<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
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 000-26745
================================================================================
ORATEC INTERVENTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3180773
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
3700 Haven Court
Menlo Park, California 94025
(Address of principal executive offices, including zip code)
650-369-9904
(Registrant's telephone number, including area code)
================================================================================
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
As of July 31, 2000, there were 22,114,780 shares of the registrant's
Common Stock outstanding.
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INDEX
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited).
Condensed Balance Sheets - June 30, 2000 and 3
December 31, 1999
Condensed Statements of Operations - Three and six months 4
ended June 30, 2000 and 1999
Condensed Statements of Cash Flows - Six months 5
ended June 30, 2000 and 1999
Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and 8
Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 17
Item 2. Changes in Securities and Use of Proceeds. 17
Item 3. Defaults Upon Senior Securities. 17
Item 4. Submission of Matters to a Vote of Security Holders. 17
Item 5. Other Information. 17
Item 6. Exhibits and Reports on Form 8-K. 17
SIGNATURES 18
</TABLE>
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
ORATEC INTERVENTIONS, INC.
CONDENSED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
----- ----
(unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents......................................................... $ 55,524 $ 5,943
Short term investments............................................................ -- 2,931
Accounts receivable, net.......................................................... 8,898 6,306
Inventories....................................................................... 5,144 3,248
Prepaid expenses and other current assets......................................... 1,681 1,004
---------- ---------
Total current assets......................................................... 71,247 19,432
Property and equipment, net........................................................... 8,398 4,409
---------- ---------
$ 79,645 $ 23,841
========== =========
Liabilities and stockholders' equity
Current liabilities:
Bank borrowings................................................................... $ -- $ 3,427
Accounts payable.................................................................. 1,970 1,735
Accrued compensation and benefits................................................. 3,378 2,953
Other accrued liabilities......................................................... 2,000 1,817
Current portion of notes payable.................................................. 3,502 1,705
Current portion of equipment financing obligations................................ 440 1,425
---------- ---------
Total current liabilities............................................................. 11,290 13,062
Long term notes payable............................................................... -- 2,295
Long term equipment financing obligations............................................. 10 2,053
Commitments
Redeemable convertible preferred stock, $0.001 par value.............................. -- 35,816
Common stock, $0.001 par value ....................................................... 22 4
Additional paid-in capital............................................................ 98,444 1,625
Deferred stock compensation........................................................... (275) (320)
Receivable from stockholder........................................................... -- (9)
Accumulated deficit................................................................... (29,846) (30,685)
---------- ---------
$ 79,645 $ 23,841
========== =========
</TABLE>
See accompanying notes.
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ORATEC INTERVENTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data, unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Sales .................................................................... $ 13,563 $7,703 $ 26,226 $ 12,899
Cost of sales ............................................................ 3,782 3,433 7,428 6,261
------ ------- -------- --------
Gross profit ............................................................. 9,781 4,270 18,798 6,638
Operating expenses:
Research and development ............................................. 1,486 978 2,804 2,022
Sales and marketing .................................................. 6,196 4,240 12,231 7,494
General and administrative ........................................... 1,239 823 2,274 1,820
Stock compensation (1)................................................ 661 247 920 247
------ ------- -------- --------
Total operating expenses ................................................. 9,582 6,288 18,229 11,583
Income (loss) from operations ............................................ 199 (2,018) 569 (4,945)
Interest and other income ................................................ 771 175 939 341
Interest and other expense ............................................... (303) (408) (624) (680)
------ ------- ------ --------
Income (loss) before income taxes......................................... 667 (2,251) 884 (5,284)
Provision for income taxes................................................
34 -- 45 --
------ ------- -------- --------
Net income (loss) ........................................................ $ 633 $(2,251) $ 839 $ (5,284)
====== ======= ======== ========
Basic net income (loss) per share ........................................ $ 0.03 $ (0.55) $ 0.07 $ (1.29)
====== ======= ======== =======
Diluted net income (loss) per share ...................................... $ 0.03 $ (0.55) $ 0.04 $ (1.29)
======= ======= ======== =======
Pro forma diluted net income (loss) per share ............................ $ 0.03 $ (0.14) $ 0.04 $ (0.33)
====== ======= ======== =======
Shares used in computing basic net income (loss) per share ............... 21,138 4,113 12,847 4,088
Shares used in computing diluted net income (loss) per share ............. 24,561 4,113 21,717 4,088
Shares used in computing pro forma diluted net income (loss) per share ... 24,561 16,193 21,717 16,157
</TABLE>
(1) Stock compensation expense relates to research and development expenses.
See accompanying notes.
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ORATEC INTERVENTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(In thousands, unaudited)
<TABLE>
<CAPTION>
Six months ended
June 30,
2000 1999
----- ----
<S> <C> <C>
Operating activities:
Net income (loss) ...................................................................... $ 839 $(5,284)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization ....................................................... 1,739 1,825
Stock compensation expense .......................................................... 920 216
Issuance of equity for non-cash benefits ............................................ 120 36
Changes in operating assets and liabilities:
Accounts receivable ............................................................... (2,592) (2,056)
Inventories ....................................................................... (1,896) (919)
Prepaid expenses and other current assets ......................................... (677) (754)
Accounts payable .................................................................. 235 444
Accrued compensation and benefits ................................................. 425 171
Other accrued liabilities ......................................................... 183 857
------- -------
Net cash used in operating activities .................................................. (704) (5,464)
------- -------
Investing activities:
Purchases of short term investments .................................................... -- (2,998)
Maturities of short term investments ................................................... 2,931 3,974
Capital expenditures ................................................................... (5,727) (1,323)
------- -------
Net cash used in investing activities .................................................. (2,796) (347)
------- -------
Financing activities:
Proceeds from issuance of common stock ................................................. 60,025 136
Repayment of stockholder receivable .................................................... 9 --
Proceeds from notes payable ............................................................ -- 4,000
Repayment of bank borrowings ........................................................... (3,427) --
Repayment of notes payable ............................................................. (498) --
Proceeds from equipment financing obligations .......................................... -- 386
Repayment of equipment financing obligations ........................................... (3,028) (137)
------- -------
Net cash provided by financing activities .............................................. 53,081 4,385
------ -------
Net increase (decrease) in cash and cash equivalents ................................... 49,581 (1,426)
Cash and cash equivalents at beginning of period ....................................... 5,943 11,583
------- -------
Cash and cash equivalents at end of period ............................................. $55,524 $10,157
======= =======
</TABLE>
See accompanying notes.
5
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ORATEC INTERVENTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation:
In the opinion of management, the accompanying unaudited condensed financial
statements contain all adjustments (all of which are normal and recurring in
nature) necessary to present fairly the financial position, results of
operations and cash flows of ORATEC Interventions, Inc. for the periods
indicated. Interim results of operations are not necessarily indicative of the
results to be expected for the full year or any other interim periods. These
condensed consolidated financial statements should be read in conjunction with
financial statements for the years ended December 31, 1998 and 1999 contained in
our Registration Statement on Form S-1 (No. 333-95815). The balance sheet at
December 31, 1999 was derived from audited financial statements; however, the
financial statements in this report are condensed and do not include all
disclosures required by generally accepted accounting principles.
2. Computation of Net Income (Loss) Per Share:
Basic net income (loss) per share is computed using the weighted-average number
of common shares outstanding. Diluted net income (loss) per common share is
computed using the weighted average number of common shares, redeemable
convertible preferred shares (on an as-if-converted basis) and common equivalent
shares outstanding during the period. Common equivalent shares are computed
using the treasury stock method and consist of shares outstanding related to
stock options and warrants. Common stock equivalents and redeemable convertible
preferred stock are excluded from the computation of diluted earnings per share
if their effect is anti-dilutive. Redeemable convertible preferred shares have
been treated as converted from the date of issuance in the pro forma
calculations of net income (loss) per share.
The following is a reconciliation of the computation for basic, diluted and pro
forma diluted net income (loss) per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------- --------
2000 1999 2000 1999
----- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss).................................................... $ 633 $(2,251) $ 839 $ (5,284)
======= ======= ======= ========
Shares used in the calculation:
Weighted-average common shares outstanding
used to compute basic net income (loss) per share................ 21,138 4,113 12,847 4,088
Weighted-average effect of dilutive securities:
Options.......................................................... 2,567 -- 2,567 --
Warrants......................................................... 192 -- 192 --
Redeemable convertible preferred shares.......................... 664 -- 6,111 --
------- ------- ------- --------
Weighted-average shares used to compute
diluted net income (loss) per share.............................. 24,561 4,113 21,717 4,088
Pro forma adjustment to reflect weighted-
average effect of assumed conversion of
redeemable convertible preferred shares.............................. -- 12,080 -- 12,069
------- ------- ------- --------
Weighted-average shares used to compute pro forma
diluted net income (loss) per share.................................. 24,561 16,193 21,717 16,157
======= ======= ======= ========
Net income (loss) per share:
Basic................................................................ $ 0.03 $ (0.55) $ 0.07 $ (1.29)
======= ======= ======= ========
Diluted.............................................................. $ 0.03 $ (0.55) $ 0.04 $ (1.29)
======= ======= ======= ========
Pro forma diluted.................................................... $ 0.03 $ (0.14) $ 0.04 $ (0.33)
======= ======= ======= ========
</TABLE>
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The Company issued 4,600,000 shares of common stock at the close of its initial
public offering on April 10th, 2000.
3. Comprehensive Income (Loss):
Comprehensive income (loss) is comprised of net income and other comprehensive
income (loss) such as foreign currency translation gain/loss and unrealized
gains or losses on available-for-sale marketable securities. For the three and
six month periods ended June 30, 2000 and June 30, 1999, reported net income
(loss) approximated comprehensive net income (loss).
4. Balance Sheet Detail (in thousands):
June 30, December 31,
2000 1999
---- ----
Inventory:
Raw materials...................... $ 2,333 $ 1,087
Work-in-process.................... 121 284
Finished goods..................... 1,755 790
Generators held for sale........... 935 1,087
----- -----
Total................................. $ 5,144 $ 3,248
======= ========
Other accrued liabilities:
Accrued professional fees.......... $ 579 $ 581
Dealer commissions................. 362 299
Clinical and development costs..... 165 189
Other.............................. 894 748
------- --------
Total................................. $ 2,000 $ 1,817
======= ========
5. Recent Accounting Pronouncements:
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements." SAB 101 summarizes certain of the SEC's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. In June 2000, the SEC issued SAB No. 101B which
defers the effective date of SAB 101 until no later than the fourth quarter
of 2000. ORATEC is currently evaluating the effect of SAB 101 on its
operations and financial position.
6. Segment Information:
ORATEC's spine and arthroscopy product sales are as follows (in thousands):
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------- --------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Spine..................................... $ 7,286 $ 3,922 $14,045 $ 5,619
Arthroscopy............................... 6,277 3,781 12,181 7,280
-------- -------- ------- ---------
$ 13,563 $ 7,703 $26,226 $ 12,899
======== ======== ======= =========
</TABLE>
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," and similar
expressions identify such forward-looking statements. These statements are not
guarantees of future performance and are subject to risks and uncertainties,
which could cause actual results to differ materially from those expressed or
forecasted. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Factors That May Affect
Future Results" and those appearing elsewhere in this Form 10-Q. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
reflect management's analysis only as of the date hereof. The Company assumes no
obligation to update these forward-looking statements to reflect actual results
or changes in factors or assumptions affecting such forward-looking statements.
Overview
ORATEC Interventions develops and markets innovative medical devices that
use controlled thermal energy to treat spine and joint disorders. From inception
in 1993 until February 1997, our operations consisted primarily of various
start-up activities, including development of technologies central to our
business, recruiting personnel and raising capital. In December 1995 we gained
FDA 510(k) clearance for our first product, our TAC probe for the treatment of
joint disorders. In March 1997, after 18 months of funding scientific and
clinical studies, we formally launched this product at the American Academy of
Orthopedic Surgeons convention. We received FDA 510(k) clearance for our
SpineCATH product in March 1998 and formally launched this product at the North
American Spine Society, or NASS, conference in October 1998. In November 1999,
we introduced the new Vulcan ElectroThermal Arthroscopy System.
All of our revenues are generated from sales of our spine and arthroscopy
products. For the six months ended June 30, 2000, 90% of our total sales was
derived from our disposable spine catheters and arthroscopy probes and 10% was
derived from sales of generators and accessories. During the six months ended
June 30, 2000, our results of operations produced a profit for the first time of
$839,000. This profitability is primarily attributable to increased unit sales
of our spine and arthroscopy products. At June 30, 2000 we had an accumulated
deficit of $29.8 million.
In the six months ended June 30, 2000, only 2% of our sales was derived
from markets outside the U.S., and we do not expect international sales to
increase significantly in the near future. In international markets, we expect
to rely exclusively on third-party distributors. Our gross margins on sales
through international third-party distributors are lower than our gross margins
on U.S. sales as a result of price discounts. We have limited or no control over
the sales efforts of these third-party distributors.
We recognize revenue upon shipment of products to customers or, in some
instances, when inventory provided to customers by our employees and sales
agencies has been used at their facilities, as evidenced by receipt of a
purchase order. Our return policy allows customers to return unopened products
up to 90 days after a sale. To date, returns have been insignificant. As is
common in the arthroscopy market, we have retained title to the majority of
arthroscopy generators, which we have placed with customers for their use with
our disposable arthroscopy probes. In connection with the market launch of our
spine products, we have been placing spine generators with customers for a
demonstration period, after which we convert these placements to sales.
Our early product sales have mainly been to a group of early adopting
physicians who are receptive to minimally invasive techniques. As we gain market
share, our opportunity for further market penetration may slow and require
additional sales efforts, longer term supporting clinical data, greater
reimbursement acceptance by payors, and further training, in order to convince
physicians who currently favor open surgery or other treatment alternatives to
switch to our minimally invasive procedures.
The medical device market is litigious. Although we are involved in a few
product liability actions, we do not believe that any of these are material to
our business or financial condition. In addition, we may become subject to
patent proceedings. The costs of such lawsuits may be material and could affect
our earnings and financial position. An adverse outcome in a patent lawsuit
could require us to cease sales of affected products or to pay royalties, which
could harm our results of operations.
Our future growth depends on expanding our current markets and finding
new high growth markets in which we can leverage our core technologies of
applying thermal energy to treat soft tissue disorders. To the extent any
current or additional markets do not materialize in accordance with our
expectations, our sales could be lower than expected.
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<PAGE>
Results of Operations
Sales
Sales increased 76% to $13.6 million for the three months ended June 30,
2000 from $7.7 million for the three months ended June 30, 1999. Sales increased
103% to $26.2 million for the six months ended June 30, 2000 from $12.9 million
for the six months ended June 30, 1999. The sales increase was led by continued
market adoption of our SpineCATH IntraDiscal Electrothermal Therapy (IDET)
system, for which sales have increased from $5.6 million to $14.0 million, or
150%, between the first six months of 1999 and the first six months of 2000. Our
arthroscopy business increased from $7.3 million to $12.2 million, or 67%,
between the first six months of 1999 and the first six months of 2000, as the
introduction of our Vulcan arthroscopy system led to greater account penetration
and probe utilization rates. The increased sales in both product lines is
attributable to new product introductions, increased numbers of physicians
trained in the use of our products, the increasing effectiveness of our spine
and arthroscopy sales forces and the numbers of generators placed in hospitals
and clinics.
Cost of sales
Cost of sales increased to $3.8 million for the three months ended June
30, 2000, a 10% increase from $3.4 million for the three months ended June 30,
1999. Cost of sales increased to $7.4 million for the six months ended June 30,
2000, a 19% increase from $6.3 million for the six months ended June 30, 1999.
The increase in overall cost of goods sold between the first two quarters of
1999 and the first two quarters of 2000 was driven by higher unit shipments and
costs of increased manufacturing capacity. Cost of sales consists of material,
labor and overhead costs, as well as depreciation on generators placed with
customers for their use with our disposable products.
Gross profit
Gross profit increased to $9.8 million, or 72% of sales, for the three
months ended June 30, 2000 from $4.3 million, or 55% of sales, for the three
months ended June 30, 1999. Gross profit increased to $18.8 million, or 72% of
sales, for the six months ended June 30, 2000 from $6.6 million, or 51% of
sales, for the six months ended June 30, 1999. The increases in overall gross
profit are attributable to sales growing at a faster pace than manufacturing and
depreciation costs and overall increases in manufacturing efficiency.
Research and development expenses
Research and development expenses increased 52% to $1.5 million for the
three months ended June 30, 2000 from $1.0 million for the three months ended
June 30, 1999. Research and development expenses increased 39% to $2.8 million
for the first six months of 2000 from $2.0 million for the first six months of
1999. The increases are related to the addition of headcount and office space
for increased development efforts on next-generation spine devices and advanced
arthroscopy probes. Research and development expenses consist of costs related
to our research and development, regulatory and clinical affairs functions, as
well as costs associated with scientific and clinical studies. We expect to
continue to make substantial investments in research and development and
anticipate that research and development expenses will continue to increase in
the future.
Sales and marketing expenses
Sales and marketing expenses increased 46% to $6.2 million for the three
months ended June 30, 2000 from $4.2 million for the three months ended June 30,
1999. Sales and marketing expenses increased 63% to $12.2 million in the first
six months of 2000 from $7.5 million for the first six months of 1999. Increased
expenses were primarily due to greater overall sales and marketing headcount,
higher commission expenses, increased marketing and training costs and expenses
associated with our reimbursement function. Sales and marketing expenses consist
primarily of costs for sales, marketing and reimbursement staff, sales
commissions, medical conference participation and physician training programs.
We anticipate that sales and marketing expenses will increase as we continue to
develop our sales and reimbursement support staffs and expand our physician
training programs.
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<PAGE>
General and administrative expenses
General and administrative expenses were $1.2 million for the three
months ended June 30, 2000, a 51% increase from $0.8 million for the three
months ended June 30, 1999. General and administrative expenses were $2.3
million for the six months ended June 30, 2000, a 25% increase from $1.8 million
for the first six months ended June 30, 1999. Increased expenses were primarily
from higher costs associated with increased headcount and patent legal costs,
along with expenses related to being a public company following our initial
public offering in April 2000. General and administrative expenses consist
primarily of personnel costs, professional service fees, expenses related to
intellectual property rights and general corporate expenses. We expect general
and administrative expenses to increase in the future as we add personnel,
continue to expand our patent portfolio and incur reporting and investor-related
expenses as a public company.
Stock compensation expense
Stock compensation expense was $661,000 and $247,000 for the three months
ended June 30, 2000 and June 30, 1999, respectively. Stock compensation expense
was $920,000 and $247,000 for the six month periods ended June 30, 2000 and
1999, respectively. Stock compensation expense relates principally to options
granted to consultants for services rendered. Stock compensation expense for
consultant options is calculated using the Black-Scholes option pricing model,
in which the price of our common stock is one of the key variables. The stock
compensation expense for the six months ended June 30, 2000 was based on the
company's average monthly stock prices for each month of 2000. To the extent
that our average price of our common stock for the remaining months of 2000 is
higher, this charge could increase significantly.
Interest and other income (expense), net
Net interest and other income was $468,000 for the three months ended
June 30, 2000, a 301% change from net interest and other expense of $(233,000)
for the three months ended June 30, 1999. Net interest and other income was
$315,000 for the six months ended June 30, 2000, a 193% change from net interest
and other expense of $(339,000) for the six months ended June 30, 1999. Net
interest and other income (expense) is comprised primarily of interest earned on
cash balances and short term investments, offset by interest expense on
equipment and debt obligations. In 2000, interest income exceeded interest
expense due to proceeds received from the company's initial public offering in
the second quarter of 2000. During the three months ended June 30, 2000, the
company paid down some of its debt balances, which will decrease future interest
expense. We expect that our future interest expense will further decrease due to
the use of additional proceeds to pay down debt balances.
Provision for income taxes
The income tax provision for the three and six months ended June 30, 2000
is based on an estimated effective annual tax rate of 5%. The income tax
provision represents primarily current state and federal minimum income taxes
after utilization of net operating loss carryforwards.
As of December 31, 1999, we had net operating loss carryforwards of
approximately $24.1 million for federal and $4.5 million for California income
tax purposes. We also had research and development credit carryforwards of
$400,000 for federal income tax purposes. The net operating loss carryforwards
will expire at various dates beginning in 2009 through 2019, if not utilized.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the ownership change limitations of the
Internal Revenue Service Code of 1986. The annual limitation may result in the
expiration of the net operating losses before utilization.
Liquidity and Capital Resources
Net cash used in operating activities was $0.7 million for the six months
ended June 30, 2000, compared to net cash used of $5.5 million for the six
months ended June 30, 1999. The decrease related mainly to the company's
profitability in the first six months of 2000, partially offset by increased
working capital requirements.
Net cash used in investing activities was $2.8 million for the six months
ended June 30, 2000, compared to $347,000 for the six months ended June 30,
1999. The increase was related to higher capital expenditures for generators and
facilities in the first six months of 2000, partially offset by the timing of
maturities of our short term investments.
Net cash provided by financing activities was $53.1 million for the six
months ended June 30, 2000, compared to net cash provided by financing
activities of $4.4 million for the six months ended June 30, 1999. The increase
is due mainly to proceeds
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<PAGE>
from the company's initial public offering and the exercise of stock options and
was partially offset by the repayment of debt balances. During the six months
ended June 30, 1999, we drew down a subordinated debt facility for $4.0 million,
which accounted for substantially all of the financing activity for that period.
As of June 30, 2000, our principal debt and other commitments consisted
of $0.4 million outstanding under our equipment loans, $3.4 million under our
subordinated debt facility and amounts payable under various operating leases
and financing agreements. We expect to increase our capital expenditures
consistent with our anticipated growth in manufacturing, infrastructure and
personnel. We also may increase our capital expenditures as we expand our
product lines or invest to address new markets.
As of June 30, 2000, we had available debt facilities totaling
approximately $4.0 million under our asset-based line of credit. Our loan
agreements with Transamerica Business Corporation and one loan agreement with
Silicon Valley Bank require the lender's consent before we can incur additional
debt. One of our loan agreements contains various financial covenants, including
a maximum debt to tangible net worth ratio of 3:1. We are currently in
compliance with all covenants.
Our principal source of liquidity at June 30, 2000 consisted of $55.5
million of cash and cash equivalents, primarily from our initial public offering
which was completed on April 10th, 2000. Our offering raised net proceeds of
approximately $58.8 million. We believe that our current cash position, along
with cash generated from the future sales of products, will be sufficient to
meet our operating and capital requirements for at least the next 18 months. If
existing cash and cash generated from operations is insufficient to satisfy our
liquidity requirements, we may seek to sell additional equity or debt securities
or obtain an additional credit facility. If additional funds are raised through
the issuance of debt securities, these securities could have rights senior to
holders of common stock, and could contain covenants that restrict our
operations. Any additional funding, if required, may not be available in amounts
or on terms acceptable to us, if at all. If we are unable to obtain this
additional funding, if needed, we may be required to reduce the scope of our
planned product development and marketing efforts, which could harm our results
of operations and financial condition.
Factors That May Affect Future Results
In addition to the other information in this report, the following
factors should be considered carefully in evaluating the Company's business and
prospects.
If physicians do not support the use of our products, we may not achieve future
sales growth.
Our product sales have mainly been to a group of early adopting
physicians who are receptive to minimally invasive techniques. Other physicians
may not purchase our products until there is long term clinical evidence to
convince them to alter their existing treatment methods and recommendations from
prominent physicians that our products are effective in treating spine and joint
disorders. In addition, physicians tend to be slow to change their medical
treatment practices because of perceived liability risks arising from the use of
new products and the uncertainty of third party reimbursement. If we fail to
gain further physician support for our products, we may not achieve expected
revenues and may not sustain profitability.
Because several large insurance companies have refused to reimburse health care
providers for our procedures, physicians, hospitals and other health care
providers may be reluctant to use our products and sales may decline.
Physicians, hospitals and other health care providers are unlikely to
purchase our products if they do not receive reimbursement from payors for the
cost of the procedures using our products. There are payors, including several
large insurance companies, that have refused to reimburse for the cost of
procedures using our products until peer reviewed clinical data has been
published. In addition, even upon the publication of peer reviewed data, payors
still may not reimburse for the procedure. The advent of contracted rates per
procedure has also made it difficult to receive reimbursement for disposable
products, even if the use of these products improves clinical outcomes.
Because we lack sufficient long term outcomes data regarding the efficacy of our
products, we could find that our long term data does not support our current
clinical results.
Because our spine products are supported by only two years of patient
follow up and our arthroscopy products are supported by only three years of
patient follow up, we could discover that our current clinical results cannot be
supported. If longer term patient studies or clinical experience indicate that
treatments with our products do not provide patients with sustained benefits,
our sales could decline. If longer term patient studies or clinical experience
indicate that our procedures cause tissue damage, motor impairment or other
negative effects, we could be subject to significant liability. Further, because
some of our data has been produced in studies that are not randomized and
involve small patient groups, our results may not be reproduced in wider patient
populations. In addition, we are aware of pre-clinical studies related to our
arthroscopy products that have produced data
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that is inconsistent with our scientific findings. If we are unable to produce
clinical data that is supported by the independent efforts of other clinicians,
our business could suffer.
Because we expect operating expenses to increase substantially in the forseeable
future and cannot be certain that revenues will continue to increase, we may not
sustain profitability.
We anticipate that our operating expenses will increase substantially in
absolute dollars for the foreseeable future as we expand our sales and
marketing, manufacturing, product development and administrative staff. Although
we attained profitability during the first two quarters of 2000, if sales do not
continue to grow, we may not be able to maintain profitability in the future. In
particular, we incurred losses of $11.3 million in 1998 and $9.7 million in
1999. As of June 30, 2000, we had an accumulated deficit of approximately $29.8
million.
Because we are introducing new products and technology into the spine and
arthroscopy markets, we may fail to gain market acceptance for our products and
our business could suffer.
We have developed products for spine and joint disorders that we believe
are not effectively addressed by existing medical devices. Because we are
introducing novel technology into these markets, we face the challenge of
gaining widespread acceptance of our products. If we fail at this task, we may
not achieve expected revenues and may not sustain profitability.
You may have a difficult time evaluating our company because we have a limited
operating history.
You can only evaluate our business based on a limited operating history
because we began selling arthroscopy products in 1997 and spine products in
1998. This short history may not be adequate to enable you to fully assess our
ability to successfully develop our products, achieve market acceptance of our
products and respond to competition.
Because we face significant competition from companies with greater resources
than we have, we may be unable to compete effectively.
The market for our products is intensely competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants. We compete with many larger companies that
enjoy several competitive advantages, including:
. established distribution networks;
. products that are supported by long term clinical data;
. productsthat have been approved for reimbursement;
. established relationships with health care providers and payors; and
. greater resources for product development, sales and marketing and
patent litigation.
At any time, other companies may develop additional directly competitive
products. For example, Stryker Corporation entered into an agreement with
Arthrocare Corporation and announced and began marketing a competing line of
arthroscopy products during the second quarter of 2000.
Because of the importance of our patent portfolio to our business, we may lose
market share to our competitors if we fail to protect our intellectual property
rights.
Protection of our patent portfolio is key to our future success,
particularly because we compete in the medical device industry. We rely on
patent protection, as well as a combination of copyright, trade secret and
trademark laws, and nondisclosure and confidentiality agreements and other
contractual restrictions to protect our proprietary technology. However, these
legal means afford only limited protection and may not adequately protect our
rights or permit us to gain or keep any competitive advantage. For example, our
patents may be challenged, invalidated or circumvented by third parties. Our
patent applications and the notices of allowance we have received may not issue
as patents in a form that will be advantageous to us. Our patents and
applications cover particular aspects of our products and technology. There may
be more effective technologies, designs or methods. If the most effective
treatment method is not covered by our patents or applications, it could have an
adverse effect on our sales. If we lose any key personnel, we may not be able to
prevent the unauthorized disclosure or use of our technical knowledge or other
trade secrets by those former employees. Furthermore, the laws of foreign
countries may not protect our intellectual property rights to the same extent as
the laws of the U.S. Finally, even if our intellectual property rights are
adequately protected, litigation may be necessary to enforce our intellectual
property rights, which could result in substantial costs to us and result in a
substantial diversion of management attention. If our intellectual property is
not adequately protected, our competitors could use the intellectual property
that we have developed to enhance their products and compete more directly with
us, which could result in a decrease in our market share.
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Because the medical device industry is litigious, we are susceptible to an
intellectual property suit.
There is a substantial amount of litigation over patent and other
intellectual property rights in the medical device industry generally, and in
the spine and arthroscopy market segments particularly. Whether a product
infringes a patent involves complex legal and factual issues, the determination
of which is often uncertain. While we attempt to ensure that our products do not
infringe other parties' patents and proprietary rights, our competitors may
assert that our products and the methods they employ may be covered by U.S.
patents held by them. In consultation with our experts, we have made a careful
analysis of patents covering related technology, and, based on this analysis, we
believe that either those patents or claims are invalid, or if valid, that we do
not infringe. In addition, because patent applications can take many years to
issue, there may be applications now pending of which we are unaware, which may
later result in issued patents which our products may infringe. There could also
be existing patents that one or more of our products may inadvertently be
infringing of which we are unaware. As the number of competitors in the markets
for minimally invasive treatment of spine and joint disorders grows, the
possibility of a patent infringement claim against us increases. Infringement
and other intellectual property claims, with or without merit, can be expensive
and time consuming to litigate and divert management's attention from our core
business.
If we are sued for patent infringement, we could be prevented from selling our
products and our business could suffer.
We are aware of the existence of patents held by competitors in the spine
and arthroscopy markets which could result in a patent lawsuit against us.
However, following a review of those patents with outside experts, we believe
they are invalid or that if valid, we do not infringe. In the event that we are
subject to a patent infringement lawsuit and if the relevant patent claims are
upheld as valid and enforceable, we believe we have defenses based on
noninfringement. If our products are found to infringe a valid patent, we could
be prevented from selling them unless we can obtain a license or are able to
redesign the product to avoid infringement. A license may not be available or if
available may be on terms unacceptable to us, or we may not be successful in any
attempt to redesign our products to avoid any infringement. Modification of our
products or development of new products could require us to conduct additional
clinical trials for these new or modified products and to revise our filings
with the FDA, which is time consuming and expensive. If we are not successful in
obtaining a license or redesigning our products, we may be unable to sell our
products and our business could suffer.
Product liability claims brought against us could result in payment of
substantial damages to plaintiffs.
We manufacture medical devices that are used on patients in surgical
procedures, and we are thus subject to product liability lawsuits as part of our
ordinary course of business. Although we are involved in a few product liability
actions, we do not believe any of these are material to our business or
financial condition. We have reported to the FDA instances in which burns were
reported in connection with the use of our arthroscopy products and instances of
nerve inflammation caused by an arthroscopic procedure performed on the
shoulder. We have also reported instances in which the tip of the SpineCATH
catheter broke off in the patient's body as the catheter was being removed and
instances in which the SpineCATH catheter experienced an electrical short during
the procedure, resulting in a small burn at the entry point on the skin. We
believe that both the catheter breakage and electrical shorts were related, in
the majority of the reported instances, to overmanipulation of the catheter
which caused the catheter to kink. In addition, we have reported instances in
which the SpineCATH catheter caused motor and nerve impairment. We do not
believe that any of these instances were the result of design flaws. During
1999, we sent a letter to our physician customers informing them of the close
association between catheter kinking and breakage and a safety alert emphasizing
the importance of following the correct protocol during the IDET procedure.
Any product liability claim brought against us, with or without merit,
could result in the increase of our product liability insurance rates or the
inability to secure coverage in the future. In addition, we would have to pay
any amount awarded by a court in excess of policy limits. Our insurance policies
have various exclusions, and thus we may be subject to a product liability claim
for which we have no insurance coverage, in which case we may have to pay the
entire amount of any award. Even in the absence of a claim, our insurance rates
may rise in the future to a point where we decide not to carry this insurance.
Finally, even a meritless or unsuccessful product liability claim would be time
consuming and expensive to defend and could result in the diversion of
management's attention from our core business.
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Any failure to build and manage our sales organization may negatively affect our
market share and revenues.
We currently have two separate sales forces, one for each of our spine
and arthroscopy product lines, and we rely on a combination of direct sales
employees and sales agents to sell each product line in the U.S. We need to
expand both the spine and arthroscopy sales teams during this fiscal year to
achieve our market share and revenue growth goals. There are significant risks
involved in building and managing our spine and arthroscopy sales forces,
including:
. failure to manage the development and growth of two distinct sales
forces;
. failure to adequately train both our employees and our outside sales
agents in the use and benefits of our products; and
. dependence on outside agencies, over which we have limited or no
control.
Any failure in our physician training efforts could significantly reduce product
sales.
It is critical to the success of our sales effort to train a sufficient
number of physicians and to provide them adequate instruction in the use of our
products. We rely on physicians to spend their time and money to attend our
training sessions. If physicians are not properly trained, they may misuse or
ineffectively use our products. This may result in unsatisfactory patient
outcomes, patient injury, negative publicity or lawsuits against us, any of
which could have an adverse effect on our product sales.
If we fail to support our anticipated growth in operations, our business could
suffer.
To succeed in the implementation of our business strategy, our management
team must rapidly execute our sales strategy and further develop products, while
managing anticipated growth by implementing effective planning and operating
processes. To manage anticipated growth in operations, we must increase our
manufacturing and quality assurance staff, expand our sales teams and expand our
manufacturing facility. Our systems, procedures and controls may not be adequate
to support our expected growth in operations.
If we fail to meet the demand for generators as we fully transition their
manufacture to internal operations, we may experience a decrease in sales.
We transitioned the manufacture of our generators, including the Vulcan
generator, to internal operations in October 1999. We have limited experience
manufacturing generators and our internal production may have difficulty meeting
customer demand. In addition, we may be unable to obtain a sufficient number of
generators from a third party supplier to satisfy customer needs. Any failure to
manufacture a sufficient number of generators to keep pace with demand, or any
failure to make generators of sufficient quality or at a commercially reasonable
cost will lead to lower than expected generator placements and a corresponding
decrease in the sale of the disposable products.
Because we have limited control over third party distributors, we may be unable
to sell our products in international markets.
We intend to rely on third-party distributors, over whom we have limited
control, to sell our products in international markets. We have entered into an
exclusive agreement with, and are dependent upon, DePuy AcroMed for the
marketing and sales of our spine products internationally. We also have
exclusive distributor relationships for the sale of our arthroscopy products in
foreign countries, including Australia, Belgium, Canada, Italy, the Netherlands,
Spain, Taiwan and the United Kingdom.
Because we compete with Mitek, an Ethicon division of Johnson & Johnson, in the
arthroscopy market, a conflict with them could negatively affect our
international spine sales efforts which are conducted exclusively by DePuy
AcroMed, another division of Johnson & Johnson.
Because our exclusive international spine product distributor is
affiliated with competitors in both the spine and arthroscopy markets, they may
devote insufficient resources to sales of our products or a conflict may arise
which could disrupt international sales. If DePuy AcroMed fails to devote
adequate resources to our products, we could fail to achieve expected
international sales. If a conflict arises which we could not readily resolve,
there could be a period of declining international sales as we search for an
alternative means of international product distribution.
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Complying with FDA and other regulations is an expensive and time consuming
process, and any failure to comply could result in substantial penalties.
We are subject to a host of federal, state, local and international
regulations regarding the testing, manufacture, distribution, marketing,
promotion, record keeping and reporting of our products. In particular, our
failure to comply with FDA regulations could result in, among other things,
recalls of our products, substantial fines and/or criminal charges against us
and our employees.
Product sales, introductions or modifications may be delayed or canceled as a
result of the FDA regulatory process, which could cause our sales to decline.
Before we can sell a new medical device in the U.S., we must obtain FDA
clearance, which can be a lengthy and time consuming process. The products we
market have obtained the necessary clearances from the FDA through premarket
notification under Section 510(k) of the Federal Food, Drug, and Cosmetic Act or
were exempt from the 510(k) clearance process. We have modified some of our
products, but we do not believe these modifications require us to submit new
510(k) notifications. However, if the FDA disagrees with us and requires us to
submit a new 510(k) notification for modifications to our existing products, we
may be required to stop marketing the products while the FDA reviews the 510(k)
notification, or if the FDA requires us to go through a lengthier, more rigorous
examination than we had expected, our product introductions or modifications
could be delayed or canceled, which could cause our sales to decline. In
addition, the FDA may determine that future products will require the more
costly, lengthy and uncertain premarket approval, or PMA, process.
Off label use of our products could result in substantial penalties.
510(k) clearance only permits us to promote our products for the uses
indicated on the labels cleared by the FDA. We may request additional label
indications for our current products, and the FDA may deny those requests
outright, require additional expensive clinical data to support any additional
indications or impose limitations on the intended use of any cleared product as
a condition of clearance. If the FDA determines that we have promoted our
products for off label use, we could be subject to fines, injunctions or other
penalties.
Our disposable probes have been cleared by the FDA for single use, but we
are aware that from time to time physicians reuse our disposable products. We
have strongly advised physicians against reuse of our products.
Our stock price, like that of many early stage medical technology companies, may
be volatile.
If our future quarterly operating results are below the expectations of
securities analysts or investors, the price of our common stock would likely
decline. Stock price fluctuations may be exaggerated if the trading volume of
our common stock is low.
In the past, securities class action litigation has often been brought
against a company after a period of volatility in the market price of its stock.
Any securities litigation claims brought against us could result in substantial
expense and the diversion of management's attention from our core business.
We may need to raise additional capital in the future and may be unable to do so
on acceptable terms.
We may need to raise additional funds for operations and to execute our
business strategy. The sale of additional equity or convertible debt securities
could result in additional dilution to our stockholders. If additional funds are
raised through the issuance of debt securities, these securities could have
rights senior to holders of common stock, and could contain covenants that would
restrict our operations. Any additional financing may not be available in
amounts or on terms acceptable to us, if at all.
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Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval.
Our executive officers and directors, and their respective affiliates,
own a substantial percentage of our outstanding common stock. Accordingly, these
stockholders may, as a practical matter, be able to exert significant influence
over matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combinations. This
concentration could have the effect of delaying or preventing a change in
control.
Our certificate of incorporation, our bylaws and Delaware law contain provisions
that could discourage a takeover.
Provisions of our certificate of incorporation, bylaws and Delaware law
may discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market risk disclosures have not changed significantly from those set
forth in Management's Discussion and Analysis of Financial Condition and Results
of Operations in our Form S-1 filing dated April 4, 2000 for the year ended
December 31, 1999.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings. From time to time we are a party to various legal
proceedings arising in the ordinary course of our business. We are not currently
subject to any material legal proceedings.
Item 2. Changes in Securities and Use of Proceeds.
(d) On April 4, 2000, in connection with our initial public offering, a
Registration Statement on Form S-1 (No. 333-95815) was declared effective by the
Securities and Exchange Commission, pursuant to which 4,600,000 shares of our
common stock were sold on April 10, 2000 for the account of the Company at a
price of $14.00 per share, generating aggregate gross proceeds of $64.4 million
before payment of underwriting discounts and commissions and transaction
expenses. The managing underwriters were Merrill Lynch & Co., J.P. Morgan & Co.
and U.S. Bancorp Piper Jaffray. After deducting approximately $4.5 million in
underwriting discounts and commissions and $1,100,000 in other transaction
expenses, the net proceeds of the offering were approximately $58.8 million.
None of the payments for underwriting discounts and commissions and other
transaction expenses represented direct or indirect payments to directors,
officers or other affiliates of the Company. The net proceeds of the offering
have been invested in short term, investment grade, interest bearing securities.
As of June 30, 2000, we had used approximately $6.5 million of the proceeds of
the offering to repay debt balances. We intend to use the proceeds from the
offering to expand sales, marketing and reimbursement activities, to develop the
Company's product lines, to fund acquisitions or investments and to fund general
corporate purposes, including working capital.
Item 3. Defaults Upon Senior Securities. Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders. Not applicable.
Item 5. Other Information. Not applicable
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
27.1 Financial Data Schedule
(b) Reports on Form 8-K: Not applicable.
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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.
ORATEC INTERVENTIONS, INC.
By: /s/ Nancy V. Westcott
----------------------------------
Nancy V. Westcott
Chief Financial Officer and Vice
President of Administration
Date: August 14, 2000
<PAGE>
EXHIBIT INDEX
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27.1 Financial Data Schedule.
