipment (8,642) (2,221,153)
Purchase of available-for-sale securities (34,991,110)
Proceeds from maturities of available-for-
sale securities 2,582,782
Increase in other assets (51,659)
------------------------------------------------------
Net cash used in investing activities (8,642) (34,681,140)
FINANCING ACTIVITIES
Capital contributed 27,406
Distributions to sole proprietor (18,344)
Proceeds from issuance of promissory note 100,000 100,000
Repayment of promissory note (100,000) (100,000)
Proceeds from issuance of convertible
promissory notes, net 196,173 196,173
Proceeds from issuance of convertible
preferred stock 3,777,206 4,748,010
Proceeds from issuance of common stock 2,717 84,238,352
------------------------------------------------------
Net cash provided by financing activies 3,985,158 89,182,535
Net increase in cash and cash equivalents 3,864,758 48,892,562
Cash and cash equivalents at beginning
of period 3,333 -
------------------------------------------------------
Cash and cash equivalents at end of period $ 3,868,091 $ 48,892,562
------------------------------------------------------
------------------------------------------------------
Supplemental schedule of non cash investing and
financing activities:
Conversion of promissory notes for Series A
preferred stock $ 200,000
</TABLE>
See accompanying notes.
6
<PAGE>
CARDIOTHORACIC SYSTEMS, INC.
(a company in the development stage)
NOTES TO FINANCIAL STATEMENTS
September 30, 1996
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited 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, 1996 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 December 31, 1995 included in the Company's Registration Statement on Form
S - 1 (No. 333-1840) filed with the Securities and Exchange Commission.
Note 2. Formation and Business of the Company
CardioThoracic Systems, Inc. (the Company) was incorporated in the state of
California on June 15, 1995 and subsequently acquired all of the intellectual
property assets of its predecessor, Informed Creation, a sole proprietorship,
and expensed the purchase price to research and development as purchased in
process research and development technology. The Company designs, develops,
manufactures and markets surgical products and systems for minimally invasive
cardiothoracic surgery. The Company is in the development stage and since
inception has devoted substantially all of its efforts to develop its products,
raise capital and recruit personnel.
Informed Creation (the Sole Proprietorship) designed and developed surgical
products and systems for minimally invasive surgery. The Sole Proprietorship
was formed on November 3, 1993 and from inception until the sale of its
intellectual property devoted substantially all of its efforts to develop its
products and raise capital.
Note 3. Available-for-Sale Securities
The Company has adopted the provisions of Financial Accounting Standard No.
115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS
No.115"). Under the provisions of SFAS No. 115, 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
7
<PAGE>
CARDIOTHORACIC SYSTEMS, INC.
(a company in the development stage)
NOTES TO FINANCIAL STATEMENTS
September 30, 1996
(Unaudited)
Note 3. Available-for-Sale Securities (cont)
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 September 30, 1996, available-for-sale securities consist of the
following:
<TABLE>
<CAPTION>
Unrealized Accrued Estimated
Cost Gain Interest Fair Value
------------ ---------- -------- -----------
<S> <C> <C> <C> <C>
Certificate of Deposit $ 1,000,000 $ - $ - $ 1,000,000
U.S. Government Securities 7,910,907 - 67,942 7,978,849
Corporate Obligations 23,317,399 - 112,080 23,429,479
------------ ---------- -------- -----------
$32,228,306 - $180,022 $32,408,328
------------ ---------- -------- -----------
------------ ---------- -------- -----------
</TABLE>
At December 31, 1995, available-for-sale securities consist of the
following:
<TABLE>
<CAPTION>
Unrealized Accrued Estimated
Cost Gain Interest Fair Value
------------ ---------- -------- -----------
<S> <C> <C> <C> <C>
U.S. Government Securities $2,561,854 $ - $20,928 $2,582,782
</TABLE>
All available-for-sale securities had maturity dates of less than eighteen
months from September 30, 1996. There were no realized gains or losses for 1995
or for the nine months ended September 30, 1996.
Note 4. Net Loss Per Share
Except as noted below, net loss per share is computed using the weighted
average number of common shares outstanding. Common equivalent shares from
stock options and convertible preferred stock are excluded from the computation
as their effect is antidilutive except that, pursuant to the Securities and
Exchange Commission Staff Accounting Bulletins, common and common equivalent
shares issued during the period beginning twelve months prior to the Company's
April 1996 initial public offering at prices substantially below the initial
public offering price have been included in the calculation as if they were
outstanding for all periods presented prior to the effective date of the
Company's initial public offering (using the treasury stock method at the
initial offering price for stock options and the if-converted method for
convertible preferred stock).
8
<PAGE>
CARDIOTHORACIC SYSTEMS, INC.
(a company in the development stage)
NOTES TO FINANCIAL STATEMENTS
September 30, 1996
(Unaudited)
Note 5. Initial Public Offering
The Company sold 5,117,500 shares of common stock (including 667,500 shares
from the exercise of the underwriter's over-allotment option) at $18.00 per
share through an initial public offering in April 1996. Net proceeds (after
underwriters' commissions and fees along with other costs associated with the
offering) totaled approximately $84,229,000. Upon completion of the offering,
all outstanding shares of Preferred Stock ( a total of 5,025,000 shares) were
converted into shares of Common Stock on a one-for-one basis.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial condition and results of
operations of CardioThoracic Systems, Inc. ("CTS" or the "Company") should be
read in conjunction with the Financial Statements and the related Notes thereto
included herein. The following Management's Discussion and Analysis of
Financial Condition and Results of Operations contains forward-looking
statements that involve risks and uncertainties. The Company's actual results
of operations could differ materially from those anticipated in such forward-
looking statements as a result of certain factors set forth below under "Factors
Affecting Operating Results".
OVERVIEW
The business of the Company was commenced in November 1993 as a sole
proprietorship, Informed Creation, and to date the business has been engaged
primarily in organizational, research and product development efforts. 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 sole proprietorship.
Since inception, the Company has been engaged in the development of
instruments and systems to allow the majority of cardiothoracic surgeons, using
their existing skills coupled with Company-sponsored training, to perform
Minimally Invasive Direct Coronary Artery Bypass ("MIDCAB") surgery, a
revascularization procedure performed on a beating heart.
Before the Company can market its products under development in the United
States, the Company must obtain clearance or approval from the FDA. In May 1996
the Company was notified by the FDA that it is exempted from filing a premarket
notification for the Access Platform and the Stabilizer and is allowed to market
these products in the United States. In September 1996 the Company filed 510(k)
premarket notifications for clearance to market additional components of the
MIDCAB System and certain components of the Saphenous Vein Harvesting System.
RESULTS OF OPERATIONS
CardioThoracic Systems, Inc. for the three and nine months ended September
30, 1996 compared the three months ended September 30, 1995 for
CardioThoracic Systems, Inc. and the nine months ended September 30, 1995
for Informed Creation from January 1, 1995 to June 14, 1995 and
CardioThoracic Systems, Inc. from June 15, 1995 to September 30, 1995 (the
"Combined Entity").
No revenues were recorded in either the three and nine months ended
September 30, 1996 or 1995.
The research and development expenses for the three and nine months ended
September 30, 1996 were $3,130,895 and $8,279,667, respectively compared to
$76,815 and $82,199 for the three and nine months ended September 30, 1995,
respectively. These increases were due in part to a $1,327,270 and $3,997,172
charge for amortization of deferred compensation in the three and nine months
ended
10
<PAGE>
September 30, 1996, respectively, with no such charges in 1995. The remaining
increases were due to an increase in research and development staff and
increased expenditures related to the continuing development of the instruments
associated with the MIDCAB System and Saphenous Vein Harvesting System. The
Company expects that research and development expenses will continue to increase
substantially in the fourth quarter of 1996 and 1997 as the Company expands its
research and development activities related to the MIDCAB System, Saphenous Vein
Harvesting System, valve repair and replacement and other research efforts.
Marketing, general and administrative expenses increased to $2,070,676 and
$4,659,093 for the three and nine months ended September 30, 1996, respectively
compared to $153,061 and $158,796 for the three and nine months ended September
30, 1995, respectively. These increases were due in part to a $341,699 and
$1,065,793 charge for amortization of deferred compensation in the three and
nine months ended September 30, 1996, respectively, with no such charges in
1995. The remaining increase was due primarily to the hiring of marketing and
administrative personnel and consultants, the Company's promotional efforts to
increase market awareness of the Company and the MIDCAB procedure and
establishing the Company's administrative infrastructure. The Company expects
that sales and marketing and administrative expenses will continue to increase
substantially in the fourth quarter of 1996 and 1997 as the Company builds its
sales and marketing and administrative organizations, develops and sponsors
surgeon training programs, puts in place financial and management information
and control systems, and makes expenditures to increase market awareness of the
MIDCAB procedure and the CTS MIDCAB System.
The Company has recorded deferred compensation of $13,965,605 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. 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. Amortization of deferred
compensation charged to operating expenses in the three and nine months ended
September 30, 1996 totaled $1,668,969 and $5,062,965, respectively.
Interest income increased to $1,097,259 and $1,989,316 for the three and
nine months ended September 30, 1996, respectively, compared to $278 and $302
for the three and nine months ended September 30, 1995, respectively. The
increase was primarily due to the interest received on higher average cash
balances resulting from the completion of the Company's initial public offering
in April 1996 as described in note 5 of the CardioThoracic Systems, Inc. Notes
to Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed operations primarily from the
sale of equity securities. As of September 30, 1996, the Company had raised
approximately $89.2 million (net of stock issuance costs) from the sale of
equity securities. As of September 30, 1996, cash, cash equivalents and
available-for-sale securities totaled $81.3 million. The Company's cash used in
operations was $5,018,774 for the nine months ended September 30, 1996,
reflecting expenditures made primarily to increase research and development, to
commence marketing activities, to support its administrative infrastructure and
provide loans to certain officers. The Company also spent $2.2
11
<PAGE>
million for the purchases of property and equipment, the majority of which was
related to leasehold improvements required for the new facility the Company
occupied in August 1996.
The Company sold 5,117,500 shares of common stock (including 667,500 shares
from the exercise of the underwriter's over-allotment option) at $18.00 per
share through an initial public offering in April 1996. Net proceeds (after
underwriter's commissions and fees along with other costs associated with the
offering) totaled approximately $84,229,000.
The Company plans to finance its operations principally from the
approximately $84.2 million raised in its recent initial public offering and
interest thereon, its existing capital resources and, to the extent available,
lines of credit. The Company currently has an agreement with a bank for a $3.5
million line of credit fully secured by cash, cash equivalents and
available-for-sale securities. The Company believes that the net proceeds from
the initial public offering, together with interest thereon and the Company's
existing cash balances, will be sufficient to fund its operations through 1998.
The Company's capital requirements 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 hire and develop a direct sales force in the United
States and to expand manufacturing capacity and facilities. The timing and
amount of such capital requirements cannot be accurately predicted.
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 September 30, 1996, the Company had approximately $1,517,000 in federal
and $1,478,000 in state net operating loss carryforwards, which expire in the
years 2010 and 2000, respectively. 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 losses and research and development credits before
they can be fully utilized.
12
<PAGE>
FACTORS AFFECTING OPERATING RESULTS
This quarterly report on Form 10-Q contains forward-looking statements
which involve risks and uncertainties. The Company's actual results could
differ materially from those anticipated by such forward-looking statements as a
result of certain factors including those set forth in the following risk
factors and elsewhere in this quarterly report on Form 10-Q.
LIMITED OPERATING HISTORY; HISTORY OF LOSSES AND EXPECTATION OF FUTURE
LOSSES. 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. To date, the Company
has engaged primarily in organizational and research and product development
efforts, and a number of the Company's key management and technical personnel
have only recently joined the Company. The Company has never generated revenues
and does not have experience in manufacturing, marketing or selling its products
under development. There can be no assurance that the Company's development
efforts will result in commercially available products, that the Company will be
successful in introducing its products under development, or that required
regulatory clearances or approvals will be obtained in a timely manner, or at
all. The Company has experienced operating losses since its inception, and, as
of September 30, 1996, the Company had an accumulated deficit of $12,159,875.
The development and commercialization of the Company's products will require
substantial development, regulatory, sales and marketing, manufacturing and
other expenditures. The Company expects its operating losses to continue at
least through 1997 as it continues to expend substantial resources to complete
development of the its products, obtain regulatory clearances or approvals,
build its marketing, sales, manufacturing and finance organizations and conduct
further research and development. There can be no assurance that the Company's
products under development will ever gain commercial acceptance or that the
Company will ever generate revenues or achieve profitability.
UNCERTAINTY OF CLINICAL ADOPTION OF MIDCAB PROCEDURE. The Company's MIDCAB
System is being developed in order to enable the majority of cardiothoracic
surgeons, using their existing skills coupled with Company sponsored training,
to perform the Minimally Invasive Direct Coronary Artery Bypass ("MIDCAB")
procedure. Accordingly, the Company's success is dependent upon acceptance of
the MIDCAB procedure by the medical community as a reliable, safe and cost
effective alternative to existing treatments for revascularizing blocked
coronary arteries. To date, the MIDCAB procedure has only been performed on a
very limited basis by a small number of highly skilled cardiothoracic surgeons.
Of the procedures performed to date, the vast majority have been performed on a
single artery, typically the left anterior descending artery ("LAD") or, in
substantially fewer instances, the right coronary artery ("RCA"), and an
extremely limited number have been performed on the circumflex artery. A
significant percentage of coronary artery bypass graft ("CABG") procedures are
performed on multiple vessels. To date, multiple vessel MIDCAB procedures have
only been performed on an extremely limited basis, and there can be no assurance
that the MIDCAB procedure will be effectively utilized for multiple bypasses on
a more frequent basis. The Company is unable to predict how quickly, if at all,
the MIDCAB procedure will be adopted by the medical community or, if it is
adopted, the number of MIDCAB procedures that will be performed. The medical
conditions that can be treated with the MIDCAB procedure can also be treated by
widely accepted surgical procedures such as CABG surgery and catheter-based
treatments, including balloon angioplasty, atherectomy and coronary stenting.
Broad-based clinical adoption of the MIDCAB procedure will not occur until
13
<PAGE>
physicians determine that the procedure is an attractive alternative to current
treatments for coronary artery disease. The Company believes that physician
endorsements will be essential for clinical adoption of this procedure, and
there can be no assurance that any such endorsements will be obtained in a
timely manner, if at all. Clinical adoption will also depend upon the Company's
ability to facilitate training of cardiothoracic surgeons to perform minimally
invasive bypass surgery on a beating heart, and the willingness of such surgeons
to perform such a procedure. Patient acceptance of the procedure 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 the procedure as compared to other treatments.
Even if the clinical efficacy of the MIDCAB procedure 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 MIDCAB procedure as compared to other
currently available treatments. There can be no assurance that the MIDCAB
procedure will gain clinical adoption. Failure of the MIDCAB procedure to
achieve significant clinical adoption would have a material adverse effect on
the Company's business, financial condition and results of operations.
DEPENDENCE ON THE MIDCAB SYSTEM; UNCERTAINTY OF MARKET ACCEPTANCE OF THE
MIDCAB SYSTEM. The MIDCAB System is the Company's primary near-term product
focus and is expected to account for the great majority of the Company's
revenues for the foreseeable future. The components of the MIDCAB System are in
the early stages of development, and only certain of these instruments have been
tested on humans on a limited basis. Therefore, they will require further
development, as well as regulatory clearance or approval, before they can be
marketed in the United States or internationally. Designs for certain of these
components have not yet been formalized, and final prototypes have not yet been
developed. The Company has never sold any products, and there can be no
assurance that the Company's development efforts will be successful or that its
products under development will be shown to be safe or effective, capable of
being manufactured in commercial quantities at acceptable costs, cleared or
approved by regulatory authorities or successfully marketed. Nor can there be
any assurance that demand for the MIDCAB System will be sufficient to allow
profitable operations. Failure of the MIDCAB System to be successfully
commercialized would have a material adverse effect on the Company's business,
financial condition and results of operations.
LACK OF REGULATORY APPROVALS. The design, manufacturing, labeling,
distribution and marketing of certain components of the MIDCAB System and the
Saphenous Vein Harvesting System will be subject to extensive and rigorous
government regulation in the United States and certain other countries where the
process of obtaining and maintaining required regulatory clearance or approvals
is lengthy, expensive and uncertain. In order for the Company to market certain
of its 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 intends to seek clearance to market each of the remaining
components of the MIDCAB System and the Saphenous Vein Harvesting System through
a 510(k) premarket notification. The Company has been notified by the FDA that
it is exempted from filing a premarket notification for the CTS Access Platform
and the Stabilizer and is allowed to market these products in the United States.
In September 1996 the Company filed 510(k) premarket notifications for clearance
to market additional components of the MIDCAB System and certain components of
the Saphenous Vein Harvesting System. There can be no assurance that the FDA
will act favorably or quickly on the Company's 510(k) submissions, or that
significant difficulties and costs will not be encountered by the Company in its
efforts to obtain FDA clearance or approval. Any such difficulties could delay
or preclude obtaining regulatory clearance or approval. In addition,
particularly if the Company packages and labels the components of the MIDCAB
System as a surgical
14
<PAGE>
kit as currently planned, there can be no assurance that the FDA will not
request additional data, require that the Company conduct clinical studies or
require a more extensive regulatory submission known as a premarket approval
("PMA") application, causing the Company to incur substantial costs and delays.
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 of a 510(k) premarket notification or approval of a PMA, 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
and agents must 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. There can be no assurance that the Company will obtain regulatory
registrations or approvals in 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 registrations or approvals to
market the Company's products under development, failure to receive these
registrations or approvals, or future loss of previously received registrations
or approvals could have a material adverse effect on the Company's business,
financial condition and results of operations.
The European Union has promulgated rules that require that medical products
receive by mid-1998 the right to affix the CE mark, an international symbol of
adherence to quality assurance standards and compliance with applicable European
medical device directives. In order to obtain the right to affix the CE mark to
its products under development, the Company will need to obtain certification
that its processes meet ISO 9000 quality standards. Failure to receive the right
to affix the CE mark will prohibit the Company from selling its products in
member countries of the European Union after mid-1998. There can be no assurance
that the Company will be successful in meeting ISO 9000 quality standards or
other certification requirements.
CONTINUING GOVERNMENT REGULATION. Regulatory clearances or approvals, if
granted, may include significant limitations on the indicated uses for which the
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 will be required to comply with
the Good Manufacturing Practices ("GMP") regulations of the FDA. These
regulations include design, testing, production, control, documentation and
other requirements. Enforcement of GMP regulations has increased significantly
in the last several years, and the FDA has publicly stated that compliance will
be more strictly scrutinized. The Company's facilities and manufacturing
processes, as well as those of any future third-party suppliers, will be subject
to periodic inspection by the FDA, the California Department of Health Services
and other agencies. To date, the Company has not undergone such an inspection.
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
15
<PAGE>
clearance or premarket approval for devices, withdrawal of clearances or
approvals and criminal prosecution, which could have a material adverse effect
on the Company's business, financial condition and results of operations.
HIGHLY COMPETITIVE MARKET; RISK OF ALTERNATIVE THERAPIES; RISK OF REUSE.
The medical device industry and the market for treatment of cardiovascular
disease, in particular, are characterized by rapidly evolving technology and
intense competition. A number of competitors, including Johnson & Johnson,
Boston Scientific Corporation, Cordis 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 and 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
cardiothoracic surgery is expected to be intense and to increase. Heartport,
Inc., Medtronic, Inc., Research Medical Inc. and United States Surgical Corp.
have announced that they are developing products to be used in minimally
invasive coronary procedures. There can be no assurance that the MIDCAB
procedure will replace any current treatments. Additionally, even if it is
widely adopted, there can be no assurance that the Company's competitors will
not succeed in developing alternative procedures and technologies or competing
devices to perform the same procedure or therapeutic drugs that are more
effective than the Company's products or that render the Company's products or
technologies obsolete or not competitive. In addition, there can be no assurance
that existing products for other surgical uses will not be used in MIDCAB
procedures. Furthermore, sales of the MIDCAB System could be adversely affected
by reuse of the Company's products, notwithstanding the instructions in the
Company's clinical protocols and product labeling indicating that each of the
components of the MIDCAB System is a single-use device. Such competition or
reuse could have a material adverse effect on the Company's business, financial
condition and results of operations.
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 two issued
United States patents. The issued patents do not contain any claims that protect
the Company's products that are currently under development. The Company is the
licensee of a United States patent application for bipolar electrosurgical
scissors that are used in the IMA Harvester and the Saphenous Vein Harvesting
System. The Company has recently filed fourteen patent applications. 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 application or United States and
international patent applications will provide any competitive advantages for
the Company's products or that they will not be successfully challenged,
invalidated or circumvented 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 United States Patent and Trademark Office ("USPTO")
to determine the
16
<PAGE>
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 proceedings to which the Company may
become a party, including any litigation that may arise against the Company as
described in "Potential Litigation" below, could subject the Company to
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.
Legislation is pending in Congress that, if enacted in its present form,
would limit the ability of medical device manufacturers in the future to obtain
patents on surgical and medical procedures that are not performed by, or as part
of, devices or compositions which are themselves patentable. While the Company
cannot predict whether the legislation will be enacted, or precisely what
limitations will result from the law if enacted, any limitation or reduction in
the patentability of medical and surgical methods and procedures could have a
material adverse effect on the Company's ability to protect its proprietary
methods and procedures.
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.
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 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 also claims 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.
EARLY STAGE OF DEVELOPMENT AND COMMERCIALIZATION; NO ASSURANCE OF ABILITY
TO MANAGE GROWTH. The Company believes that, if successfully developed, the
Company's products under development could address a large potential market.
There can be no assurance that the Company's development and marketing efforts
will result in commercially available products to address this market, or that
demand for the Company's products, once they are available, will grow. Even if
demand for the Company's products does grow, there can be no assurance that the
Company will be able to
17
<PAGE>
develop the necessary manufacturing capability; build and train the necessary
manufacturing, sales and marketing teams; attract, retain and integrate the
required key personnel; or implement the financial and management systems to
meet growing demand for its products. Failure of the Company to successfully
manage its growth would have a material adverse effect on the Company's
business, financial condition and results of operations.
DEPENDENCE UPON KEY PERSONNEL. The Company's ability to operate
successfully depends in significant part upon the continued service of certain
key scientific, technical, managerial and finance personnel, and its continuing
ability to attract and retain additional highly qualified scientific, technical,
managerial and finance personnel. Competition for such personnel is intense, and
there can be no assurance that the Company can retain such personnel or that it
can attract or retain other highly qualified scientific, technical, managerial
and finance personnel in the future, including key manufacturing, sales and
marketing personnel. The loss of key personnel or the inability to hire or
retain qualified personnel could have a material adverse effect upon the
Company's business, financial condition and results of operations. In addition,
many employees of the Company, including a number of its key scientific,
technical and managerial personnel, are subject to the terms of confidentiality
agreements with respect to proprietary information of their former employers.
The failure of these employees to comply with the terms of their agreements
with, or other obligations to, such former employers could result in assertion
of claims against the Company and such employees, which, if successful, could
restrict their role with the Company and have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE UPON SCIENTIFIC ADVISORS. The Company has established a
Scientific Advisory Board including cardiothoracic surgery opinion leaders,
prominent surgeons and leading interventional cardiologists who the Company
believes have performed the vast majority of MIDCAB procedures. Members of the
Scientific Advisory Board consult with the Company regarding research and
development efforts at the Company, but are employed elsewhere on a full-time
basis. As a result, they can only spend a limited amount of time on the
Company's affairs. Although the Company has entered into consulting agreements,
with terms ranging from six months to four years, and confidentiality agreements
with each of the members of its Scientific Advisory Board, there can be no
assurance that the consulting and confidentiality agreements between the Company
and each of the members of the Scientific Advisory Board will not be terminated
or breached, and there can be no assurance that any of such agreements will be
renewed upon expiration.
LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE. The Company
currently has no sales and only has a small sales and marketing organization. In
the event the Company is successful in developing its products, manufacturing
them in commercial quantities, and receiving necessary FDA clearances or
approvals and other regulatory registrations or approvals, the Company intends
to sell them in the United States and certain European countries through a
direct sales force. In other markets, the Company intends to sell its products
under development primarily through distributors or by means of collaborative
arrangements. There can be no assurance that the Company will be able to build a
direct sales force or marketing organization, that establishing 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 enter into agreements with distributors or
collaborative arrangements on a timely basis or at all, or that such
distributors or collaborators will devote adequate resources to selling the
Company's products under development. In addition, to the extent that the
Company enters into distribution agreements or collaborative arrangements for
the sale of its products under development, the Company will be dependent upon
the
18
<PAGE>
efforts of third parties, and there can be no assurance that such efforts will
be successful. Failure to build an effective sales and marketing organization or
to establish effective distribution or collaborative relationships could have a
material adverse effect on the Company's business, financial condition and
results of operations.
RELIANCE ON THIRD-PARTY DEVELOPER. The Company has an agreement with
Enable Medical Corp. ("Enable"), which provides for the co-development by Enable
and the Company of the IMA Harvester and the Saphenous Vein Harvesting System.
The Company is the exclusive licensee of the Saphenous Vein Harvesting System
and has an exclusive license to the IMA Harvester in the area of minimally
invasive cardiothoracic surgery. The successful development of these products
will be largely dependent upon the efforts of Enable. The failure of Enable and
the Company to develop the licensed products successfully could have a material
adverse effect upon the Company's business, financial condition and results of
operations.
NO MANUFACTURING EXPERIENCE; SCALE-UP RISK. To date, the Company's
manufacturing activities have consisted only of building certain prototype
devices. As a result, the Company has no experience manufacturing its products
under development in the volumes that would be necessary for the Company to
achieve significant commercial sales, if the necessary regulatory clearances,
registrations or approvals are obtained and the Company's products are
successfully introduced. There can be no assurance that reliable, high-volume
manufacturing can be established or maintained at commercially reasonable costs.
In August of 1996, the Company relocated its operations to a larger facility,
which will be used to manufacture its products. The Company is currently setting
up its manufacturing line at the new facility. Companies often encounter
difficulties in scaling up production, including problems involving production
yield, quality control and assurance, and shortages of qualified personnel. In
addition, the Company's manufacturing facilities will be subject to GMP
regulations, international quality standards and other regulatory requirements.
Difficulties encountered by the Company in manufacturing scale-up or failure by
the Company to implement and maintain its facilities in accordance with GMP
regulations, international quality standards or other regulatory requirements
could entail a delay or termination of production, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
POTENTIAL COMPONENT SHORTAGES; DEPENDENCE ON SOLE SOURCES OF SUPPLY. If
and when the Company begins to manufacture its products, it will contract 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 under development until a new source of
supply is qualified. 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.
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 under development, 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,
19
<PAGE>
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 will 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 under development to obtain sufficient reimbursement
from health care payors for the procedure 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.
If the Company obtains the necessary foreign regulatory registrations or
approvals, market acceptance of the Company's products in international markets
would be 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.
RISKS RELATING TO INTERNATIONAL OPERATIONS. In the event the Company is
successful in developing its products, manufacturing them in commercial
quantities, and receiving necessary FDA and foreign regulatory registrations or
approvals, the Company plans to market its products in international markets.
Changes in overseas economic conditions, currency exchange rates, foreign tax
laws, or tariffs or other trade regulations could have a material adverse effect
on the Company's business, financial condition and results of operations. The
anticipated international nature of the Company's business is also expected to
subject it and its representatives, agents and distributors to laws and
regulations of the foreign jurisdictions in which they operate or the Company's
products under development are sold. The regulation of medical devices in a
number of such jurisdictions, particularly in the European Union, continues to
develop and there can be no assurance that new laws or regulations will not have
an adverse effect on the Company's business, financial condition and results of
operations. In addition, the laws of certain foreign countries do not protect
the Company's intellectual property rights to the same extent as do the laws of
the United States.
PRODUCT LIABILITY RISK; LIMITED INSURANCE COVERAGE. The development,
manufacture and sale of medical products entail significant risk of product
liability claims and product recalls. The Company's current product liability
insurance coverage limits are $3,000,000 per occurrence and $3,000,000 in the
aggregate, and there can be no assurance that such coverage limits are adequate
to protect the Company from any liabilities it might incur in connection with
the development, manufacture and sale of its products. In addition, the Company
may require increased product liability coverage if any products are used in
clinical trials or successfully commercialized. 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.
20
<PAGE>
POSSIBLE FUTURE CAPITAL REQUIREMENTS. The Company's capital requirements
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 generate market acceptance and demand, and other factors. The Company
expects to devote substantial capital resources for research and development, to
hire and develop a direct sales force in the United States and to expand
manufacturing capacity and facilities. The timing and amount of such capital
requirements cannot be accurately predicted. Consequently, the Company may be
required to raise additional funds through public or private financing,
collaborative relationships or other arrangements. There can be no assurance
that the Company will not require additional funding or that such additional
funding, if needed, will be available on terms attractive to the Company, or at
all, which could have a material adverse effect on the Company's business,
financial condition and results of operations. Any additional equity financing
may be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants.
POTENTIAL VOLATILITY OF STOCK PRICE. The stock markets have experienced
price and volume fluctuations that have particularly affected medical technology
companies, resulting in changes in the market prices of the stocks of many
companies that may not have been directly related to the operating performance
of those companies. Such broad market fluctuations may adversely affect the
market price of the Company's Common Stock. In addition, the market price of the
Common Stock may be highly volatile. Factors such as variations in the Company's
financial results, comments by securities analysts, announcements of
technological innovations or new products by the Company or its competitors,
changing government regulations and developments with respect to FDA
submissions, patents, proprietary rights or litigation may have a significant
adverse effect on the market price of the Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE; POTENTIAL ADVERSE EFFECT ON PRICE OF
COMMON STOCK. Sales of a substantial number of shares of the Company's
Common Stock in the public market could adversely affect the market price of
the Common Stock. The number of shares of Common Stock available for sale in
the public market is limited by restrictions under the Securities Act of
1933, as amended (the "Securities Act"); however, shares held by existing
stockholders will become eligible for sale at various times over a period of
less than two years, subject in some cases to volume restrictions. In
addition, the Company has filed a registration statement on Form S-8 under
the Securities Act to register the future issuance of all shares of Common
Stock reserved for issuance under the Company's Incentive Stock Plan,
Nonstatutory Stock Option Plan, Director Option Plan and Employee Stock
Purchase Plan. Accordingly, shares registered thereunder will, subject to
Rule 144 limitations applicable to affiliates, be available for sale in the
public market, except to the extent that such shares are subject to vesting
restrictions with the Company or certain contractual restrictions on sale or
transfer. The holders of approximately 5,025,000 shares of Common Stock are
entitled to certain demand and piggyback rights with respect to registration
of such shares under the Securities Act. If such holders, by exercising their
demand registration rights, cause a large number of securities to be
registered and sold in the public market, such sales could have an adverse
effect on the market price of the Company's Common Stock. If the Company were
to initiate a registration and include shares held by such holders pursuant
to the exercise of their piggyback registration rights, such sales could have
an adverse effect on the Company's ability to raise needed capital.
ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER AND BYLAWS PROVISIONS ON PRICE OF
COMMON STOCK. Certain provisions of the Company's Restated Certificate of
Incorporation and Bylaws may have the
21
<PAGE>
effect of making it more difficult for a third party to acquire, or discouraging
a third party from attempting to acquire, control of the Company. Such
provisions could limit the price that certain investors might be willing to pay
in the future for shares of the Company's Common Stock. Certain of these
provisions allow the Company to issue Preferred Stock without any vote or
further action by the stockholders, eliminate the right of stockholders to act
by written consent without a meeting and specify procedures for director
nominations by stockholders and submission of other proposals for consideration
at stockholder meetings and may eliminate cumulative voting in the election of
directors. Certain provisions of Delaware law applicable to the Company could
also delay or make more difficult a merger, tender offer or proxy contest
involving the Company, including Section 203 of the Delaware General Corporation
Law, which prohibits a Delaware corporation from engaging in any business
combination with any interested stockholder for a period of three years unless
certain conditions are met. The possible issuance of Preferred Stock, the
procedures required for director nominations and stockholder proposals and
Delaware law could have the effect of delaying, deferring or preventing a change
in control of the Company, including without limitation, discouraging a proxy
contest or making more difficult the acquisition of a substantial block of the
Company's Common Stock. These provisions could also limit the price that
investors might be willing to pay in the future for shares of the Company's
Common Stock.
CONTROL BY DIRECTORS, EXECUTIVE OFFICERS AND AFFILIATED ENTITIES. The
Company's directors, executive officers and entities affiliated with them, in
the aggregate, beneficially own a substantial amount of the Company's
outstanding shares of Common Stock. These stockholders, if acting together,
would be able to significantly influence all matters requiring approval by the
stockholders of the Company, including the election of directors and the
approval of mergers or other business combination transactions.
22
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8 - K.
a) Exhibits
` 3.1* Restated Certificate of Incorporation, as in effect
prior to initial public offering.
3.2* Restated Certificate of Incorporation.
3.3* Bylaws of Registrant.
4.1* Specimen Common Stock Certificate.
10.1* Form of Indemnification Agreement between the Company
and each of its directors and officers.
10.2* Incentive Stock Plan and form of Agreements thereunder.
10.3* Director Option Plan and form of Director Stock Option
Agreement thereunder.
10.4* Employee Stock Purchase Plan and forms of agreements
thereunder.
10.5* Nonstatutory Stock Option Plan and form of
Nonstatutory Stock Option Agreement thereunder.
10.6* Form of Employment, Confidential Information and
Invention Assignment Agreement.
10.7* Consulting Letter Agreement, dated May 17, 1994,
between Informed Creation and Susan W. Vican.
10.8* Consulting Agreement, dated June 30, 1995, between the
Company and Federico Benetti, M.D.
23
<PAGE>
10.9* 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* Employment Letter Agreement, dated September 5, 1995,
between the Company and Charles S. Taylor.
10.11* Assignment Agreement, dated September 7, 1995, between
the Company and Charles S. Taylor.
10.12* 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* Letter Agreement regarding Heartport trade secret
allegations, dated October 11, 1995, between the
Company and Charles S. Taylor.
10.14* 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.
10.15* Assignment, Assumption of Lease and Consent, dated
November 9, 1995, between the Company and CVC for the
premises located at 3280 Alpine Road, Portola Valley,
California 94028.
10.16* Promissory Note, dated December 4, 1995, between the
Company and Ivan Sepetka.
10.17* 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.
10.18* Consent to Assignment, dated December 22, 1995, among
the Company, Viking, CVC and General Surgical
Innovations, Inc. for the premises located at 3280
Alpine Road, Portola Valley, California 94028.
10.19* 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.
10.20* First Amendment to Assignment, Assumption of Lease and
Consent, dated December 22, 1995, between the Company
and CVC for the premises located at 3280 Alpine Road,
Portola Valley, California 94028.
10.21* Consulting Agreement, dated February 21, 1996, between
the Company and Thomas J. Fogarty, M.D.
10.22* Development and License Agreement, dated February 19,
1996, between the Company and Enable Medical Corp.
10.23* Employment Letter Agreement, dated March 15, 1996,
between the Company and Steve M. Van Dick.
10.24* Lease dated March 29, 1996 for space located at 10600
North Tantau Avenue, Cupertino, California between the
Company and Spieker
24
<PAGE>
Properties, L.P.
10.25(1) Employment Letter Agreement, dated February 22, 1996,
between the Company and Thomas Afzal.
10.26(1) Employment Letter Agreement, dated March 13, 1996,
between the Company and Robert Rosenbluth.
10.27(2) Employment Agreement, dated April 19, 1996, between the
Company and Steve Van Dick.
10.28(2) Promissory Note for $300,000 dated April 29, 1996,
between the Company and Thomas Afzal.
10.29(2) Promissory Note for $35,000 dated May 20, 1996, between
the Company and Michael J. Billig.
10.30(2) Promissory Note for $55,000 dated June 5, 1996, between
the Company and Thomas Afzal.
10.31 Promissory Note for $750,000 and Security Agreement
dated August 16, 1996, between the Company and Richard
Ferrari.
11.1 Calculation of earnings per share.
- -------------------
* 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).
(1) Incorporated herein by reference to the same-numbered exhibit previously
filed with the Company's Form 10Q for the period ended March 31, 1996.
(2) Incorporated herein by reference to the same-numbered exhibit previously
filed with the Company's Form 10Q for the period ended June 30, 1996.
b) Reports on Form 8 - K
None
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 12, 1996 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)
26
<PAGE>
EXHIBIT INDEX
Exhibit Page
Number Exhibit Description Number
- ------ ------------------------------------------ ------
10.31 Promissory Note for $750,000 and Security Agreement
dated August 16, 1996, between the Company and
Richard Ferrari.
11.1 Calculation of earnings per share.
27
<PAGE>
NOTE
$750,000 CUPERTINO, CA
August 16, 1996
FOR VALUE RECEIVED, Richard M. Ferrari promises to pay to CardioThoracic
Systems, Inc., a Delaware corporation (the "Company"), or order, the principal
sum of Seven Hundred Fifty Thousand and 00/100 Dollars ($750,000), together with
no interest.
Principal shall be due and payable on the earlier of (a) August 16, 2000,
and (b) the date which is 120 days after the date when the undersigned shall
cease to be an employee or consultant of the Company. Should the undersigned
fail to make full payment of principal for a period of 10 days or more after the
due date thereof, the whole unpaid balance on this Note of principal shall
become immediately due at the option of the holder of this Note. Payments of
principal shall be made in lawful money of the United States of America.
The undersigned may at any time prepay all or any portion of the principal
owing hereunder.
This Note is secured in part by a pledge of the company's common Stock
under the terms of a Security Agreement of even date herewith and is subject to
all the provisions thereof.
The holder of this Notes shall have full recourse against the undersigned,
and shall not be required to proceed against the collateral securing this Note
in the event of default.
In the event the undersigned shall cease to be an employee or consultant of
the company for any reason, this Note shall, at the option of the Company, be
accelerated, and the whole unpaid balance on this Note of principal shall be due
and payable on the date which is 120 days after the date on which the
undersigned ceased to be an employee or consultant of the company.,
Should any action be instituted for the collection of this Note, the
reasonable cost and attorneys' fees therein of the holder shall be paid by the
undersigned.
/s/ Richard M. Ferrari
----------------------------------------
Richard M. Ferrari
<PAGE>
SECURITY AGREEMENT
This Security Agreement is made as of August 16, 1996 between
CardioThoracic Systems, Inc., a Delaware corporation ("Pledgee"), and Richard M.
Ferrari ("Pledgor").
RECITALS
Pursuant to Pledgor's Note date and given to Pledgee on the date hereof
(the "Note"), Pledgor has borrowed $750,000 form Pledgee and wishes to secure
repayment of the Note with shares of Pledge's Common Stock (the "Shares").
NOW, THEREFORE, it is agreed as follows:
1. CREATION AND DESCRIPTION OF SECURITY INTEREST. In consideration of
the loan of $750,000 to Pledgor under the Note, Pledgor, pursuant to the
California Commercial Code, hereby pledges 75,000 Shares (herein sometimes
referred to as the "Collateral") represented by certificate number ______, duly
endorsed in blank or with executed stock powers, and herewith delivers said
certificate to the Secretary of Pledgee ()"Pledgeholder"), who shall hold said
certificate subject to the terms and conditions of this Security Agreement.
The pledged stock (together with an executed blank stock assignment for use
in transferring all or a portion of the Shares to Pledgee if, as and when
required pursuant to this Security Agreement) shall be held by the Pledgeholder
as security for the repayment of the Note, and any extensions or renewals
thereof, executed by Pledgor, and the Pledgeholder shall not encumber dispose of
such Shares except in accordance with provisions of this Security Agreement.
2. PLEDGOR'S REPRESENTATIONS AND COVENANTS. To induce Pledgee to enter
into this Security Agreement, Pledgor represents and covenants to Pledgee, its
successors and assigns, as follows:
a. PAYMENT OF INDEBTEDNESS. Pledgor will pay the principal sum of
the Note secured hereby, together with interest thereon, at the time and in the
manner provided in the Note.
b. ENCUMBRANCES. The Shares are free of all other encumbrances,
defenses and liens, and Pledgor will not further encumber the Shares without the
prior written consent of Pledgee.
c. MARGIN REGULATIONS. In the event that Pledgee's Common Stock is
now or later becomes margin-listed by the Federal Reserve Board and Pledgee is
classified as a "lender" within the meaning of the regulations under Part 207 of
Title 12 of the Code of Federal Regulations
<PAGE>
("Regulation G"), Pledgor agrees to cooperate with Pledgee in making any
amendments to the Note or providing any additional collateral as may be
necessary to comply with such regulations.
3. VOTING RIGHTS. During the term of this pledge and so long as all
payments of principal and interest are made as they become due under the terms
of the Note, Pledgor shall have the right to vote all of the Shares pledged
hereunder.
4. STOCK ADJUSTMENTS. In the event that during the term of the pledge
any stock dividend, reclassification, readjustment or other changes are declared
or made in the capital structure of Pledgee, all new, substituted and additional
shares or other securities issued by reason of any such change shall be
delivered to and held by the Pledgee under the terms of this Security Agreement
in the same manner as the Shares originally pledged hereunder. In the event of
substitution of such securities, Pledgor, Pledgee and Pledgeholder shall
cooperate and execute such documents as are reasonable so as to provide for the
substitution of such Collateral and, upon substitution, references to "Shares"
in this Security Agreement shall include the substituted shares of capital stock
of Pledgor as a result thereof.
5. OPTIONS AND RIGHTS. In the event that, during the term of this
pledge, subscription Options or other rights or options shall be issued in
connection with the pledged Shares, such rights, Options and options shall be
the property of Pledgor and, if exercised by Pledgor, all new stock or other
securities so acquired by Pledgor as it relates to the pledged Shares then held
by Pledgeholder shall be immediately delivered to Pledgeholder, to be held under
the terms of this Security Agreement in the same manner as the Shares pledged.
6. DEFAULT. Pledgor shall be deemed to be in default of the Note and of
this Security Agreement in the event:
a. Payment of principal or interest on the Note shall be delinquent
for a period of 10 days or more; or
b. Pledgor fails to perform any of the covenants contained in this
Security Agreement for a period of 10 days after written notice thereof from
Pledgee.
In the case of an event of default, as set forth above, Pledgee shall have
the right to accelerate payment of the Note upon notice to Pledgor, and Pledgee
shall thereafter be entitled to pursue its remedies under the California
Commercial Code.
7. RELEASE OF COLLATERAL. Subject to any applicable contrary rules under
Regulation G, there shall be released from this pledge a portion of the pledged
Shares held by Pledgeholder hereunder upon payments of the principal of the
Note. The number of the pledged Shares which shall be released shall be that
number of full Shares which bears the same proportion to the initial number of
Shares pledged hereunder as the payment of principal bears to the initial full
principal amount of the Note.
-2-
<PAGE>
8. WITHDRAWAL OR SUBMISSION OF COLLATERAL. Pledgor shall not sell,
withdraw, pledge, substitute or otherwise dispose of all of any part of the
Collateral without the prior written consent of Pledgee.
9. TERM. The within pledge of shares shall continue until the payment of
all indebtedness secured hereby, at which time the remaining pledged stock shall
be promptly delivered to Pledgor, subject to the provisions for prior release of
the Collateral as provided in paragraph 7 above.
10. INSOLVENCY. Pledgor agrees that if a bankruptcy or insolvency
proceeding is instituted by or against it, or if a receiver is appointed for the
property of Pledgor, or if Pledgor makes an assignment for the benefit of
creditors, the entire amount unpaid on the Note shall become immediately due and
payable, and Pledgee may proceed as provided in the case of default.
11. PLEDGEHOLDER LIABILITY. In the absence of willful or gross
negligence, Pledgeholder shall not be liable to any party for any of his acts,
or omissions in the case of default.
12. INVALIDITY OF PARTICULAR PROVISIONS. Pledgor and Pledgee agree that
the enforceability of invalidity of any provisions or provisions of this
Security Agreement shall not render any other provision or provisions herein
contained unenforceable or invalid.
13. SUCCESSORS OR ASSIGNS. Pledgor and Pledgee agree that all of the
terms of this Security Agreement shall be binding on their respective successors
and assigns, and that the term "Pledgor" and the term "Pledgee" as used herein
shall be deemed to include, for all purposes, the respective designees,
successors, assigns, heirs, executors and administrators.
14. GOVERNING LAW. This Security Agreement shall be interpreted and
governed under the laws of the State o California.
-3-
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the day and year first above written.
"PLEDGOR" By: /s/ Richard M. Ferrari
-----------------------------------
-----------------------------------
Richard M. Ferrari
Address: 19575 Three Oaks Way
-----------------------------------
Saratoga, Ca. 95070
-----------------------------------
"PLEDGEE" CARDIOTHORACIC SYSTEMS, INC.,
a Delaware corporation
By: /s/ Steve Van Dick
-----------------------------------
Title: CFO
----------------------------------
"PLEDGEHOLDER" /s/ J. Casey McGlynn
----------------------------------------
J. Casey McGlynn
Secretary of
CardioThoracic Systems, Inc.
-4-
<PAGE>
Exhibit 11.1
CardioThoracic Systems, Inc.
(a company in the development stage)
Statement Re: Computations of Earnings Per Share
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
September 30, 1996 September 30, 1995
------------------ ------------------
<S> <C> <C>
Net loss $ (4,317,530) $ (229,598)
-------------- -------------
-------------- -------------
Weighted average common
shares outstanding 12,966,283 2,782,857
Shares related to SAB No. 55,
64, and 83 - 6,666,197
-------------- -------------
Total weighted average
common shares outstanding 12,966,283 9,449,054
-------------- -------------
-------------- -------------
Net loss per share $ (0.33) $ (0.02)
-------------- -------------
-------------- -------------
<CAPTION>
Period from
June 15, 1995
Nine Months Ended (date of inception) to
September 30, 1996 September 30, 1996
------------------ -----------------------
<S> <C> <C>
Net loss $ (11,162,662) $ (12,159,875)
-------------- --------------
-------------- --------------
Weighted average common
shares outstanding 4,752,761 3,922,574
Shares related to SAB No. 55,
64, and 83 6,666,197 6,666,197
-------------- --------------
Total weighted average
common shares outstanding 11,418,958 10,588,771
-------------- --------------
-------------- --------------
Net loss per share $ (0.98) $ (1.15)
-------------- --------------
-------------- --------------
</TABLE>
33
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10Q FOR
THE PERIOD ENDED SEPTEMBER 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 48,892,562
<SECURITIES> 32,408,328
<RECEIVABLES> 115,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 81,591,374
<PP&E> 2,221,153
<DEPRECIATION> 116,159
<TOTAL-ASSETS> 84,732,610
<CURRENT-LIABILITIES> 2,386,800
<BONDS> 0
0
0
<COMMON> 103,195,187
<OTHER-SE> (8,689,502)
<TOTAL-LIABILITY-AND-EQUITY> 84,732,610
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 13,151,978
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (11,162,662)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,162,662)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,162,662)
<EPS-PRIMARY> (.98)
<EPS-DILUTED> (.98)
</TABLE>
